Second Circuit Provides Cautionary Tale For Contractual Provisions Negating Third Party Enforcement

It has long been the case that third party beneficiaries may, under certain circumstances, enforce a contract to which they are not a party. This is a well-recognized exception to the general rule that only parties to the contract, i.e. those in privity, can sue to enforce it. Under New York law, a third party is an intended beneficiary entitled to enforce a contract where "recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties and either (a) the performance of the promise will satisfy an obligation of the promisee to pay money to the beneficiary; or (b) the circumstances indicate that the promisee intends to give the beneficiary the benefit of the promised performance."1 To determine the intention of the parties, courts will look to the language of the contract at issue as well as the circumstances surrounding the transaction. 2

Accordingly, to make their intentions clear, many contracting parties will include in their agreements "no third party beneficiary" clauses. These clauses typically state, in varying forms, that the agreement is for the benefit of certain parties only and that no other party shall have any rights under the agreement. Provisions such as these are considered "controlling" when determining whether an agreement is enforceable by a third party.3 Importantly, this is true even where the contract is intended to benefit a third party. Indeed, "courts applying New York law have consistently found that, even where a contract expressly sets forth obligations to specific individuals or categories of individuals, those individuals do not have standing to enforce those obligations by suing as third-party beneficiaries when the contract contains a negating clause."4 To be controlling, however, the clauses must be "complete, clear, and unambiguous."5

In that regard, the recent Second Circuit decision in Bayerische Landesbank v. Aladdin Capital Mgmt. LLC6 ("Aladdin") provides a cautionary tale for practitioners who regularly include such clauses in agreements. In Aladdin, the plaintiffs were banks who purchased notes in a collaterized debt obligation ("CDO"). The defendant was the portfolio manager for the CDO. As portfolio manager, the defendant selected the various securities underlying a credit default swap linked to the CDO. The credit default swap was between the issuer of the CDO and Goldman Sachs Capital Markets, L.P. ("GSCM"). The defendant‟s responsibilities as portfolio manager were contained in a Portfolio Management Agreement ("PMA") between it and the issuer of the CDO. The plaintiffs were not parties to the credit default swap or the...