As articulated in FH Partners v. Cajbin, 2009 U.S. Dist. LEXIS 109986 (N.D. Ind. 2009) (.pdf), under Indiana law to be an enforceable negotiable instrument, such as a promissory note, it must be validly negotiated. Representatives of commercial lending institutions and their counsel need to know that both endorsement and delivery must occur for a promissory note to be enforceable.
The situation. The loan at issue in FH Partners was pretty standard. It involved a 1999 promissory note, a mortgage and personal guaranties. The twist surrounded a Chapter 11 bankruptcy filing by the borrower/mortgagor and specifically an effort to renegotiate the underlying promissory note in 2007, after approval of the bankruptcy reorganization plan. Counsel for the lender sent a new promissory note and mortgage to counsel for the borrower, and requested that the documents be executed and delivered back. Evidently the borrower may have signed the promissory note, but the note was never delivered back to the lender. The lender/mortgagee ultimately sued to enforce the original (1999) loan.
The defense. In response to the lender’s motion for summary judgment, the defendants (borrower/mortgagor and guarantors) contended that the suit was based upon the wrong debt instrument. Specifically, the defendants asserted that the 2007 proposed promissory note served to extinguish the 1999 promissory note, as well as the individual guaranties of that note.
Enforceability of note. Magistrate Judge Nuechterlein of the Northern District of Indiana found the defendants’ arguments to be “unpersuasive.” In Indiana, to have an enforceable negotiable instrument, “there must be a valid negotiation.” The Court noted that a valid negotiation is a “two-step process” that “requires the endorsement and the delivery of the instrument.” Ind. Code § 26-1-3.1-201.
Applying the legal principles. It was undisputed in FH Partners that the 2007 promissory note was never returned to the lender/mortgagee. “This undisputed fact is fatal to the defendants’ argument.” Although the 2007 proposed promissory note may have been signed and thus validly endorsed, the defendants offered no evidence to establish that the note was transferred to the lender/mortgagee. As such, the note was not properly negotiated between the parties and thus was not enforceable.
Novation. A similar, alternative legal theory asserted by the defendants surrounded the defense of “novation.” The defendants claimed that the failed attempt to renegotiate the original promissory note amounted to a novation. But, “to have a novation there must be a valid new contract which extinguishes the old contract.” In FH Partners, the Court found that there was no new contract between the parties, so “obviously [there] could be no novation.” The defendants failed to complete the necessary conditions of the proposed new note, and those failures “precluded the formation of a new contract.”
Judgment for lender. The defendants in FH Partners argued that they entered into a subsequent, valid and enforceable promissory note that resulted in their release from the original loan obligations. Normally cases like these surround the lender’s contention that a particular promissory note is valid and enforceable. Here, the lender succeeded by taking the opposite position for purposes of enforcing a prior loan. The Court granted the lender/mortgagee’s motion for summary judgment on all counts.
One thing secured lenders can take away from the FH Partners case is to be careful when entering into negotiations to restructure debt. For example, as I’ve posted here before, certain steps must be undertaken to avoid unwittingly releasing a guarantor from his or her obligations. In FH Partners, the lender/mortgagee helped to protect itself by utilizing a transmittal letter of the 2007 proposed promissory note, which letter requested that the documents be executed, notarized and delivered back to it. Those preconditions were not met. For those and other reasons, the alleged replacement promissory note was neither valid nor enforceable.