Fried Tomato Grower, Part II: Lack of Consideration

Today’s post will explore the second, and successful, defense asserted by defendant Jackson, namely that the Note was unenforceable for lack of consideration.  Part I of my commentary about Jackson v. Luellen Farms discussed how the Indiana Court of Appeals arrived at its conclusion that Jackson could be personally liable on the Note.  Keep reading, however, to gain an understanding of the concept of “consideration,” particularly in situations involving antecedent debt, and how the Court ultimately ruled in Jackson’s favor.

Consideration, general rules.  Because the Court deemed the Note not to be a negotiable instrument, the UCC and specifically I.C. § 26-1-3.1-303(b) did not apply.  (Section 303 articulates what “consideration” is under the UCC.) 

For a contract to be valid, there must be an exchange of consideration, as noted by the Court in Jackson:

  Consideration is defined as ‘[s]omething of value (such
  as an act, a forbearance, or a return promise) received
  by a promisor from a promisee.’  ‘To constitute
  consideration, there must be a benefit accruing to the
  promisor or a detriment to the promisee.’

The plaintiff creditor, LFI, argued that there was consideration for the Note because of the unpaid balance owed by HPI to LFI at the time of the Note’s execution. 

Past consideration.  In fact, the Note was a promise by Jackson to pay an antecedent (prior) debt of a third party, HPI.  The Indiana Court of Appeals held that the promise was not enforceable because “past consideration” generally cannot support a new obligation or promise.  As stated by the Court, in Indiana:

  if a person has been benefitted in the past by some
  act or forbearance for which he incurred no legal
  liability and afterwards, whether from good feeling
  or interested motives, he makes a promise to the
  person by whose act or forbearance he has benefited,
  and that promise is made on no other consideration
  than the past benefit, it is gratuitous and cannot be
  enforced. 

Neither HPI nor Jackson received any benefit in exchange for the Note.  Jackson, personally, had no liability on the debt when he signed the Note – only HPI did.  There was no evidence that Jackson signed the Note in exchange for LFI’s promise to delay collection (forbear), in which case there would have been consideration.   

Valid guaranty?  LFI actually was angling to assert that the Note was a personal guaranty.  Under Indiana law, “it is not necessary for a guarantor to derive any benefit from the principal contract or the guaranty for consideration to exist.”  But, generally the guaranty must be made “at the time of the principal contract” (for example, when the tomatoes were delivered).  There are exceptions to this general rule, but none of them existed in Jackson.  There was, therefore, no legal consideration to support the alleged guaranty of HPI’s debt to LFI. 

Too late.  The tomato grower lost the case for a lot of reasons, including most importantly the fact that Jackson, individually, did not promise to pay HPI’s debt at the time the tomatoes were delivered.  Even then, once HPI began having trouble paying LFI, there still could have been personal liability had Jackson signed the Note in exchange for LFI’s forbearance in collecting against HPI.  The Court said, “[t]he problem in Jackson is that neither Jackson nor [HPI] received anything of benefit pursuant to the Note.  Instead, the only party that benefitted from the Note’s execution was the promisee, LFI.  Although Jackson had some motive to sign the Note, the Note was not supported by consideration.  Under these circumstances, LFI may not enforce the Note against Jackson.” 

In most commercial cases, there will be appropriate and timely loan documentation.  So, the circumstances present in the Jackson case may not be common in the day-to-day operations of most commercial lending institutions.  If, however, you as a lender agree to forbear on a borrower’s debt and, as a part of that agreement, intend to obtain for the first time some kind of personal guaranty, make sure the loan documents are clear that the parties intend for there to be personal liability and that appropriate consideration (exchange of benefit) exists. 

Fried Tomato Grower, Part I: Personal Liability

Informalities in connection with loans often lead to costly results.  In Jackson v. Luellen Farms, 2007 Ind. App. LEXIS 2754 (JacksonOpinion.pdf), the Indiana Court of Appeals discussed in its December 12, 2007 opinion how a thirty-year business relationship turned into $200,000 in losses for a supplier of raw tomatoes.  This is the first of two posts that address the Jackson case and the efforts of a party owed money to collect an antecedent debt from an owner/operator of a corporation.  Advanced planning and documentation sometimes may be inconvenient, expensive or awkward, but it almost always can help protect lenders against financial losses. 

Context.  The plaintiff was LFI, a grower and supplier of tomatoes.  Defendant Jackson was the owner and operator of HPI, a corporation that purchased and canned tomatoes.  HPI often would not pay LFI on delivery but would wait until the first of the year.  In October, 1999, HPI owed LFI about $225,000 for tomatoes delivered in 1998 and 1999.  LFI evidently became nervous about getting paid, so for the first time the parties executed a Note to memorialize the amount owed.  HPI made some payments on the Note but ultimately went under, owing $2.5-$3.0 million dollars to various creditors.  LFI sought recovery from Jackson individually, and Jackson asserted two defenses:  (1) he was not personally liable on the Note because he signed in a representative capacity and (2) the Note failed for a lack of consideration.  I discuss the first defense in this post.

Was the Note a negotiable instrument?   A sub-issue was whether Indiana’s UCC, specifically I.C. § 26-1-3.1-402 dealing with negotiable instruments, applied.  (Typically, the UCC applies because most promissory notes meet the requirements of a negotiable instrument.)  If the UCC applied, the burden of proof was on Jackson to in essence prove a negative:  that both parties did not intend for him to be personally liable under the Note.  Was the document was in fact a “negotiable instrument” as defined in I.C. § 26-1-3.1-104?  The Court of Appeals concluded it was not, essentially because it purported to incorporate by reference the terms of a separate contract.  The Note not only referred to a non-existent mortgage but, more importantly, indicated that all agreements and covenants in that mortgage applied to the Note – a no-no under the UCC.  So, Jackson was not held to the heavy burden “to show that both parties to the Note intended that Jackson not make himself liable.” 

Contract law.  The issue of personal liability thus turned on the common law of contracts, not the UCC.  And, plaintiff LFI had the burden of proof.  In this scenario, courts apply a set of rules of construction and interpretation to arrive at a decision as to what the parties intended in the written document.  The Court weighed a plethora of details about the language in the Note and the circumstances leading up to its execution.  For example, after his signature, Jackson did not have the word “President.”  In the final analysis, the Court concluded that “based on the manner in which Jackson signed the Note and our consideration of the surrounding circumstances, we conclude that the Note evidences a promise on the part of Jackson to pay LFI the amount owed by [HPI].”  So, despite winning on the UCC/burden of proof issue, Jackson still got beat on his first defense.   

On the hook?  The Court’s conclusion in Jackson is favorable to Indiana creditors, particularly in the rare scenario where a Note does not constitute a negotiable instrument under the UCC.  Absent clear and unambiguous language and/or facts showing that the amount of money was owed solely by the corporate entity, owners purporting to sign in a representative capacity could be at risk.  In part II of this post, however, I’ll explain why the Indiana Court of Appeals ultimately found the Note to be unenforceable as to Jackson.  LFI won a battle, but lost the war. 

Off Topic: Residential Lenders Continue To Take a Beating

As my regular readers are aware, this blog is not dedicated to residential mortgage or consumer lending matters, in part because those issues are not the focus of my practice.  However, my Firm represents lenders in all sorts of legal disputes, and the sub-prime mortgage crisis may have far-reaching consequences that could ultimately affect commercial lenders.  Plus, the political climate surrounding the problem is compelling, so I can't resist periodically posting news stories about the subject. 

Here are links to two national articles from today that address the City of Cleveland's "public nuisance" lawsuit against several banks:  CNN and MSNBC.  The case represents an interesting combination of politics and law.  I have not read the court filings, and at this time know nothing about the case other than what these two stories say.  I will be curious to see whether the case can survive a pre-trial motion to dismiss.  I would agree with one of the quotes:  this indeed is a "one-of-a-kind" case.  From purely a legal perspective, I have difficulty believing the case has much merit.  But, I've been wrong before....   

Media Reports On Health Of Central Indiana Commercial Real Estate Market

Pieces from today's Indianapolis Star and Indianapolis Business Journal discuss the status and future of Central Indiana's commercial real estate market, including the impact of the lending crisis.  Click for the stories:  IndyStar1, IndyStar2 and IBJ.  Once again, the theme seems to be that, while development may be down, there are few if any signs of substantial increases in commercial loan defaults, foreclosures or bankruptcies in deals tied to commercial real estate.  Relative to the rest of the country, Indiana appears to be in decent shape in the commercial real estate and commercial lending sectors.  Please e-mail me if you feel otherwise or are aware of contrary media reports, thanks.   

Indiana Legislation, 2008

According to my sources, it appears the only state legislation in the hopper that may affect commercial foreclosures is Senate Bill No. 62.  Here's the bill:  (SenateBill62.pdf).  Here's the fiscal impact statement:  (FiscalImpactStatement.pdf).  The proposed change - a minor one to say the least - "eliminates the requirement that a sheriff post notice of a foreclosure sale in at least three public places in each township where the real estate is located."  The bill really affects civil sheriff's offices, not lenders or borrowers. 

As an aside, it's my understanding that some other states are exploring the enactment of more dramatic changes to foreclosures, including ways to expedite the sometimes lengthy process.  I was studying Florida law for a case last month and learned that, unlike Indiana, counterclaims filed against the foreclosing lender will be severed (bifurcated/split) from the original foreclosure claim filed against the borrower.  In Indiana, counterclaims filed by the mortgagor, even claims without merit, can result in substantial delays of the process.  I'm involved in a contested residential foreclosure case right now that has been around for almost three years, primarily due to the tactics of borrower's counsel and also court-related delays.  We finally tried the case in September and successfully obtained a judgment and decree of foreclosure.  Alas, the defendant borrower is pursuing an appeal....