Fried Tomato Grower, Part II: Lack of Consideration
January 24, 2008
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
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.