Tag: surety

Statute Of Frauds Doesn’t Prevent Guaranty Claim Where Main Purpose Is To Benefit Guarantor- IL First Dist.

66381928 Photo credit: www.template.net (1.21.15)

 

I’m surprised at how often I see contracts where it’s unclear whom the parties are.  Sometimes, a contract’s main text will say it’s between two companies but it’s clearly signed by two individuals. I’ve also experienced the reverse: the contract body says it’s between two individuals but the signature block provides that it’s signed by corporate agents on behalf of their corporate employers.  When the contract is breached, it becomes a challenge to sort out who’s entitled to sue and who should be named as defendant.

Sullivan & Crouth Holdings, LLC v. Ceko, 2014 IL App (1st) 133028-U examines the impact of conflicting language in a promissory note and how textual contradictions affect the note’s enforceability.

Plaintiff sued the guarantor defendant for breach of a $100K promissory note (“Note”). The Note was between an LLC borrower and a lender but the Note body provided that the individual defendant (the LLC’s manager) will personally guarantee payment of the Note.

The Note signature line read:

 “MGT Lottery, LLC”

 By: [Peter Ceko]

 Peter Ceko, One of Its Managers

The defendant moved for summary judgment on the basis that he signed the Note purely in his capacity as LLC manager – as reflected by the “one of its managers” notation in the signature line.  He also argued that plaintiff’s claim was barred by the Statute of Frauds, 740 ILCS 80/1 (“SOF”) provisions that require a writing to enforce a promise to pay another’s debt (example: a guaranty).  The trial court agreed and entered summary judgment for the defendant and the plaintiff appealed.

Held: Reversed.

Q: Why?

A: There was a facial inconsistency between the Note and its signature line. The Note clearly reflected the intent for the defendant to personally guaranty the LLC borrower obligations yet the defendant clearly signed the Note as LLC manager.

In Illinois, where language in the body of a contract clashes with the apparent representation by the officer’s signature, it’s  an issue of fact for a jury or judge to decide.

The court found that based on its conflicting language, the Note was ambiguous – it was reasonably subject to differing interpretations.  The murky Note, then, required the parties to submit additional evidence of their intent.

The Court also found there was a question of fact as to whether the SOF defeated the plaintiff’s claim.  The SOF requires the promise to pay the debt of another to be in writing.  An exception to this rule is where the “main purpose” or “leading object” of the promisor is to advance his own business interest.  Whether a promisor’s main purpose is to further his personal interest (as opposed to benefit the promisee) is a fact question that defeats summary judgment. 

The court found the record too sparse to discern the LLC manager’s main reason for signing the Note.  As a result, more evidence was needed and summary judgment was improper.

Afterwords:

– Parties to a contract should take pains to specify whether it’s a corporate or individual obligation;

– Where there is a clash between the body of a written contract and its signature block, this will likely signal a fact question that defeats summary judgment;

– The requirement that a promise to pay a third party’s debt be in writing can be tempered where the promisor is signing a contract to advance his own economic interest. 

The Contractual ‘Pay-If-Paid’ Clause – How Broad Is Its Scope?

A pay-if-paid (PIP) clause in a construction contract says “I, the general contractor, will only have to pay you, the subcontractor, if the owner – the guy I contract with – pays me.”  Substitute “when” for “if” in the above example and you have a pay-when-paid clause.  Both of these clauses are standard in multi-layered construction projects (ones that involve multiple contractors and contracts). 

Neither term can be used to defend a mechanics’ lien foreclosure suit, though.  Section 21(e) of the Illinois Mechanics’ Lien Act (770 ILCS 60/21(e)) prevents a general contractor from using pay-if-paid or pay-when-paid provisions as a defense to a subcontractor’s mechanics’ lien claim.  But the terms are valid defenses to regular breach of contract claims. 

BMD Contractors, Inc. v. Fidelity and Deposit Company of Maryland, 679 F.3d 643 (7th Cir. 2012), examines whether a third party (i.e., a guarantor or surety) can use a PIP clause in defense of a subcontractor’s payment bond claim.  Under Indiana law, the answer is yes.

Facts:  When an Indiana manufacturer declared bankruptcy, it caused a chain reaction of defaults starting with the prime contract between the owner and the general contractor and cascading down to lower tier subs.

When the entity that hired plaintiff failed to pay, plaintiff sued the subcontractor’s bonding company under a payment bond.  The bonding company moved for summary judgment because of a PIP clause in the sub-subcontract. 

The bonding company said that since the subcontractor – the bonding company’s principal – wasn’t paid by the general contractor, the subcontractor didn’t have to pay the plaintiff.  The District Court agreed and granted summary judgment.  The plaintiff appealed.

Held: District Court affirmed.

Why?:

The Court defined a PIP clause as one that provides a subcontractor will be paid only if the contractor is paid by the owner; with each contractor bearing the risk of loss.  By contrast, a pay-when-paid (PWP) clause denotes a timing issue: the general contractor is obligated to pay the subcontractor – but only when or within a fixed time after the contractor is paid by the owner.  (p. 648). 

The Court, looking to other jurisdictions, held that the term “condition precedent” in a construction contract usually signals a PIP provision.  And viewing the unambiguous language of the operative contracts, the plaintiff’s right to  payment was only triggered if the subcontractor was paid by the general contractor.  (pp. 649-650)

Public Policy and Surety (Guarantor) Liability

The Court found that PIP terms don’t violate Indiana public policy reflected by two statutes that (1) prohibit contractual waivers of payment bond claims and (2) prevent conditioning a contractor’s right to record a lien on first receiving payment from a third person.  Indiana Code 32-28-3-16(b), 18(c). 

The Seventh Circuit held that these statutes didn’t apply to whether a contractual PIP term was a defense to a breach of contract suit.  Based on Indiana’s strong policy favoring freedom of contract, and because no statute outlaws PIP provisions as a breach of contract defense, the PIP term didn’t violate public policy. BMD at 652.

Summary judgment for the bonding company was also proper based on the general rule that a surety’s (the person guaranteeing another’s debt) obligations mirror those of its principal.  A surety can have no greater liability than its principal (the person whose debts are being guaranteed). 

In Indiana, payment bonds and the contracts they secure are construed together.  BMD at 654.  And since the subcontractor didn’t have to pay the plaintiff unless the subcontractor was paid by the general contractor, the bonding company’s obligations weren’t triggered and it didn’t have to pay the plaintiff.

Conclusions

(1) if a contract contains “condition precedent” (to payment) or similar language, this will signal a pay-if-paid clause and it will present a valid defense to a breach of contract suit;

2) lower-tier subcontractors should actively monitor the financial health of  the project so they aren’t caught off-guard by an owner’s or higher-tier contractor’s default.