News and practical information from our attorneys.
BLISSFULLY IGNORANT? NOT GOOD ENOUGH IN A REAL ESTATE DEAL
We have often discussed in this blog how the Indiana courts will look at contracts and typically enforce the exact terms that were agreed to by the parties. The courts will also look at those contracts and hold the parties to the terms that were negotiated. However, in a recent case, the Court of Appeals went even further, most likely to get to what was in the court’s opinion the best result.
The two parties to the dispute had entered into a “property contract” whereby the seller was offering to sell certain real estate “property” to the buyer. However, the seller did not actually own the property, but in fact had rights under a lease, and another person actually owned the real estate. Therefore, the contract was not with the actual owner of the property; it was between the buyer and the person who was leasing the property from another person who actually was leasing from the owner.
After the buyer defaulted on the contract due to not paying the monthly payments, the seller filed a lawsuit to evict the buyer and to collect the amounts that had not been paid. At that point, the buyer, for the first time, conducted a title search and realized that the seller did not own the property, but rather only had been leasing it.
The buyer then filed a counterclaim against the seller because the buyer claimed to have been defrauded by the seller given that the seller did not own the property and therefore could not sell it to the buyer.
The Court of Appeals rejected that argument. The seller had in fact recorded a copy of the lease and its assignment of the lease with the appropriate county recorder. The Court of Appeals found that the buyer knew, or should have known, that it was buying an assignment of the lease and was not buying the actual real estate. The Court of Appeals noted that when a lease is recorded as required, that recording is constructive notice of its existence, and anyone seeking an interest in the real estate after that is on constructive notice of the lease’s existence and is “charged with notice of all that is shown by the record, including any terms contained in the lease that is recorded.”
The Court of Appeals went on to say that actual notice may be inferred from the fact that a person who had a duty to search the records had the means of knowledge that he did not use.
Whatever fairly puts a reasonable, prudent person on inquiry is sufficient notice to cause that person to be charged with actual notice, where the means and knowledge are at hands and he omits to make the inquiry from which he would have ascertained the existence of a deed or mortgage. Thus, the means of knowledge combined with the duty to utilize that means equates with knowledge itself. Whether knowledge of an adverse interest will be imputed in any given case is a question of fact to be determined objectively from the totality of the circumstances.
In summary, the court was not going to allow the buyer, who easily had the ability to find out the real status of what it was buying, to get out of the contract (or after the fact rationalize why it quit paying on the contract) because it chose not to do some due diligence prior to entering the contract. In this case, the court went past the actual terms of the contract and looked at some other issues raised by the transaction, including the means by which the parties could have ascertained what was really going on. In this way the court was trying to fashion a just result under the circumstances, and was not going to allow the buyer to get out of its contract by simply remaining blissfully ignorant.
Just When You Think You Know the Law . . .
Regular readers of this blog know that we have spent a fair amount of time giving examples of how courts in Indiana regularly state that there is a strong public policy to enforce contracts. In doing so, the court’s goal is to determine the intent of the parties at the time they made the contract, beginning with the plain language of the contract, reading it in context, and then determining if any part of the contract is ambiguous. If it is ambiguous, then the court will construe the terms in the contract to determine and give effect to the intent of the parties at the time of the contract. Otherwise, the court will enforce the plain language of the contract.
In a recent case that is pending in the United States District (Federal) Court for the Southern District of Indiana, the Court acknowledged this basis principle of Indiana law, but ultimately determined that despite the plain language of a settlement agreement from a previous case, the settlement agreement and release could not be enforced against a plaintiff. In other words, it would not enforce the contract despite the fact that the Court admitted the contract was not ambiguous and the intent of the parties was clear.
The case involved the second of two class actions in which the plaintiffs had alleged violation of certain constitutional rights. The plaintiffs were involved in both cases, the first of which had been settled through the terms of a settlement agreement. The court noted, and it is important for the readers to know, that a person can contract away certain constitutional rights. However, any such waiver of constitutional rights must be done “knowingly and voluntarily.” In this case, the court was not convinced that at least one of the plaintiffs had “knowingly and voluntarily” waived her constitutional rights because there was no evidence that she had read the settlement agreement from the first class action. Another of the plaintiffs had actually signed that settlement agreement, and therefore the court did dismiss her claim.
The court went so far as to say that it was “troubled” by the result and its possible implications. Indeed, such a holding could call into question other class actions where there is no evidence that all of the class members knowingly and voluntarily relinquished certain constitutional rights. Nevertheless, the court felt compelled, at least at the early stages of the litigation, to hold that the class member’s constitutional right to procedural due process trumped Indiana’s public policy of enforcing contracts, the parties’ contractual intent, and the plain language of the settlement agreement.
It is hoped that this case truly is an outlier and that Indiana courts will continue to enforce the intent of the parties as demonstrated by the plain meaning of the language used by the parties in their contracts. This is the only way to find certainty in the law and to be able to more accurately predict for clients the ultimate result in cases involving contract disputes.
How Much is this Going to Cost?
That question is one that attorneys often hear from existing and new clients who are involved in matters for which they are seeing the attorney. While some projects are capable of being estimated in terms of the cost, in litigation, where at least two parties are arguing over something that is important to each of them, because no one party has control over what the other one will do, it is often nearly impossible to estimate “How much it is going to cost.”
A perfect example of this was recently reported here. While the particulars of the case are not necessarily important for today’s purposes, the significance is that there was a legal fight that lasted approximately 38 years concerning some property in Madison County, Indiana. Imagine in 1978 trying to answer the client’s question of “How much is this going to cost?” Thirty eight years later, the real estate is going to be sold at an auction.
In another relatively recent case, two landowners fought over a strip of land 35’ X 100’, which had been valued at $890. That litigation lasted 3 years and involved 2 separate appeals. It is fair to say that each party incurred far more than $890 in fees, not to mention the value of their own time invested in the fight.
We have written extensively before about how slow litigation can proceed; the true cost of that litigation; and the toll it can take on the parties involved. These cases are yet further examples of how unpredictable, time consuming, and undoubtedly expensive litigation can be. Attorneys seek the most efficient and thereby cost effective way to resolve disputes for clients, but sometimes these types of disputes still last for decades. While these cases certainly are anomalies, they do serve as good examples of what can happen when two parties dig in and for whatever reasons are unable to resolve their differences or otherwise continue to fight.
Key Man Life Insurance and Corporate Knowledge: A Lesson for All to Remember
What a corporation’s officers and shareholders know concerning the business of the corporation, the corporation knows. This knowledge that is imputed to a corporation remains with the corporation throughout its life, and a recent case involving “key man life insurance” highlights this important lesson for all business owners that a corporation is not allowed to suffer from “amnesia” and to otherwise ignore information that its officers have been told or that is in the corporate files.
Key man life insurance is an important tool for all small business owners, as it allows the company or the other shareholders to purchase the shares from a family of another shareholder who may have deceased. The proceeds of that life insurance policy are used to purchase those shares, thereby allowing continuity of ownership but also providing some value for those shares to the decedent’s estate.
In a recent case decided by the 7th Circuit, a corporation had purchased key man life insurance, insuring the life of the majority shareholder. The beneficiary originally was the other shareholder, but that was then changed so that the beneficiary was the corporation itself. There was evidence that the intent did not change, i.e., it was the intent to have the shares of the “key man” purchased with the proceeds of the life insurance.
The key man eventually retired, and sold his shares to a new owner, who became the president of the corporation. The insurance policy remained in place. When the retired “key man” died, the insurance company paid the $1,000,000 of proceeds to the original beneficiary (by mistake). That beneficiary was still the minority owner/shareholder of the company.
That person then attempted to do what had been intended all along, i.e., to use the insurance proceeds to purchase the remaining shares of the company. The new owner, however, did not go along with the plan (and there was no written contract requiring him to do so), and eventually had the minority owner removed as an officer and board member of the corporation.
The corporation, which everyone agreed was supposed to receive the insurance proceeds, then sued the insurance company, which understandably did not want to pay another $1,000,000. The insurance company admitted its mistake, but said that the corporation should not be allowed to collect because it knew what was going on, and allowed the insurance proceeds to be paid to the minority shareholder.
The new owner/president claimed to have been misled by the insurance company, saying “he did not know” who was supposed to get the money. Therefore, he and the corporation argued that the insurance company must make sure that it pays the correct beneficiary, which in this case was the corporation. During the course of the case, it was revealed that at a board meeting after the key man’s death, the corporation’s board was told and shown that the corporation was the beneficiary. In fact, it was told this information by the minority shareholder, who ultimately received the insurance proceeds. The corporation’s records were changed to try to conceal this fact. There also were several copies of the correct beneficiary form in both the corporation’s files and the personal files of the new president.
Armed with this information, the court granted judgment in favor of the insurance company, finding that the company knew what was going on and chose to ignore it. The 7th Circuit affirmed the judgment in favor of the insurance company, and found that it was not required to make another $1,000,000 payment.
The practical lesson here is summarized in a few of the comments from the 7th Circuit:
The corporation knew the truth, because its principal officers in 2003 had negotiated the policy and were well aware of its contents. What the President and COO knew, [the corporation] knew. There is no such thing as corporate amnesia.
* * *
Turnover in a corporation’s management does not wipe out the corporation’s fund of knowledge. That [the new president] did not know something does not mean that [the corporation] was ignorant.
* * *
From beginning to end, [the corporation’s argument] rests on the assertion that [the president] was misled by [the insurance company] and did not know that [the corporation] was the policy’s beneficiary. That approach commits the legal error of confusing [the president] with [the corporation]; the corporation’s knowledge, not [the president’s] is what matters.
Lesson: What the officers of the corporation know, the corporation knows. That knowledge does not go away throughout the life of the corporation, even as the officers change. There is no such thing as “corporate amnesia”, even if the ownership and management of that corporation changes completely from the time that corporation gained that knowledge.
It should also be noted that the new president’s behavior in changing the corporation’s records and otherwise claiming ignorance of the situation likely played a role in the outcome. We always advise clients that they want to be the “ones wearing the white hat” in the courtroom. In this situation, thanks to the actions of its president, the corporation seeking the $1,000,000 clearly was not.
Bankruptcy: The Fraud Exception
While the general rule is that a person who files for bankruptcy is relieved from all debts incurred by that person before the filing of the bankruptcy, as with all general rules, there are exceptions, and one of those exceptions has been the subject of some debate in recent years. Specifically, the Bankruptcy Code does not allow a person to discharge a debt to the extent that debt was obtained by fraud. Exactly how that provision of the Bankruptcy Code was to be enforced has been the subject of some disagreement, but the Supreme Court has now offered its opinion pursuant to a case arising out of Texas.
In Husky International Electronics, Inc. v. Ritz, the United States Supreme Court has found that the term “actual fraud” found in §523(a)(2)(A) of the Bankruptcy Code encompasses forms of fraud, like fraudulent conveyance schemes, that can be effected without making a false representation.
In Husky, a company controlled by Ritz incurred unsecured debt to Husky. Rather than paying the debt, Ritz caused the assets of the debtor entity to be transferred to other entities owned and controlled by Ritz. Husky then filed a lawsuit against Ritz seeking to hold him personally responsible for the company’s debt citing a Texas statute which made shareholders liable for their “actual fraud”. In response, Ritz filed for Chapter 7 bankruptcy relief.
Husky contended that Ritz could not discharge his obligations to Husky in bankruptcy because the inter-company transfer scheme constituted “actual fraud” pursuant to 11 U.S.C. §523(a)(2)(A). That section reads as follows:
A discharge under [Chapter 7, 11, 12, or 13] of this title does not discharge an individual debtor from any debt . . . for money, property, services or an extension, renewal, or refinancing of credit to the extent obtained by . . . false pretenses, a false representation or actual fraud.
The Bankruptcy Court and the 5th Circuit Court of Appeals found the debt to be dischargeable. The 5th Circuit held, specifically, that a necessary element of “actual fraud” is a misrepresentation from the debtor to the creditor, such as when a person applying for credit adds an extra zero to her income or falsifies her employment history.
The Supreme Court disagreed. It reasoned that actual fraud has two parts: “actual” and “fraud”. The word “actual” simply means any fraud that “involves moral turpitude or intentional wrong”. The word “fraud” generally connotes deception or trickery and is difficult to define more precisely. The Court, however, found that “from the beginning of English bankruptcy practice, courts and legislatures have used the term ‘fraud’ to describe a debtor’s transfer of assets that, like Ritz’s scheme, impairs a creditor’s ability to collect the debt”.
The Husky decision provides a powerful new tool for creditors – – provided that they can establish, under the relevant state law, a cause of action against corporate insiders. All creditors and debtors should be mindful of this new opinion.
 Indiana does not have this statute. Personal liability would have to be found on a piercing theory or aiding and abetting liability.