The Need for Unambiguity and an Underlying Agreement

A recent Ohio Court of Appeals case exemplifies the need to strive for contract terms with little ambiguity and the requirement to generate an underlying agreement in support of a promissory note.

The case, Cranberry Fin., LLC v. S&V P'ship, 186 Ohio App. 3d 275, involved a dispute regarding the terms of a promissory note. The debtor entered into a promissory note and subsequently argued that the terms of the underlying agreement were different from the note.

The court, in its opinion, stated, “A promissory note is a contract and rules of contract interpretation apply to the interpretation of promissory notes. If a contract is clear and unambiguous, then its interpretation is a matter of law and there is no issue of fact to be determined. If, however, an ambiguity is present such that parole evidence is necessary to resolve the ambiguity, a factual determination of intent or reasonableness may be necessary to supply the missing term. The fact-finder may also examine the surrounding circumstances of the transaction to determine the parties' intent. Further, it is axiomatic that contracts -- including promissory notes -- are construed against the drafter. The rule is well established that where there is doubt or ambiguity in the language of a contract it will be construed strictly against the party who prepared it. In other words, he who speaks must speak plainly or the other party may explain to his own advantage.”

But the court went further, “When a party voluntarily places his signature upon a note or other writing within the Ohio Statute of Frauds, and where that party's sole defense to an action brought upon the writing is that a different set of terms was orally agreed to at that time, such defense shall not be countenanced at law regardless of the theory under which such facts are pleaded. In such event, the writing alone shall be the sole repository of the terms of the agreement.”

In this case, the Sixth Appellate Court, merely restated what is known in the law as the “Parole Evidence” rule. Basically, the rule imparts that oral testimony may not be introduced into evidence to alter the terms of a written agreement. Only if the terms of the agreement have ambiguities, may the court entertain testimony to interpret the ambiguous portions of the agreement. Therefore, if the terms in an agreement are unambiguous, the court will not permit testimony that would alter those terms.

In this case, the court deemed the terms of the promissory to be unambiguous. Therefore, the party could not introduce evidence in derivation of those terms.

Most promissory notes are fairly simple and do not set forth underlying agreements relating to the note. Therefore, it is vitally important that the parties enter into an agreement setting forth the terms underlying the note and that agreement be referenced as part of the covenants set forth in the note.

The Use of Limited Liability Companies in Ohio

The use of LLCs have become very prevalent by business in Ohio. LLCs are popular because they combine the limited liability features of a corporation with the flexibility of a partnership. Under prior law, the only way to limit one’s liability for the misdeeds of others in your organization was to form a corporation. But, the use of a corporation also required s ver structured adherence to certain rules required by Ohio’s corporation law, plus a bifurcated tax structure that, sometimes, resulted in double tax to the owner of the company.

A Brief History

Corporations are “artificial” entities that are permitted under Ohio law. As a business entity became larger, with attendant increased liability issues, the use of a corporation permitted a business owner to shield himself from personal liability for the debts of the corporation and a shield from personal liability in the event of some catastrophic event that was not covered by liability insurance.

Of course the use of a corporation also presented structuring requirements that necessitated mandated meetings of directors and shareholders. In addition, the use of a corporation necessitated the filing of a separate corporate tax return, aside from the individual return filed by the owner of the company.

The consequence in failing to follow these rules was the possibility of piercing the corporate veil and holding the shareholders personally liable for the debts and liabilities of the corporation.

A number of years ago, Congress recognized the unfair nature of a tax structure that resulted in the double taxation of small businesses and permitted such corporations to make an “election” to be taxed as an individual. This became the so-called “Sub-chapter S corporation.” After the election, instead of filing a corporate tax return, the corporation filed an informational return with the IRS, but distributed what were called K-1s that distributed the income of the corporation (both distributed and undistributed) between the shareholders based upon the numbers of share they owned. But this election failed to address the underlying issues involving the mandated meetings and other structured requirements of a corporation.

Recently, a number of states, including Ohio recognized this problem and introduced the concept of the Limited Liability Company. The establishment of an LLC permits the benefits inherent with the limited liability of a corporation combined with the flexibility and lower tax burden of a partnership or individual.

The LLC in Ohio

Ohio’s law incorporates this philosophy of limited personal liability while allowing lower tax consequences. Forming an LLC is quite simple in Ohio. As in the established of any artificial entity, there are forms that need to be completed. But once executed, the LLC becomes a self-perpetuating entity requiring little structuring as is required of a formal corporation.

NEXT Blog - Is an LLC good for me?

New EPA Lead Paint Regulations Take Effect April 22, 2010

A number of years ago the EPA established regulations relating to the disclosure of lead-based paint in residential housing built prior to 1978. The regulations required the landlord to provide a lead-based paint disclosure form to prospective tenants. Only certain types of housing were exempt including those that had been certified lead-free by a certified inspector.

On April 22 new EPA regulations take affect that apply to any renovations of pre-1978 housing. The new “EPA Renovation, Repair and Painting Rule” applies to all “renovations performed for compensation in target housing and child occupied structures.” Target housing is defined as housing constructed prior to1978, with the exception of housing for seniors or the disabled, unless a child under 6 is expected to reside, and 0-bedroom (studio) apartments. “Renovation” is defined as “the modification of any existing structure that results in the disturbance of painted surfaces. To qualify, more than 6 square feet per room of interior painted surface must be disturbed or 20 square feet of exterior painted surface.

These rules call for the contractor to use lead dispersal prevention techniques when performing renovations - much like those required of asbestos abatement firms.

Housing which is tested and determined to be lead-free in accordance with the regulations are not subject to the provisions. Also exempt is work done by an owner in an owner-occupied home where there is no child under 6 and no pregnant women.

The regulations require that the entity performing the work must be EPA certified. If the owner is performing the work personally, they must become certified. The EPA accredits training providers.

The rules regarding lead-based paint disclosure by landlords has not changed. A disclosure statement must be given to all prospective tenants prior to their tenancy unless a certified inspector has declared the structure to be lead free. But any contractors or owners performing renovations of housing built prior to 1978 must now comply with the new construction rules.

Know Your Rights When Your Loan or Account Is Sold

In recent years loans and retail accounts have been bought and sold much like any other product. Most of us know that our mortgage is rarely owned by the company who originally executed the loan documents. Today, a “book” of loans are placed on the market by a bank or retail loan company hoping to reap instant cash. The originator’s profits are made from origination fees and loan document fees that are added to the mortgage. The same can be said for credit card accounts. The card producer packages a “book” of accounts for sale, eventually selling them to a liquidation company at a discounted fee.

Ordinarily, you pay on these loans and accounts not knowing that you are actually paying a third party who, by assignment, has become your creditor. But what happens when these loans become overdue? Collection procedures become very complicated due to the assignment of these “securities.”

A recent Third District case highlights the problems inherent to purchasers of these accounts. The case, Retail Recovery Serv. of NJ v. Conley, 2010 Ohio 1256, involved the attempted recovery by the Plaintiff of monies owed on a credit card. The balance included interest, and “recovery” and other fees that were added to the account.

Retail Recovery Services is a company who purchases accounts at discount and then liquidates the account seeking to recover the discount it paid the retailer plus other interest and fees. In this case it attempted to recover an account owed by the Defendant.

Pertinent facts included the following:

1. Although the Plaintiff attached bills of sale and assignments detailing a chain of custody to it, none of these documents itemized the Defendant’s account as part of those sales, and

2. The Plaintiff failed to produce a signed contract showing the Defendant agreed to the terms of interest and other fees the Retail Recovery was attempting to collect.

The court’s opinion stated, “In Natl. Check. Bur. v. Ruth, 9th Dist. No. 24241, 2009 Ohio 4171, the Ninth Appellate District reversed a trial court's grant of summary judgment to a creditor on the basis that it had failed to establish a clear chain of title, partly based on the fact that the bill of sale purporting to demonstrate chain of title indicated the seller bank was conveying to the purchaser bank "accounts described [an exhibit] attached hereto,” where no such exhibit was attached to the bill of sale in the record.”

Further, citing Minster Farmers Coop. Exchange Co., Inc. v. Meyer, 117 Ohio St.3d 459, 2008 Ohio 1259, the court opined, “a plaintiff-creditor cannot prove an interest rate merely by producing account statements reciting an interest rate, where it does not demonstrate that the interest rate was a term assented to by the parties in the written contract, such as by producing the terms of the underlying cardholder agreement.”

The court went on, and “[found] that the plaintiff-creditor had not shown that the specific fees were terms of a contract between it and the defendant-debtor.”

The court reversed and remanded the case ordering the lower court to review its findings in light of the appellate court’s decision.

Disclosure of Principal Vital in Avoiding Personal Liability

A recent Eight Appellate District case exemplifies the importance of definitively identifying an agency relationship to a third person with whom your are dealing. A failure to do so could result in personal liability.

The case, Independent Furniture Sales, Inc. vs. Dan Martin, dba, Martin's Appliance, 2009 Ohio 5697 involved the failure of the operating manager of a corporate buyer to disclose his agency relationship to the Plaintiff.

As stated by the court, “To avoid personal liability, an agent must demonstrate that he disclosed to a third party: (1) the agency relationship; and (2) the identity of the principal. If this disclosure is not made, then the agent may be personally liable for contracts entered in his own name...A corporate officer has a responsibility to clearly identify the capacity in which he is dealing in a specific transaction. The failure to comply with this rule will expose the corporate officer to individual liability on the resulting contract.”

In this instance, even the issuance of two checks on the corporate account was insufficient disclosure that Mr. Martin was the agent of the corporation. As occurred in this matter, the Defendant continually failed to disclose the principal-agency relationship over a ten year period. Although two checks were drawn over the decade from the corporate account, this was insufficient evidence to put the Plaintiff on notice that the Defendant was the agent for the corporation

Therefore, I advise clients as follows:

1. Any communications with third parties should be made on a document clearly citing the name and address of the principal.

2. When one signs any communication with the third party, that person’s title and relationship should be clearly set forth on the signature line or immediately underneath.

3. Never pay for a corporate debt using a personal credit card or personal check.

4. Never execute a personal guarantee or surety agreement unless required to do so to obtain credit for the corporation.

Carefully Drafted Agreements are a Paramount Necessity

When drafting an agreement it is vitally important that the goal is to set forth language that is indisputable. While this may be an impossible goal, careful drafting of the terms can limit expensive costs of collection.

A good example of the issue occurred in the recent case of Cranberry Fin. v. S&V P'ship, 2010 Ohio 464. In that case the parties entered into a promissory note and mortgage. The mortgages recited three properties as collateral for the notes. Sometime after the agreements were drafted the notes and mortgages were rewritten. One of the properties was mistakenly omitted from the subsequent agreements. But, the second agreement contained the following language:

"COLLATERAL. Borrower acknowledges this Agreement is secured by a Mortgage dated April 27, 2001, to Lender on real property located in Huron County, State of Ohio, all the terms and conditions of which are hereby incorporated and made part of this Agreement.”

"CONTINUING VALIDITY. Except as expressly changed by this Agreement, the terms of the original obligation or obligations, including all agreements evidenced or securing the obligation(s), remain unchanged and in full force and effect. * * *."

The Plaintiff sought judgment on the notes and foreclosure of all three properties against the Defendant and two individuals that were personal guarantors. The guarantors claimed the omission of the one property precluded the Plaintiff from foreclosing on that property.

While the court ultimately sided in favor to Plaintiff, due to the terms quoted above, one can only imagine the cost of litigation in having to try and appeal this matter because the drafter of the second agreement was not careful in their rewrite of the agreement.

Proper drafting is a key to limiting the cost of litigation. As this court stated:

“A promissory note is a contract and rules of contract interpretation apply to the interpretation of promissory notes...If a contract is clear and unambiguous, then its interpretation is a matter of law and there is no issue of fact to be determined...If, however, an ambiguity is present such that parol evidence is necessary to resolve the ambiguity, a factual determination of intent or reasonableness may be necessary to supply the missing term. The fact-finder may also examine the surrounding circumstances of the transaction to determine the parties' intent...It is axiomatic that contracts -- including promissory notes -- are construed against the drafter... The rule is well established that where there is doubt or ambiguity in the language of a contract it will be construed strictly against the party who prepared it...In other words, he who speaks must speak plainly or the other party may explain to his own advantage."

Luckily for the Plaintiff, there was sufficient language in the subsequent agreement to protect its secured interest in the omitted property. But, the failure to carefully draft the subsequent agreement severely increased their cost of collection.

Can I Charge Interest

Many clients ask if they can charge interest to customers if invoices or statements are not paid within the time period set forth on the statement or invoice. The simple answer is yes. But when you can charge and how much you can charge is the question.

Simply saying a “a service charge on unpaid balances” is insufficient. ORC 1343.03(A) provides that a creditor is entitled to interest at the "legal rate" of interest on any money due on an account "unless a written contract provides a different rate of interest...." Under Ohio law, the annual rate of interest is determined each year by the Ohio Tax Commissioner. The creditor is permitted to charge this rate of interest unless the contract entered into between the creditor and their customer calls for a greater rate of interest.

So, for example, if your invoices state you will charge interest at the rate of 1½ percent per month (18% per annum) on any unpaid balance, a court will not enforce this rate unless the original contract calls for that interest rate. Otherwise, a court will only permit the interest rate prescribed by the Ohio Tax Commissioner. This year the rate is 4%.

So, if you intend to charge interest on the unpaid balance owed by customers, the maximum rate you can charge is the rate set by the Ohio Tax Commissioner each year. If you wish to charge a higher rate, you must set that rate in your contract with the customer.

This brings us to the discussion of compound interest. The rate set by the tax commissioner is simple interest. Therefore, you are not permitted to charge interest on the interest previously added to the balance unless your contract states otherwise.

The recent case of Mayer v. Medancic, 124 Ohio St. 3d 101, is a perfect example of this issue. In that case three creditors foreclosed on a debtor’s home and charged compound interest on the promissory notes signed by the debtor. None of the notes stated that the interest rate would be compounded.

In its opinion the court stated, “Simple interest is calculated only on principal and not on accumulated interest. Compound interest, on the other hand, is paid both on the principal and the previously accumulated interest. In other words, simple interest does not merge with the principal and thus does not become part of the base on which future interest is calculated.”

The court went on to say, “Because R.C. 1343.02 does not provide for it, compound interest is not available upon a default on a written instrument absent agreement of the parties or another statutory provision expressly authorizing it. However, upon a default on a written instrument, simple interest accrues on the entire amount owed, which includes both the principal and interest due and payable at that time.

Therefore, if your statement or invoice states a given rate of interest will be charged on the unpaid balance:

1. The interest rate can not be more than the simple interest rate set annually by the tax commissioner unless it is set forth in the contract between you and your customer, and

2. Can not be compounded unless it is set forth in the contract between you and your customer.