Failure to Enforce Contract Terms Resulted in Modification

Many contracts which require payment in exchange for performance, require that the payment be made by a date certain. One would assume that the failure to pay by the agreed date would result in a breach of contract. But, this isn’t always true as the parties in the recent case of Bull Market, Inc. v. Elrafei discovered.

In Bull Market, Mr. Elrafei agreed to buy a gas station from Bull Market. Elrafei promised to make his monthly payment by the 15th day of each month. If Elrafei failed to pay as promised, then Bull Market could declare him in breach and foreclose on the gas station.

From 2009 through late 2015, Elrafei paid, albeit on irregular dates roughly within 5 days both before and after the 15th day of each month. Bull Market accepted the irregular payments without complaint until August 2015, when Bull Market suddenly returned Elrafei’s August 18th payment with a letter declaring Elrafei in breach and demanding that Elrafei abandon the gas station. Eventually Bull Market sued and obtained an eviction.

Elrafei appealed and the Court of Appeals reversed, finding that over the course of time, the irregular payments by Elrafei, and the continued acceptance of same by Bull Market, resulted in a modification of the contract’s terms. Bull Market and Elrafei created a new contract regarding the, “monthly amount, the maturity date, and the day of the month when the payments are due.” In other words, unintentionally or not, the parties had an entirely new deal.

The Court did not discuss whether or not the written contract contained a “no waiver or modification” provision, which generally provides that the failure to enforce strict compliance of an obligation doesn’t result in a waiver of strict compliance or modification going forward. It seems that had the contract at issue contained such a clause, the result may have been different. In any event, understanding all the terms of a contract is crucial and it is equally crucial to consider what omitted provisions should be included as well.

The Value of Operating Agreements

Small business owners have enough challenges considering taxes, regulations, laws, and other barriers to success. Having poorly thought out operating agreements doesn’t need to be on a list of challenges. The recent case of Hamer v. Southeast Resource Group, Inc., et al., highlights this issue.
John Hamer and Southeast Resource Group, Inc., were members (i.e. the owners) in a limited liability company called Action Financial Company, LLC. The owners had enough forethought to have a written operating agreement in place. Hamer and Southeast Resource Group, Inc., however, came to debate whether the terms of the operating agreement required that Hamer "must disclose and make available to [Action Financial Company, LLC]…" the new business opportunity that Hamer came across or whether the exception applied. The disclosure exception provided, "no such disclosure or offer shall be required with respect to business opportunities that are not within the scope and purpose of [Action]." Hamer said the exception applied, while Action and Southeast said the disclosure was mandatory.
Litigation followed and ultimately turned on the express word choice within the operating agreement. The court agreed with Hamer and found that the new business opportunity was not required to be disclosed or made available to Action as it was "not within the scope and purpose of [Action]."
An operating agreement is the LLC's controlling document and sets forth the "rules" for the members to follow. Although an operating agreement is not mandatory, it is good practice to have one in place. In this particular dispute, the written operating agreement provided a solid framework for the court to follow in resolving the dispute between the owners.
Hamer v. Southeast Resource Group, Inc., et al., Case No. M2015-00643-COA-R3-CV, March 3, 2016.

Personally Guaranteeing Company Debt

One of the benefits of forming a company instead of operating as a sole proprietorship, is to try and limit personal liability for company debts. Generally, an owner of a company is not liable for the company's obligations so long as the company and its owner act as distinct and separate entities. However, in practice, personal liability cannot always be guarded against, especially when the company's owner signs a personal guaranty.
In the recent case of Cardinal Health 108, Inc., et al. v. East Tenn. Hematology-Oncology Associates, P.C., et al., a physician medical practice entered into a credit application with a specialty pharmaceutical supplier for various medications. As part of the application, the three physician-owners of the medical practice company each signed a personal guaranty for all supplies purchased. The medical practice racked up over $1.2 Million in unpaid orders and the supplier demanded payment. Ultimately, the supplier filed a lawsuit and obtained a judgment against the practice as well as the individual practice owner physicians. The Court of Appeals affirmed the judgment.
Personal guarantees may appear inescapable as many business owners find that suppliers or lenders require such documents. However, in negotiating for any business transaction which seemingly requires such a guaranty, it never hurts to try to negotiate the guaranty out of the transaction, a limitation on the amount guaranteed, or simply negotiate with other suppliers who may not require such agreements. If a guaranty is in place, however, and a dispute arises between the company and the supplier, care must be taken in the approach to resolving that dispute, or more than just the company's assets will be at stake. Legal counsel can be helpful with both the negotiations as well as if a dispute arises.

Family Business Woes

Family businesses are everywhere. They often start with an idea, a part-time job, and a transition to full-time work. Running a business involves understanding a myriad of employment laws, tax issues, and filing requirements, all on top of simply trying to make a profit. More often than should occur, family run businesses fall short in one crucial area – transitioning from current to successive owners while instilling that founder mindset in second or third generations. The recent case of Carlene Guye Judd v. Carlton Guye, et al. highlights these issues.
In short, the parents started a business in 1961. They had two children. In 1995, the parents incorporated the business. One year later, the parents and both children entered into a series of agreements, whereby all shares in the company were sold equally to the two children, with the company making the required payments.
In 2013, Carlene Judd, the daughter/sister, became concerned that Carlton Guye, the son/brother, was misusing company funds for his own personal benefit. Ms. Judd sued her brother to recover the misused funds and to judicially dissolve the company. These issues went to trial and Ms. Judd won. The court ordered the company dissolved and found that Mr. Guye misused company funds. The parents appealed, but neglected to have the order stayed (halted) during the pending appeal. By the time oral argument took place, the company's assets were fully liquidated.
The court of appeals never weighed in on the merits of the case because it found that the parents' failure to seek a stay made moot the entire appeal. Compounding the founding parents' problems, the court of appeals additionally found the appeal frivolous and awarded Ms. Judd her attorneys' fees in defending against the appeal.
Without weighing in on whether the case was lost due to procedural or substantive reasons, it can't be overlooked that the family business, which existed for four decades, is now shut down completely. Readers are left to ponder whether the involvement of trusted legal and financial counsel earlier in the company's history may have helped to safeguard against the problems of greed which apparently afflicted one of the second generation owners. Unfortunately, absent such safeguards, litigating this type of dispute can be costly and involves an understanding of both corporate and trial law. In the end, it is unclear if this case saw any real winners.

Business Purchase Agreement Litigation

Last week we examined an appellate case dealing with a poorly thought out severance agreement. This week's case involves the purchase of an existing insurance agency that didn't produce the post-sale level of business the buyer expected. When business wasn't as good post-sale, the buyer sued the seller for fraud, breach of contract, that the seller failed to shred the old client files as promised, and allegations that the seller improperly diverted business to his wife's competing insurance agency. The seller also sued the buyer when the buyer failed to make the monthly payments on the promissory note for the purchase of the business assets. The seller additionally claimed that the post-sale agency suffered business losses due to the poor management of the buyer.
The case was tried to a Judge. The Court eventually found that the seller failed to shred all the files as agreed and therefore breached the contract. However, the Court noted that the seller's breach was not material, and thus the buyer was not relieved of its obligations to pay on the note. Rather, the Court noted the buyer's after-the-fact arguments of breached contract were hyper technical. Further, the Court found that the buyer fully disclosed all matters to the seller before closing and thus the seller had a complete picture at the time of the sale. Finally, the Court found that the buyer not only owed the remaining balance of the promissory note, but that the payments were accelerated so that the entire balance was now due. In other words, the buyer lost.
Buying or selling a business or its assets requires careful deliberation, time, and attention to details. This process necessarily involves working with professional advisors in the accounting and legal industries. Crafting the correct documents in advance is crucial, although this doesn't guarantee that litigation won't occur. When litigation does arise, as in this case, understanding the issues and big picture as opposed to relying on hyper technical arguments may result in a smoother resolution.
Ensures, LLC v. Douglas S. Oliver, et al., No. M2014-00410-COA-R3-CV, (Tenn. Aug. 31, 2015).

Contracts are Enforceable

If you think you may change your mind about the terms in a proposed contract, don’t sign it. One farmer’s co-op apparently had a change of heart, which resulted in a $380,000 mistake.
In the recent case of Hensley vs. Cocke Farmer’s Cooperative, the employer, Cocke Farmer’s Cooperative, entered into a written agreement with a senior level employee, Jimmy Hensley, which was designed to induce him into ceasing his job search and retiring with the co-op. To provide him with incentive to sign, the co-op essentially guaranteed his salary and health insurance through 2024 – 14 years after signing the contract. Mr. Hensley was convinced. He quit job searching and signed on the dotted line, testifying at trial that he planned to retire with the co-op.
A mere 3 months later, the co-op had a change of heart and terminated Mr. Hensley. He sued for breach of contract. In Court, the co-op argued the contract – presumably drafted by the co-op – was vague, ambiguous, unenforceable, and lacked consideration. The Court didn’t buy it and found in favor of Mr. Hensley awarding him $380,000 in accrued benefits plus health insurance premiums through 2024.
Employment issues, as seen last week, are often intertwined with other legal and practical considerations. In this case, it appears that the lack of attention to all these issues led to this very costly financial and HR mistake.
Hensley v. Cocke Farmer’s Cooperative, No. E2014-01775-COA-R3-CV, (Tenn. Aug. 31, 2015).

Read Carefully and don't Procrastinate

When buying or selling real estate, it's a good idea to make sure the deed actually conveys what you intend to covey. However, if it doesn't, acting sooner rather than later to correct the deed is preferable to waiting 2 ½ years.
In the recent case of Brenda Benz-Elliott v. Barrett Enterprises, LP, et al., the Court discussed the nearly 7 year history of litigation between the buyer and seller which included at least 1 trip to the Tennessee Supreme Court. In essence, the litigation resulted from an omission in the real estate deed which failed to include the seller's reservation of a 60-foot strip of land providing her road access to her remaining 86 acres of land after agreeing to sell 5 acres to her neighbor, the noted firearms manufacturer. The sales contract specifically reserved the strip of land, but whoever drafted the deed of conveyance apparently failed to include the reservation and the property was conveyed without the reservation.
Once the seller realized the mistake – 2 ½ years after the property was sold – she requested a deed of correction, but was rebuffed, thus setting in motion nearly a decade of litigation. Eventually, the seller prevailed, received monetary compensation, and ended up with a road leading to her back acreage. In prevailing, she defeated several seemingly reasonable arguments that she waived her right to enforce the contract by waiting as long as she did to bring suit. Fortunately for her; however, the Court found her suit to be timely.
One can only wonder how much money and time could have been saved had the seller paid more attention to her deed before signing it or at least read it before 2 ½ years passed.
Brenda Benz-Elliott v. Barrett Enterprises, LP, et al., No. M2013-00270-COA-R3-CV, (Tenn. Ct. App. Aug. 14, 2015).

Choose Your Words Carefully

Word choice in drafting wills carries significant ramifications. A recent Tennessee Appellate Court's decision turned on whether land that was to "be given to my son…" meant the same thing as "devised to my son…" or "bequeathed to my son…". This interpretation mattered as the verb chosen impacted the timing of the legal conveyance of the land (i.e. immediately at his mother's death or as part of the administration of her estate).
In the case of In re: Estate of Martha B. Schubert, there was a disagreement as to how a will was to be interpreted regarding specific gifts of real property. On one hand, the property would pass to her one son immediately upon his mother's death, while on the other hand, the same property would pass through the mother's estate. The trial court resolved the issue by determining that the property transferred to the son immediately upon his mother's death by statute (T.C.A. 31-2-103) since the will did not permissibly opt out of the automatic transfer.
The Court of Appeals disagreed, finding that the mother's choice of both sentence structure and words showed her intent was that the transfer was for a future act, not an immediate act upon her death. The Court observed, "[t]he specific phrase with regard to the [land], however, contains only the words 'be given,' not the words 'devise' or 'bequeath.' The direction that the property 'be given' indicates that this property is to be administered as part of [mother's] estate and 'given' to [her son] 'as part of his share of [her] estate' by the personal representative of the estate. The words 'be given' without words such as 'devise' or 'bequeath' show that further action is necessary before the property can vest in [her son], especially in light of [the mother's] specific direction that it be a 'part of [her son's] share of my estate.'"
Choosing words in legal drafting, whether in business contracts, employment agreements, releases, or wills, is crucially important. Words and phrases can have numerous meanings and result in unintended consequences. As such, it is important to work closely with your trusted advisors while drafting. Further, always remember to read and then re-read important documents before they are finalized.
In re: Estate of Martha B. Schubert, No. E2014-01754-COA-R3-CV, (Tenn. Ct. App. July 15, 2015).

The Tax Man Cometh

The State of Tennessee imposes numerous taxes, one of which is the sales and use tax. This tax, in part, essentially taxes the sale of tangible personal property "when the tangible personal property is not sold, but is used, consumed, distributed, or stored for use or consumption in this state." T.C.A. 67-6-203. In the case of McCurry Expeditions, LLC, et al. v. Richard Roberts,Tennessee imposed a $100,000 plus tax bill on an out of state limited liability company (LLC), which had its single owner maintaining his personal residence in Tennessee. The LLC previously bought a $900,000 motor home for the purpose of traveling throughout the United States to use it as a "mobile office to research, develop and purchase recreational parks and other real property in states outside the State of Tennessee." The LLC stored the motor home in Tennessee part of the year and all trips originated from its owner's residence in Tennessee.
The LLC challenged the tax bill and penalty in Chancery Court. The LLC and the State of Tennessee both presented their evidence via summary judgment motions. The case turned on the interpretation of the statutory terms "used" in Tennessee or "stored for use" in Tennessee. The LLC, which prevailed at the trial court level, argued, " that it did not “exercise any right or power” over the motor home in Tennessee because the motor home is “used exclusively for out of state purposes, was not maintained in the State of Tennessee for operational purposes and driven any distance on a Tennessee roadway to a state line to begin the out of state use trip."
The Court of Appeals didn't agree and found that the act of driving the motor home in Tennessee constituted use. Thus, the motor home was subject to taxation. The Court of Appeals went on to determine other issues, but ultimately reversed the trial court. Thus, the LLC owed the tax bill.
Taxation is not something to be taken lightly. I often hear from accountants and bookkeepers that the sales and use tax is one of the more vexing state taxes for their clients. Thus, it is crucial that competent accountants and bookkeepers are on each and every company's core team of professionals.
McCurry Expeditions, LLC, et al. v. Richard Roberts, No. M2014-00526-COA-R3-CV, (Tenn. Ct. App. Nov. 14, 2014).

Not All Assignments Are Valid?

In Action Chiropractic Clinic., LLC v. Prentice Hyler, Prentice Hyler, was involved in a car crash, which was apparently not his fault. Following the crash, he sought chiropractic treatment with Action Chiropractic. Before beginning treatment, he executed an assignment prepared by Action Chiropractic, which apparently was intended to ensure that Action Chiropractic got paid for the services it rendered and attempted to impose a payment obligation on the at fault insurance carrier. The assignment stated in part, that the injured party's “medical expense benefits allowable, and otherwise payable” to Hyler by his “Health Insurance, Auto Insurance, or any other party involved,” were assigned to Action Chiropractic. However, the court deemed this assignment ineffective as to the tortfeasor's insurance carrier, finding it didn't do what Action intended it to do. 
Mr. Hyler ran up about $5,000 in bills and settled his case with the at-fault party's insurance carrier for about $8,500. In the release he signed – provided by the at-fault insurance carrier – he released the at-fault driver and his carrier, but did not explicitly promise to pay off any outstanding medical bills from the settlement funds. Mr. Hyler cashed the check and no one paid Action Chiropractic.
Action sued both Mr. Hyler and the at-fault insurance carrier for the $5,000 in services rendered. The insurance carrier filed a Motion for Summary Judgment arguing that the assignment executed by Mr. Hyler was not effective as against it. Both the trial court and court of appeals agreed finding that Mr. Hyler did not actually execute a valid assignment of potential third-party insurance proceeds. At best, he assigned insurance proceeds from his own policy of insurance, not the at-fault party's policy. In other words, inartful drafting killed the assignment.
The court of appeals did not address whether with proper drafting an assignment by an injured party of the at-fault party's insurance carrier's payment obligation could be effective. Likewise, the court did not address any policy defenses that may preclude such an assignment. Finally, the court didn't address Mr. Hyler's remaining obligation to Action Chiropractic. At the end of the day, Hyler received the services and didn't pay the bill. It seems that both Mr. Hyler and Action Chiropractic may have been better served had they engaged counsel to prepare the assignment and handle the resolution of the personal injury claim respectively.
Action Chiropractic Clinic, LLC v. Prentice Hyler, No. M2013-01468-SC-R11-CV, (Tenn. Ct. App. July 1, 2015).

Arbitration Clause Found Unenforceable

A recent Tennessee Court of Appeals case, Capps v. Adams Wholesale Co., Inc.,  found that an arbitration agreement contained within a decking manufacturer’s limited warranty was unenforceable as there was no meeting of the minds between the purchaser/homeowner and the manufacturer – despite the fact that “similar arbitration agreements had been upheld” in other cases. Six months after installation of the deck, the decking started to fail. The homeowner sought to replace the material directly from the manufacturer pre-suit; however, the manufacturer refused to do so, stating the complaints were merely cosmetic.
Without the manufacturer’s cooperation, the homeowner filed a lawsuit in the Greene County Chancery Court. In response, the manufacturer moved to dismiss the lawsuit and compel arbitration based on the mandatory arbitration clause in the limited warranty. The decking was sold without any documentation about the warranty or arbitration clause other than a small written notice with each decking bundle stating that the product was subject to a limited lifetime warranty and that the customer could obtain a copy by either calling the provided 1-800-number or visiting the manufacturer’s website. The manufacturer never gave the homeowner a copy of the limited warranty until after the homeowner requested replacement of the defective product.
The trial court denied the manufacturer’s motion to dismiss and the Court of Appeals affirmed. The Court reasoned that although the homeowner was not required to sign off on the arbitration clause or even to read it for it to be enforceable, the homeowner was never given notice of the arbitration clause prior to taking delivery of the decking material and thus never had a chance to refuse acceptance of the product. As such, the Court found the arbitration clause unenforceable due to the lack of mutual assent of the terms. The Court noted that its holding was limited to the specific fact pattern before it.
Warranties, both express and implied, are often the subject of litigation. In a situation like the one reviewed, the corporate defendant attempted to avoid a trial in a county court and instead force the homeowner into a private arbitration forum. Arbitration, however, may not be the most desirable forum, whether from a consumer’s or a manufacturer’s viewpoint. In deciding whether to incorporate a mandatory arbitration clause in a contract – whether for services or manufacturing – significant thought must be given to the risks and benefits of such a clause. Additionally, before a lawsuit is filed, it is important to determine whether an arbitration clause may apply as they often exist in both consumer and commercial contracts and are routinely enforced by courts.

Capps v. Adams Wholesale Co., No. E201401882COAR3CV, 2015 WL 2445970, at *3 (Tenn. Ct. App. May 21, 2015).