The following is an update analyzing a recent case of interest:
The Supreme Court of Kentucky, relying on provisions in the Kentucky version of the Uniform Commercial Code, ruled that a promissory note was a “negotiable instrument” even though it referenced the possibility of another agreement when defining indebtedness and default. [Community Financial Services Bank v. Stamper, 2019 WL 5678461 (Ky. Oct. 31, 2019)]. To view the entire opinion, click here.
In 1997 Ronny Stamper obtained a loan from Community Financial Services Bank (Bank) to purchase an automobile and executed a document titled “Note, Disclosure, and Security Agreement” (Note). The Note, payable in monthly installments, had a maturity date of April 22, 2002. In 2000, Stamper defaulted on the loan and Bank notified him by letter that it would sell the automobile at auction and he would be responsible for the remaining balance in excess of $12,000. After the auction, also by letter, Bank notified him of a balance of $9,700 and stated that the balance must be paid or a satisfactory repayment plan accepted by September 2000 or legal action would be initiated.
For reasons not pertinent here, the legal action was not initiated until January 2016. Not surprisingly, the statute of limitations was raised as a defense. In the trial court, the question of when the 15-year statute of limitations for a suit on a written contract under KRS 413.090(2) began running was legally contested. Granting summary judgment for Bank, the trial court concluded the relevant date was the maturity date in 2002, not the default date in 2000 as favored by Stamper, so the 15-year statute had not run and the action was timely. On appeal, the Court of Appeals first determined that the cause of action accrued on the maturity date in 2002, agreeing with the trial court, but it then raised sua sponte that both parties were referring to the incorrect statute of limitations; the Note was a negotiable instrument under KRS 355.3-104(1) and therefore the six-year statute found in KRS 355.3-118 applied. (KRS 355 is the Uniform Commercial Code; the provisions referred to here were enacted without alteration in Kentucky.) Based on the applicable six-year limitation period, the suit was untimely and the decision was reversed.
After first determining that it was appropriate for the Court of Appeals to raise the legal issue of which statute of limitations applied on its own, the Kentucky Supreme Court then addressed whether the Note qualified as a negotiable instrument. Bank asserted it did not because it referenced other agreements and would therefore require one to look beyond the Note to determine exactly how much Stamper owed. The court disagreed, concluded it was a negotiable instrument, and affirmed.
The court first looked at the specific language alluded to by Bank, found in the Note’s definition of “indebtedness”:
the indebtedness evidenced by this Agreement, together with all renewals of, extensions of, modifications of, refinancings [sic] of, consolidations of, and substitutions for this Agreement, including all principal and interest, all other amounts, costs and expenses for which [Stamper is] responsible under this Agreement or under any other agreement with Lender pertaining to the loan.
The court then drilled down on the crux of Bank’s argument: whether the reference to “any other agreement with the Lender” made the Note something other than an unconditional promise to pay a fixed amount of money. It considered, then distinguished, a series of cases – from various states construing Official Comments to the same version of the UCC – which concluded that notes which were “subject to” or “incorporated” outside agreements were not negotiable instruments. In doing so, the Kentucky Supreme Court looked to the language in KRS 355.3-106(1)(c) which expressly states “A reference to another record does not of itself make the promise or order conditional.” With that in mind, it reasoned that the Note was more similar to those discussed in cases which held that a “reference” in a note to an extrinsic agreement which did not make the note subject to terms of that agreement did not destroy negotiability.
The Kentucky Supreme Court concluded that the Note’s mere reference to “any other agreement” in the definition of indebtedness did not make it conditional or subject to anything which might be in those “other agreements” and therefore did not make it nonnegotiable.
This case has universal significance because it interprets provisions of the UCC adopted by Kentucky without alteration and most states have statutory or caselaw authority which explicitly allows litigants to cite to other state’s decisions when referring to the UCC. Lenders, or any other party attempting to enforce a promissory note, should be alerted to the possibility that the note might be considered a negotiable instrument under the UCC, making various provisions of the Code applicable, including the relevant statute of limitations. That the parties here never considered the Note as a negotiable instrument is instructive in itself because the “disguise” of this note in a multi-purpose document is not unique. Litigants would be well served to look at any promise to pay in question and determine whether it would qualify as a negotiable instrument before becoming embroiled in litigation.
The second lesson here goes to the drafters of promissory notes or other agreements which include a promise to pay. Drafters should first determine the pros and cons of the agreement being a negotiable instrument for the circumstance they are addressing. Once that determination – yes or no – has been made, then the drafters can insert language which would make the agreement nonnegotiable if that best serves the needs of the client or avoid such explicit reference if the desire is to create a negotiable instrument. An agreement which is conditioned on or subject to any extrinsic documents arguably will not be negotiable.
These materials were authored by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal., Ret.), a member of the Business Law Section ad hoc group. Editorial contributions were made by Monique D. Jewett-Brewster, an attorney with Hopkins & Carley, ALC, a member of the ad hoc group and 2018-19 Chair of the CLA Business Law section. The opinions expressed herein are solely those of the author. Thomson Reuters holds the copyright to these materials and has permitted the Commercial Transactions Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.
This ebulletin was prepared by Walter K. Oetzell, Walter K. Oetzell, APC, email@example.com.