Often, when a business is sold, the purchase price is paid by the new owner with a combination of cash (certified checks, etc.) and promissory notes. By use of promissory notes, the new owner is able to defer part of the costs so that, hopefully, it will eventually be paid out of the profits of the business. These notes are sometimes made payable on a monthly basis, and other times the entire amount is made due in a few months, or years down the road.

At the time that the business is transferred and the promissory notes are given, the seller usually also makes a few promises to the buyer. One of the most important of these is the seller’s promise and guarantee that there are no existing debts of the business that have not been disclosed to the buyer.

Additionally, at most closings, the seller will guarantee that he will be responsible for, and will immediately pay, all existing obligations of the business he is selling, whether disclosed or not, including those of which he may not even be aware.

In most transactions of this type, a part of the cash purchase price is held in escrow by the attorney for the seller solely for the purposes of payment of these debts guaranteed by the seller. Often, however, when a part of the purchase price is in the form of notes not payable for sometime, the buyer is not too concerned with the holding of an escrow because if a problem arises in the future, he can, at that time, withhold payment of the notes until it is cleared up by his seller. As one unhappy purchaser of a business recently found out, however, this is not always so.

The facts of this case are simple. A business was sold on July 22, 2002, with $62,000 of the purchase price being paid by a series of promissory notes. On Oct. 14, the seller transferred and assigned these notes to a third party in a transaction totally unrelated to the sale of the business. In fact, as it was later brought out, the notes were given to this third party as part payment of a totally unrelated indebtedness of $90,000 which the seller had owed this third party for many years.

In March of 2003, the buyer of the business refused to continue making the required monthly payments to this third party. He stopped because he claimed there had been many debts and obligations of the business which existed at the time of his purchase which were not disclosed to him and, he claimed, were fraudulently concealed from him.

The notes, although payable in monthly installments, contained the usual clauses giving the holder of the notes, in the event a payment was missed, the right to accelerate all the notes so that the entire balance would become immediately due and payable. That is exactly what the third party who was now holding these notes did. In fact, not only did he accelerate the notes, he immediately sued the buyer for the entire balance.

Both parties immediately made motions for summary judgment on the law. The buyer sought to dismiss the suit against it on the grounds that the seller of the business breached the contract of sale and the warranties it contained by the fraudulent concealment of outstanding debts which debts it now refused to pay. The buyer also claimed that the seller transferred the notes to the third party solely to avoid its obligations.

The third party, on the other hand, claimed that since it was not a party to the original transaction and that since it had accepted the notes in satisfaction of a prior debt that it was a holder in due course and so entitled to its money no matter what defenses the buyer might have against the seller.

The court, in its decision, noting that summary judgment is a drastic remedy since it deprives a litigant of the opportunity of presenting the merits of his case at a full trial, closely examined the contentions of both sides.

After discussing both sides of the case, the court found that since the third party, the plaintiff in this lawsuit, was, in fact, a holder in due course it had no choice but to grant it summary judgment, against the buyer, for the full value of the unpaid notes.

Next time, we will examine the concept of a holder in due course more closely and see just why it is so important.