Verification Letters are Key in Factoring Agreements

February 3, 2014 in Construction, Creditors Rights, Indiana Courts by Brad Council

The Indiana Court of Appeals overturned a superior court ruling finding that the doctrine of promissory estoppel is applicable to verification letters in factoring contracts and should control in the case of Sterling Commercial Credit – Michigan, LLC v. Hammert’s Iron Works, Inc. 998 N.E.2d 752 (Ind. Ct. App. 2013). The case was brought to the court on Sterling’s appeal following a superior court ruling in favor of Hammert’s on both cross-motions for summary judgment.

The conflict addressed in this case arose from a contract for construction of a clinic in Evansville, Indiana. Hammert’s, which was responsible for the structural steel framing & decking, entered into a $490,000 subcontract with National Steel Erectors, Inc. (“NSE”) with terms calling for payment only after Hammert’s was paid by the general contractor. To provide liquidity, NSE entered into a Factoring and Security Agreement with Sterling. Sterling agreed to pay NSE 85% of the amount due when invoiced and would later receive the full payment directly from Hammert’s. Before making the payment, Sterling required a verification letter from Hammert’s asserting that the invoiced amount was earned, due, owing, and final except for payment.

Sterling purchased three invoices from NSE and received verification letters from Hammert’s for all three. Hammert’s paid the first invoice received without issue. Before paying the second invoice, Hammert’s inquired about the status of NSE’s payments to subcontractors who were currently owed $50,116.49. With the second invoice payment, Hammert’s included a letter indicating that NSE’s subcontractors must be paid and requested that the letter be signed and returned. Sterling disregarded the letter and kept the payment for the second invoice. NSE failed to pay its subcontractors and subsequently filed for bankruptcy. Hammert’s paid the subcontractors on NSE’s behalf and finished the construction itself but did not pay Sterling for the third invoice it had purchased from NSE.

Sterling filed suit against Hammert’s asserting breach of contract and that they detrimentally relied on Hammert’s verification letter in providing funding to NSE. Sterling argued that the doctrine of promissory estoppel should obligate Hammert’s to pay the third invoice. Hammert’s counter-claimed alleging breach of the agreement to pay NSE’s subcontractors, misappropriation of funds, and argued that the doctrine of promissory estoppel was inapplicable.

 Rather than rule on the breach of contract issues, the Indiana Court of Appeals decided the controversy solely using promissory estoppel. The doctrine is based on equitable principles and has been found to be applicable to commercial transactions under the Uniform Commercial Code. Promissory estoppel requires “(1) a promise by the promisor (2) made with the expectation that the promisee will rely thereon (3) which induces reliance by the promisee (4) of a definite and substantial nature and (5) injustice can be avoided only by enforcement of the promise.” The Appeals court found that the verification letter sent by Hammert’s satisfied the requirements of promissory estoppel as they were promises to pay the invoices with the expectation that Sterling would lend money to NSE based on the letter. As such, Hammert’s was estopped from refusing to pay the invoices and was not permitted to attach the additional terms to the payment requiring payments to NSE’s subcontractors.

The appeals court reversed and remanded the trial courts decision with instructions to enter judgment in favor of Sterling on the claim and counter-claim. The court also indicated that the decision was a continuation of doctrine from other courts finding that the issuance of a verification letter to a factor will prevent the debtor from refusing to pay the debt at a later date, regardless of intervening circumstances. Care should therefore be taken in submitting and securing verification letters in factoring agreements as the letter will prevent the later reduction or offset of the payment for other obligations that arise.

The Full Text of the Opinion May Be Found Here:  http://www.in.gov/judiciary/opinions/pdf/11271303ebb.pdf

 

** Many thanks to William Abbey for his contributions to this article.  William is a law clerk with Slovin & Associates Co., L.P.A. and student at the University of Cincinnati College of Law.  **