Nicholas D. Krawec, Esq.
Partner, Bernstein-Burkley, P.C.
Commercial credit applications are contracts which will govern the credit account transactions between the credit grantor and its customer, and therefore are subject to the same rules of interpretation and enforceability as other contracts. The goal of contractual interpretation is to ascertain and to effectuate the intent of the contracting parties. In determining the intent of parties to a written contract, the court looks to what the parties have clearly expressed, because the law does not assume that the language of the contract was chosen carelessly. Thus, the terms and conditions of a commercial credit application are to be construed according to the intent of the parties as determined by a reasonable interpretation of the language used in the light of the attendant facts and circumstances. Furthermore, the parties have the right to make their own contract, and it is not the function of a court to rewrite it or to give it a construction in conflict with the accepted and plain meaning of the language used.
As with all contracts, a commercial credit application must be construed as a whole. One part of a contract cannot be interpreted so as to nullify another part, and a contract must be construed, if possible, to give effect to all of its terms. Proper construction of a contract may involve a consideration of its subject matter, the circumstances surrounding its execution, the purpose, and the legal effect of the contract as a whole. Neither the form of a contract nor the name given to it by the contracting parties controls the interpretation of the contract.
The meaning of a clear and unambiguous written contract and the intent of the contracting parties must be determined from the contents of the contract document itself. If the written contract is ambiguous, a court may look to extrinsic evidence to resolve the ambiguity and determine the intent of the parties. Additionally, ambiguous contract terms will be construed against the drafter of the contract, because that person controlled the wording that is used.
Needless to say, disputes often arise between a creditor and its customer, particularly if the customer (who has now become a debtor), seeks to avoid some terms of the credit application which he considers to be particularly onerous or, in his perception, unconscionable. Under Article 2-302 of the Uniform Commercial Code, if, in the course of adjudicating such a dispute, the court as a matter of law finds the contract or any clause of the contract to have been unconscionable at the time it was made, the court may: (1) refuse to enforce the contract; (2) enforce the remainder of the contract without the unconscionable clause; or (3) so limit the application of any unconscionable clause as to avoid any unconscionable result. When it is claimed or appears to the court that the contract or any clause thereof may be unconscionable, the parties must be afforded a reasonable opportunity to present evidence as to its commercial setting, purpose, and effect to aid the court in making the determination. A contract or a clause in a contract is to be considered unconscionable if there is an absence of meaningful choice on the part of one of the parties together with contract terms which are unreasonably favorable to the other. However, a finding of unconscionability of a contract or a contract term, is very rare when the contracting parties are commercial enterprises, who have meaningful choices at their disposal when entering into the credit agreement.
The rights and obligations of the parties to a contract, which the words of the contract clearly express, must be recognized and enforced. The following provides a brief discussion of the enforceability of various contract clauses found in commercial credit applications.[related]
Personal Guaranty Clause
A personal guaranty is a separate agreement by one person to pay some debt or perform some contract or duty upon the default of another person who was initially liable for that payment or performance. Generally, a personal guaranty is prospective and not retrospective in operation. Liability continues as long as is expressly or impliedly provided for in the personal guaranty. The determination of whether a personal guaranty is continuing or noncontinuing depends on the language of the contract, or from the course of dealings between the parties or from both.
As with other contracts, a personal guaranty is not enforceable unless based on sufficient legal consideration. A mere promise to pay the existing debt of another without any consideration is void, however, it is not necessary that consideration pass directly to the guarantor; the extension of credit to the principal obligor is sufficient consideration to support the promise of the guarantor.
Where a personal guaranty is conditional, the guarantee must make diligent effort to collect from the principal before he can resort to the guarantor. On the other hand, where the personal guaranty is absolute, the guarantor is bound immediately on the failure of the principal to perform his contract without further legal proceedings. Statutory law has codified the distinction at common law between a surety, who became immediately liable upon default, and a guarantor, who did not become liable until efforts to collect from the defaulting principal proved unavailing. Pursuant to 8 P.S. §1, all agreements to answer for the debt of another will be regarded as a suretyship, unless the agreement shall contain words in substance stating that “this is not intended to be a contract of suretyship.” The surety and principal obligor for debt are both primarily liable for obligation upon default, meaning the surety’s liability is direct and immediate, and liability to obligee is coextensive with the primary liability of principal.
The nature and extent of the liability of a guarantor or surety depend on the terms of the personal guaranty. A guarantor is liable for all consequences of the failure of his principal to perform under the principal contract, and, if the terms and conditions of the contract so state, he may assume greater liability than that of his principal.
Disclaimer of Warranties Clause
A warranty is an assurance by one party to a contract of the existence of a fact upon which the other party may rely, thus relieving the promisee of any duty to ascertain the fact. Warranties applicable to the sale of goods may be express or implied. The scope of the warranty may vary, depending on the circumstances, such as the terms of the seller’s actual promise, express or implied in fact, the seller’s express or tacit representations of facts serving as inducements to the bargain, and broader considerations of policy. A warranty is ordinarily a matter of contract, but if a warranty is part of the contract or transaction of sale, no separate consideration to support it is necessary.
In general, implied warranties may be expressly excluded or waived by the terms of the contract of sale, and such terms are valid unless, as related to the particular subject matter of the sale, they are violative of statutes or against public policy.
The Uniform Commercial Code provides for contractual modification or limitation of the remedies of the buyer for breach of warranty. In general, a buyer is protected from unexpected and unbargained language of the disclaimer, since general language disclaiming warranties is insufficient, must be in specific language, and the preclusion of implied warranties is accomplished only by appropriate, conspicuous language of disclaimer. A provision in a contract of sale that the contract contains all of the agreements between the parties does not preclude an implied warranty of merchantability.
Pursuant to Article 2-316 of the Uniform Commercial Code, to exclude or modify the implied warranty of merchantability or any part of it, the language of exclusion must mention “merchantability,” and, if the disclaimer is in a writing, must be conspicuous. To exclude or modify any implied warranty of fitness for a particular purpose, the exclusion must be in writing and conspicuous. Language to exclude all implied warranties of fitness for a particular purpose is sufficient if it states that “There are no warranties which extend beyond the description on the face hereof.”
Unless the circumstances indicate otherwise, all implied warranties are excluded by expressions like “as is,” “with all faults” or other language which in common understanding calls the buyer’s attention to the exclusion of warranties and makes plain that there is no implied warranty.
Words or conduct relating to the creation of an express warranty and words or conduct tending to exclude or limit warranties are construed, wherever reasonable, as consistent with each other, but, subject to the provisions of the Uniform Commercial Code with reference to sales of goods, on parol or extrinsic evidence, exclusion or limitation of warranties is inoperative to the extent that such construction is unreasonable.
Confession of Judgment Clause
A confession of judgment is a voluntary submission by a debtor, to the jurisdiction of the court, given by consent and without the service of process. Thus, a confession of judgment clause permits a creditor or its attorney simply to apply to the court for judgment against a debtor in default without requiring or permitting the debtor, or its guarantors if a confession of judgment clause is included in a guaranty, to respond at that juncture. Generally, a confession of judgment may be made by the defendant himself or herself, or by some person duly authorized to act for him or her in their behalf, as by a warrant of attorney.
In general, the law does not favor confession of judgment provisions. Confession of judgment is a powerful tool because it effectively prevents the debtor from having his or her day in court prior to the entry of judgment. Such power must be exercised fairly and with exacting precision. The use of confessed judgment in all “consumer credit transactions” has been abolished. Confessed judgments are still permissible in commercial transactions, but must be exercised fairly and in strict accordance with the requirements of the law and the rules of civil procedure.
In analyzing a confession of judgment clause in a commercial credit application, the court is guided by rules that apply to other written contracts. The right to enter a judgment on a confession of judgment clause is a question governed by the intent of the parties. Depending on the circumstances, a confession of judgment clause contained in a commercial credit application may be invalid on the ground of unconscionability. For example, if the confession of judgment clause is not in conspicuous print on the credit application, or the debtor’s signature on the credit application does not relate directly to the confession of judgment clause, a confession of judgment debtor might successfully challenge a confession of judgment, and have the judgment stricken by the court, on the basis that enforcing the confession of judgment clause under the foregoing circumstances would be unconscionable.
A “warrant of attorney” is a means of giving a creditor security by his or her debtor authorizing an attorney to confess judgment against the debtor for an agreed upon amount. It constitutes a grant of authority by one contracting party to the other, upon the happening of a certain event, specifically, a breach of the terms of the agreement wherein the warrant of attorney is contained, to enter a judgment.
When a party to a contract seeks to bind the other party with a warrant of attorney authorizing the confession of judgment, the warrant of attorney must appear in the body of the contract, and cannot be incorporated by casual reference to a separate document, with a designation not its own. The grant of authority to confess judgment must be clear and explicit. However, no particular phraseology in confessing judgment is required, it being substance rather than form which is important. The warrant of attorney to confess judgment need not contain any form of the word “confess,” nor any other specific words, provided that proper intention to confess judgment is displayed.
Because a warrant of attorney authorizing confession of judgment can be an oppressive weapon, a judgment entered pursuant to a warrant of attorney can be accomplished only by strict adherence to the provisions of the warrant. Justification for the entry of a judgment by confession must be found in the terms of the instrument itself, and may not be extended beyond the definite power which the law confers. Thus, the validity of such a confessed judgment rests upon a strict construction of the language of the warrant of attorney, which should be strictly construed against the party favored thereby. Any ambiguity or doubt as to the validity of a judgment by confession upon the authority of a warrant of attorney must be resolved against the party entering the judgment. If the confessed judgment includes an item not authorized in the warrant, the judgment is void in its entirety and must be stricken.
Forum Selection Clause
As a general rule, private parties cannot, by contract, change the rules of jurisdiction or venue embodied in the various laws of the states. However, an agreement between the parties, purporting to determine the forum where future disputes between them should be litigated is not per se invalid or without legal effect. Where the parties have freely agreed that litigation shall be conducted in a specified forum, and where such agreement is not unreasonable at the time of the litigation, the court in which venue is proper and which has jurisdiction should decline to proceed with the cause.
In view of the vast growth of interstate (and international) transactions, forum selection clauses have been increasingly enforced by federal and state courts, at least in interstate transactions, Forum-selection clauses in commercial credit applications are prima facie valid and should be enforced in the absence of fraud, undue influence and overbearing bargaining power, or if the clause is not shown by the resisting party to be unreasonable under the circumstances. Such a clause would be unreasonable only where its enforcement would, under all circumstances existing at the time of litigation, seriously impair a party’s ability to pursue or defend a cause of action. Mere inconvenience or additional expense is not the test of unreasonableness, since it may be assumed that a party received under the contract consideration for these things. A forum selection clause in a commercial credit application, mandating that suit be brought in a jurisdiction where the defendant does not reside or does not have its principal place of business, will be found unenforceable where: (1) absent the contractual provision, venue would properly lie in another jurisdiction; and (2) all the essential contacts, witnesses, and circumstances of the case exist in that other jurisdiction, and it would cause the objecting party unjustifiable and onerous expense to litigate the matter in a contractually created forum.
In summary, these contractual clauses – personal guaranty, disclaimer of warranties, confession of judgment and forum selection clauses – are enhancements to the creditor’s position which should be incorporated into commercial credit applications to the maximum extent possible. If the credit applicant resists, at the very least the exclusion of one or more of these clauses can be used as negotiating points to extract a quid pro quo, in terms of other concessions from the credit applicant.
For additional information on perfection of security interests and the usage of other credit enhancements, please see the other articles in this Publications section.
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