Edelstein, Peter M

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North East Journal of Legal Studies Volume 1 Spring 1993 Article 8 Spring 1993 Can Demand Notes Really Be Demanded Peter M. Edelstein Follow this and additional works at: https://digitalcommons.fairfield.edu/nealsb Recommended Citation Edelstein, Peter M. (1993) "Can Demand Notes Really Be Demanded," North East Journal of Legal Studies: Vol. 1 , Article 8. Available at: https://digitalcommons.fairfield.edu/nealsb/vol1/iss1/8 This item has been accepted for inclusion in DigitalCommons@Fairfield by an authorized administrator of DigitalCommons@Fairfield. It is brought to you by DigitalCommons@Fairfield with permission from the rights-holder(s) and is protected by copyright and/or related rights. You are free to use this item in any way that is permitted by the copyright and related rights legislation that applies to your use. For other uses, you need to obtain permission from the rights-holder(s) directly, unless additional rights are indicated by a Creative Commons license in the record and/or on the work itself. For more information, please contact digitalcommons@fairfield.edu. 120 information obtained illegally or obtained legally and then illegally misappropriated for personal use. Phillips & Zutz, supra note 93, at 86-93; Barbara Bader Aldave, Misappropriation: A General Theory of Liability for Trading on Nonpublic Information, 13 Hofstra L. Rev. 101, 122 (1984). Under a constructive insider theory one "who knowingly receives nonpublic material information from an insider has a fiduciary duty to disclose before trading." Dirks, 463 U.S. at 656. See Phillips & Zutz, note 93, at 93-95. The breach of duty under each of these theories, however, is not to the investing public and, therefore, each is a rather roundabout way of protecting the public. Under the misappropriation theory the wrong is to the rightful possessor of the information. Under the constructive insider theory the wrong is to the corporate shareholders. 111. See, e.g., United States v. Carpenter, 484 U.S. 19 (1987); Dirks v. SEC, 463 U.S. 646 (1983) ; Chiarella v . United States, 445 U.S. 222 (1980); Santa Fe Industries v. Green, 430 U.S. 462 (1977); Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976); SEC v. Texas Gulf Sulphur C., 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969); In re Cady, Roberts & Co., 40 S.E.C. 907 (1961). 112. An example of "mere good fortune" is inadvertently, while waiting on line at the movies, overhearing a conversation about a particular corporation's business, and then, in reliance on the overheard information, buying shares of the corporation's stock. The corporate information on which Chiarella traded, on the other hand, was not obtained because of Chiarella's "mere good fortune." It was available to him because of his special relationship as an employee of the corporation's printing contractor. I CAN DEMAND NOTES REALLY BE DEMANDED? by Peter M. Edelstein* 121 Introduction Facts: Issue: Decision: ABC Bank lends $100,000 to B. Benny. B. Benny and delivers to the bank a negotiable note payable "on demand". ABC later demands payment. B. Benny refuses. ABC sues B. Benny for $100,000. B. Benny defends on the grounds that reasonable notice was required and not given. Whether a holder of a demand note can demand payment at any time? Maybe •. . . . A "demand note" is an instrument payable on demand and thos7 payable at sight or on presentation and those no t7me for payment is stated. 1 By its nature, and as reflected long accepted case law and in the u c c demand note entitles the holder to freely determine tlm: payment. In fa?t, such a note is actually due on the date I_Rade,, and has been suggested that its name is no actual prior demand is necessary to enforce payment. Questions concerning a holder's ability to require payment of f3 note at any time arise because of two apparently rules of law and because the intent of the not always clear. A two step analysis is call7d. for: (1) what is the effect of the applicable of the Code? and, (2) what is the intent of th e *Professor of Law,,Pace University, Pleasantville, New York. Member of & Lochner, Armonk, New York. 122 The Problem u.c.c. Section 1 - 203, a principle l?ng part of the common law of contracts, by imposing an obl1gat1on of good faith with respect to all by the Code: "Every contract or duty w1 th1n th1s Act 1mposes an obligation of good faith in its enforcement." Good faith is defined as "honesty 1n fact 1n the conduct or transaction concerned 11 • 4 Since negotiable are cover7d in Article 3 (Commercial Paper) and secur1ty agreements 1n Article 9 (Secured Transactions), one .could fairly that demand notes are subject to the requ1rement of good fa1th. The Official Comment to Section 1-208, however, proves this assumption to be incorrect.. Section 1-208,. entitled "Option to Accelerate at Will", 1mposes the requ1rement of good faith on a party, who among other things, desires to accelerate payment or performance "at will" or "when deems himself insecure." The Official Comment states: "Obv1ously, this section has no application. to in.struments very nature permit call at any t1me w1th or w1thout reason . (emphasis added). While the authors of the Code could have been more precise by setting forth the two rules in the body of Article 2, the Official Comment is not unclear. The of good faith simply does not to 1nstruments. Determining whether a demand instrument ex1sts, based on the intent of the parties may not be so clear. A "pure" demand note is simple and classic and by its terms is due "on demand". In the absence of any inconsistent language, either within or without the instrument, it may be called at any time with or without reason. By contrast, there is the note which was born as a demand note, but may have been bastardized into something else. Consider a demand note which contains a provision that it is due on demand, but if no demand is made, .the note. is payable "at a certain date"; or a demand note wh1ch a default interest rate which is "due and payable at matur1ty, on demand or otherwise"; or a demand note given in with the execution and delivery of a loan agreement wh1ch contains covenants, ratios, and other requirements, the default of which constitutes an "event of default". Since a court will look to the documents as a whole to determine the intent of the parties, it might conclude when reviewing the foregoing examples that the parties did not, in fact intend the instrument to be payable on demand. The court might wonder why the parties agreed to such additional and unnecessary language if the note was really due on These "demandable" types of notes have been labelled "impure" demand notes and can become a lender's worst nightmare. 123 . Shaughnessy v. Mark Twain State Bank, addressed this 1ssue and concluded that the so-called "demand note" in question was not entitled to be treated as one: "First, the words "(o]n demand, and if no demand is made, then on the" are printed on the form but according .to the s l .anguage the date 16, 1980 1s typewr1tten 1n. Second the interest rate is prime plus two but after note becomes "due and payable (whether at maturity on demand or otherwise)" the interest rises to plus three paragraph 16 of the deed of trust l1sts .e1ght events which constitute default. The deed 1tself recites 26 paragraphs of covenant by The deed then states that defaults or fa1lure to perform the covenants shall cause the to due and payable regardless of Aga1n, we apply the court's analysis [in an earl1er case] to underscore the point that a demand note is, on issue, due. Further, in the security ... agreement, agreed that fa1lure to pay at maturity constituted default. Therefore, had the note been a demand note it would m.ature . and Shaughnessy would have been 1mmed1ately 1n default. Likewise, with the deed of trust language, if this were a demand note, the note would not need default for it to be due and payable at the option of the bank. It would already have been due. 117 Once the conclusion is reached that the instrument a117ged by the lender to be a demand instrument is not to be treate? as such, the u.c.c. requirements of good fa1th apply by v1rtue of u.c.c. Section 1-203. In the context of commercial instruments this means that "neither party which will have the effect of destroy7ng or 1n)ur1ng the right of the other party to receive the fru1ts of the contract". 8 This obligation to protect the legal expectations of a party translates, in the case of demand notes,into an obligation to give fair notice to the borrower before requiring payment. K:M.c. Co.,. v. Irving Trust Company/ did not directly deal W1th the r1ght of the lender to demand its note but did require "the exercise of reasonableness" and "valid 1 business judgment"10 in electing to terminate a line of credit under an agreement by which the loan was payable on demand. K.M.c., a wholesale grocer, entered into a financing agreement with.Irving .Trust Company ("Irving") whereby Irving agreed.to . prov1de a l1ne of credit, in its discretion, up to $3.5 m1ll1on. The loan was due on demand and was secured by all of K. M. C. 's accounts receivables and inventory. The 124 proceeds of all of K.M.C.'s receivables were required to be deposited into a "blocked account" to which only Irving had access. K.M.C. requested an advance of $800,000, which was available under its line. Irving, which was fully collateralized, refused and eventually K. M.C. was forced to liquidate its business. K.M.C., in its lawsuit against Irving alleged, among other things, that Irving its implied. duty of faith and fair dealing by term1nat1ng the l1ne w1thout not1ce. Irving defended by arguing that since the line was due on demand and that because advances were discretionary, it could terminate the line at any time. The court found for K.M.C. The jury awarded K.M.C. $7.5 million in damages on the theory Ir;'ing breached; implied duty of good faith and fa1r deal1ng by .not g1v1ng K.M.C. notice of its intention to terminate the l1ne. The court noted that even though the obligation of K. M.C. was evidenced by a demand note (to which the of good faith under the. u.c.c. did not applX), pr?v1s1ons 1n the loan agreements ind1cated that the part1es d1d actually intend the instrument to be due on demand. The ex1stence of financial c.ovenants and events of default required that Irving exercise discretion, in good faith. The court held: "The record clearly established that a medium-sized company . . . such as K.M.C. could not without outside financing. Thus, the l1teral interpretation of the financing agreement . . . as supplemented by the "blocked account" mechanism, would leave K.M.C.'s continued existence entirely at the whim or mercy of Irving, absent an obligation of good faith performance ... Logically, at such time as Irving might wish to curtail financing K.M.C., as was its right under the agreement, this obligation to act in good faith would require a Period of notice to K.M.C. to allow it a reasonable . f . . n11 opportunity to seek alternat1ve 1nanc1ng Avoiding the Problem The problem, once recognized, is subject to avoidance by early and thorough attention to drafting. If a pure demand note is intended, care should be taken not to 1nclude any language inconsistent with the right to demand at any time, for any reason, or for no reason. If the transaction requires a demand instrument together 125 with other; loan documents, use a pure demand instrument together w1th clear and specific "saving" language in another document stating that the note is due on demand, in all events, . and that any other language is to be construed for the lender's benefit and not in derogation C?f r1ght to demand without notice. Any apparently 1ncons1stent language may be justified as serving to assure the continued credit-worthiness of the borrower or to provide borrower with notice of circumstances when the note is l1kely to be called. The together interest wish. issue will never arise if you use a time instrument with such due dates, events of default, default rates and covenants, and like provisions, as you Related Problems "Dis t' d . c:e.1onary avances" language is subject to an analys1s s1m1lar to demand notes. Even where the language of the loan makes advances discretionary, the lender may be requ1red, by the rules of good faith and commercial (as in K.M.C.), to give the borrower fair not1ce that future advances will not be made. If in the loan documents require commitment fees or payments, for example, a court might find prov1s1ons 1nconsistent with the right to make d1scret1onary advances , and infer an obligation on the part of the lender to make the advances. To avoid this issue, consider using language in the loan which commit the lender to make the advances making . them discretionary, but make the agreement 1n each 1nstance, to the borrower's satisfaction of a . of conditions (ratios, performance standards, negative covenants, absence of default, etc . ) wh1ch w1ll g1ve the lender sufficient comfort. The right to accelerate the entire indebtedness in the of default usually causes no problems. The risk lies w1th ti:e use of language permitting acceleration "at will" or when 11 1nsecure". The u.c.c., in Section 1-208, states that lender may accelerate at will or when it deems itself 1nsecure only if it believes in good faith that the prospect of payment or performance is impaired (emphasis added). If the lender accelerates pursuant to an "acceleration at.will" clause the file should support the belief in good fa1th, that the loan is in jeopardy. As noted this U.C.C. section does not apply to demand instruments ther7fore, avoid the issue consider, when appropriate: the 1nstrument as "demand' and avoiding the use of the "at w1ll" language, or alternatively, using a time instrument 126 with well-defined events of default tied to performance standards. Like the "acceleration at will" language, an "insecurity" clause is subject to the provisions of u.c.c. Section 1-208, requiring the lender to believe in good faith that the prospect of repayment or performance is impaired .. cover this situation include in the loan documents a of "insecure" or 'set forth those acts or events which would render the lender insecure; for example, state that a breach of a covenant requiring certain financial ratios to be maintained renders the lender insecure. Your client's file should then contain information evidencing the breach and supporting the determination of insecurity before the loan is called. Better yet, do not use or rely upon the"insecurity" clause. Whatever would make the lender feel insecure should be included as an event of default, in the case of a time instrument: or use a pure demand instrument to which the u.c.c. section does not apply. conclusion The K.M.C. decision and subsequent cases12 constitute notice to the bar that the courts will not consider the title of the instrument to be determinative of the intent of the parties. If the instrument is a pure demand instrument and there exists no documentary evidence indicating otherwise (ratios, covenants, events of default, etc.), the courts will not impose an obligation of good faith. Where, however, notwithstanding the title of the instrument, the intent of the parties is clear from other related agreements, the instrument may be held not to be a demand but a "dema':ldable" instrument, and subject to the obl1gat1ons of good fa1th. At least one author has stated that"··· it is rarely, if ever appropriate to document a commercial loan transaction with a demand note ... ". 13 This suggestion surely deserves more than casual consideration. It is a common feeling by lenders that a demand note gives them more control over their money and its repayment. They feel that by being able to demand repayment at any time they can constantly.monit?r the credit-worthiness of their borrowers. Well, wh1le th1s may seem to make sense, consider the following: 1. Case law (K.M. C.) tells us that the demandable instrument may not be subject to demand without reasonable notice. 2. The same control and monitoring can be obtained by the use of time instruments with performance standards (tied to events of default) covenants, and ratios. 3. Most importantly, as a matter of fairness and equity, what business person, dealing at arms length would 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 127 ever voluntarily execute and deliver a demand note which could have the effect, if demanded without notice of causing it substantial economic difficulties? ' ENDNOTES u.c.c. §3-108. Halt & Willier, "Commercial Paper" in 2 Bender's u.c.c. serv. §5.02[2) (1988). Restatement (Second) of Contracts, §205. See also: Palisades Properties, Inc. v. Brunetti, 44 NJ 117, 207 A2d 522, 531 (1965). u.c.c. Section 1-201(19). See: Centerre Bank of Kansas City, NA v. Distributors, Inc., 705 SW2d 42 (Mo. Ct. App. 1985). "The Law of Lender Liability", Helen Davis Chaitman published by Warren, Gorham & Lamont, 1990, §2.01[4][a)(ii].' Shaughnessy v. Mark Twain State Bank, 715 SW2d 944, 951 (Mo. Ct. App. 1986). Palisades Properties, Inc. v. Brunetti 44 NJ 117, 207 AD2d 522, 531 (1965) • I K.M.c. Co .. Inc. v. Irving Trust Company, 757 F2d 752 (6th Cir. 1985). DI<;I See: Centerre Bank of Kansas city. NA v. 1s r1 u ors. Inc., 705 SW2d 42 (Mo. ct. App. 1985). Id, at 759 - 760. s7e: Reid v. Key Bank of Southern Maine, Inc., 821 F2d 9 (1st C1r. 1987); MSV, Inc. v. Bank of Boston, 87 BR 752 (Bankr. D. Mass. 1988): Spencer Cos v. Chase Manhattan B k N an , . A. , 81 BR 194 (D. Mass 1987). "The Law of Lender Liability", Helen Davis Chaitman published by Warren, Gorham & Lamont, 1990, §2.01[4)[a). ' 

Can Demand Notes Really Be Demanded

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Can Demand Notes Really Be Demanded

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