Stephen T. Whelan,
,
Blank Rome LLP

Two words that strike fear in every lawyer seeking to enforce a contract are the words in a court’s decision: nudum pactum, which is a Latin term signifying that the contract is not an enforceable agreement because it lacks “consideration” — a term denoting that value has been exchanged on both sides of the contract. A recent federal district court opinion, although abjuring any Latin phrasing, held that various payment agreements were unenforceable because there was no “mutual assent.” That is, the documents lacked essential contract terms.

In Balboa Capital v. Okoji Home Visits, a company (America’s Medical Home Team) recruited physicians to join the MHT Network Program under which they “could remotely supervise nurse practitioners making house calls in the physicians’ region.” MHT required each physician to create a limited liability company “to handle the MHT Program’s financing, which purportedly would be used to pay for licenses, software and other operational costs.” The physician would purchase licenses from MHT for its nurse practitioner to work in the program and obtain financing to fund the purchase of the license. The physician would guarantee that financing.

The court’s opinion observes that MHT generally represented to the physicians that “the doctors would not have to repay the loans themselves because the loans would be paid by revenue generated from patient billing, and if not sufficient, MHT would make [deficit funding] payments” to the lender. Balboa Capital was a lender in the MHT Program. The form of physician credit application was co-branded with both Balboa’s and MHT’s logos, and an MHT representative would visit the physician’s office to have the Balboa forms of installment payment and guaranty agreements signed.

The decision of the court observed that the executed documents did not state “the number of licenses being financed, the cost per license or otherwise identify the software or equipment” or contain a payment schedule, a total loan amount, an interest rate or the total amount to be paid by Balboa to MHT on behalf of the physician. The court added that “Balboa never received or confirmed the existence of any executed license or software agreement,” as referenced in the physician’s payment agreements. Nevertheless, after receiving the signed loan documents and making oral verification calls, Balboa would fund “the full loan amount to MHT.”

MHT declared bankruptcy less than a year after commencing the funding program with Balboa, and “announced that it was terminating all license agreements” with the physicians. It also stopped making deficit funding payments to Balboa. Not surprisingly, the physicians ceased making payments on their loans and Balboa sued to collect on the installment payment and guaranty agreements.

The court was found in favor of the defendant physicians, citing bedrock contract law that there must be mutual assent to the subject matter of a contract for it to be enforceable. Noting that the IPAs lacked a loan amount and interest rate, the court held that “there was no mutual assent or consent to contract, and as a result, the executed … agreements are not enforceable contracts.” Rejecting Balboa’s assertion that the Exhibit A1 referred to in each installment payment agreement amounted to incorporation by reference, the court declared that “Exhibit A1 is neither known nor easily available to the contracting parties … let alone that Exhibit A1 was provided to physicians in conjunction with the execution of the agreements.” The result was “nudum pactum” — no (enforceable) contract.

Worse yet, the court also concluded that the agreements contained no authorization by the physicians to make lump sum payments of the entire loan amount to MHT. “On the contrary, the language contemplates Balboa acting in lieu of [the physician] in making multiple payments under the relevant license of software agreement,” especially since the license and software agreements both provide for early termination by both MHT and the physician and “Balboa funded each loan without confirming that there was any agreement between MHT and [the physician].” Accordingly, the court found that Balboa’s lump sum payments to MHT were gratuitous and not pursuant to any contract between Balboa and the physician.

A 1960s hit song by the Supremes, titled “The Happening,” contained the lyrics “it happened to me, and it can happen to you.” What happened to Balboa could have happened to anyone; the possible urgency of documenting a major new program, the (perhaps) hurried assembly of paperwork, the good faith transfer of funds to an entity apparently entitled to the monies. The rest of this article offers several procedures which can help avoid a “nudum pactum” outcome.

1. Conduct due diligence. Confirm that the borrower really has a contract with the third party provider of equipment, software or services. Have the borrower certify a true copy of that agreement — then read it to verify that the borrower actually is getting value from that agreement and confirm its periodic payment obligations. Your review should cover whether the underlying contract is terminable: By either party? Upon payment of what amount?

2. Obtain the usual documents for a tri-party transaction. Your borrower should deliver a certificate of delivery and acceptance, whether for equipment, software or a license to conduct mission-critical business.

3. Guard against an unenforceable agreement by having your borrower (the underlying obligor or account debtor) sign a consent to assignment, certifying the periodic payments it is obligated to make under the underlying contract, and agreeing, come hell or high water, to pay $X every Y day of the month for Z months. That will establish an independent contract, so that even if the underlying contract is rejected (for instance, by MHT in bankruptcy proceedings), you will have a written agreement with the obligor — who is your source of payment — to make payments to you unconditionally.

In a 1980s bankruptcy decision arising from the bankruptcy proceedings of OPM Leasing Services, the court ruled that such a consent to assignment constituted an independent contract which was enforceable against the equipment user, even though the lessor had rejected the equipment lease. This is where UCC 9 406 comes into play and benefits the financier. That section stresses that, after a lessee or underlying borrower has received notice that its payment obligations have been assigned to a third party, “the account debtor may discharge its obligation by paying the assignee and may not discharge the obligation by paying the assignor.”

4. Beware of structures which depend on unguaranteed third party payments, such as the revenues projected to flow to the physicians under the MHT Program. If such a feature is part of a transaction offered to you, then a hell or high water consent to assignment is essential. In a series of reported decisions from Iowa, courts routinely upheld the HHW clause obligating the account debtor to remit payments to the financier, even though the account debtor did not receive revenue expected to flow from advertising placed on the leased golf carts.

5. Finally, insist on receiving a pay proceeds letter, signed by both your borrower and the underlying account debtor. This customary document has become even more significant in the post COVID-19 world, where remote working has resulted in several publicized incidents when the bank has received phony email instructions to wire loan proceeds to an account operated by a scammer.

Whether the risk is of fraud or inadequate documentation, there are measures which lessors and lenders can take — such as a hell or high water consent to assignment, a D&A certificate and a signed pay proceeds letter — to avoid a complete loss when a transaction goes awry.

ABOUT THE AUTHOR: Stephen T. Whelan practices law with Blank Rome LLP in New York City, is a former member of the Board of Directors of the Equipment Leasing & Finance Association, and for 30 years, has been a co-author of the American Bar Association Annual Survey on Leases.