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1. On the status of assuming grantees, and the distinction between assuming grantees and non-assuming grantees, see the Note following Vrooman v. Turner, supra p. 1346. It does not appear that the heating plant in the principal case was sold subject to a security interest (e.g., a conditional sale or chattel mortgage); the F.H.A. guaranty no doubt made such an arrangement unnecessary. In the absence of a security arrangement covering the heating plant, Rouse would not have been liable for the unpaid balance of the purchase price if he had not assumed the debt. Presumably he paid Winston less for the house than he would have done if he had not agreed to take over the monthly payments for the heating plant.2
2. Winston's Liability on the Note: Disregard for the moment the sale to Rouse and assume that Winston still owned the house. When she bought the heating plant from Associated Contractors she executed a note for the purchase price. If the seller, having kept the note itself (or having been required to take the note up after default) sued Winston, she could interpose her defense of faulty installation. Such defenses as failure of consideration, breach of warranty, and the like are always available between the original parties to the underlying transaction. There is no way in which Associated Contractors can set up the transaction so that it can sue Winston free of such defenses.3
Associated Contractors financed the sale by selling Winston's note to Union Trust Company. Let us assume that the note was negotiable and that Union Trust Company qualified as a holder in due course. (On negotiable instruments and the holder in due course concept, see the Note following Muller v. Pondir, infra p. 1444.) Normally, one who is the holder in due course of an instrument takes it free of all defenses of the sort involved in the Rouse case (failure of consideration and what is usually termed fraud "in the inducement"). If the Trust Company, as a holder in due course, held Winston's note free of her defenses against Associated Contractors, she would be liable for the full amount of the note; having paid the Trust Company, however, she could then sue Associated Contractors to recover damages for the faulty installation or breach of warranty. That is, the seller never escapes liability to the buyer for his default, even though the buyer may have become obligated to a financing institution to pay the full price without regard to the default.4
Today, however, it is extremely unlikely that Winston could become obligated in this way. Some states flatly forbid the use of negotiable instruments in consumer transactions like the one between Winston and Associated Contractors (with the result that the Trust Company could not become a holder in due course of her note in the first place); other states have, by statute or judicial decision, made the defenses of a consumer-purchaser available against anyone who subsequently acquires a negotiable instrument issued in a consumer transaction (making the Trust Company's holder in due status worthless as a practical matter). For statutes illustrating these two approaches, see Wis. Stat. Ann. 422.406 (1974) and Mo. Ann. Stat. §408.405 (Vernon 1979). A leading case on the subject is Unico v. Owen, 50 N.J. 101, 232 A.2d 405 (1967).5
When the note went into default, the United States, under the F.H.A. guaranty, was required to pay off Union Trust Company. As part of that transaction it acquired Winston's note from the Trust Company and succeeded to whatever rights the Trust Company had in the note. If the United States had sued Winston on the note, the situation would have been the same as that described in the preceding paragraph.6
3. Rouse's Liability: Rouse was not liable on Winston's note because he was not a party to it (i.e., he had never signed it in any capacity). This, as the court says, is a standard rule of negotiable instruments law. Nor was he a party to the contract of sale between Winston and Associated Contractors. His liability thus is predicated on his assumption of the debt in his purchase of the house from Winston.7
Rouse's first defense was that Winston had fraudulently misrepresented the condition of the heating plant and the court held that this defense, if established, was good against the United States. In third party beneficiary terminology, Rouse was the promisor and Winston was the promisee. Rouse's argument, with which the court agreed, was that the promisor, when sued by the beneficiary, could interpose the defense of fraud (or, presumably, failure of consideration) between himself and the promisee. It seems clear that if the United States had elected to collect from Winston, and Winston, having paid, had sued Rouse, the defense of Winston's fraud would have been available to Rouse. Does it necessarily follow that it should also be available against the United States? If it were held that the defense was not available to Rouse against the United States, what further remedies would Rouse have?8
Rouse's second defense was faulty installation of the heating system by Associated Contractors — that is, failure of consideration or breach of warranty between the promisee (Winston) and the seller. The court held that this defense was not available to Rouse. Thus, if he fails to establish the fraudulent misrepresentation defense, he will have to pay the full amount of the unpaid purchase price even if the heating system had been improperly installed and was worthless. Did the court say that the United States, in its action against Rouse, was in the same position that Associated Contractors would have been in if they had sued Rouse after taking up the note from the United States? Or that the defense was not available against the United States but would have been available against Associated Contractors? If Rouse paid the United States, could he then bring an action for breach of warranty against the Contractors? Or could Winston bring such an action after Rouse had paid? It does seem necessary, does it not, to find a solution that will make Associated Contractors liable to someone if it has breached its contract with Winston.9
4. In the last paragraph of his opinion, Judge Edgerton quoted from Williston on Contracts. Williston proposed a distinction between cases in which the promisor should, and cases in which he should not, be able to use the promisee's defenses against the beneficiary. Did the court in the Rouse case misapply Williston's distinction?10
5. Reconsider the discussion of Lawrence v. Fox in the Introductory Note to this section. If Holly had a defense against Lawrence, should Fox be able to plead it? What would Williston say? If you conclude that Holly's defense would not be available to Fox, would it follow that Winston's defense would not be available to Rouse if he were sued by Associated Contractors?
June 30, 2014
Contract Technical Writer
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