Opinion
NO. 2011-CA-002119-MR
01-10-2014
SCIENTIFIC IMAGING TECHNOLOGY ENTERPRISES, INC., F/K/A NIGHTEYES, INC.; PIXELVISION OF OREGON, INC.; WAYNE MICHAEL PUTNAM; STEPHEN L. WHITMAN; AND BETH DIANE GUDEMAN APPELLANTS v. MARY MARGARET PHELPS; MELANIE MCCOOL; BILL PHELPS, JR.; PHIL HAYES; U.S. BANK, NA AND THE ESTATE OF JOSEPH WILLIAM PHELPS APPELLEES
BRIEFS FOR APPELLANTS: D. Duane Cook Georgetown, Kentucky William C. Shouse Lexington, Kentucky BRIEF FOR APPELLEES: William J. Walsh Louisville, Kentucky Stuart E. Alexander, III Louisville, Kentucky Sam P. Burchett Lexington, Kentucky
NOT TO BE PUBLISHED
APPEAL FROM FAYETTE CIRCUIT COURT
HONORABLE ERNESTO M. SCORSONE, JUDGE
ACTION NO. 05-CI-01717
OPINION
AFFIRMING IN PART, REVERSING IN PART AND REMANDING
BEFORE: CLAYTON, MAZE AND THOMPSON, JUDGES. THOMPSON, JUDGE: This case concerns Joseph William Phelps's mental capacity to enter into a settlement agreement and release with his co-guarantors, Wayne Michael Putnam, Stephen L. Whitman and Beth Diane Gudeman, and the amount recoverable on certain assigned loan documents. We affirm in part, reverse in part and remand.
Putnam, Whitman and Gudeman directed and controlled various companies, including Scientific Imaging Technology Enterprises, Inc., f/k/a Nighteyes, Inc., Pixelvision of Oregon, Inc. and CBA Pharma, Inc.
Putnam, Gudeman and Whitman owned numerous companies, the identity of which are not relevant to this appeal and, therefore, are omitted. We note that Scientific Imaging and Technology Enterprises, Inc. is the successor to Nighteyes. As did the trial court, we refer to both as Nighteyes. Further, Pixelvision Inc. is a holding company for Nighteyes and Pixelvision of Oregon, Inc. We have chosen to use Pixelvision when identifying Pixelvision of Oregon, Inc.
During 2001 and 2002, Phelps, a man with substantial financial assets, made a series of loans to Pixelvision that were consolidated into a promissory note on August 31, 2002, in the amount of $4,450,000. A several, but not joint, guarantee was executed by Putnam, Whitman and Gudeman the following day, pursuant to which each agreed to reimburse Phelps one-third of any outstanding balance should Pixelvision default.
Numerous loans were made by Phelps to their companies. We have limited our discussion to those transactions pertinent to this appeal.
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In October 2002, Nighteyes borrowed $4,000,000 from U.S. Bank, pursuant to a revolving credit note to fund working capital needs and repay Phelps $1,500,000. The U.S. Bank loan was guaranteed by Phelps, Putnam and Gudeman. Whitman did not guaranty the U.S. Bank loan but he, Putnam, and Gudeman signed a secondary guarantee pursuant to which each agreed to reimburse Phelps one-third of any amount Phelps might be required to pay U.S. Bank should Nighteyes default.
On June 6, 2003, Phelps entered into a letter agreement settlement and release (2003 settlement agreement) with Nighteyes, Putnam, Whitman, and Gudeman. In exchange for 2,000,000 shares of stock in CBA Pharma, Phelps agreed to release (1) the existing corporate debt of $2,950,000 (the amount still owing on the $4,450,000 consolidated promissory note); (2) any contingent debt resulting from the existing financing with U.S. Bank; and (3) the personal guarantees of Putnam, Whitman and Gudeman for all existing and contingent financing.
After Nighteyes could not repay the U.S. Bank loan on its October 1, 2003, maturity date, the repayment date was extended to October 1, 2004. Subsequently, Phelps, Gudeman and Putnam agreed to execute new personal guarantees and the maturity date of the loan was extended to February 4, 2005.
Nighteyes defaulted and U.S. Bank filed this action against Nighteyes, as the primary borrower, and Phelps, Gudeman and Putnam as personal guarantors. Nighteyes, Putnam and Gudeman filed their answer and a cross-claim against Phelps alleging under the terms of the 2003 settlement agreement, Phelps agreed to pay the note, extensions, interests and expenses in the event of default and they were entitled to be indemnified in the event of a judgment against them.
Phelps answered and filed cross-claims against Nighteyes, Pixelvision, Putnam and Gudeman. He asserted several defenses, including the guarantees were obtained by fraud and he lacked the necessary mental and legal capacity to enter into a valid contract at the time the guarantees were executed. He asserted pursuant to the October 2002 secondary guarantee, Putnam and Gudeman were required to severally indemnify him by repaying one third of the total amount he was required to pay U.S. Bank.
Phelps died in 2005 and his wife, Mary Margaret, was appointed Executrix of his estate and substituted as a party. U.S. Bank filed an amended complaint against the Phelps family (consisting of Mary Margaret, Melanie McCool and Bill Phelps, Jr.) and Phillip Hayes (Phelps's previous financial advisor) alleging misrepresentation and fraud. Specifically, the amended complaint alleged but for the defendants' reassurances the loan would be paid pursuant to Phelps's role as guarantor, the maturity date of the loan would not have been extended, resulting in damages. The Phelps family and Hayes then filed a counterclaim against U.S. Bank for abuse of process.
In a separate action, U.S. Bank filed a complaint against the Joseph William Phelps Trust.
On August 27, 2007, U.S. Bank entered into a mediated settlement agreement with the Estate, Hayes, the Trust and the Phelps family fully resolving all outstanding claims among them. The mediated settlement agreement was followed by a settlement agreement and release and an assignment agreement. We recite only the terms of these agreements which are relevant to the issues on appeal.
Under the mediated settlement agreement, the parties agreed the Estate, Hayes, the Trust and the Phelps family would pay $675,000 to U.S. Bank and U.S. Bank would assign the loan documents to the Estate. Further, U.S. Bank would be paid 20% of any gross amount actually collected from Gudeman, Putnam, Pixelvision and Nighteyes for settlements or judgments obtained pursuant to U.S. Bank's rights and 20% of the gross proceeds of any sale by the Estate of its interest in stocks of CBA Pharma, Nighteyes and related companies.
Under the settlement agreement and release and an assignment agreement that followed, the terms of the mediated settlement agreement were incorporated with the alteration that the U.S. Bank loan was assigned to the Phelps family, not the Estate. Although the assignment agreement specified the Phelps family would pay the $675,000 owed for the assignment of the loan documents, the Estate paid this amount.
U.S. Bank was dismissed as a party due to the settlement agreement. The Estate and the Phelps family were substituted as plaintiffs and filed a third party complaint against Whitman.
The case proceeded to trial on the incapacity and fraud claims, and for collection of the amount owed under the consolidated promissory note and the U.S. Bank loan documents, against Nighteyes, Pixelvision, Putnam, Whitman and Gudeman. At the close of the defendants' case, the trial court granted the plaintiffs' motion for a directed verdict regarding the enforceability of the loan documents, subject to further review on the question of damages.
The jury found Phelps lacked the mental capacity to enter into the 2003 settlement agreement. It did not reach the fraud claim.
In its final judgment, the trial court ordered: (1) the Phelps family recover from Nighteyes and Pixelvision, and guarantors Putnam and Gudeman, jointly and severally, the entire balance due on the U.S. Bank loan ($7,250,974); (2) the Estate recover from Pixelvision and guarantors Putnam, Gudeman and Whitman, severally but not jointly, the entire remaining balance due on the consolidated promissory note ($4,384,623); and (3) the Estate recover from guarantors Putnam, Gudeman and Whitman, severally but not jointly, the amount paid by the Estate to settle the claims of U.S. Bank, plus interest ($799,091). Nighteyes, Pixelvision, Putnam, Gudeman and Whitman (hereafter collectively appellants) filed a CR 59 motion, which was denied and they appealed.
The appellants claim the trial court erred by: (1) denying the appellants' motion for a directed verdict on the incapacity claim; (2) denying the appellants' motion to dismiss and for a directed verdict on the fraud claim; (3) ruling the Phelps family recover the entire balance of the U.S. Bank loan; (4) ruling the Phelps family and the Estate did not ratify the settlement agreement by using CBA Pharma stock as part of the consideration for the assignment of the U.S. Bank loan; and (5) ruling the 2003 settlement agreement did not prohibit the Estate or the Phelps family from taking assignment of the U.S. bank loan documents.
The appellants contend the jury's finding Phelps lacked mental capacity to enter into the 2003 settlement agreement was flagrantly against the evidence and, therefore, the trial court erred by denying their motion for a directed verdict. In considering a denial of a motion for directed verdict, an appellate court must take all evidence which favors the prevailing party as true. Lewis v. Bledsoe Surface Min., Co., 798 S.W.2d 459, 461 (Ky. 1990).
The prevailing party is entitled to all reasonable inferences which may be drawn from the evidence. Upon completion of such an evidentiary review, the appellate court must determine whether the verdict rendered is palpably or flagrantly against the evidence so as to indicate that it was reached as a result of passion or prejudice.Id. at 461-462 (internal quotations omitted). We turn to the issue of Phelps's mental capacity to enter into the 2003 settlement agreement.
A settlement agreement is a contract. Frear v. P.T.A. Industries, Inc. 103 S.W.3d 99, 105 (Ky. 2003). "To create a valid, enforceable contract, there must be a voluntary, complete assent by the parties having capacity to contract." Conners v. Eble, 269 S.W.2d 716, 717-718 (Ky. 1954) (internal citations omitted). If a party is mentally incapable of understanding the consequences of the contract, there can be no meeting of the minds and, therefore, no contract. Id. at 718. It has long been recognized that a higher degree of capacity is required to negotiate and execute a contract than a will. The heightened capacity requirement was explained in Langford's Ex'r v. Miles, 189 Ky. 515, 225 S.W. 246, 249 (1920):
[E]ach party to [a contract] has to combat the sagacity and cunning which may be exercised by the other contractor. In such cases one of the parties might be enabled, through a selfish desire to obtain an advantage, to get the better end of the bargain because of his superior mind over that possessed by the one with whom he is contracting.Nevertheless, mere mental weakness of a party will not render a contract unenforceable. As stated in Caldwell v. Hatcher, 248 S.W.2d 892, 894 (Ky. 1952) (quoting Hagemeyer v. First Nat. Bank & Trust Co., 306 Ky. 774, 776, 209 S.W.2d 320, 321 (1948)): "[C]ourts will hesitate to upset a transaction which is entered into in good faith and where no undue advantage or fraud is shown; and the true test is the person's capacity to understand and assent to the particular transaction in question." The fairness of a contract is relevant in determining whether a party had the mental capacity to enter into the contract when it was made. See Coomer v. Phelps, 172 S.W.3d 389, 393-394 (Ky. 2005). In considering whether Phelps had mental capacity to enter into the 2003 settlement agreement, the jury could properly consider evidence regarding his mental capacity before and after the agreement. Jefferson Standard Life Ins. Co. v. Cheek's Adm'r, 258 Ky. 621, 80 S.W.2d 518, 520-521 (1935).
Medical testimony was presented that as early as 2000, Phelps had symptoms of Lewy body disease, a condition presenting with depression, Parkinson-type symptoms and dementia. In spring 2004, during assessments at the Cleveland Clinic by Dr. Lederman, Phelps presented with a history of intermittent confusion, forgetfulness and abnormal cognition, including becoming confused about when to take his medications and how to read a calendar. Dr. Lederman was concerned about dementia with Lewy body disease, cognitive impairment, and senile dementia and diagnosed Phelps with emerging dementia.
Dr. Corwin first saw Phelps in October 2004, when Phelps was hospitalized after having difficulty following simple instructions or commands and suffered from apraxia. Dr. Corwin diagnosed Phelps with Lewy body disease that he opined affected Phelps since at least 2000. Dr. Corwin testified Phelps was unable to understand the consequences of his actions when he executed the 2003 settlement agreement.
Dr. Edelson reviewed Phelps's medical records. He testified by spring of 2003, Phelps could not make decisions requiring memory, reasoning, judgment, working memory, attention and concentration.
Lay witnesses testified Phelps's professional background made him a careful investor and his large investments through the consolidated loan and U.S. Bank loan guarantee were uncharacteristic. Witnesses also testified concerning Phelps's mental decline years before the 2003 settlement agreement, including specific instances of memory loss and disorientation. By 2003, Phelps was unable to care for himself and could no longer drive.
There was sufficient evidence for the jury to find Phelps lacked the mental capacity to execute the 2003 settlement agreement. We cannot say it was palpably or flagrantly against the evidence so as to indicate it was reached as a result of passion or prejudice.
The jury did not reach the fraud issue. Nevertheless, the appellants argue the trial court erred by denying their motions to dismiss and for a directed verdict on the fraud claim because they were prejudiced by evidence of fraud, the fraud instruction and counsel's closing argument regarding that claim. The appellants point out much of the evidence and counsel's closing was focused on the contention the appellants were "bad people" and the CBA Pharma stock was worthless.
The evidence and counsel's argument pertaining to fraud were relevant to not only the fraud claim but also the claim Phelps lacked mental capacity to enter into the 2003 settlement agreement. The general rule is as follows:
The nature and circumstances of the transaction are relevant evidence of the capacity of the parties to the contract. Inequity or foolishness of the agreement is an important factor to consider in determining whether or not mental capacity existed at the time of entering into a contract.17B C.J.S. Contracts § 967 (footnotes omitted); see also Collins v. Isaacs, 231 Ky. 377, 21 S.W.2d 484, 486 (1929). Consequently, the appellants cannot establish reversible error by the trial court's refusal to direct a verdict on the fraud claim.
The appellants argue the trial court erred in ruling the Phelps family can recover the entire balance of the U.S. Bank loan even though the Estate only paid $675,000 to obtain the assignment of the loan documents. First, we address whether the error was preserved.
The appellants did not challenge their liability on the U.S. Bank loan or under the surety agreement with U.S. Bank. However, the appellants' argument on appeal pertains to damages, not liability. The appropriate amount of damages was not an issue until after trial when the appellees filed their motion for summary judgment on damages and not decided until final judgment was entered awarding damages. The appellants properly preserved the issue of damages by responding to the motion for summary judgment and filing a CR 59 motion. See Commonwealth, Dep't of Highways v. Williams, 317 S.W.2d 482, 484 (Ky. 1958). Therefore, we address this issue on the merits.
KRS 412.080 provides:
If a surety pays any part of a debt or liability for which he is bound as surety, he may recover the amount, with interest from the time of payment, from the principal by action at law or by motion . . . [the surety] may also sue a cosurety . . . and in like manner recover judgment . . . for his proper part of the debt or liability so paid[.]KRS 412.080 was interpreted by Napier v. Duff, 281 Ky. 779, 136 S.W.2d 1083, 1085-1086 (1939), as follows:
This statute limits the amount to be recovered by a surety who discharges the obligation of his principal to the amount actually paid by the surety. Although the surety takes an assignment of the obligation from the creditor and brings his action against the principal on the assigned obligation, nevertheless the substance of that action is one by a surety against a principal, and by the express terms of the statute he may recover only the amount paid by him. A surety may not be permitted to circumvent the statute by suing on the original obligation rather than on the obligation of indemnity. The court looks to the substance rather than to the form, and in doing this
determines that it is an action by a surety against his principal to recover for the loss he may have sustained by reason of his suretyship.
Here, the issue is whether KRS 412.080 applies to the loan assigned to the Phelps family. The appellants argue because the Estate had the right to have the loan documents assigned to it under the mediated settlement agreement and paid the $675,000 to U.S. Bank, the Estate was the assignee and bound by KRS 412.080. The appellants reason the Phelps family received the assignment from U.S. Bank via the Estate and, therefore, is likewise bound by KRS 412.080 as an assignee of the Estate. We disagree.
The Estate never received the assignment. Instead, pursuant to the final settlement agreement and release which accompanied the assignment agreement, the Phelps family received assignment of the loan documents. Although the Estate paid the $675,000 to U.S. Bank, the Phelps family received the assignment directly from U.S. Bank and became the Bank's assignee.
An assignee acquires the same rights as those possessed by his assignor subject to the same defenses, which could have been asserted against the assignor. Whayne Supply Co. v. Morgan Const. Co., 440 S.W.2d 779, 782-783 (Ky. 1969). As assignee of U.S. Bank, any defenses the appellants could raise against the Estate are inapplicable to the Phelps family and the Phelps family is entitled to recover the same amount U.S. Bank could have recovered.
The appellants are correct there cannot be a double recovery by the Estate under the secondary guaranty for its payment of $675,000 and by the Phelps family as an assignee of the loan. The Phelps family was obligated to pay for the assignment of the loan under the terms of the assignment agreement and only the family can benefit from the assignment. Any reimbursement for the Estate's payment must come from the Phelps family, rather than from the appellants. To the extent the judgment awards the Estate the consideration paid to U.S. Bank for the assignment, it is erroneous.
The appellants argue the trial court erred in ruling the Estate did not ratify the 2003 settlement agreement by using CBA Pharma stock as part of the consideration for the settlement with U.S. Bank. Ratification of a voidable settlement agreement may be made either by express words or unequivocal acts. Toppass v. Perkins' Adm'x, 268 Ky. 186, 104 S.W.2d 423, 431 (1937). A clear intent must be shown to affirm a contract by accepting its benefits or acting in a manner inconsistent with repudiation. Hampton v. Suter, 330 S.W.2d 402, 406 (Ky. 1959).
The Estate's settlement with U.S. Bank was not an unequivocal ratification of the 2003 settlement agreement because it only gave U.S. Bank a contingent interest of 20% of the gross in any future sale of stock in the appellants' companies in which the Estate had an interest. U.S. Bank had no right to force a sale of the stock and whether a sale took place was entirely within the Estate's discretion.
Moreover, whether the Estate actually owned the 2,000,000 shares of CBA Pharma stock Phelps received pursuant to the 2003 settlement agreement was not resolved at the time the Estate and U.S. Bank entered into their settlement agreement. U.S. Bank was aware the Estate was pursuing an action to prove the 2003 settlement agreement was voidable on the basis of incapacity or fraud. Because the Estate was actively rejecting the 2003 settlement agreement, the agreement with U.S. Bank cannot be considered in isolation and is insufficient to establish ratification without the Estate taking the affirmative action of selling these specific shares. Additionally, other shares Phelps previously acquired were still held by the Estate and subject to U.S. Bank's contingent interest.
The appellants' final argument is the 2003 settlement agreement prohibited the Estate or the Phelps family from taking assignment of the U.S. Bank loan documents. Because we affirm the judgment finding the 2003 settlement agreement was unenforceable, we need not reach the issue of whether it precluded such an assignment.
We affirm the judgment of the Fayette Circuit Court except we reverse and remand the portion of the judgment ordering recovery for the Estate's payment under the secondary guarantee.
ALL CONCUR. BRIEFS FOR APPELLANTS: D. Duane Cook
Georgetown, Kentucky
William C. Shouse
Lexington, Kentucky
BRIEF FOR APPELLEES: William J. Walsh
Louisville, Kentucky
Stuart E. Alexander, III
Louisville, Kentucky
Sam P. Burchett
Lexington, Kentucky