Litigating any form of unwritten promise is always a challenge. In an age of ubiquitous electronic communications, judges and juries have more reason than ever to be skeptical of alleged oral agreements.
Sometimes, however, a litigant has no other option than to pursue a claim based on an unwritten agreement. In the business context, this can often occur where one party verbally agrees to be responsible for the debt of another. A typical example arises where a business has a written contract with an entity that is not making the required payments. When the business presses the issue, an individual affiliated with the entity, such as a shareholder or member, verbally agrees to pay the business instead in order to induce the business to continue performing under the contract. Thereafter, both the individual and the entity fail to make the payments, but by that time, the entity has frequently become insolvent, bankrupt or otherwise judgment-proof, leaving the promisee with only the third-party guarantor or surety as a potential source of recovery.
Attorneys representing a potential plaintiff faced with this situation may believe that their client’s claim based on the third party’s verbal promise is precluded by Pennsylvania’s statute of frauds, which bans the enforcement of unwritten agreements to “answer for the debt or default of another.” Fortunately, however, that is often not the case. The Pennsylvania courts have developed an exception to the statute of frauds that permits promisees to pursue a guaranty or surety claim in some circumstances. This exception, known as the “leading object” or “main purpose” rule, states that whenever the main purpose and object of the promisor was not to answer for the debt of another, but rather to serve some pecuniary or business purpose of its own, the promise is not barred by the statute of frauds, even though it may be in the form of a provision to pay the debt of another.
Thus, in order to effectively represent a client making a claim on a verbal guaranty or surety agreement under the leading-object rule, business litigators must plead and prove facts that demonstrate that the primary motivation of the promisor was to further its own interests. Pleading the requisite intent is usually not difficult. The Pennsylvania Rules of Civil Procedure permit intent to be averred generally (see Pennsylvania Rule of Civil Procedure 1019(b)), and the standard for granting preliminary objections in the nature of a demurrer only permits the court to dismiss the claim where the facts alleged are clearly insufficient to establish the plaintiff’s right to relief, with all doubts resolved against granting the demurrer. (See, e.g., Webb Manufacturing v. Sinoff, 674 A.2d 723 (Pa. Super. 1996) (reversing and remanding an order sustaining a demurrer where the plaintiff alleged that the defendants made a verbal promise to pay their company’s debt to the plaintiff in order to induce the plaintiff to enter into a contract with their company).)
In contrast, proving the leading-object or main-purpose exception can be a challenge. First, the existence of the oral promise itself must be demonstrated by clear and convincing evidence (Thomas A. Armbruster Inc. v. Barron, 491 A.2d 882, 886 n.1 (Pa. Super. 1985)). Thereafter, the intent of the promisor must be shown through the economics of the relevant transactions, that is, by analyzing “the complex of objective manifestations surrounding the making of the promises,” as said by John Edward Murray Jr. in Murray on Contracts.
Courts reviewing leading-object claims have recognized that some fact patterns, if sufficiently proven, generally serve as evidence of a primary intent by the promisor to further its own interests. Examples of such situations include: (1) a promise made by the owner of 100 percent of the outstanding equity of a company to pay a trade debt of the company in exchange for the trade creditor agreeing not to pursue the debt or force the company into bankruptcy; and (2) a promise made to a subcontractor by a construction project owner or architectural firm to honor the debts of a general contractor if the subcontractor completes its work on the project, where the promisor would reap an economic benefit if the work is completed (or completed sooner).
Most cases, however, involve closer calls. For example, the mere fact that a promisor has some ownership interest in the entity that incurred the debt that is being guaranteed does not, in and of itself, establish that its main purpose is to advance its personal interests. Instead, courts construe the promisor’s intent by tracing the economic relationships involved. If the promise was made to secure some special, direct or immediate benefit to the promisor, it is generally found to be enforceable. If it was made simply to protect the value of the promisor’s equity interest in the entity, it is generally found to be unenforceable.
For example, a promise by the owner of a one-third interest in a company to personally guarantee a debt owed by the company to a construction contractor in exchange for the contractor’s promise to continue working on the project was found to be mainly for the purpose of furthering the owner’s self-interest where he was seeking to protect and preserve, among other things, his personal investments in the construction project, his interest in not losing future income from the project, and his interest in protecting the viability of his company, which was a “fledgling corporation” that was still in the “embryonic stages of its development” and may not have succeeded without his personal efforts. (See Armbruster, 491 A.2d at 886; see also Kowalewski v. Whittington, 71 Pa. D. & C.4th 157, 163 (Lackawanna Cty. Ct. Comm. Pl., Jan. 18, 2005) (promise of 80-percent owner to repay company’s loans to induce the company’s lender to advance additional funds was mainly to advance personal interests where the company was a “fledgling business” under new ownership, the loaned funds were needed to keep the business operating, and the promisor made partial payments on the company’s debt to induce the lender to make additional loans to the company).)
Counsel representing defendants who are alleged to have provided a verbal guaranty or surety agreement should consider their tactics carefully. If the pleadings fail to allege facts demonstrating that the client’s promise was mainly for its own benefit, the client can file preliminary objections in the nature of a demurrer or a motion for judgment on the pleadings. A wiser strategy, however, may be to simply plead the statute of frauds as new matter under Pennsylvania Rule of Civil Procedure 1030(a) and then develop a record on discovery that provides a basis for a summary judgment motion. A plaintiff faced with preliminary objections on this issue can easily amend its pleadings, and, once it is educated on the relevant case law, it will be sure to thoroughly prepare its witnesses to address the promisor’s intentions.
In addition to arguing that the plaintiff lacks evidence of the promisor’s main purpose, defendants filing motions for summary judgment on the leading-object exception should strongly consider arguing that the plaintiff has failed to meet its burden of proving the existence of the alleged verbal guaranty or surety agreement by clear and convincing evidence. Such motions may meet with success where the basis for the plaintiff’s claim amounts to little more than he said/she said, particularly where there is evidence that the plaintiff had a course of conduct or policy of requiring written agreements in other business transactions.   •
Jeffrey S. Feldman is senior counsel in the Fort Washington, Pa., office of Starfield & Smith. He has extensive experience in business and commercial litigation, and is the manager of the firm’s commercial litigation and creditors’ rights department.