Federal Deposit Insurance Corp. v. Registry Hotel Corp.

Brief Fact Summary. A bank had a security interest in a contract between construction company 1 and a hotel.  Because a condition did not occur, the contract between the construction company 1 and the hotel was terminated.  The hotel entered into a contract with construction company 2 to do the same work construction company 1 was supposed to.  Construction company 2 entered into a sub-contract with a Construction company 3, controlled by the owner of construction company 1.

Synopsis of Rule of Law. An assignee with rights in a contract between parties A and B, does not necessarily have recourse in a contract between parties C and D, after the contract between A and B is terminated in good faith, even if the owner of party D was the owner of party B.

Facts. The Plaintiff, the Federal Deposit Insurance Corp. (the "Plaintiff"), acting as the receiver of a Kansas bank, brings suit to recover loans of $102,217.92, extended by the aforementioned Kansas bank to Frownfelter Construction Company ("FCC").  On February 24, 1982, FCC and the Defendant, Registry Hotel Corp. (the "Defendant"), entered into a $170,000 construction contract.  The Kansas bank was given a security interest in the construction contract between the Defendant and the FCC.  The owner of FCC, Stanley Frownfelter ("Mr. Frownfelter"), signed the security agreement.  On April 16, 1982, the Defendant accepted the assignment to the Kansas bank, and agreed to name the bank as co-payee on any disbursements on the contract.  Before November 1982, the Defendant terminated the contract because FCC did not obtain the necessary bonds.  In December 1982, the Defendant contracted with one of FCC's former subcontractors, Uni-Lock Pavestone ("Pavestone") to do the job.  In January of 1993, Pavestone subcontracted with another of Mr. Frownfelter's companies, Pave-Lock Systems to provide certain services.  There is no indication Pavestone knew about Mr. Frownfelter's original contract with FCC.  FCC defaulted on the loans with the Kansas bank, and the Plaintiff sued the Defendant for $102,217.92.  The court denied the Defendants motion for summary judgment.

Issue. Where the Plaintiff had rights in Contract 1 between party A and party B, but Contract 1 is terminated, does the Plaintiff have rights in Contract 2 if party A is the same, but party B is not involved?

Held. The court first observes that §9.318(b) of the Tex.Bus. & Com. Code Ann. governs here.  This sections reads:  "[s]o far as the right to payment or a part thereof under an assigned contract has not been fully earned by performance, and notwithstanding notification of the assignment, any modification of or substitution for the contract made in good faith and in accordance with reasonable commercial standards is effective against an assignee unless the account debtor has otherwise agreed but the assignee acquires corresponding rights under the modified or substituted contract." 
•    The court first observes that there are two new contracts involved, the one between the Defendant and Pavestone and the one between Pavestone and Pave-Lock Systems, another of Mr. Frownfelter's companies.  Thus, one contract was not substituted for the original contract.  The court then recognizes Pavestone was not a party to the original contract and there is no evidence that Pavestone knew about the prior security arrangement between the Defendant and FCC.  There was also no indication that either of the two aforementioned contracts were ever assigned.  As such, "[n]either contract existed in a prior form so as to qualify as a substitution or modification of an earlier contract."  Further, since there was no longer privity between the original parties to the assigned agreement, the Defendant could not obtain rights in any of the new contracts.  The new contracts were unrelated to the original agreement.  It was legally irrelevant that the Defendant and Mr. Frownfelter were "parties to the same general transaction."  It is also irrelevant that the Defendant "was aware of Frownfelter's new role at the time the Registry-Pavestone contract."
•    The court then recognizes the Plaintiff was not without recourse, because §9-318(2) requires any modification or substitution of the contract to be made in good faith and pursuant to commercial reasonableness.  Meaning, those          "modifications or substitutions that are fraudulent or intended to circumvent the assignee's rights are ineffective against the assignee."

Discussion. This case offers an interesting discussion into the rights and remedies of an assignee, after the contract the assignee has rights in, is terminated.