Indiana Law Review


VI. Contracts, Commercial Law, and Consumer Law

Gerald L. Bepko*

A. Introduction

The following discussion reviews some of the most important
developments during the past year in contracts, commercial, and

related consumer law. Some of the developments which raise con-
tract, commercial, or related consumer law problems may also raise
questions concerning secured transactions or creditors' rights and

may be discussed in the portion of the Survey devoted to those sub-
jects.* No effort will be made to duplicate the analysis of statutes
and cases considered in that part of the Survey.

B. Scope of UCC Article 2

In Stephenson v. Frazier,^ the Indiana Court of Appeals examined

the applicability of Article 2 of the Uniform Commerical Code^ (UCC)

to an agreement by which there was a commitment to both deliver
goods and provide services. The agreement involved the sale of a
modular home along with a commitment by the seller to construct a
septic system and a foundation on the rural property on which the

modular home was to be assembled. The court's analysis began with
the premise that UCC Article 2 applies to "transactions in goods"*
and that the word "goods" means "all things (including specially
manufactured goods) which are moveable at the time of identifica-

tion to the contract for sale."^ Of course, under this definition, the

modular home constituted goods. However, the commitment to con-
struct the foundation and septic system was a different matter. It
did not constitute an agreement for the sale of goods but, instead,
was an agreement to provide services. Generally, agreements to pro-
vide services are governed by common law contract principles.^

When faced with the question of whether to apply UCC Article
2, or principles of the common law of contracts, some courts have

*Associate Dean and Professor of Law, Indiana University School of Law — Indi-
anapolis. B.S., Northern Illinois University. 1962; J.D.. IIT/Chicago-Kent College of
Law, 1965; L.L.M., Yale University, 1972.

'Townsend, Secured Transactions and Creditors' Rights, 1980 Survey of Recent
Developments in Indiana Law, 14 IND. L. Rev. (1981).

^399 N.E.2d 794 (Ind. Ct. App. 1980).

'U.C.C. §§ 2-101 to -725. All sections hereinafter cited to the U.C.C. are also

found in Ind. Code §§ 26-1-1-101 to -3-7-36 (1976 & Supp. 1980).
*U.C.C. § 2-102; Ind. Code § 26-1-2-102 (1976).
=U.C.C. § 2-105(1); Ind. Code § 26-1-2-105(1) (1976).

'J. Calamari & J. Perillo, Contracts § 1-7, at 16-17 (2d ed. 1977).

223



224 INDIANA LAW REVIEW [Vol. 14:223

concluded that the dominant feature of the contract should control;'

if the sale of goods is predominant, UCC Article 2 governs; if the
commitment to provide service is predominant, common law con-
tract principles govern. In the Stephenson case the court took a dif-

ferent approach and concluded that agreements should be divided

into components. Those components of the agreement which involved

the sale of goods (goods components) were governed by UCC Article
2; those components of the agreement which involved the sale of ser-

vices (service components) were governed by common law contract
principles.* The substantive issue raised in the Stephenson case had
to do with whether the buyer could call off the deal by virtue of the

seller's breach. The court addressed the goods component under
UCC Article 2 in terms of rejection,^ cure,^° revocation" and cancella-
tion.*^ The court addressed the services component under principles
of the common law of contracts in terms of rescission and substan-
tial breach.'^

This analysis is logical, yet it may be difficult to apply in cases
where the contract cannot be easily divided, such as a contract for
laying an asphalt driveway.'^ Also, this approach could lead to dif-

ficulties where the substantive issue is not related to performance,
but is related to creation of the agreement, such as a question con-

cerning the Statute of Frauds. For example, a court could find that

the services component may be enforced, but the goods component
could not be enforced because of a failure to satisfy the writing re-

quirement of UCC 2-201(1).'^ Partial enforcement of the contract
could result in prejudice to the seller who may have offered services
at a lower price because the goods were being sold as part of the
same transaction.*^

'See, e.g., Pittsburgh-Des Moines Steel Co. v. Brookhaven Manor Water Co., 532
F.2d 572 (7th Cir. 1976).

«399 N.E.2d at 797.

'IND. Code § 26-1-2-601 (1976).

"Id. § 26-1-2-508.

"Id. § 26-1-2-608.

''Id. § 26-1-2-711.

'^399 N.E.2d at 798. The trial court had dismissed the buyer's suit for rescission.

The court of appeals reversed; it held that with respect to the services component the

buyer had made a prima facie case that the seller's failure to perform constituted a

material breach of the entire contract.

"See Rose Acre Farms, Inc. v. L.P. Cavett Co., 151 Ind.App. 268, 279 N.E.2d 280

(1972).

'^IND. Code § 26-1-2-201(1) (1976).

'"This may be similar to the problem that arises in cases where part payment or
part performance provides a basis for enforcement of the contract. See U.C.C. §
2-201(3)(a), (b); Ind. Code § 26-l-2-201(3)(a), (b) (1976). In those instances the contract is

enforceable only to the extent of payment or performance which may result in the



1981] SURVEY- CONTRACTS 225

C. Are Farmers Merchants?

The question of whether a farmer is a merchant under UCC
2-201(2)" has been litigated in a number of states with somewhat
mixed results.'* These cases have usually involved an alleged oral

contract for the sale of grain by a farmer to a grain dealer. The
grain dealer usually has sent a written confirmation of the alleged

oral contract to the farmer, and the farmer has failed to register an

objection to the confirmation. When the grain dealer has sued on the
alleged oral contract, the farmers have defended with the Statute of

Frauds writing requirement of UCC 2-201(1).'^ Grain dealers have
countered with UCC 2-201(2) which provides that

[b]etween merchants if within a reasonable amount of time a
writing in confirmation of the contract and sufficient against

the sender is received and the party receiving it has reason

to know its contents, it satisfies the requirements of subsec-
tion (1) against such party unless written notice of objection

to its contents is given within 10 days after it is received.^"

The farmer has generally claimed that he is not a merchant, and
thus the transaction is not "between merchants." If the transaction

is not between merchants, UCC 2-201(2) does not apply, and the
Statute of Frauds defense could be successful since there is no

writing signed by the farmer — the person against whom enforce-
ment is being sought.

This year, the Indiana Court of Appeals addressed this question

in Sebasty v. Perschke.^^ In the Sebasty case the defendant had

same prejudice as described in the text. However, that is an unavoidable conclusion

produced by a statute. The courts should be reluctant to reach that conclusion in the
absence of a specific direction in a statute. For a discussion of the problem of the

prejudice resulting from partial enforcement and a proposed solution see R. NORD
STROM, Handbook on the Law of Sales § 27, at 71 (1970).

"IND. Code § 26-1-2-201(2) (1976).

"See Cook Grains, Inc. v. Fallis, 239 Ark. 962. 395 S.W.2d 555 (1965) (not a mer-
chant); Sierens v. Clausen, 60 111. 2d 585, 328 N.E.2d 559 (1975) (farmer is a merchant);

Campbell v. Yokel, 20 111. App. 3d 702, 313 N.E.2d 628 (1974) (farmer is a merchant);

Decatur Coop. Ass'n v. Urban. 219 Kan. 171, 547 P.2d 323 (1976) (not a merchant); Ohio

Grain Co. v. Swisshelm, 40 Ohio App. 2d 203, 318 N.E.2d 428 (1973) (farmer is a mer-

chant); Lish V. Compton, 547 P.2d 223 (Utah 1976) (not a merchant).

"U.C.C. § 2-201(1) (1978 version) provides that

a contract for the sale of goods for the price of $500 or more is not enforce-
able by way of action or defense unless there is some writing sufficient to in-
dicate that a contract for sale has been made between the parties and signed
by the party against whom enforcement is sought ....

IND. Code § 26-1-2-201(1) (1976).

'°IND. Code § 26-1-2-201(2) (1976).
^'404 N.E.2d 1200 (Ind. Ct. App. 1980).



226 INDIANA LAW REVIEW [Vol. 14:223

been a farmer all his life and owned 1300 acres of land, of which
1000 were farmed. Three crops were grown on the land and sold by
Sebasty as a means of earning his livelihood. Sebasty was familiar
with the customs and practices involved in selling grain, was aware

that the price of grain rises and falls daily, and had entered into

four other oral agreements with the grain dealer for future sales

which were followed by written confirmations. On the basis of these
characteristics, the court of appeals affirmed the trial court decision

that the farmer was a merchant.^^ This conclusion was supported by
two separate aspects of the definition of the word "merchant." UCC
2-104(1) provides that a merchant is "[a] person who deals in goods of
the kind or otherwise by his occupation holds himself out as having

knowledge or skill peculiar to the practices or goods involved in the

transaction."^^ First, the court emphasized that in this context the

test for merchant status is whether the farmer has by his occupa-

tion represented or held himself out as having knowledge or skill

peculiar to the practices in the transaction.^^ The court said that "[a]
person whose livelihood includes the selling of a commodity
necessarily represents to those who purchase the commodity that he
has the skill and knowledge involved in such a sale."^'' Second, the

court found that the farmer was a merchant for a separate and in-
dependent reason. If a person deals in goods of the kind involved

then the dealer is a merchant for the transaction. The court held
that a farmer who regularly sells his crops is a person who deals in

'Ud. at 1203.

'^IND. Code § 26-1-3-104(1) (1976).
''^It is important to recognize that the definition of merchant has two different

points of focus: The practices in the transaction or the goods involved in the transac-
tion. For purposes of the problem in this case and other questions involving offer, ac-

ceptance, or modification, the practices focus of the definition is most important. Offi-

cial Comment 2 of U.C.C. § 2-104 (1978 version) provides that for purposes of these for-
mation questions

almost every person in business would ... be deemed to be a "merchant"
under the language "who ... by his occupation holds himself out as having
knowledge or skill peculiar to the practices . . . involved in the transaction

. .
." since the practices involved in the transaction are non-specialized busi-

ness practices such as answering mail.

On the other hand, if the issue has to do with one of the UCC provisions dealing with
quality, such as the warranty of merchantability, the emphasis shifts. In that case the
warranty is created only "'if the seller is a merchant with respect to goods of that

kind.'" U.C.C. § 2-314(1); Ind. Code § 26-1-2-314(1) (1976). There is a third group of
cases in which merchant status is to be measured either by the practices or the goods
involved in the transaction. This group deals with such things as merchant buyer's

responsibility for following seller's instruction (U.C.C. § 2-603 (1978 version)) or risk of

loss (U.C.C. § 2-509 (1978 version)) or adequate assurances of performance (U.C.C. §
2-609 (1978 version)).

"404 N.E.2d at 1202-03.



1981] SURVEY- CONTRACTS 227

goods of that kind and is a merchant in those transactions in which

he sells his crops/®

D. Recovery of Attorney's Fees in Consumer Warranty Actions

Where defective consumer products cause personal injury or
property damage, the stakes are usually high enough to justify a

suit against the seller. The costs of the suit, particularly the fee for
the plaintiff's attorney, can usually be paid out of the recovery ob-

tained in the personal injury action. The lawyer's contingent fee
agreement has provided a method for even poor consumers to pro-
secute complex litigation. This assumption is often not true in cases

where defective consumer goods cause only disappointed expecta-
tions, not personal injury or property damage. Traditionally, courts

have refused to award costs and attorney's fees to the successful
plaintiff-buyer and the stakes usually are not high enough to justify

the cost of suit. Thus, consumer buyers have had limited practical
recourse in cases where their only complaint is that products did not
meet the agreed standard of quality.

This problem was addressed in two ways in the Magnuson-Moss
Warranty Act." First, the Act provides incentives for suppliers to

create informal dispute settlement mechanisms.^* Where established,
these mechanisms offer nonbinding resolution of disputes at no cost

to the consumer. Second, the Act includes an effort to change the

economics of litigation by providing for recovery of costs and at-

torney's fees in suits brought under the Act.^® The Act provides that
a consumer who is damaged by breach of an implied warranty may
bring suit under the Act for damages and,

[i]f a consumer finally prevails in any action ... he may be
allowed by the court to recover as part of the judgment a
sum equal to the aggregate amount of cost[s] and expenses
(including attorneys' fees based on actual time expended)

determined by the court to have been reasonably incurred

by the plaintiff for or in connection with the commencement
and prosecution of such action, unless the court in its discre-

tion shall determine that such an award of attorneys' fees
would be inappropriate.^"

^'Id. at 1203.

"Magnuson-Moss Warranty — Federal Trade Commission Improvement Act, 15
U.S.C. §§ 2301-12 (1976).

-Vd § 2310(aMl).

''Id. § 2310(d)(2).

'"Id.



228 INDIANA LAWREVIEW [Vol. 14:223

The only additional requirement for plaintiffs who seek to sue under
the Act, and take advantage of this potential for recovery of fees, is

that the person obligated under the warranty be "afforded a

reasonable opportunity to cure such failure to comply" with the war-

ranty obligation.^'

The appellate courts have not considered many cases under this
provision of the Act. This may be due to the fact that many of these
cases are resolved in trial court or by settlement. Indeed, the costs

and attorney's fees provision of the Act may provide an incentive
for defendant-sellers to settle. However, this year the Indiana Court
of Appeals dealt with a case in which there was an award of at-
torney's fees under the Act. In Jameson Chemical Co. v. Love,^^ a
buyer purchased some roof coating which was applied on the buyer's
various construction projects. The roof coating was defective. The
buyer sued and, although no evidence was presented on the number
of hours actually worked by the buyer's attorney, the buyer
recovered a judgment including an award under Magnuson-Moss of
$800 for attorney's fees. In its appeal the seller argued that there

was no evidence to support the award of attorney's fees. In response
the buyer argued that a trial judge has the power to make an award
of attorney's fees without evidence by relying on her knowledge of

what a reasonable attorney's fee should be. In resolving this conflict

the court of appeals focused on the language of the Act.'^ The Act
authorizes an award of attorney's fees "based on actual time ex-
pended."^^ The court said that, in the absence of evidence of the
amount of time spent by the buyer's lawyer on the case, the trial
court was without authority to award attorney's fees.^^ Thus, in its
first opinion, the court remanded the case for a hearing on the ques-
tion of the number of hours worked by the buyer's lawyer.^® Later,
on its own motion, the court reversed its decision.^^ Its first opinion
had overlooked the fact that the buyer in question was not a con-
sumer and the product was not a consumer product.^* Thus the

''Id. § 2310(e).

^^401 N.E.2d 41 (Ind. Ct. App. 1980).

''Id. at 45.

^nS U.S.C. § 2310(d)(2) (1976).
'''401 N.E.2d at 45.

''Id. at 48.

"It said, "The Court of Appeals has inherent power to correct, on its own motion,
an error in a decision and an opinion it has handed down. . . . Accordingly, this court

modifies its previous decision and opinion in this cause, which are reported at 410

N.E.2d 41." Jameson Chem. Co. v. Love, 403 N.E.2d 928, 928 (Ind. Ct. App. 1980).

^The right to sue under 15 U.S.C. § 2310(d) (1976) is available to consumers who
claim defects against suppliers or warrantors of consumer products. Consumer is de-
fined in 15 U.S.C. § 2301(3) (1976) as:



1981] SURVEY- CONTRA CTS 229

Magnuson-Moss Warranty Act did not apply and could not be the

basis of an award of attorney's fees.^'

The importance of the Jameson Chemical case, other than to call

attention to the potential for recovery of attorney's fees, is in the

commentary of the court on the proof required to support an award

of fees. The court stated that some evidence of the number of hours

actually expended in representing the plaintiff-buyer must be of-

fered/" This conclusion emphasizes the importance of good record

keeping. It also suggests that the courts may review the proof of
hours in a manner similar to the review of fees in other cases such

as bankruptcy."" Some of the insights on such things as the concept
of billable hours could be borrowed from these other cases. Finally,

the buyer should probably introduce some evidence of the

reasonable fee per hour to which the plaintiff's lawyer would be en-

titled.

E. Monetary Damages for Breach of Warranty

In Coyle Chevrolet Co. v. Carrier,*'^ a case which may have been

[A] buyer (other than for purposes of resale) of any consumer product, any

person to whom such product is transferred during the duration of an im-
plied or written warranty (or service contract) applicable to the product, and

any other person who is entitled by the terms of such warranty (or service
contract) or under applicable State law to enforce against the warrantor (or

service contractor) the obligations of the warranty (or service contract).

Consumer product is defined in 15 U.S.C. § 2301(1) (1976) as:
[Ajny tangible personal property which is distributed in commerce and which
is normally used for personal, family, or household purposes (including any

such property intended to be attached to or installed in any real property

without regard to whether it is so attached or installed).

''Jameson Chem. Co. v. Love, 403 N.E.2d at 929.

"/d at 928-29.
- "See In re First Colonial Corp. of America, 544 F.2d 1291 (5th Cir. 1977); Johnson

v. Georgia Highway Express, Inc., 488 F.2d 714 (5th Cir. 1974). Both of these cases
were remanded to the district courts due to insufficient documentation of the amount
of time spent by the attorneys and the type of work involved. 544 F.2d at 1298; 488
F.2d at 717. The judges also failed to justify the awards with findings and reasons. 544
F.2d at 1298; 488 F.2d at 717. These cases listed several factors which should be utilized

by judges when awarding the fees, including the time and labor required, the difficulty
of the question, and the customary fee. 544 F.2d at 1298-99; 488 F.2d at 717 19. See

also Rose Pass Mines, Inc. v. Howard, 615 F.2d 1088 (5th Cir. 1980), in which lawyers

were required to distinguish between partner and associate time; In re City Planners

& Developers, Inc., [1980] 6 Bankr. Ct. Dec. (CRR) 707 (District of Puerto Rico 1980)
requiring the same distinction; In re St. Pierre, [1980] 6 Bankr. Ct. Dec. (CRR) 607
(District of Rhode Island 1980) prohibiting claims for study of the law which is in the
nature of the continuing legal education exercise. Other courts have required lawyers

to distinguish between travel time, clerical work, and lawyer work. All of these factors

could be brought into play in a suit to recover fees under the Magnuson-Moss War-

ranty Act.

"397 N.E.2d 1283 (Ind. Ct. App. 1979).



230 INDIANA LAW REVIEW [Vol. 14:223

more appropriate for the award of attorney's fees under the
Magnuson-Moss Warranty Act, but in which the issue was not raised,
the court of appeals offered some insight on the meaning of the
language of UCC 2-714(2)" regarding the subject of the buyer's
damages for breach of warranty. That section provides that "[t]he
measure of damages for breach of warranty is the difference at the
time and place of acceptance between the value of the goods ac-

cepted and the value they would have had if they had been as war-

ranted, unless special circumstances show proximate damages of a
different amount.""^

In Coyle, the plaintiff-buyer purchased an automobile which

proved to be defective. After several efforts to have the dealer cure

the defects, the buyer filed suit. A jury awarded $9,500, which
amount was in excess of the purchase price of the car.''^ On appeal
the defendant argued that the damage award was excessive. In
analyzing the trial judge's decision, the court of appeals concluded

that the basic measure of recovery was to be computed under UCC
2-714.''* The defendant argued that the plaintiff had not proved the
value of the automobile as accepted. The only evidence in the record
was the testimony of the buyer that the car was worth about $500."^

On this issue, the court of appeals concluded that the owner of per-
sonal property is competent to testify as to its value and that the

testimony of the buyer that the car was worth $500 could have been
the basis for a decision by the jury that the automobile had a value

of $500 at the time of acceptance."** The lesson in this case for
buyer's lawyers is that it may be advisable for plaintiff-buyers to
testify on the issue of the value of the goods at the time of accep-

tance. The buyer apparently need not show any special knowledge
or expertise, but will be competent to testify because he is the

owner.

Even if the buyer's estimate of value was admissible and served
as the basis for the jury's verdict, the total $9,500 award was still
not justified. This award raised the further issue of the scope of con-

sequential and incidental damages which may be recovered under
UCC 2-715 in addition to the value of the goods which may be
recovered under UCC 2-714. The court stated that sales tax of forty
dollars could be recovered as incidental damages resulting from ex-
penses "reasonably incurred in . . . receipt" of the car."' Also, the

"IND. Code § 26-1-2-714(2) (1976).

"M
'=397 N.E.2d at 1284.

"IND. Code §§ 26-1-2-714 to -715 (1976).
"397 N.E.2d at 1287.

Vd. at 1287-88.

*'Id. at 1286-87.



1981] SURVEY-CONTRACTS 231

court stated that the finance charge of $1,581.38, which was paid to

finance the purchase of the automobile, could be recovered as conse-

quential damages.^" These conclusions may be inconsistent with UCC
1-106(1) which provides that the UCC is to "be liberally administered
to the end that the aggrieved party may be put in as good a position
as if the other party had fully performed . . . ."^' The court based its

decision on the assumption that the buyer had retained the

automobile and was entitled to damages under UCC 2-714. If the
goods are accepted and revocation of acceptance is unavailable, the

complete measure of recovery is usually provided by the formulation

found in UCC 2-714(2) — the difference between the value of the
goods as warranted and as accepted. Sales tax is not something

which must be recovered over and above the amount produced by

that formula in order to achieve the full performance position. In-

stead, sales tax seems to be the sort of expense which the buyer

was willing to contribute in order to bring about the full perfor-

mance position. This criticism also applies to the amount recovered
to compensate the buyer for the finance charge. This, too, was an

amount which the buyer had agreed to contribute in order to bring
about the full performance position.

To support its conclusion that the buyer should recover the
finance charge, the court relied on the recent decision of the Indiana

Court of Appeals in Hudson v. Dave Mclntire Chevrolet, Inc.^^ In
that case the court of appeals volunteered in a concluding footnote

that interest could be recovered as a form of consequential damages
where the seller had reason to know that the buyer needed to bor-
row money in order to complete the purchase.^^ However, in the
Hudson case the buyer had revoked acceptance with respect to the
auto. Where there has been a rightful revocation of acceptance, the
contract is cancelled and the computation of damages begins with
the assumption that the buyer has returned the goods, has no
obligation to pay the purchase price, and should receive a refund of

any amount paid. In this type of case, the finance charge actually
paid may be a cost which should be attributed to the breaching
seller.^^ However, this reasoning should not be transferred to a case,
such as the Coyle case, where the buyer kept possession of the

^IND. Code § 26-1-1-106 (1976).
"390 N.E.2d 179 (Ind. Ct. App. 1979).

*Vd at 184 n.4.

^*Even if the seller returned the purchase price and the buyer paid off the auto

loan, the buyer would still have incurred a portion of the prepaid finance charge. The

amount of the finance charge would be computed on the basis of the rule of 78's. Ind.

Code § 24-4.5-2-210 (1976).



232 INDIANA LAWREVIEW [Vol. 14:223

goods and recovered the full performance position by receiving the

value of the goods as promised.

F. Warranty of Hahitability—Notice Requirement

Several years ago, in Theis v. Heuer,^^ the Indiana Supreme
Court held that a seller of a new home makes a warranty of
hahitability to the buyer.^* The buyer may sue for breach of warranty
of hahitability if there are defects in the home which substantially
interfere with enjoyment/^ A few years later, in 1976, the Indiana
Supreme Court decided Barnes v. Mac Brown and Co.,^^ which ex-
tended the warranty protection beyond the first buyer of the home.
Under the reasoning of the Barnes case a person who bought the
home from the original buyer could sue the builder, even though
there was no privity of contract.^® The second buyer could sue the
builder as long as the defect was latent, was not discoverable by
reasonable inspection, and had manifested itself after the second

purchase.*"

This past year, in Wagner Construction Co. v. Noonan,^^ the
court of appeals again had occasion to deal with the warranty of

hahitability, and imposed an important new condition on the buyer's
right to sue for breach. In that case, Wagner constructed a house
and sold it to Hill in 1973. Five years later Hill sold the house to

Noonan who took occupancy on June 26, 1978. On July 4, 1978, a prob-
lem arose concerning the septic system which caused raw sewage to
back up into the basement. Noonan employed a plumbing contractor
who made corrections which temporarily alleviated the problem. In
November 1978, Noonan called Wagner and asked about changing
some drainage pipes inside the house, but he apparently made no
mention of the exact nature of the problem. On January 13, 1979,
the same problem arose and the sewage again backed up into the
basement. The plumbing contractor was called back to repeat the
procedure which had been successful in July 1978. A week later
sewage backed up for a third time and again the plumbing contrac-

tor was called to repeat the procedure. At this point the plumbing

=^264 Ind. 1. 280 N.E.2d 300 (1972), aff'g 149 Ind. App. 52, 270 N.E.2d 764 (1971).
="264 Ind. at 12, 280 N.E.2d at 306.

"M at 10, 280 N.E.2d at 305 (quoting Bethlahmy v. Bechtel, 91 Idaho 55, 415 P.2d
698 (1966), wherein the Supreme Court of Idaho stated that "major defects which
render the house unfit for habitation, and which are not readily remediable, entitle the

buyer to rescission and restitution." Id. at 68, 415 P.2d at 711).
^^'264 Ind. 227, 342 N.E.2d 619 (1976).

'Ud. at 229. 342 N.E.2d at 620.

'"Id. at 229. 342 N.E.2d at 621.
«'403 N.E.2d 1144 (Ind. Ct. App. 1980).



1981] SURVEY- CONTRACTS 233

contractor recommended digging into the septic tank as soon as the

ground thawed to determine the root of the problem. Again, in

April, the problem occurred. At that time, the recommended excava-

tion was performed, the septic tank was opened, and it was

discovered that the lead-in pipe extended some three feet into the

septic tank. At the trial, Wagner admitted that this condition con-
stituted a defect in the construction and that this was the cause of

Noonan's problems. After discovery of the lead-in pipe problem,

Noonan did not call Wagner to report the defect or give Wagner an
opportunity to repair it. Instead, Noonan sued Wagner on June 8,
1979. The first knowledge Wagner had of the problem was when he
received the complaint in June 1979. The small claims court held for

Noonan and awarded $632.66 damages.

On appeal, the court first disposed of some general questions
concerning the scope of the warranty of habitability. Wagner argued
that the warranty should not extend indefinitely and that five years

was beyond its period of protection. The court of appeals held that
the implied warranty of habitability extends for a reasonable

period,*^ and that the small claims court decision extending the war-

ranty to a defect discovered five years after completion of the house

was not unreasonable.*^ Also, Wagner argued that the defect did not
make the premises "uninhabitable" since Noonan was not forced to
vacate the premises. The court of appeals held that the warranty of
habitability protects not only against conditions which make the
premises uninhabitable but also protects against conditions which

substantially impair the owner's use.*^ The presence of the sewage
was a sufficient impairment of use to support the trial court's deci-
sion.®^

Finally, and most importantly, Wagner argued that Noonan was
obligated to give notice of the defect within a reasonable period of

time or his right to recovery would be barred. To advance this argu-
ment, Wagner relied on a California Supreme Court case, Pollard v.
Saxe & Yolles Development Co.,^^ which held that failure to give
notice constituted a bar to recovery for breach of warranty of

habitability.*^ In the Pollard case, the plaintiff purchased an apart-

ment building and took possession on April 1, 1963. The plaintiffs
discovered defects at the time they took possession, but did not

notify the defendants until January 1967. In concluding that this delay

"Id. at 1148.

''Id.

«n2 Cal. 3d 374, 525 P.2d 88, 115 Cal. Rptr. 648 (1974).

"Id. at 380. 525 P.2d at 92, 115 Cal. Rptr. at 652.



234 INDIANA LAW REVIEW [Vol. 14:223

operated as a bar to recovery, the California Supreme Court took
note of the purposes for requiring notice.** The court said that notice
afforded the defendant an opportunity to repair the defective item,

to reduce damages, to avoid defective products in the future, to

negotiate settlements, and to protect against stale claims.*' These

are the same concerns which serve as underpinning for the notice
requirement of UCC 2-607(3)(a),^" applicable in sales of goods. Under
that section, the buyer must give notice to the seller within a
reasonable period of time after discovery of a defect in goods, or

recovery is barred. Both the California and Indiana courts referred

to UCC 2-607(3)(a) in support of imposing a notice requirement in a
warranty of habitability case and, in this discussion, it is assumed
that these notice requirements are parallel.

In the Wagner Construction case, the Indiana Court of Appeals
adopted the notice requirement created by the California Supreme
Court.^' The Indiana court focused on the fact that no notice was
given until the time of suit. The contact which Noonan made in
November 1978, concerning some possible, but unspecified change in
interior piping, when no difficulty with the septic system was being
encountered, did not constitute notice which would preserve the

right to sue.^^ The court stated that "[n]o particular form of notice is
required, but the purchaser must at least inform the builder-vendor

of the problem and give him a reasonable opportunity to cure or

repair."" Because Noonan did not meet the notice requirement he
was not entitled to sue, and the trial court's decision in his favor
was reversed.^*

There may be some basis for criticism of the court's reasoning in
the Wagner Construction case. First, the court said that notice was
necessary to give the seller a right to "cure" or repair.^^ If the court

was thinking of an analogue to the concept of "cure," defined in

UCC 2-508, this emphasis was improper. There is no right to cure
defects in goods that have been accepted. "Cure" under UCC 2-508
can be initiated only to block a rejection under UCC 2-601 and
cancellation under UCC 2-711. In the Wagner Construction case, the
buyer had accepted and was keeping the seller's performance (the
house). Therefore, the principle of cure found in UCC 2-508 would

''Id.

''Id.

'"IND. Code § 26-1-2-607 (1976).
"403 N.E.2d at 1150.

''Id.

''Id.

''Id.

"Id.



1981] SURVEY- CONTRACTS 235

not be applicable. Second, under UCC 2-607, the reasonable period
during which notice must be given begins when the buyer
"discovers or should have discovered any breach." The notice period

does not run from the date of original sale. In the Wagner case, it
seems that the buyer did not realize there was any defect for which

the builder could be held responsible until after an investigation of

the septic tank in April 1979. It was on this date that the buyer
discovered a breach. Therefore, the trial court may have been
justified in concluding that the period for notice began in April 1979.

Because Wagner received a copy of the complaint in June 1979, the
trial court may have concluded that notice was given within a
reasonable, time.

Even if the buyer had discovered the breach when the backup
problem first arose, in July 1978, the trial court's decision could still

be defended. Some compassion in measuring the reasonable time
period must be shown for consumers who could not be expected to
know about notice requirements. Official Comment 4 to UCC 2-607
states that " '[a] reasonable time' for notification from a retail con-

sumer is to be judged by different standards so that in his case it
will be extended, for the rule of requiring notification is designed to

defeat commercial bad faith, not to deprive a good faith consumer of

his remedy."'* Furthermore, the buyer's delay was not in any way
comparable to the delay in the Pollard case where the buyer knew
of the defects when he took possession, but did not give notice until
nearly four years later.

The court of appeals may have based it decision on the assump-
tion that the suit could not serve as notice. Such an assumption sug-

gests that there must be some form of notice prior to filing suit. The
purpose of such a notice requirement may be to give the seller an
opportunity to settle the claim. This presumes that it is more dif-
ficult to settle after suit is filed. However, this is a rather for-
malistic approach. It would require all consumers to give notice

prior to filing suit to permit the seller to explore settlement. Fur-

thermore, its application would be especially attenuated where suit
was filed, as in the Wagner Construction case, in a small claims
court with rather informal procedures and lower costs for initiating

suit. These lower costs and informal procedures may form less of an
obstacle to settlement than a suit in a court of general jurisdiction.

Finally, the court of appeals concluded that Noonan's call to

Wagner in November 1978, did not constitute notice because it did
not specifically identify defects." This suggests a more rigorous re-

'"U.C.C. § 2-607. Official Comment 4.
"403 N.E.2d at 1150.



236 INDIANA LAW REVIEW [Vol. 14:223

quirement than is imposed by UCC 2-607. The notice required by
UCC 2-607 need not specify the exact nature of a defect. Official
Comment 4 to UCC 2-607 states that "[t]he content of the notifica-
tion need merely be sufficient to let the seller know that the trans-
action is still troublesome and must be watched." The trial court
could have found that the call of November 1978, informed the seller
that the transaction was troublesome.

G. Liability of Agents on Checks

Shareholders and officers of closely held corporations and

representatives in other small businesses sometimes execute

negotiable instruments without making clear in what capacity they
are signing. They may intend to create only corporate liability; they
may intend only personal liability; or they may intend corporate
liability with personal liability as a surety or accomodation party.

The resulting uncertainty as to the liability of the signer is of
special concern where the contracts are made on negotiable in-
struments. To address this problem, UCC 3-403^* provides some
strict operating rules on the subject. To begin, there are obvious ex-
treme cases resolved as a matter of law under UCC 3-403(2)(a).^* If
the signer neither names the person represented nor shows the
representative capacity, the signer is personally obligated. On the
other hand, if the signer both names the person represented and in-
dicates a representative capacity, UCC 3-403(3) provides that the
signer is not liable and has made a contract on the instrument only
on behalf of the principal.*" In between these extreme cases there
are some signatures which may create ambiguities. If the instru-
ment names the person represented, but does not show that the
representative signed in a representative capacity, or if the instru-

ment does not name the person represented, but does show the
representative signed in a representative capacity, UCC 3-403(2)(b)
causes the analysis to be governed by the identity of the parties in

the litigation.*^ It provides that an authorized representative who
signs his own name to an instrument,

[e]xcept as otherwise established between the immediate

parties, is personally obligated if the instrument names the
person represented but does not show that the representa-

"IND. Code § 26-1-3-403 (1976).

'Vd § 26-l-3-403(2)(a). Courts have been generous in finding some indication of

representative capacity to avoid assessing personal liability as a matter of law. Seei

Weather-Rite Inc. v. Southdale Pro-Bowl Inc.. 301 Minn. 346, 222 N.W.2d 789 (1974).

''Id. § 26-1-3-403(3).

"Id. § 26-l-3-403(2)(b).



1981] SURVEY- CONTRACTS 237

tive signed in a representative capacity, or if the instrument

does not name the person represented but does show that
the representative signed in a representative capacity.**^

Thus, if the suit is between the immediate parties to the instrument,

such as the maker and payee of a note, the dispute can be resolved
in the same manner as it would be in the context of a simple con-
tract.*^ The agent may show, by any relevant evidence, that her sig-
nature was made in a representative capacity and that the parties
did not intend her to have personal responsibility. However, if the

suit is not between the immediate parties, but is between a subse-
quent holder and the agent, the special needs of negotiable paper

are brought into focus and the ambiguity is resolved against the

agent.

With regard to corporate checks, UCC 3-403(2)(b) may present
special dangers of accidental liability for agents of closely held cor-

porations. If a check bears the printed name of the corporation, but
does not have an indication under the drawer's signature line that

the drawer is signing in a representative capacity, the liability of

the agent on the check may be governed by UCC 3-403(2Kb). This
check would be an instrument which named the principal but did not
indicate a representative capacity. If the person suing on the check

is the payee, then, of course, even under UCC 3-403(2)(b), the agent
would be able to show that the parties intended her signature to be
in a representative capacity. However, if the suit on the check is

brought by someone other than the payee, that is, someone other
than one of the immediate parties to the instrument, the agent may
not be able to show by other evidence that the signature was made
in a representative capacity. Under UCC 3-403(2)(b) she may be per-
sonally liable as a matter of law.

A case involving just this type of check was presented to the
court of appeals last year in Highfield v. Lang.^* Fortunately for the

agent, the suit was brought by the payee and was thus between the
immediate parties. The court permitted the representative of the
closely held corporation to introduce evidence of his representative

capacity. The representative showed that the payee was an
employee of the corporation who knew that the representative was
Vice-President and was signing in a representative capacity.*^ The
trial court held for the agent and the court of appeals affirmed.*®

''Id.

»*394 N.E.2d 204 (Ind. Ct. App. 1979).

"Id. at 206.

"Id.



238 INDIANA LAWREVIEW [Vol. 14:223

However, the important lesson of the Highfield case is not in the
holding, it is in the attention it calls to the risk that someone other
than the payee could bring suit against the agent on the check. For

example, the suit could have been brought by a collecting bank. In

that case, the agent may not have been able to prove his representa-
tive capacity and may have been personally liable as a matter of
law. The lesson for lawyers is to make certain that company checks
have some indication of representative capacity near the line for the
drawer's signature.

H. Customer's Duty to Examine Bank Statements

UCC 4-406(1) provides a standard of care for bank customers
with respect to bank statements. When a bank sends "a statement
of account accompanied by items paid in good faith . . . the customer

must exercise reasonable care and promptness [in examining] the
statement and items to discover . . . unauthorized signature[s] or

alteration[s]."*^ Furthermore, the customer must notify the bank
promptly after a forgery or alteration is discovered. A customer's
failure to comply with these duties with respect to any item may
preclude the customer from asserting that the item was not prop-
erly payable in the following circumstances.** If a customer was the
victim of forgery or alteration by the same wrongdoer on a series of
items which the bank paid and forwarded to the customer at periodic

intervals, the customer may be precluded from asserting the forgeries
or alterations that took place after the customer had the statement

for a reasonable period not exceeding fourteen calendar days and

before the bank received notice from the customer of this forgery or

alteration.*' However, if the bank was negligent in paying the item
the customer's negligence would be cancelled out; the customer

would be able to claim that the checks bearing forgeries or altera-

tions were not properly payable and could still insist on recredit to
her account.'"

In Indiana National Corp. v. Faco, Inc^^ the Indiana Court of

Appeals had occasion to deal with UCC 4-406 in a situation which
presented a very common fact pattern. In that case, there was a dis-
honest employee of a closely held family corporation (Faco) who was
responsible for its books. The employee repeatedly forged the signa-

ture of a corporate officer as drawer on Faco checks, made the

°'IND. Code § 26-1-4-406(1) (1976).

''U.C.C. § 4-406(2): IND. Code § 26-1-4-406(2) (1976).

''U.C.C. § 4-406(2): Ind. Code § 26-1-4-406(2) (1976).

'"U.C.C. § 4-406(3); Ind. Code § 26-1-4-406(3) (1976).
"400 N.E.2d 202 (Ind. Ct. App. 1980).



1981] SURVEY- CONTRACTS 239

checks payable to himself or to his daughter and thus embezzled

$51,809.09 from Faco. The checks were all paid by the payor bank

and were forwarded to Faco along with monthly statements. Of

course, since the forger was the bookkeeper, the forgeries and fraud

did not come to the attention of the officers of Faco and were not
discovered until the scheme had operated for two years. At that

time, the corporation sued the payor bank alleging that these forged

checks were not properly payable. The trial court entered a judg-
ment in favor of Faco for the entire amount.'^

On appeal, the bank raised some interesting questions with
respect to the customer's negligence under section 4-406. First, the

bank urged that the failure of the officers of Faco to discover the

fraud committed by their employee was a failure to exercise reason-

able care and promptness in examining statements under UCC
4-406(1). The court of appeals agreed.'^ The court noted that no audit
was performed and none of Faco's officers took the time to inspect
the items or the statements provided by the bank. Thus, Faco had

been negligent, presumably as a matter of law. This approach differs

from the approach taken by other courts. One court held that the
test of negligence is whether the entity was negligent in selecting
the employee on the basis of the facts known to it at the time.®^
Other courts have held the customer is chargeable with knowledge

of such facts as an honest agent would acquire from a prudent ex-

amination of the statement.'^ The formulation used by the Indiana
Court of Appeals is close to this latter approach and seems to be the
better reasoned position.

Once the customer's negligence is established the bank can
avoid liability for these forgeries unless the bank was negligent. In
the Faco case the court of appeals concluded that there was evi-
dence that could support a decision that the bank was negligent and
could therefore support the trial court's judgment for the customer.'*
First, Faco had presented evidence that three unsigned checks

drawn on the Faco account had been paid. Further, an employee of
the bank, who was to examine the checks for unauthorized signa-
tures, testified that these three checks should not have been paid.

Finally, Faco presented evidence of the extremely heavy workload

''Id. at 203.

''Id. at 204-05.

'*Jackson v. First Nat'l Bank of Memphis, Inc., 55 Tenn. App. 545, 403 S.W.2d 109

(1966).

'^Exchange Bank and Trust Co. v. Kidwell Constr. Co., 463 S.W.2d 465 (1971). See

J. White & R. Summers, Handbook of the Law Under the Uniform Commercial
Code § 16-7. at 630 (2d sd. 1980).

''400 N.E.2d at 205.



240 INDIANA LAW REVIEW [Vol. 14:223

of bank employees responsible for examining checks and that the

bank was unable to produce copies of thirty of the forged checks
which had been sent to Faco.^^ This negligence cancelled out the cus-

tomer's negligence and caused the bank to be responsible for the

checks because they were not properly payable.
However, despite the bank's negligence, there was one final step

in the analysis of this problem under UCC 4-406. UCC 4-406(4^
creates a condition precedent to recovery by the customer. It pro-

vides that

[wjithout regard to care or lack of care of either the cus-

tomer or the bank a customer who does not within one (1) year
from the time the statement and items are made available to
the customer (subsection (1)) discover and report his un-

authorized signature or any alteration ... is precluded from

asserting against the bank such unauthorized signature . . . .^'

The purpose of this provision is to encourage promptness and good
business practices on the part of bank customers and to relieve

banks of any liability to their customers who fail to follow those
practices. The court noted that Faco had reported the forgeries to
the bank in August IQTS.'"" Under UCC 4-406(4), the bank was re-
sponsible only for those forged checks which had been received by

Faco within one year prior to the date of notice. In other words,

those checks which were sent to the customer before August 1974,
were the responsibility of the customer, not the bank. Applying this
provision, the court affirmed the trial court's judgment for Faco, but
instructed the trial court to deduct the sum of the forged checks
which were sent to the customer prior to August 1974.""

/. Check Forgery

The court of appeals last year decided two cases on the subject
of check forgery. One case. Insurance Co. of North America v. Pur-
due National Bank,^°^ dealt with a forgery of an endorsement; the

other case. Payroll Check Cashing v. New Palestine Bank,^''^ dealt
with a forgery of the drawer's signature. In both cases, the court of

appeals addressed interesting and important forgery issues.

"IND. Code § 26-1-4-406(4) (1976).

'"MOO N.E.2d at 205.

""Id. at 206.

'"'401 N.E.2d 708 (Ind. Ct. App. 1980).
"'^401 N.E.2d 752 (Ind. Ct. App. 1980).



1981] SURVEY- CONTRACTS 241

1. Drawer Forgery. —In the Payroll Check Cashing case,"*^
checks on which the drawer's signature was forged were cashed at

the Payroll Check Cashing Service (Payroll). Payroll forwarded them
through regular banking channels and they were paid by the

drawee, New Palestine Bank (payor bank). After the cancelled
checks and monthly statement were sent to the drawer named on
the checks, the drawer notified the payor bank of the forgeries. The

payor bank recredited the drawer's account and sued Payroll. The
trial court entered a judgment in favor of the payor bank for the

amount of the checks,'"^
Any analysis of the payor bank's right to sue for payment made

on checks bearing drawer forgeries must take account of the finality

principle codified in UCC 3-418.""' That section provides in part that
"payment or acceptance of any instrument is final in favor of a
holder in due course, or a person who has in good faith changed his
position in reliance on the payment."'"^ This principle is built on the

assumption that once an instrument is finally paid, the payment
should not be recovered unless there are special circumstances. This

follows because there are usually numerous transactions firmed up
by the payment of an instrument and there may be decisions in
various subordinate transactions made in reliance on payment. To
reopen those transactions could cause considerable dislocation."**

Among other things, this finality principle operates to prevent a
payor bank from suing to recover money paid out on a check bear-
ing a forged drawer's signature.'"* However, this result should not
engender excessive sympathy for payor banks. A payor bank should
discover the forgery of the drawer's signature when the check is
presented for payment. It should have the drawer's signature on file

and should be able to verify the signature on the check. If it does

not discover the forgery, there is little to commend permitting the
payor bank to shift the loss to parties who have handled the check
in the collection process.""

""Id.

""Id. at 754.

'""IND. Code § 26-1-3-418 (1976).
""M
lOSf
"Official Comment 1 to U.C.C. § 3-418 provides that "it is highly desirable to end

the transaction on an instrument when it is paid rather than reopen and upset a series
of commercial transactions at a later date when the forgery is discovered."

'"'Official Comment 1 to U.C.C. § 3-418 provides that the text of § 3-418 "follows
the rule of Price v. Neal, 3 Burr. 1354 (1762), under which a drawee who accepts or
pays an instrument on which the signature of the drawer is forged is bound on his ac-
ceptance and cannot recover back his payments."

""Official Comment 1 to U.C.C. § 3-418 provides that "[t]he traditional justification
for the result is that the drawee is in a superior position to detect a forgery because
he has the maker's signature and is expected to know and compare it . . . ."



242 INDIANA LAW REVIEW [Vol. 14:223

Despite the finality principle, the payor bank may still be able to
recover its payment if it can show that there are special cir-
cumstances which constitute breach of a presentment warranty.'"

Presentment warranties liability constitute an exception to the finali-

ty principle."^ These presentment warranties include a warranty that:

(1) The presenting party has good title to the item, (2) the presen-
ting party has no knowledge that the signature of the maker or
drawer is unauthorized, and (3) the item has not been materially
altered."' Unfortunately for payor banks, in drawer forgery cases
there is usually no breach of presentment warranty. The warranty
of good title is not breached simply by virtue of the forgery of the

drawer's signature."'' Since the forgery operates as the signature of

the forger, the check is simply the forger's check bearing the

forger's order and drawer's contract. Thus, the presenting party has

good title. "^ The most likely way for payor banks to establish a pre-
sentment warranty breach is to show that the person presenting the
check had knowledge of the drawer's forgery."^

In the Payroll Check Cashing case, the trial court's decision in

favor of the payor bank had to be affirmed by the appellate court if

there was any basis for the trial court's decision. The court of ap-
peals noted that there was no evidence that Payroll had breached a
presentment warranty."^ Therefore, the only basis for the trial

court's decision was the assumption that Payroll was not entitled to
the benefit of the finality principle. UCC 3-418 states that the final-
ity principle operates only in favor of two groups: (1) Persons who
have changed position in reliance on payment, and (2) holders in due

course. There was no evidence that Payroll had changed position in

reliance on payment. Thus, Payroll had to establish that it was a
holder in due course. In general, the burden of proof is on the per-

son claiming the rights of a holder in due course. UCC 3-307(3) pro-

'"U.C.C. § 3-417(1); IND. Code § 26-1-3-417(1) (1976). There is a special set of war-

ranty provisions that apply to transfer and presentment in the context of bank collec-

tion. These warranties are found in U.C.C. § 4-207(1); Ind. Code § 26-1-4-207(1) (1976).

"^U.C.C. § 3-418 states that "except for liability for breach of warranty of present-

ment . . . payment or acceptance ... is final . . . ."

"^IND. Code § 26-1-3-417(1) (1976).
"Whaley, Forged Instruments and the UCC's "Holder," 6 Ind. L. Rev. 45, 61-62

(1972).

"^U.C.C. § 3-404 provides that an unauthorized signature "operates as the signa-

ture of the unauthorized signer in favor of any person who in good faith pays the in-
strument or takes it for value." Ind. Code § 26-1-3-404(1) (1976). The instrument is

simply the forger's check and there are no title questions.

"'U.C.C. § 3-417(l)(b) provides that the party making the presentment warrants

"he has no knowledge that the signature of the maker or drawer is unauthorized." Ind.

Code § 26-l-3-417(l)(b) (1976).
'"401 N.E.2d at 756-57.



1981] SURVEY- CONTRACTS 243

vides that "[ajfter it is shown that a defense exists a person claiming

the rights of a holder in due course has the burden of establishing

that he or some person under whom he claims is in all respects a
holder in due course.""* The court of appeals concluded that neither

the general principle with regard to the burden of proof, nor this

language was applicable to this case.'" The court concluded that this

language applied to cases where a holder in due course was attempt-
ing to sue on an instrument with respect to which there were

defenses.'^" In the Payroll Check Cashing case, the payor bank

brought suit against an intermediate holder who needed the protec-
tion of the finality principle. The court held that on this issue the
burden of proof was on the payor bank in its effort to establish that
Payroll was not a holder in due course.'^' Since there was no evi-

dence in the trial record to show that Payroll was not a holder in

due course, Payroll was entitled to the benefit of the finality princi-

ple. As a result, the trial court's decision in favor of the payor bank
was erroneous and it was reversed with instructions to enter judg-
ment for Payroll.

Some courts and authors have argued that it is not necessary to
examine UCC 3-418 where the payment has been made by a bank on
a check bearing a drawer forgery. '^^ The argument begins with UCC
4-102(1) which provides that "[i]n the event of conflict the provisions

of this Article govern those of Article 3 . . . ."''' UCC 4-213(1) pro-'
vides that "[u]pon a final payment . . . the payor bank shall be ac-
countable for the amount of the item."'^^ This language suggests a
broader final payment principle imposed by UCC Article 4 on banks
which make payment on instruments. It is broader in the sense that
it operates in favor of all parties who act in good faith, not only in
favor of holders in due course and persons who change position in
reliance on payment. The fact that the Indiana Court of Appeals
analyzed the Payroll Check Cashing case under UCC 3-418 suggests
that it has rejected this argument and has concluded that the only
finality principle is found in UCC 3-418.

2. Forged Indorsements. — In Insurance Co. of North America
V. Purdue National Bank,^^^ the court of appeals addressed the ques-

"«lND. Code § 26-1-3-307(3) (1976).
"MOl N.E.2d at 758.

'"Id.

'"Id.

'"See J. White & R. Summers supra note 95, § 16-2, at 613-17.
'^^IND. Code § 26-1-4-102(1) (1976).
"*Id. § 26-1-4-213(1).

'^=401 N.E.2d 708 (Ind. Ct. App. 1980).



244 INDIANA LAW REVIEW [Vol. 14:223

tion of whether the drawer could sue a depositary bank'^^ which pre-

sented a check bearing a forged endorsement. In that case Freyman
forged a power of attorney for Helen Creech who had a savings ac-
count at the Lafayette Savings Bank (Savings Bank). Using this
forged power of attorney, Freyman made a withdrawal of $8,000
from Helen Creech's savings account. The funds withdrawn were
paid out by way of a check drawn by Savings Bank on the Lafayette
National Bank (National) payable to Helen Creech. Although Savings
Bank had a signature card bearing Helen Creech's signature, the
forgery of the power of attorney was not discovered. There was no
evidence that the signatures were compared. Freyman forged Helen
Creech's endorsement on the back of the check and deposited it in

his account at the Purdue National Bank of Lafayette (Purdue). It
was presented through regular banking channels and paid. In a very
similar transaction, Freyman went to Savings Bank with a notice of
administration for the estate of James Paul Davis, another depositor
at Savings Bank. On the basis of his representation that he was at-
torney for the estate, Freyman withdrew $1,000 from Davis' savings
account and a check in the amount of $1,000 was drawn by Savings
Bank on National, payable to Ruth A. Braun, the executrix of the
Davis estate. Freyman forged Braun's endorsement on the check
and deposited it in his account at Purdue. It was presented for pay-
ment through regular banking channels and paid by National. There-
after, Savings Bank discovered the forgeries on the two checks and
the fraud which had been perpetrated against the accounts of its

two customers. It recredited the accounts of Creech and Davis in
the amount of the respective withdrawals and demanded reimburse-
ment from the depositary bank, Purdue, which refused. The Insur-
ance Company of North America paid Savings Bank under a policy
of insurance against loss from forgery and filed suit as subrogee of

the claim against Purdue. The case was tried on this stipulation of
facts and the trial court entered a judgment for Purdue.'"

In deciding the insurance company's appeal the court of appeals

first considered whether it was appropriate to permit a suit by the
drawer of a check bearing a forged endorsement against the

depositary bank. It is clear that, absent negligence, the drawer has a

claim against the payor bank,'^* which in turn could sue the collec-

'^^A depositary bank is "the first bank to which an item is transferred for collec-

tion . . . ." Ind. Code § 26-l-4-105(a) (1976). The question raised in the case also applies

to all collecting banks which are any banks handling items for collection. Id. §

26-l-4-105(d).

'"401 N.E.2d at 710.

'^'A check which does not bear the endorsement of the payee is not properly pay-

able. The payor bank may charge the customer's account only in the case of a properly



1981] SURVEY- CONTRACTS 245

ting bank,'^* but it is a direct suit by the drawer with which we are
concerned. Several theories have been advanced for this type of

direct suit: (1) The collecting bank may be liable to the drawer for
conversion;'^" (2) the drawer may be a third party beneficiary of the
presentment warranty of good title made by collecting banks;'^' (3)
the drawer is an assignee of the drawee's right to sue on the

presentment warranty of good title;'^^ or (4) the drawer is an "other

payor" within the meaning of UCC 4-207(1), is thus a person to
whom presentment warranties are made, and can sue collecting
banks on the presentment warranty of good title/^^ These theories

have produced mixed results in the courts. At the center of the con-
troversy seems to be a problem of deciding which parties should

litigate questions concerning the drawer's negligence. To
demonstrate this proposition, assume that the drawer had just
discovered the forgeries and was contemplating how to recoup its
losses. The most likely defendant would be the payor bank which
had paid the forged checks improperly. The drawer could demand
that payor bank recredit her account, but in response to this de-

mand the payor bank could raise various issues of negligence. The
drawer may have been guilty of negligence which substantially con-
tributed to the forgery and may thus be precluded from asserting
it.'^* Similarly, the drawer may have failed to exercise reasonable
care in examining her statement and may be precluded from assert-
ing later forgeries by the same wrongdoer. '^^ Finally, the drawer
may have failed to give notice within three years from the time the
forgery was discovered and thus would be precluded from asserting
the forgery against the payor bank.'^^ The proof of these various
types of negligence would be more readily available to the payor

payable item. See U.C.C. § 4-401(1); Ind. Code § 26-1-4-401(1) (1976). The customer has a
claim for any improper charge to an account.

'^The payor bank can sue the collecting bank for breach of the presentment war-
ranty of good title. 401 N.E.2d at 711-14. A check as to which there has been a forgery
of the payee's signature is still owned by the payee, and persons handling the check do
not have good title. For a discussion of the effect of a forgery on the rights of the
payee and subsequent holders, see J. White & R. Summers supra note 95, § 15-2.

'^"This theory has been rejected because the drawer does not have a property in-
terest in the check which can be the subject of a conversion. The property in the check
is owned by the payee. See Allied Concord Fin. Corp. v. Bank of America Nat'l Trust
& Sav. Ass'n, 275 Cal. App. 2d 1, 80 Cal. Rptr. 622 (1969).

"'Commonwealth v. National Bank & Trust Co., 46 Pa. D. & C.2d 141 (1968).
"^Insurance Co. of North America v. Atlas Supply Co., 121 Ga. App. 1, 172 S.E.2d

632 (1970).

'^^U.C.C. § 3-406; Ind. Code § 26-1-3-406 (1976).
''^U.C.C. § 4-406; Ind. Code § 26-1-4-406(1), (2) (1976).
'^'U.C.C. § 4-406(4); Ind. Code § 26-1-4-406(4) (1976).



246 INDIANA LAW REVIEW [Vol. 14:223

bank. It would probably be the only bank which would have

knowledge of the drawer's negligence or sloppy practices or the

customer's failure to exercise reasonable care in examining

statements. Because these defenses can be best raised by the payor

bank, the drawer should be required to proceed against the payor
bank and not be entitled to sue directly against the collecting bank
which would not be as well prepared to raise negligence defenses.

UCC 4-406(5) seems to support this argument. It provides that, "[i]f .
. . a payor bank has a valid defense against a claim of a customer . . .

and . . . fails upon request to assert the defense the bank may not
assert against any collecting bank ... a claim based upon the
unauthorized signature . . . giving rise to the customer's claim."'^'

This is the position advanced by White and Summers, the authors of
the most popular treatise on the subject.'^*

The Indiana Court of Appeals, however, was less impressed with
these concerns than with a recent decision of the California Su-

preme Court, Sun' N Sand, Inc. v. United California Bank.^^^ In that
case the court focused on the language of UCC 4-207(1) in permitting
the drawer's suit against the collecting bank. That section provides

that a presentment warranty extends to "the payor bank or other
payor who in good faith pays or accepts the item."'*" The court in
Sun' N Sand, concluded that the drawer of a check qualifies as an
"other payor who . , . pays."'*' This interpretation is supported by
the internal logic of UCC 4-207(1). Some presentment warranties are
specifically not made to a drawer. For example, the presenting party
warrants that she has no knowledge that the signature of the

drawer is unauthorized. However, this warranty is not made by a
collecting bank which is a holder in due course acting in good faith,

"to a drawer with respect to the drawer's own signature."'" By
specifically excluding drawers from this warranty protection, the

drafters created a negative implication that other warranties are

made for the benefit of the drawer. The Indiana Court of Appeals
adopted this reasoning in Insurance Co. of North America.^*^ In addi-

tion, the court concluded that some weight had to be given to avoid-
ing the circuity of action created by requiring the drawer to look

first to the payor bank.'"

'"IND. Code § 26-1-4-406(5) (1976).

'^'J. White & R. Summers supra note 95, § 15-5, at 602.
'^'21 Cal. 3d 671, 582 P.2d 920, 148 Cal. Rptr. 329 (1978).

'"/d. at 682, 582 P.2d at 928, 148 Cal. Rptr. at 337 (emphasis added).

'"U.C.C. § 4-207(1); IND. Code § 26-1-4-207(1) (1976) (emphasis added).

'"U.C.C. § 4-207(l)(b)(ii); Ind. Code § 26-l-4-207(l)(b)(ii) (1976).
'"401 N.E.2d at 714.

"Vd.



1981] SURVEY- CONTRACTS 247

Even though the drawer may bring a direct action against a col-
lecting bank on the presentment warranty of good title, the collect-

ing bank may raise any defense which could be raised by the payor
bank against its customer. '^^ Thus, if the drawer were guilty of some
negligence which substantially contributed to the forgery or if there

were some other basis for the payor bank to refuse to recredit the
drawer's account, the collecting bank would be able to raise the

defense. In Insurance Co. of North America, there was evidence that
Savings Bank's negligence substantially contributed to the forgeries.

Savings Bank had allowed withdrawals from the savings accounts of
its customers on the fraudulent assertions of the forger that he had

authority to make the withdrawals. With respect to the first check,
the forger used a Power of Attorney bearing a forged signature
which Savings Bank did not discover even though the genuine signa-
ture was in its files. Instead, Savings Bank simply issued a check
payable to its customer, Helen Creech, and gave it directly to the

forger. As for the other check, there was no written authorization
for withdrawal from the savings account. The forger presented a
Notice of Administration which identified him as attorney for the
estate. Savings Bank made no attempt to verify his authority. On
the basis of these facts the trial court could have found that the

drawer failed to use ordinary care in dealing with the accounts of its

customers and in delivering these checks to the forger. Further, the

negligence was a substantial factor contributing to the unauthorized
indorsements. Thus, the trial court was correct in holding that the
collecting bank was not liable to the drawer, and its judgment was
affirmed.'"

J. Truth in Lending

1. Truth in Lending Simplification. — Ot\ March 31, 1980, Presi-
dent Carter signed into law the Depositary Institutions Deregula-

tion and Monetary Control Act of 1980.'" A major part of this Act is
Title VI, devoted to Truth in Lending Simplification — a -subject
which has been under discussion in Congress for the past several

years.'" Title VI on Truth in Lending Simplification (TILS)'" is quite

'"U.C.C. § 4-406(5); Ind. Code § 26-1-4-406(5) (1976).
'"401 N.E.2d at 715.

'"Pub. L. No. 96-221, 94 Stat. 132 (codified in titles 12, 15. 22, and 42 U.S.C.
(1976)).

'"S. 2802, 95th Cong., 2d Sess., 124 Cong. Reg. 4498, 7226 (1978) (incorporating S.
1312. 95th Cong.. 1st Sess.. 124 Cong. Rec. 11332 (1977); S. 1501. 95th Cong.. 1st Sess.,
123 Cong. Reg. 14536 (1977); S. 1653, 95th Cong., 1st Sess.. 123 Cong. Rec. 18200
(1977); S. 1846. 95th Cong.. 1st Sess., 123 CONG. Rec. 22747, 22800 (1977)).

'"Truth in Lending Simplification and Reform Act, Pub. L. No. 96-221. 94 Stat.
168 (1980) (amending 15 U.S.C. §§ 1601-92 (1976)).



248 INDIANA LAWREVIEW [Vol. 14:223

complex, and an exhaustive discussion of its provisions is beyond
the scope of this survey. However, in the few paragraphs that
follow, an attempt is made to review some of its highlights.

a. Definitions. — Some key definitions were modified by TILS.
First, the term "creditor" was redefined to eliminate some persons
from its scope. To understand this modification it may be useful to
consider two illustrations. First, assume that Acme Health Spa sold
memberships for $500 payable in twenty-four monthly installments.
On the date each membership contract was created, Acme assigned
the contract to the Universal Finance Company at a substantial dis-
count. Second, assume that Sally Broker was a real estate agent
who worked with consumer house buyers. After finding houses, Sally
helped buyers obtain financing by participating in the preparation of

documents required in connection with mortgage loans. Under Truth
in Lending (TIL),'^" the possibility exists that both Universal and Sally
could be creditors and incur liability for failure to make proper dis-
closures because they either extend or arrange for credit. ^^' This

potential has been eliminated by TILS. The new definition of credi-
tor refers only to a person who "is the person to whom the debt
arising from the consumer credit transaction is initially payable on
the face of the evidence on indebtedness."'^^ Under the new law
assignees and arrangers will not be creditors unless they are named
on the face of the evidence of indebtedness.

TILS also modified the definition of "open-end credit." Under
TIL some credit sellers were avoiding disclosure requirements by
casting their transactions in the form of open-end credit extensions.

Creditors did not actually contemplate that the consumer would

engage in a series of transactions, and, for the most part, these ar-

rangements amounted to a sham designed to avoid making the more
significant disclosures required in closed-end transactions.'^^ Open-

end credit is now defined to mean "a plan under which the creditor
reasonably contemplates repeated transactions."'" Under this lan-
guage a creditor will be able to treat an extension as open-end only

if she contemplates repeated transactions.

b. Scope of TIL.— TILS brings about a fundamental change in
the scope of TIL. With reference to credit transactions, TIL defines

iso-i

161 (

"15 U.S.C. § 1601-91 (1976).

"See, e.g., Glaire v. LaLanne Paris Health Spa, Inc.. 528 P.2d 357 (Cal. 1974);

Regulation Z. 12 C.F.R. § 226.2(s) and (L) (1980).

'Tub. L. No. 96-221. § 602(a). 94 Stat. 168 (1980) (amending 15 U.S.C. § 1602(f)

(1976)).

'''See S. Rep. No. 73. 96th Cong.. 2d Sess. 10 (1979) reprinted in [1980] U.S. CODE

Cong. & Ad. News 834. 885.
"^Pub. L. No. 96-221, § 604. 94 Stat. 169 (1980) (amending 15 U.S.C. § 1602(i)

(1976)).



1981] SURVEY- CONTRACTS 249

the adjective "consumer" to include extensions for personal, family,

household, or agricultural purposes. '^^ As a result, agricultural credit
extended to a natural person is consumer credit under TIL and,
among other things, disclosures are required. TILS changes the defi-
nition of the word "consumer" in TIL to cover only extensions for
personal, family or household purposes. Now exempt from TIL are
"[c]redit transactions involving extensions of credit primarily for

business, commercial, or agricultural purposes."^^^ This new defini-
tion and exclusion are in furtherance of the premise that agricultural

credit is essentially commercial in nature and that TIL protections
are unnecessary.'" Although in some states this change in scope of
TIL will eliminate complexity, it may cause significant headaches for
Indiana creditors who extend credit for agricultural purposes
because the disclosure requirements of the Indiana Uniform Con-

sumer Credit Code may continue to apply. '^*

The scope of TIL has been expanded to include one increasingly
important transaction — extension of credit secured by an interest in
a mobile home. Again, this change can be understood best by way of
an illustration. Assume that a consumer borrows more than $25,000.
Currently this extension is not covered by TIL. The assumption is
that customers who have the capacity to borrow large amounts are
not in need of disclosures. However, where the consumer credit is
secured by an interest in real property, this assumption may not
operate. The most important credit transaction for many consumers
is the purchase of a home through a loan secured by a mortgage.
Borrowers in this context are assumed to need TIL protection. As a
result, TIL applies to all extensions of consumer credit, regardless
of the amount, in connection with which a security interest in real

property is or will be retained or acquired.'^® However, credit ex-

tended for the purpose of acquiring a mobile home is not subject to
this exception because no security interest in real property is ac-

quired. An extension of credit in excess of $25,000 secured by a
mobile home is not covered by TIL because it falls within the gen-

'«15 U.S.C. § 1602(h) (1976).

'^Pub. L. No. 96-221. § 603(c)(1). 94 Stat. 169 (1980) (amending 15 U.S.C. § 1603(1)
(1976)) (emphasis added).

'"Sec note 153 supra.

'"IND. Code § 24-4.5-2-301(3) (1976) provides that "information which would other-
wise be required pursuant to the Federal Consumer Credit Protection Act is sufficient
even though the transaction is one of a class of credit transactions exempted from that
Act pursuant to regulation of the Board of Governors of the Federal Reserve System."
Generally, it is believed that this language will not exempt agricultural credit from
state UCCC requirements for disclosure. See Miller, Living with Both the UCCC and
Regulation Z, 26 Okla. L. Rev. 1 (1973).

'^'15 U.S.C. § 1603(3) (1976).



250 INDIANA LAW REVIEW [Vol. 14:223

eral exclusion of large credit extensions. TILS changes this result
and gives parallel treatment to transactions secured by mobile

homes or real property. Under TILS, credit transactions in which
the amount financed exceeds $25,000 are excluded "other than those
in which a security interest is or will be acquired in real property,

or in personal property used or expected to be used as the principal

dwelling of the consumer."^^"

c. Model Forms. —TILS provides that "[t]he board [of Governors
of the Federal Reserve System] shall publish model disclosure forms

and clauses for common transactions to facilitate compliance with the
disclosure requirements."'*' Other than numerical disclosures, if

creditors use forms published by the Board, they shall be deemed to
be in compliance with TIL disclosure requirements.'*^ This should
aid small creditors who have had difficulty in drafting or adapting
their own forms. The model forms will be of less significance to ma-
jor creditors who, because of the complexity of their transactions,

may not be able to adapt the model disclosure forms as readily.
Also, large creditors may have a sufficient volume of transactions to
justify the expense of drafting complying forms suited to specialized

transactions.

d. Effective dates for regulations. — TILS also provides that
new regulations, amendments, or interpretations which require any
disclosure differing from the disclosure previously required "shall

have an effective date of that October 1 which follows by at least six

months the date of promulgation."'®' The likely effect of this provi-
sion will be to cause most changes to take effect on October first of

any given year with at least six months warning to give creditors

time to prepare. This will aid creditors in changing their forms and

gearing the purchase of forms to these effective dates. However,

TILS provides that a creditor may comply with a new regulation
prior to the October first effective date.'"

e. Disclosures. —TILS brings about major changes in the mat-
ters which must be disclosed. First, under TILS the key disclosures
in other than open-end transactions must "be conspicuously segre-
gated from all other terms, data, or information provided in connection
with the transaction including any computations or itemization.""^

""Pub. L. No. 96-221, § 603(c)(2), 94 Stat. 169 (1980) (amending 15 U.S.C. § 1603(3)

(1976)).

""Pub. L. No. 96-221, § 605, 94 Stat. 170 (1980) (amending 15 U.S.C. § 1605 (1976)).

'"Id.

'''Id.

"*Id.

"Tub. L. No. 96-221, § 614(b). 94 Stat. 179 (1980) (amending 15 U.S.C. § 1638(b)
(1976)).



1981] SURVEY- CONTRACTS 251

Second, some disclosures have been simplified.'** For example, TIL
requires disclosure of "[a] description of any security interest held

or to be retained or acquired by the creditor in connection with the

extension of credit."'*^ Under TILS, a creditor need only disclose a
statement that a security interest has been taken in property pur-

chased as part of the transaction or other property identified by

item or type.'** Similarly, under TIL the creditor must disclose "[t]he
amount or method of computing any default, delinquency, or similar

charges payable in the event of late payments."'*® TILS provides
that the creditor must disclose "[a] statement that the consumer

should refer to the appropriate contract document for any informa-

tion such document provides about nonpayment, default, the right to
accelerate the maturity of the debt, and prepayment rebates and

penalties."'^" This should reduce litigation over whether such things

as acceleration clauses constitute default charges which must be
disclosed.'" Third, TIL requires an itemization of disclosures such as
the amount financed and the finance charge.'" TILS eliminates this
requirement of itemization and provides, for example, that "[i]n con-

junction with the disclosure of the amount financed, a creditor shall
provide a statement of the consumer's right to obtain, upon a writ-

ten request, a written itemization of the amount financed."'" Fourth,
there are some interesting new disclosures required in the context
of consumer real property mortgaged transactions. Under TIL the
creditor is required to disclose the finance charge and the total of

payments, except in cases where the credit is extended in a sale of a
dwelling or a loan secured by a first lien on a dwelling. '^^ This excep-

tion to the disclosure requirement was built on the assumption that,
in these transactions, the total of payments and finance charge could
be so forbidding that consumers would be frightened and would
withdraw from home purchase transactions. This concern seemed
doubtful and had been refuted by experience in some states where

'"See generally, S. Rep. No. 73, 96th Cong.. 1st Sess. 3.
'"15 U.S.C. § 1638(a)(10) (1976).

"•Pub. L. No. 96-221, § 614(a)(9), 94 Stat. 179 (1980) (amending 15 U.S.C. § 1638

(1976)).

'"Regulation Z. 12 C.F.R. § 226.8(b)(4) (1980).

"Tub. L. No. 96-221, § 614(a)(12). 94 Stat. 179 (1980) (amending 15 U.S.C. § 1638
(1976)).

"'See notes 176-80 infra and accompanying text.

'"Regulation Z, 12 C.F.R. § 226.8(c)(4) (1980) (amount financed); id. § 226.8(c)(8)

(finance charge); id. § 226.8(d)(1) (amount financed); id. § 226.8(d)(3) (finance charge).

"Tub. L. No. 96-221. § 614(a)(2)(B). 94 Stat. 178 (1980) (amending 15 U.S.C. §
1638(a)).

"•Regulation Z. 12 C.F.R. § 226.8(c)(8) (1980); id. § 226.8(d)(3).



252 INDIANA LAW REVIEW [Vol. 14:223

disclosures were required by state law."^ TILS requires disclosure
of the total finance charge and the total of payments in all transac-
tions. Finally, TILS requires disclosure "[i]n any residential mort-
gage transaction, [of] a statement indicating whether a subsequent
purchaser or assignee of the consumer may assume the debt obliga-
tion on its original terms and conditions.""^

/. Remedies. —TILS makes a number of changes in the remedy
provisions of TIL. First, an award of civil penalties and attorneys'
fees to consumers in private litigation for TIL violations will be
available only in the event the creditor fails to comply with one of

the important disclosure requirements."^ This may reduce some of
the litigation over technical disclosure defects. Second, TILS pro-
vides that the agencies which have responsibility for enforcing TIL
are now authorized to seek restitution from creditors who have
violated the truth in lending laws. The new law provides:

In carrying out its enforcement activities under this section,

each agency ... in cases where an annual percentage rate or
finance charge was inaccurately disclosed, shall notify the
creditor of such disclosure error and is authorized ... to re-

quire the creditor to make an adjustment to the account of
the person to whom credit was extended, to assure that such
person will not be required to pay a finance charge in excess

of the finance charge actually disclosed or the dollar equiva-

lent of the annual percentage rate actually disclosed, which-

ever is lower."*

The agency must require an adjustment when it determines that the
disclosure error resulted from a clear and consistent pattern or

practice of violations, gross negligence, or a willful violation in-

tended to mislead the persons to whom the credit was extended."'
However, there are some mitigating factors. For example, no adjust-
ment should be ordered if the adjustment would have a significantly
adverse impact upon the safety or soundness of the creditor.'*" This

potential for a broad restitution remedy poses a significant new ex-
posure for creditors.

"'S. Rep. No. 73, 96th Cong.. 2d Sess. 17, reprinted in [1980] U.S. Code Cong. &
Ad. News 834, 892.

"•Pub. L. No. 96-221, § 614(a). 94 Stat. 178 (1980) (amending 15 U.S.C. § 1638(a)(13)

(1976)).

'"15 U.S.C. § 1640(a)(3) (1976).

'"Pub. L. No. 96-221. § 608(a). 94 Stat. 171 (1980) (amending 15 U.S.C. § 1607

(1976)).

'"Id.

'"Id.



1981] SURVEY- CONTRACTS 253

Finally, there are some miscellaneous changes in remedies. For
example, multiple obligors may only recover one civil penalty.'*' This
reverses the position taken by the United States Court of Appeals

for the Seventh Circuit.'*^ Also, the period of time during which a

creditor may discover and correct an error without being exposed to
liability for civil penalties has been extended from fifteen to sixty

days.'**

2. Acceleration Clauses and Deference to Federal Reserve

Opinion. —As Section J. I.e. of this Survey suggests, TILS has elimi-
nated the requirement for disclosure of the amount or method of

computing default, delinquency, or charges payable in the event of

late payments. Instead, the creditor must state that the customer
should refer to the contract document for information on late pay-
ment charges or, in particular, acceleration rights. However, this
past year, before TILS, the United States Supreme Court decided
an issue involving this disclosure requirement which had been re-

solved in different ways by various courts and by the Federal Re-
serve Board staff.'*^ The issue is whether an acceleration clause is a
term which must be disclosed as a charge payable in the event of
late payment. In the course of deciding that acceleration clauses, in

and of themselves, were not late payment charges,'*^ the Supreme
Court made some interesting observations concerning the deference
which should be given to Federal Reserve Board staff opinions con-

struing TIL. The court said that "[u]nless demonstrably irrational.
Federal Reserve Board staff opinions construing the Act or Regula-

tion should be dispositive."'*® This is because of the general proposi-

tion that respect is due interpretations offered by agencies charged

with administration of a law, especially with respect to interpreta-

tion of regulations which were created by the agency offering the in-
terpretation. Also, Congress has recognized the influence of the

Federal Reserve Board's staff opinions by giving creditors a defense

based on good faith compliance with official staff opinions. Finally,

the sheer complexity of TIL calls for deference to the agency. In the
context of this complexity the correct answer to a problem is often a
result of compromise. "[SJtriking the appropriate balance is an em-

"Tub. L. No. 96-221, § 615(a), 94 Stat. 180 (1980) (amending 15 U.S.C. § 6140(d)
(1976)).

"'Mirabal v. General Motors Acceptance Corp.. 537 F.2d 871 (7th Cir. 1976).

^Pub. L. No. 96-221, § 615(a), 94 Stat. 180 (1980) (amending 15 U.S.C. § 1640(b)

(1976)).

"*Ford Motor Credit Co. v. Milhollin, 444 U.S. 555 (1980). The various views ex-
pressed in the courts and by the Federal Reserve are set forth in the opinion.

'''Id, at 561.

"7d. at 565.

182JI

18311



254 INDIANA LAW REVIEW [Vol. 14:223

pirical process that entails investigation into consumer psychology

and that presupposes broad experience with credit practices."'"

The Federal Reserve Board staff had repeated the opinion that

if a "creditor rebates unearned finance charges in connection with

prepayment upon acceleration using the same method as for volun-

tary prepayment and that method has been properly disclosed . . .

there is no default charge."'** The Supreme Court embraced this
reasoning and reversed the court of appeals decision which rejected

it.'*'

3. Informal Workout Agreements. —In Bright v. Ball Memorial
Hospital Association,^^'' the court of appeals for the seventh circuit

had occasion to decide whether a hospital collection procedure
amounted to a credit transaction within the meaning of TIL and
whether TIL disclosures were required. This case involved Ball
Memorial Hospital which operates a general public hospital admit-
ting all persons without regard to ability to pay. Patients who do
not pay bills upon discharge from the hospital are sent an initial bill
on the fourth day after discharge which delineates the specific

charges assessed to their accounts. On the reverse side of this initial
bill is a schedule of information headed "FINANCE CHARGE"
which informs the patient that a finance charge of three-fourths of

one per cent per month or a fifty cent handling charge, whichever is
greater, will be added to any balance unpaid for thirty days or more.

No such charge is imposed if the bill is paid in full within the thirty
days. If the patient has not made payment on the eighteenth day
after discharge, the patient is mailed the first billing statement

which indicates a total amount due. This bill states that "[y]our ac-
count is now due and payable. Please remit today." On the reverse
side of this statement there is again a schedule of information headed

"FINANCE CHARGE" which is the same as the schedule sent on
the initial bill except that there is some additional information con-
cerning the amounts that will hav6 to be paid monthly in order to
complete payment of the amount due. Where no payment arrange-
ments have been made on the forty-eighth day after discharge, the
patient is sent a second billing statement identical to the first billing

statement, except that the face of the second statement contains a

warning in the following language: "No doubt you have overlooked
payment of your account, please make your remittance now." At
this point the Ball Memorial Hospital considers the account to be

"7d. at 568-69.

'"/d. at 563-65 n.8 (quoting Federal Reserve Board information letter number

1324).

"»444 U.S. at 570.

"«616 F.2d 328 (7th Cir. 1980).



1981] SURVEY- CONTRA CTS 255

delinquent. If no payment arrangements are made, the hospital

sends a third statement on the sixty-second day after discharge. The

statement is identical to the first two, except that it contains

stronger language. Along with this statement, in-patients

automatically receive a coupon payment book which offers the patient

various monthly plans for repayment. On the seventy-sixth day after

discharge a patient who has not arranged to pay or begun paying

her bill is sent a fourth statement identical to the first three except

that it bears an even stronger statement on the delinquency. The

fifth and final statement is mailed on the ninetieth day. It is

stamped "Final Notice" in red ink and warns that the account will

soon be turned over to a collection agency. At the same time these

written statements are being sent, the hospital attempts to make

contact with the patient by telephone. The decision to turn the ac-

count over to a collection agency is made on a case by case basis

after the fifth and final statement, but no accounts are turned over to

a collection agency if the patient is making some form of payment.
'*'

Two patients who received these statements from the hospital
filed a class action alleging TIL violations. The United States dis-
trict court dismissed the action, apparently holding that as to its

billing practices, the hospital was not a creditor within the meaning
of TIL."^ The court of appeals concluded that as to some of its pa-
tients, the hospital was a creditor,'®^ however, it affirmed the dis-
trict court's dismissal of the case on the grounds that the hospital

did not consummate a credit transaction with either of the named
plaintiffs."^ One of the plaintiffs, nearly four months after discharge,
entered into an oral agreement with the hospital to pay her bill at
fifteen dollars per month. Several days later the oralagreement was
modified to require payments of twenty dollars per month. No pay-
ments were made pursuant to any of these agreements, but several
months later the plaintiff paid thirty dollars to the hospital, which

amount was credited to her account. Thereafter, another oral agree-
ment was made providing that the entire obligation of about $930
would be satisfied if the plaintiff paid fifteen dollars per month ior
twenty-four months."^ The court of appeals concluded that these
oral agreements did not constitute "consummation of a credit trans-

action.""® Instead, they were informal workout arrangements. The

'"The billing procedures are set forth in a portion of the opinion entitled "Back-

ground." Id. at 330-32.

'''Id. at 333.

"Yd at 336.
^Vd at 338-39.
"Yd at 332.
"«/d at 335.



256 INDIANA LAWREVIEW [Vol. 14:223

terms of these oral agreements were not consistent with any of the
payment plans set forth in the statements sent by the hospital and
they were not memorialized by any writing. They were thus not
credit transactions within the meaning of the TIL laws and did not
require disclosures despite the fact that they called for payment in
more than four installments and may have entailed a monthly
charge of three quarters of one per cent on any outstanding balance.

The fact that the plaintiff actually paid thirty dollars did not satisfy
either of the earlier workout agreements or the terms of the coupon

book or statements. It amounted to a one-time partial payment of
the account. The hospital's acceptance of this payment did not con-
stitute an agreement to a credit transaction.

4. Finance Charges v. Late Payment Charges. — In the Bright
case, the plaintiffs further argued that a credit agreement had been

consummated because the hospital had imposed a finance charge in
connection with their billing procedure. The plaintiffs pointed out
that the hospital actually assessed a monthly charge of three

quarter per cent of any outstanding balance or fifty cents,

whichever was greater, and attempted to collect these charges.''^
The court of appeals concluded that these charges were not finance
charges, but, instead, were late payment charges.'** A late payment
charge is distinguished from a finance charge by Regulation Z, sec-

tion 226.4(c) which provides that "[a] late payment . . . charge is not
a finance charge if imposed for actual unanticipated late payment,

delinquency, default, or other such occurrence."'*^ The plaintiffs
argued that the hospital anticipated a substantial volume of these

charges and budgeted income of $78,000 a year from this type of

charge. However, the court noted that this income was not an-
ticipated in individual cases, but was anticipated as a result of a
year's business.^"" It concluded that charges do not become finance
charges simply because a business may expect to have delinquent
accounts and anticipate revenue from these charges.^*" Rather, the

word "unanticipated" in Regulation Z section 226.4(c) refers to the
failure of any particular customer to pay her bill on time.^"^ Because

the charge was not a finance charge its imposition did not consum-
mate a credit transaction and the district court's dismissal was af-

firmed.^"^

"7d. at 338.

''^2 C.F.R. § 226.4(c) (1980) (emphasis added).
^'"'616 F.2d at 337.

^"Yd at 338-39.