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Carnegie Bank v. Shalleck

Decided: April 9, 1992.


On appeal from Superior Court of New Jersey, Chancery Division, Mercer County.

J.h. Coleman, Stern and Keefe. The opinion of the court was delivered by Coleman, J.h., P.J.A.D.



The novel issue raised in this appeal is whether a mortgage note or promissory note requiring repayment at a variable interest rate renders the instrument non-negotiable. Another significant issue raised is whether N.J.S.A. 46:9-9, which permits a mortgagor to raise personal defenses and claims against an assignee of the mortgage, applies to a holder in due course of a mortgage note or promissory note secured by a mortgage.

Plaintiff Carnegie Bank instituted suit on a variable interest rate note and sought to foreclose a mortgage given to secure the note. The mortgagor-maker of the note defended the suit by raising, among others, the personal defense of fraud in the inducement. As to the note he asserted that the variable interest rate note violates the "sum certain" requirement for negotiability in N.J.S.A. 12A:3-104 thereby preventing plaintiff from becoming a holder in due course. He defended the foreclosure action by contending there was fraud in the inducement of the note and mortgage which he could assert against plaintiff pursuant to N.J.S.A. 46:9-9 regardless of whether plaintiff was a holder in due course. The trial Judge held that plaintiff did not become a holder in due course, and if it did, the mortgagor could still assert personal defenses in the mortgage foreclosure action pursuant to N.J.S.A. 46:9-9. We disagree with both holdings and reverse.


The facts giving rise to this litigation involve a convoluted commercial loan transaction, the details of which are essential to a determination of whether plaintiff received the variable interest rate note in good faith. For some time prior to 1986, defendant Aegis Energy Systems, Inc. (Aegis Energy) was a corporation engaged in the design, manufacture, sale and installation of energy saving devices for commercial establishments. Defendant Alan B. Shalleck served as its president. In June 1984 Industrial Valley Bank and Trust Company (IVB) issued a $150,000 line of credit to Aegis Energy and in turn Aegis Energy issued its note to IVB. Shalleck personally guaranteed repayment of the loan. As part of the loan transaction, Aegis Energy gave a covenant to maintain a net worth of $200,000, calculated by subtracting liabilities from assets. In November 1985 when Aegis Energy failed to satisfy the net worth covenant, Shalleck gave a second mortgage in the sum of $150,000 on his private residence, dated November 20, 1985, to collateralize his personal guarantee of the IVB loan.

In 1986 Shalleck sought new investors for Aegis Energy to fund its operation, and he projected $500,000 would be needed. Peter Nisselson agreed to invest $325,000 if a new corporation was formed. To satisfy that condition, Aegis Systems Corporations, Inc. (Aegis Systems) was incorporated in September 1986. Aegis Systems agreed to guarantee payment of the IVB loan. Nisselson became the owner of all of Aegis Systems' outstanding stock. Shalleck became president of Aegis Systems.

As was expected by Shalleck, Nisselson's investment was not sufficient to design, manufacture and market the energy saving devices. Therefore, Shalleck in or about September 1987 renewed his search for additional venture capital for Aegis Systems. At the Conclusion of a luncheon meeting at The Princeton Venture Capital Club in September 1987, where Shalleck had made a presentation, Shalleck met defendant Dale Hagan. Hagan introduced himself as president of defendant Crossroads Marketing, Inc. (Crossroads) which was in the business of raising venture capital for businesses.

By January 1988, Aegis Systems needed additional money since it had spent most of its development capital, and Fidelity Bank, the successor to IVB, was considering calling the IVB loan because Aegis Systems' net worth had fallen below $200,000. In an attempt to stay afloat, Aegis Systems entered into a six month contract with Crossroads in February 1988 to raise additional venture capital.

In late February or March 1988, Hagan approached the president of plaintiff Carnegie Bank, Thomas L. Gray, on behalf of Aegis Systems because Hagan knew this was a new bank and was actively soliciting business. Before Carnegie officially opened on March 21, 1988, Hagan and Gray visited Aegis Systems and met with Shalleck. Shortly after that meeting, Gray decided that Carnegie would not make a loan to Aegis Systems ostensibly because it "wasn't a real business." Carnegie did, however, extend a $10,000 line of credit to Hagan

on opening day when Hagan opened a checking account and subscribed to purchase shares of Carnegie stock.

In April 1988, Hagan and Gray met at a social affair. During the social meeting, Gray inquired whether a loan had been arranged for Aegis Systems. At that point Hagan proposed that Carnegie make a loan to Hagan or to Crossroads which would in turn make the loan to Aegis Systems. Gray instructed Hagan to call him on the next regular business day. At about this same time, Hagan proposed to Shalleck that Hagan or Crossroads would fund Aegis Systems by borrowing $150,000 from Carnegie and lending that money to Aegis Systems in exchange for a note from Aegis Systems. As part of that accommodation, Shalleck would have to give a mortgage on Shalleck's private residence to collateralize the note. Also, Shalleck would have to arrange for a transfer of the controlling interest in Aegis Systems to Hagan. Gray agreed that those conditions would be essential requirements for a loan to Hagan for Aegis Systems' benefit.

Ultimately, however, Gray approved a loan for the benefit of Aegis Systems that was different than noted above. Hagan represented to Gray and Carnegie that defendant Ann J. Anderson was his wife. Hagan persuaded Carnegie to make the loan to Anderson. Carnegie, with the knowledge of its president Gray, made a $150,000 loan to Anderson for the benefit of Aegis Systems. An additional $50,000 loan was to be made by Hagan to Aegis Systems; both loans were to be secured by a mortgage on Shalleck's private residence. The loan documents were drafted by counsel for Carnegie. Hagan also promised to have Crossroads supply some weekly operating capital to Aegis Systems. The present litigation is based upon the promissory notes, personal guarantees and mortgage executed at the loan closing.

The loan documents reveal that on July 11, 1988, defendant Anderson borrowed $150,000 from Carnegie and executed a "Mortgage Note" payable to the order of "Carnegie Bank."

The note required Anderson to repay the principal sum "with interest thereon from the date hereof at the annual rate of two (2%) percent in excess of the Lender's [Carnegie Bank] Floating Base Rate, as adjusted from time to time, calculated on the basis of a 360-day year for actual days elapsed . . . ." That note also provided that it was secured by Anderson "assigning [her] interest in a certain Note in an original principal amount of $200,000.00 of even date herewith give[n] by Alan B. Shalleck, Aegis Energy Systems, Inc., and Aegis Systems Corporation, which Note is secured in part by a certain Mortgage of even date herewith by Alan B. Shalleck and Georgia Myers Shalleck . . . ." This instrument shall be referred to as the Anderson note.

Simultaneously with the execution of the Anderson note, defendants Alan B. and Georgia Myers Shalleck, as husband and wife, executed a mortgage to "Ann J. Anderson, a married individual" for $200,000 with interest at "[t]wo (2%) percent in excess of the Floating Base Rate of Carnegie Bank, as adjusted from time to time, provided, however, that at no time shall the rate be less than fifteen (15%) percent per annum." The stated consideration for the mortgage was "a loan that Alan B. Shalleck, Aegis Energy Systems, Inc. and Aegis Systems Corporation received." The mortgage covered the same premises encumbered by the IVB mortgage.

The mortgage note which was executed with the $200,000 mortgage listed the borrowers as Alan B. Shalleck, Aegis Energy Systems, Inc., and Aegis Systems Corporation. Alan B. Shalleck signed the note in his individual capacity as well as president of each of the two corporations. Dale Hagan signed it as "Assistant Secretary" without any further specificity. The note provides for payment of interest at the same variable rate specified in the mortgage. These two instruments shall be referred to as the Shalleck note and mortgage.

Also on July 11, 1988, Ann J. Anderson, "a married woman," for and in consideration of $150,000, assigned the $200,000

Shalleck mortgage as security together with the Shalleck note to Carnegie Bank. To complete the $200,000 loan transaction, Hagan gave a demand note for $50,000 to Aegis Systems. Hagan also promised to have Crossroads invest between $4,000 and $7,000 per week in Aegis Systems as working capital. Hagan also guaranteed Carnegie repayment of the $150,000 loan made to Anderson. Anderson received a security interest in Aegis Systems' inventory, fixtures, equipment and receivables.

The $150,000 loan proceeds were disbursed as follows: $102,421.70 to pay off the IVB mortgage held by its successor Fidelity Bank, for which Anderson took an assignment of that mortgage rather than discharge it; $3,000 to Carnegie as a loan fee; $6,125 legal fees; $37,682.40 to Aegis Systems as working capital; and the balance in miscellaneous closing fees.

Hagan failed in his promise to pay the $50,000 note on demand. He also failed to invest any money from Crossroads into Aegis Systems. When the $37,682.40 from the Carnegie loan was exhausted, Aegis Systems defaulted on its loan obligation as well as its obligations to its workers and creditors.


Plaintiff instituted the present litigation on April 18, 1989, and the complaint was amended on June 16, 1989. Plaintiff sought foreclosure under the Shalleck mortgage, cancellation and discharge of the IVB mortgage from the record which had been assigned to Anderson, judgment against Anderson on her note, judgment against Hagan on his guaranty, judgment against Shalleck on his note and judgment against Anderson and Hagan under a personal line of credit advanced to them.

The Shalleck defendants filed an answer in which they raised several defenses, including fraud in the inducement by Anderson and Hagan respecting the Shalleck mortgage and note and the failure of plaintiff to become a holder in due course of the Shalleck note. The Shalleck defendants also filed

a cross-claim against Anderson, Hagan and Crossroads. Anderson and Hagan filed answers and cross-claims and Crossroads filed an answer.

A bench trial was conducted in December 1990. The trial Judge rendered his decision on December 21, 1990. Pertinent to this appeal, are the following findings of fact and legal Conclusions that: (1) Anderson and Hagan defrauded Shalleck and Carnegie without Carnegie's knowledge, (2) Carnegie did not become a holder in due course of the Shalleck note because the note did not require the payment of a "sum certain," and (3) even if Carnegie became a holder in due course, Shalleck could still assert the personal defense of fraud against Carnegie by virtue of N.J.S.A. 46:9-9.

Carnegie has appealed, contending essentially that it is a holder in due course and that N.J.S.A. 46:9-9 does not apply to holders of negotiable instruments secured by a mortgage. The Shallecks have cross-appealed from that portion of the final judgment holding Carnegie took ...

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