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Nester v. O’Donnell

301 N.J. Super. 198, 693 A.2d 1214 (App. Div. 1997)

CONTRACTS; FRAUD; JOINT LIABILITY—The buyer of a business discovered seller’s fraudulent practice during the due diligence process, but didn’t act until a customer of the business made claim against the company for a transaction arising before the closing of the sale. The statute of limitations barred the buyer’s claim against its seller. Also, without a clear indication that principals of buyer only signed promissory note as accommodation party, they are personally liable.

Harry and Mary Nester (“Buyers”) bought a wire mesh business from James O’Donnell (“Seller”) in 1985. The Buyers’ obligation was secured by two promissory notes and a mortgage note (“Notes”). Just before the balloon payments in the promissory notes were to come due in December, 1992, Buyers attempted to restructure the financing. After negotiations were unsuccessful, Buyers stopped making payments on the Notes and sued Seller for breach of contract. The Buyers alleged that when Seller operated the business he regularly engaged in the practice of substituting lower grades of stainless steel than was ordered while billing the customers for the higher grade they actually ordered, with the result that Buyers were fraudulently induced to purchase the business. Buyers brought suit to rescind the seven year old contract and sought compensatory damages. Seller defended on the ground that the suit was barred by the six year statute of limitations defense relating to contract claims, and counterclaimed for payment of money owed on the Notes. Each of the Notes provided that a default on one would accelerate the balance due on the others. Two years later, Seller filed a separate action for foreclosure on a purchase money mortgage. Buyers answered that nothing was due because they had a right of setoff and recoupment because of the fraud in the inducement of the original contract. The two actions were consolidated. The trial judge ruled in favor of Seller, holding Buyers in default under the Notes and determining that because the statute of limitations had run, Buyers’ original claim was barred, as were their defenses of setoff and recoupment. On appeal, Buyers contended: (1) the statute of limitations should not apply because they could not have discovered the basis of their fraud claim until 1992, after the statute of limitations had expired, (2) they should have been able to assert the defenses of setoff and recoupment, and (3) they were only accommodation makers under the Notes, not principals. The Appellate Division upheld dismissal based on the statute of limitations, held that Buyers should have been permitted to assert the defenses of setoff and recoupment, and found Buyers to be primarily liable as principals on the Notes.

The Court held Buyers had ample time during the due diligence process to discover Seller’s fraudulent activities. The discovery rule provides that a cause of action does not accrue until the injured party discovers or should have discovered a basis for an actionable claim. The Appellate Court upheld the trial judge’s finding that Buyers were aware of the substitution of inferior materials during the due diligence period, or at the latest, not more than three months after they purchased the business. Accordingly, the cause of action accrued at that time and the statute of limitations had expired by the time Buyers brought their original claim. As to the recoupment and setoff defenses raised by Buyers, the Court distinguished them, stating that setoff is an independent claim while recoupment may be used as an affirmative defense to reduce the other party’s recovery. Accordingly, recoupment is not barred by the statute of limitations as long as the claim it is raised against is timely. Finally, the Court addressed the issue of whether the language in the Notes made Buyers only accommodation makers and not principals. It found that Buyers executed the Notes as co-makers, agreeing to be jointly and severally liable as individuals, with no indication they were signing only as an accommodation to others. Therefore, the Court held that Seller may sue Buyers as principals and collect equal or unequal amounts from each as damages.


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