Midwest Case Report- NJK Holding Corp. v. Araz Group, Inc.

NJK Holding Corp. v. Araz Group, Inc., 878 N.W.2d 515 (Minn. Ct. App. 2016)

The Minnesota Court of Appeals (“Appellate Court”)‑held that under Minnesota law, a promise to forgive debt is a credit agreement and must be in writing in order to be enforceable. 

In December 1997, the Araz Group (“Araz”)‑executed a promissory note in the original principal amount of $320,000 in favor of NJK Holding Corporation (“NJK”)‑for consideration received.  Shortly thereafter, in May 1998, the parties executed (i)‑a credit agreement (the “Credit Agreement”), (ii)‑an amended and restated promissory note and (iii)‑a security agreement (collectively, “Loan Documents”)‑pursuant to which NJK granted Araz a $700,000 line of credit, inclusive of the original loan of $320,000.  Over time, additional amounts were disbursed under the Credit Agreement until Araz owed NJK the total principal amount of $700,000 (”Loan”).  Araz recorded the loan from NJK as a liability on its financial statements from 1998 until it was removed in 2011.  Even though no payments were made on the loan until 2003, Araz periodically requested confirmation of the indebtedness from NJK.  Such confirmation was provided to Araz’s auditors.

In addition to the borrower‑lender relationship between Araz and NJK, Araz’s chief executive officer’s (“CEO”)‑sister was married to the chief executive officer of NJK until a divorce in August 2014.  The record contains testimony that when the original loan was offered to Araz, Araz’s CEO stated that she did not want the loan and could not pay it back.  Araz’s CEO also testified that on numerous occasions she was told by both her sister and the CEO of NJK that she did not have to pay the Loan back and that it had been written off.  The CEO of Araz also testified that she was asked to execute the Loan Documents so that NJK could obtain a tax write‑off.  After several attempts to collect the debt, in 2001 NJK determined that further collection attempts were pointless and, thereafter, NJK wrote off the entire Loan as a bad debt.  Subsequently to the write‑off, NJK received 13 sporadic payments and such payments were reported to the IRS as income. 

Evidence was also presented that in 2010, at a birthday party for the President of Araz (brother of the CEO of Araz), the CEO of NJK accused the CEO of Araz of stealing money and stated that NJK had to write off the debt.  The CEO of Araz testified that she believed that the statements made at the birthday party meant that NJK had forgiven the debt, despite subsequently making the 13 payments on the debt.  Araz admitted that it did not receive a form reporting cancellation of debt to the IRS from NJK nor did Araz report cancellation of indebtedness income on its 2010, 2011, 2012 or 2013 federal tax returns.  The President of Araz explained that the 13 subsequent debt payments were made as a way to keep peace in the family.  In September 2012, NJK sent its first written demand for payment of the debt to Araz.  Subsequently, NJK filed a lawsuit for breach of contract in the District Court of Minnesota (“District Court”)‑and moved for summary judgment on its claim.

The District Court:

The District Court granted NJK summary judgment as to Araz’s defense that NJK forgave the debt because no writing of debt forgiveness existed.  Due to issues of material fact, however, the District Court denied summary judgment to NJK as to Araz’s defense that the money loaned to Araz was originally a gift.  Following the District Court ruling, a trial was held pursuant to which a jury found that Araz failed to prove that the money was a gift from NJK to Araz.  In connection therewith, a judgment was entered in favor of NJK in excess of $1.3 million, plus attorney fees and costs.  Araz appealed to the Appellate Court.

The Appeal:

On appeal, Araz claimed that the District Court erred by rejecting its debt forgiveness defense by determining that NJK’s alleged promise to forgive the debt requires a writing under Minnesota Statute §513.33 (“Minnesota Statute”)‑to be enforceable.  Araz argued that the District Court agreements to forgive debt do not fall under the Minnesota Statute and that since NJK’s alleged promise to forgive the debt did not modify the underlying debt agreement, change the conditions of repayment or otherwise accommodate Araz, such was not a credit agreement under the Minnesota Statute which mandated a writing to be enforceable.  In addressing Araz’s argument, the Appellate Court first analyzed the language of the Minnesota Statute.  The Appellate Court concluded that the Minnesota Statute was ambiguous because it reasonably may be interpreted to either include or exclude debt forgiveness as a credit agreement in the nature of a forbearance or other financial accommodation.  The Appellate Court then looked to prior Minnesota case law, but acknowledged that no Minnesota authority directly addresses whether a promise to forgive debt is a credit agreement under the Minnesota Statute.  In light of the absent of precedent within Minnesota, the Appellate Court looked to case law in other states.  Citing other cases and guided by the statutory presumption that the legislature does not intend to produce absurd, impossible or unreasonable results, the Appellate Court found that a promise to forgive debt was a credit agreement within the Minnesota Statute and therefore, required a writing to be enforceable.  The Appellate Court was persuaded by the sound reasoning of the District Court that since the parties went to the trouble of documenting their original agreement in writing, it would be anomalous to require a writing for a temporary forbearance, a modification of the loan terms, or some other financial accommodation, while allowing the debtor to claim an oral forgiveness of the entire debt.  The Appellate Court held that, since  there was no writing of the promise to forgive the debt, the debt‑forgiveness defense failed as a matter of law and judgment was entered in favor of NJK.