The Sad Tale of Norvergence Illustrates the Unique Law Applicable to Finance Companies

Most people think that if a product does not work, you should not have to pay for it. This is usually true. It is not true when a finance company or a commercial factor purchases the promise to pay from the original vendor.


So, the transaction works like this. Vendor A sells a product or leases a product to Customer B. The contract says that Customer B will make payments for a five-year period. Vendor A then sells the right to collect payments to Commercial Factor C (a finance company) for cash. Vendor A remains liable on the contract and is required to complete performance. So if the equipment needs to be serviced, Vendor A is required to do it for the entire five year period. How does Commercial Factor C make money? It discounts the expected payments by the cost of money plus a profit percentage. Usually the finance company will earn a profit. However, if the underlying vendor disappears, the finance company will have to resort to litigation to collect.


The United States Court of Appeals for the Seventh Circuit decided two significant equipment leasing cases in 2008. Both cases involved Norvergence, a bankrupt supplier of phone equipment.


The cases are: IFC Credit Corp. v. United Business & Industrial Federal Credit Union, 512 F.3d 989 (7th Cir. 2008) and IFC Credit Corp. v. Burton Industries, Inc. 536 F.3d 610 (7th Cir. 2008). These are some of the many lawsuits spawned by Norvergence.


Norvergence sold a piece of telephone equipment and required its customers to sign a contract requiring them to make payments for many months.


According to the Court, the product sold by Norvergence, was not in any way special. Indeed, it was an ordinary telephone switching box. Ultimately, Norvergence collapsed and stopped providing services. When Norvergence collapsed, many of its customers stopped paying for the service.


The Plaintiff, IFC Credit was a commercial factor that "bought the right to payments under Novergence contracts." IFC Credit brought numerous lawsuits to enforce the contracts it purchased from Norvergence. IFC Credit claimed to be a holder in due course, which meant that it had no knowledge of any problems with the equipment when it purchased the Norvergence contracts.


In the cases, the customer would attempt to assert a defense to IFC Credit's claim for payment. The customer would typically claim that Norvergence lied when it sold the equipment or that the equipment did not work "as promised."


Judge Easterbrook rejected these arguments: "But IFC, and simliar entities claim to be holders in due course. If they have this status, then personal defenses that the customers could have asserted agasint Norvergence are unavailable, and the customers must pay IFC even though Norvergence told lies to make the sales"


The specific issue in the case was whether the provision in Norvergence's contract waiving a jury trial was enforceable. The Seventh Circuit held that the waiver was binding and reversed the district court's decision.


This case is an excellent example of how finance companies and commercial factors are immune from typical contract defenses to payment. The law, though well-settled, is contrary to the lawyer's typical gut reaction that the customer should be able to raise a defense if the equipment did not work "as promised."


Edward X. Clinton, Jr.
Copyright 2009