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09/25/97 KAREN OLSON ET AL. v. DEAN ETHERIDGE ET

September 25, 1997

KAREN OLSON ET AL., APPELLEES,
v.
DEAN ETHERIDGE ET AL. (AUGUST ENGELHAUPT, APPELLANT; CITIZENS FIRST NATIONAL BANK OF PRINCETON, APPELLEE).



The Honorable Justice Bilandic delivered the opinion of the court.

The opinion of the court was delivered by: Bilandic

The Honorable Justice BILANDIC delivered the opinion of the court:

Bay v. Williams, 112 Ill. 91, 1 N.E. 340 (1884), established the rule in Illinois that the rights of a third-party beneficiary in a contract are subject to immediate vesting and, once vested, cannot be altered or extinguished through a later agreement of the contracting parties without the assent of the beneficiary. Bay, 112 Ill. at 96-97. We are here called upon to determine the continued validity of the Bay rule.

The four plaintiffs in this case are third-party beneficiaries of a promise contained in a contract entered into by the appellant and another party. The circuit court of Bureau County awarded summary judgment to the plaintiffs based on Bay. The appellate court affirmed. We now reverse this award of summary judgment and remand for further proceedings, for the reasons set forth below.

FACTS

The facts are not in dispute. The four plaintiffs, Karen Olson, Nancy Stites, Cheryl Stevenson, and Carolin Polson, were the owners of Heitzler, Inc., a John Deere dealership in Walnut, Illinois. In 1979 they sold all the stock in Heitzler, Inc., to a group of three buyers, including Dean Etheridge, for $350,000 pursuant to the terms of a stock purchase agreement and a corresponding promissory note, hereinafter referred to as Agreement I and Note I. Agreement I and Note I obligated the buyers to make annual payments to the plaintiffs on December 1 of each year, along with 9% interest, and provided remedies to the plaintiffs in the event of a default. The buyers' payments were to be made directly to the plaintiffs' checking account at a bank in Walnut (the Walnut Bank). The buyers also pledged the shares of stock as security for the unpaid balance of the purchase price, with the shares to be held in an escrow account at the Walnut Bank until the debt was satisfied. The three buyers changed the corporate name of Heitzler, Inc., to Woodley Implement, Inc., and continued operation of the business.

Nearly four years later, in August of 1983, Dean Etheridge and the appellant, August Engelhaupt, executed a written agreement wherein Etheridge sold one-half of his stock in the corporation to Engelhaupt, hereinafter referred to as Agreement II. In Agreement II, Engelhaupt agreed "to assume" one-half of Etheridge's liability and obligation under Agreement I, which included the obligation to satisfy Note I. In exchange, Etheridge assigned one-half of his rights in Agreement I over to Engelhaupt. This assignment of rights was made subject to the terms of Agreement I. The entirety of Agreement I was incorporated by reference into Agreement II.

Agreement II obligated Engelhaupt to make annual payments on December 1 of each year, along with 9% interest, directly to the Walnut Bank. These payments were to be credited toward Etheridge's balance due to the plaintiffs under Agreement I and Note I. Specifically, under the terms of Agreement II, Engelhaupt agreed to pay a total purchase price of $88,900 for the corporate shares, as follows: $9,000 down, with the balance to be paid in the December 1 installments. A corresponding promissory note, hereinafter called Note II, was executed along with Agreement II for the remaining purchase price of $79,900. Note II reiterated the same payment schedule contained in Agreement II. Note II also stated that Engelhaupt's payments were to be made to the Walnut Bank "or at such other place as, from time to time, may be designated in writing."

From 1983 through 1985, Engelhaupt apparently made the payments due under Agreement II and Note II to the Walnut Bank, although the record is silent on this matter. On February 10, 1986, Etheridge directed Engelhaupt to pay the amount then due on Note II to another creditor of Etheridge, the Citizens First National Bank of Princeton (Princeton Bank). Sometime prior, Etheridge had assigned all his interest in Agreement II and Note II over to Princeton Bank as collateral security for another debt of Etheridge's.

Also on February 10, 1986, Engelhaupt and Princeton Bank entered into a written agreement entitled "Agreement Providing for Payment of Note," hereinafter referred to as Agreement III. Engelhaupt, in Agreement III, agreed "to satisfy the remaining indebtedness due on" Note II, by paying $83,385 to Princeton Bank. Princeton Bank agreed that this payment of $83,385 constituted full payment of Note II. Engelhaupt also paid Princeton Bank an extra $100 and, in exchange, Princeton Bank assigned to Engelhaupt all its interest in Agreement II. Etheridge concurrently executed a document ratifying Agreement III and transferring any remaining interest that he had in Agreement II over to Engelhaupt. No one disputes the fact that Engelhaupt paid Princeton Bank $83,485 on February 10, 1986.

In March of 1986 the plaintiffs filed a complaint against the original purchasers of the corporation, including Etheridge, and against Engelhaupt. The counts against the original purchasers charged that they had defaulted on Agreement I and Note I. Count V was directed against Engelhaupt. In count V, the plaintiffs asserted that they were intended third-party beneficiaries of Agreement II, the contract entered into between Etheridge and Engelhaupt. The plaintiffs claimed that, as third-party beneficiaries of Agreement II, they were entitled to enforce it. They requested the circuit court to enter a judgment against Engelhaupt for the sum of $76,500 plus interest and attorney fees. The plaintiffs asserted that $76,500 was the principal sum which remained owing under Agreement II.

Engelhaupt filed an answer to the plaintiffs' complaint and raised an affirmative defense. Engelhaupt first argued that the plaintiffs were not intended third-party beneficiaries of Agreement II. Alternatively, Engelhaupt argued that, even if the plaintiffs were intended third-party beneficiaries, any rights that they had under Agreement II were terminated before they brought suit. Specifically, Engelhaupt claimed that all his obligations under Agreement II and Note II were discharged by the actions taken between him, Etheridge, and Princeton Bank on February 10, 1986.

Ultimately, the circuit court granted the plaintiffs' motion for summary judgment against Engelhaupt on count V in the amount of $159,375.08 (representing principal and accrued interest) plus $22,000 in attorney fees.

Engelhaupt appealed, and the appellate court affirmed. No. 3-95-0903 (unpublished order under Supreme Court Rule 23). The appellate court held that, as a matter of law, Agreement II conferred intended third-party beneficiary status on the plaintiffs. The appellate court reached this conclusion because Agreement II (1) incorporates by reference Agreement I; (2) states that Engelhaupt assumed one-half of Etheridge's liability and obligation under Agreement I; (3) contains a payment schedule identical to that in Agreement I; and (4) required Engelhaupt to make his payments directly to the plaintiffs' account. The appellate court further reasoned that the fact that Note II allowed for altering the place of payment was irrelevant because the terms of Agreement II precisely set forth the rights and obligations of the parties.

The appellate court next rejected Engelhaupt's claim that his obligations to the plaintiffs as third-party beneficiaries under Agreement II and Note II were discharged by the actions taken between him, Etheridge, and Princeton Bank on February 10, 1986. The appellate court determined that Bay v. Williams, 112 Ill. 91, 1 N.E. 340 (1884), was dispositive of this issue. Bay established the rule in Illinois that third-party beneficiary rights are subject to immediate vesting and, once vested, cannot subsequently be altered or extinguished through a later agreement of the original parties to the contract. Bay, 112 Ill. at 96-97. Applying the Bay rule, the appellate court concluded that the plaintiffs' third-party beneficiary rights in Agreement II vested immediately upon Etheridge's and Engelhaupt's execution of that agreement. Once this vesting occurred, Etheridge and Engelhaupt were powerless to ...


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