U.S. v. Stump Home Specialties Mfg., Inc.

• Decision Date: 29 June 1990
• Docket Number: No. 89-2573,89-2573
• Citation: 905 F.2d 1117
• Parties: UNITED STATES of America, Plaintiff-Appellee, v. STUMP HOME SPECIALTIES MANUFACTURING, INCORPORATED, et al., Defendants-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1117

905 F.2d 1117

UNITED STATES of America, Plaintiff-Appellee, v. STUMP HOME SPECIALTIES MANUFACTURING, INCORPORATED, et al Defendants-Appellants.

No. 89-2573.

United States Court of Appeals Seventh Circuit.

Argued May 9, 1990.

Decided June 29, 1990.

Andrew B. Baker, Jr., Clifford D. Johnson, Asst. U.S. Attys., Hammond, Ind., for plaintiff-appellee.

Joseph V. Simeri, Kramer, Butler, Simeri, Konopa & Laderer, South Bend, Ind., for defendants-appellants.

Before POSNER and FLAUM, Circuit Judges, and WILL, Senior District Judge. ^*

POSNER, Circuit Judge.

The United States sued the guarantors of a loan that, upon the borrower's defaulting, had been assigned to the Small Business Administration, another guarantor of the loan. After a bench trial, the district judge awarded the United States a judgment for the unpaid principal balance of the loan, some $222,000, plus interest of some $253,000. The guarantors appeal, denying liability and raising fascinating questions of contract law.

Whose contract law? The Supreme Court has told us that in suits growing out of disputes over loans guaranteed by the Small Business Administration, we should use the relevant state's law--here, the law of Indiana--as the federal common law applicable to such disputes. United States v. Kimbell Foods, Inc., 440 U.S. 715, 99 S.Ct. 1448, 59 L.Ed.2d 711 (1979). See also United States v. Kelley, 890 F.2d 220 (10th Cir.1989); United States v. Irby, 618 F.2d 352, 355 (5th Cir.1980). It might be questioned whether we have always been completely faithful to this mandate, for in one case we described the issue as one of general federal common law, uncabined by any particular body of state-law doctrines, Eastern Illinois Trust & Savings Bank v. Sanders, 826 F.2d 615, 616 (7th Cir.1987), and in other cases we applied state law but implied that we had a choice whether to do so. United States v. Meadors, 753 F.2d 590, 592 (7th Cir.1985); United States v. Lair, 854 F.2d 233, 237 (7th Cir.1988). Unless Kimbell, which involved the priority of a lien held by the Small Business Administration rather than the enforcement of a guaranty, is to be read narrowly--and we can think of no reason why it should be--we are under a directive from the Supreme Court to apply state law to conditions in SBA loan agreements. So that is what we must do. We can do it in good heart. State commercial law is as suitable to the governance of those agreements as it is to the governance of any other type of loan, and the federal courts have neither the time nor the specialized knowledge to forge a new body of commercial law; by doing so they would simply be adding to the already excessive complexity of American law. Powers v. U.S. Postal Service, 671 F.2d 1041 (7th Cir.1982). Maybe a case will arise someday in which applying state law would interfere unreasonably with the administration of the Small Business Administration's programs, and then the rule of Kimbell might have to be qualified. It is enough for purposes of this case to make clear that, as a general rule, state law applies to disputes arising from loan agreements with the Small Business Administration.

Some unusual facts redeem this case from dryness. Stump Home Specialties Manufacturing, Inc., a small family company that makes sewing chairs and cabinets, applied for a loan of $270,000 from a bank in South Bend, Indiana, the loan to be guaranteed by the SBA. Without the guaranty, the bank would not have made the loan. The loan was to be for seven years. The borrower preferred a fixed rate of interest. The bank's loan officer demanded, and the borrower agreed to, a fixed rate of 9.5 percent, and the SBA approved the loan on those terms. The bank's loan committee, however, did not want a fixed rate, and it approved the loan at a floating rate of 1.5 percent over the bank's prime rate. With the SBA having approved a fixed-interest loan and the bank's loan committee a variable-interest loan, the bank's loan officer took the unusual step of preparing two promissory notes for the borrower (Stump) to sign at the closing, one specifying the fixed rate of 9.5 percent, the other the variable rate of 1.5 percent above the bank's prime. The loan agreement itself stated that the interest rate was a flat 9.5 percent.

Present at the closing were Stump's two principal officers, plus five other members of the Stump family who, however, did not and do not participate in the company's management. The officers signed both notes on behalf of the company, along with the loan agreement itself; at the same time, all seven Stumps (who are defendants in this case along with Stump itself) signed a standard-form SBA guaranty that authorized the lender, "in its uncontrolled discretion and without any notice to the undersigned, ... to modify or otherwise change any terms of all or any part of the liabilities or the rate of interest thereon (but not to increase the principal amount of the note ...)." The bank handed over the money at the closing, and the bank's loan officer then sought the SBA's approval for the variable-interest note, that being the form of loan that the bank preferred. The SBA approved everything but the use of the bank's prime rate as the basis for computing the variable interest. It asked that the loan agreement be amended to make the interest rate 1.5 percent over the New York prime rate. The bank agreed, and mailed Stump a draft agreement amending the loan agreement to change the interest rate from the flat 9.5 percent in the agreement to 1.5 percent above the New York prime rate. No notice of the amendment was sent to the guarantors as such, although the two officer-guarantors must have had notice, for they signed the amended agreement and mailed it back to the bank.

The loan had been made in April 1978, and the agreement was amended in June. The default came in 1982, and the bank assigned its rights to the SBA. On the date of default the New York prime rate was 16 percent; the interest rate called for by the amended agreement was therefore 17.5 percent. Consistent with the amended agreement and with SBA regulations, the interest due on the loan was frozen at the rate applicable on the date of default--a rate far above the 9.5 percent rate in the original loan agreement. The company could not pay, and the guarantors would not pay. The consequence was this suit, filed in 1985.

The guarantors make two major arguments (their subsidiary arguments have too little merit to warrant discussion). The first is that guarantors cannot be held liable when the obligation they have guaranteed has been modified without their consent. This argument has no possible merit with regard to the two officer-guarantors--they signed the amending agreement that the bank sent them, and if as their counsel contends they did so without consulting a lawyer and perhaps without even reading the agreement, that is their tough luck. Rights under a contract are not forfeited by the other party's failure to read it. Credit Alliance Corp. v. Campbell, 845 F.2d 725, 728 (7th Cir.1988) (applying Indiana law); Carney v. Central National Bank, 450 N.E.2d 1034, 1038 (Ind.App.1983). But we must consider the situation of the other guarantors. The SBA acknowledges that they knew nothing of the modification. They had, however, signed a guaranty which said that the lender could modify the terms of the loan without notice to them. Which is just what happened. A waiver of the guarantor's right to be discharged if there is a material change in the terms of the debt that he has guaranteed is valid. Credit Alliance Corp. v. Campbell, supra, 845 F.2d at 728-30 (applying Indiana law); Houin v. Bremen State Bank, 495 N.E.2d 753, 759 (Ind.App.1986); Jackson v. Farmers State Bank, 481 N.E.2d 395, 400 (Ind.App.1985); Skrypek v. St. Joseph Valley Bank, 469 N.E.2d 774, 777-79 (Ind.App.1984); Bowyer v. Clark Equipment Co., 357 N.E.2d 290, 294 (Ind.App.1976); Aetna Life Ins. Co. v. Anderson, 848 F.2d 104, 107 and n. 10 (8th Cir.1988). Freedom of contract is alive and well, and it is living in Indiana. Amoco Oil Co. v. Ashcraft, 791 F.2d 519 (7th Cir.1986).

The guarantors argue that the provision on modification could not have meant what it said. It excepted increases in the principal amount of the loan from the right of modification without notice; such increases therefore required the guarantors' consent if they were to bind them. The guarantors argue that to double the interest rate is to enlarge their guaranty just as surely as increasing the principal of the loan would do.

But did the modification double the interest rate? Although the loan agreement specifies a flat 9.5 percent rate of interest, far below the 17.5 percent rate at which Stump's obligation was frozen by the modified agreement, Stump had also signed a promissory note specifying a variable interest rate of 1.5 percent over the bank's prime. The record does not reveal whether the bank's prime rate turned out to be higher than, lower than, or the same as the New York prime rate during the relevant period (which runs from the date of the loan to the date of the default). For all we know, the modification harmed the guarantors not at all.

This analysis is incomplete, however, because the guarantors (other than the officers, of course) may not have been aware of the variable note when they signed the guaranty. The loan agreement itself contains no reference to variable interest--just to 9.5 percent fixed interest. The relevant modification, so far as the nonofficer guarantors are concerned, may therefore have been a change from a fixed interest rate of 9.5 percent to a floating interest rate based on the New York prime rate--and that change has proved to be highly adverse to the guarantors, for sure.

No matter. This modification, too, was within the letter of the quoted provision. And it did not violate the spirit of the exception for changes in principal. There is a difference, so far as...