Alcock, In re

Citation50 F.3d 1456
Decision Date22 March 1995
Docket NumberNo. 93-15963,93-15963
Parties, 26 UCC Rep.Serv.2d 376 In re: Charles ALCOCK; Betty Alcock, Debtors. Charles ALCOCK; Betty Alcock, Appellants, v. SMALL BUSINESS ADMINISTRATION, Appellee.
CourtUnited States Courts of Appeals. United States Court of Appeals (9th Circuit)

Robert Mehlhaff, Souza, Coats, McInnis & Mehlhaff, Tracy, CA, for appellants.

Jeffrey W. Eisinger, Asst. U.S. Atty., Fresno, CA, for appellee.

Appeal from the Ninth Circuit Bankruptcy Appellate Panel.

Before: LAY, * PREGERSON, and O'SCANNLAIN, Circuit Judges.

LAY, Senior Circuit Judge:

Charles and Betty Alcock appeal an order of the Bankruptcy Appellate Panel ("BAP") in a Chapter 11 proceeding allowing the Small Business Administration's ("SBA") claim for the deficiency on a loan upon which Charles Alcock signed as a guarantor. The bankruptcy judge rejected Alcock's arguments that he should be discharged from his guaranty obligation because the SBA and its participating lender, Crocker Bank ("Crocker"), unjustifiably impaired the collateral, disposed of the collateral in a commercially unreasonable manner, and failed to give him notice of the disposition. The BAP affirmed the order of the bankruptcy judge in an unpublished memorandum opinion. We now reverse.

BACKGROUND

On September 27, 1983, Top Pac Growers and Shippers ("Top Pac"), a tomato packing and shipping company, borrowed $600,000 from Crocker secured by a note guaranteed by the SBA for seventy-five percent of the amount due ("SBA Note"). On the same day, Crocker extended Top Pac an additional $500,000 line of credit ("Crocker Line"). The On September 28, 1983, Crocker Bank informed the SBA that it was not willing to advance the $500,000 line of credit if it only had the second lien on the real property. The SBA agreed to subordinate its interest in the real property to that of Crocker Bank on September 29, 1982, retaining the first-priority interest in the equipment. The SBA entered into this new agreement because it felt adequately collateralized by the interest in the equipment and the net worth of the guarantors. The guarantors were not informed of the change in priority of the real estate liens.

SBA was secured by a first deed of trust to the real property at one of Top Pac's plant locations. Crocker was secured by a deed of trust on the real property, subordinated to the SBA's first-priority deed. Crocker and the SBA were also secured by a perfected security interest in Top Pac's equipment; in its intangible assets; and by the guaranties of several parties, including Alcock, a Top Pac stockholder.

In the spring of 1984, Top Pac defaulted on the loan. The SBA honored its guaranty to Crocker Bank, and the SBA Note was assigned to it. The SBA declined any interest in the real property. Crocker foreclosed on the real property in March 1985 and purchased it for $130,000 at a trustee's sale in partial satisfaction of the amount owed on the Crocker Line. 1

In January 1985, Crocker recommended a broker to Top Pac to facilitate the sale of the equipment. The broker, Emilio Lemeni, and Top Pac reached an agreement for the sale of the equipment for $94,000. Lemeni was delayed in dismantling the equipment and sent three payments that were not required by the contract between July and December 1985, apparently to compensate for the failure to dismantle the equipment. The first payment was made to Top Pac, and the remaining two were made to Crocker after Crocker sent a letter to Lemeni requesting that all future payments be made to it. Also in January 1985, Crocker Equipment Leasing sent the SBA documents showing it had a first lien on a portion of Top Pac's equipment. The SBA acknowledged Crocker Equipment Leasing's lien and applied $5,000 of the money received from the sale of the equipment toward it.

At some point between December 1985 and March 1986, the equipment was disassembled and removed from Top Pac's premises. It is unclear from the record who authorized the removal or took the equipment. Only $25,000 had been received in payment; thus, $69,000 remained unpaid.

Alcock filed for Chapter 11 bankruptcy in March 1986. The SBA filed a claim for the deficiency on the SBA Note for $507,016. Alcock filed this action to bar the SBA's claim in April 1990. The bankruptcy judge adopted the findings of fact of the SBA and ruled in its favor. The BAP affirmed the judgment in favor of the SBA in April 1993.

DISCUSSION

Alcock claims his obligation as guarantor of the note is discharged because the SBA unjustifiably impaired the value of the collateral by subordinating its first lien on the real estate to that of Crocker Bank, paying out part of the proceeds from the sale of the equipment to Crocker Equipment Leasing, and permitting the equipment to be disassembled and removed before payment was received. 2 He also claims he may avoid his obligations under the guaranty because the SBA failed to dispose of the collateral in a commercially reasonable manner and because it failed to give notice to Alcock of the disposition. We need only address the change in lien priority.

Alcock relies on section 3606 of the California Commercial Code which provides in pertinent part The holder discharges any party to the instrument to the extent that without such party's consent the holder ... (b) Unjustifiably impairs any collateral for the instrument given by or on behalf of the party or any person against whom he has a right of recourse. 3

Cal.Com.Code Sec. 3606 (Deering 1988) (repealed 1992). 4 He contends that by subordinating its lien on the real property to that of Crocker Bank, the SBA unjustifiably impaired the value of the collateral without his consent, thereby discharging his obligation as guarantor. He claims that if the SBA had retained the priority lien on the property, the deficiency would have been substantially smaller because the packing plant could have been sold as a "going concern." Once the SBA no longer had a first priority lien on both the land and equipment, however, and the packing plant could not be sold as a going concern, Alcock alleges the market value of the collateral as a whole fell dramatically. 5

The BAP acknowledged there was a reduction in value. 6 The SBA never challenges Alcock's contentions that the switch reduced the value of the equipment by more than $500,000 and substantially impaired the collateral as a whole. Thus, we find the SBA had essentially waived any claim that no impairment occurred. Nevertheless, the BAP and bankruptcy judge held that Alcock was not released from his obligation under the guaranty because the impairment of the collateral by reason of the switch in lien priority was not "unjustifiable." Rather, both courts found the SBA was properly serving the interests of the corporation by ensuring that it had the credit that it needed.

Alcock continues to argue, however, that while the subordination agreement may have been justified with respect to the obligor (Top Pac), it was not justified with respect to the guarantors. We agree. Section 3606, which was taken directly from the Uniform Commercial Code ("U.C.C."), is designed to protect unconsenting sureties from lenders' actions that prejudice them by reducing the value of the collateral. See, e.g., Langeveld v. L.R.Z.H. Corp., 74 N.J. 45, 376 A.2d 931, 934 (1977) (stating this section of the U.C.C. is designed to protect sureties and provides them with all of the benefits of the principal debtor); U.C.C. Sec. 3-606, cmt. 5 (stating this protection is a "suretyship defense"). Given this statutory purpose, whether such an impairment is "unjustifiable" must be determined with reference to surety's interests, not the borrower's. For The fact that Alcock was both a guarantor and a stockholder in Top Pac does not change this result. As a stockholder, he certainly had an interest in the survival of the Top Pac. As a guarantor however, he had a potentially conflicting interest: limiting his personal liability if the company defaulted. Thus, Alcock's status as a stockholder cannot alone support the legal conclusion that the switch in lien priorities was justified towards him as a guarantor. Under these circumstances, we cannot agree with the BAP's conclusion, and we therefore hold the SBA's action was unjustified.

                this reason, numerous courts, in interpreting other states' U.C.C. Sec. 3-606 provisions, have concluded that lenders' actions which impair collateral for the benefit of the borrower are unjustified. 7  The bankruptcy judge and BAP therefore erred in holding that because the SBA reasonably believed Top Pac needed the line of credit to survive, the unconsented switch in lien priorities was justified. 8
                

WAIVER

The Alcock guaranty agreement authorizes the bank "without notice or demand (except as shall be required by applicable statute and cannot be waived) ... [to] take and hold security for the payment of this guaranty or the indebtedness and exchange, enforce, waive and release any such security...." The SBA failed to squarely address this issue in the oral argument or its brief. 9 Nevertheless, because the briefs are unclear, and because both the bankruptcy judge and BAP seemingly rely on Alcock's waiver as a alternative basis for their refusal to accept his section 3606 defense, 10 we will address the question.

We conclude that under existing Ninth Circuit precedent, the language in the SBA The bankruptcy judge distinguished Frazier because the impairment in that case occurred after default. We reject this distinction: Nothing in Frazier's analysis indicates its holding is limited to post-default impairments, and we find no basis for imposing such a limitation. The BAP agreed with the bankruptcy judge's pre- and post-default distinction, stating that because the alleged impairment in Frazier occurred after default, an additional signed waiver was needed in that case under California Comm.Code Sec. 9504(3). See note 10, sup...

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