Sumitomo Bank of Cal. v. Iwasaki

• Decision Date: 24 December 1968
• Citation: 73 Cal.Rptr. 564,70 Cal.2d 81,447 P.2d 956
• Court: California Supreme Court
• Parties: , 447 P.2d 956 SUMITOMO BANK OF CALIFORNIA, Plaintiff and Appellant, v. Frank Min IWASAKI, Defendant and Respondent. L.A. 29576.

Page 564

73 Cal.Rptr. 564

70 Cal.2d 81, 447 P.2d 956

SUMITOMO BANK OF CALIFORNIA, Plaintiff and Appellant, v. Frank Min IWASAKI, Defendant and Respondent.

L.A. 29576.

Supreme Court of California In Bank.

Dec. 24, 1968.

Mori & Katayama and Arthur S. Katayama, Los Angeles, for plaintiff and appellant.

Paul E. Homrighausen, Roland E. Brandel, Morrison, Foerster, Holloway, Clinton & Clark, San Francisco, Anderson, McPharlin & Conners and Robert C. Haase, Jr., Los Angeles, as amici curiae on behalf of plaintiff and appellant.

Robert Y. Iwasaki, Los Angeles, for defendant and respondent.

Frederick E. Watson, San Francisco, as amicus curiae on behalf of defendant and respondent.

TOBRINER, Associate Justice.

Plaintiff brought this action on a 'Continuing Guaranty' agreement which provided that defendant guaranteed all present and future indebtedness of Mikio and Yo Nagayama to the extent of $5,000 principal plus interest. Plaintiff sought recovery of the amounts owed by the Nagayamas on three loans, one of which plaintiff made several months after defendant executed the continuing guaranty. The trial court entered judgment for plaintiff in the principal sum of $2,253.13, plus $215.45 interest and $235.00 attorney's fees. Plaintiff appeals, alleging that the trial court erred in holding that defendant was discharged from liability on the third loan by plaintiff's failure to disclose to defendant that the Nagayamas required that loan to pay their federal taxes. ¹

This appeal presents an issue of first impression: whether a creditor owes a duty of disclosure to a surety on a continuing guaranty during the course, as well as at the inception, of the suretyship relationship, and if so, the nature and extent of that duty. We shall explain why we adopt the Restatement rule. That rule provides that each time the creditor accepts the continuing offer of a surety on a continuing guaranty by extending further credit to the principal debtor, the creditor owes a duty to the surety to disclose facts known by the creditor if the creditor has reason to believe that those facts materially increase the risk beyond that which the surety intended to assume and that those facts are unknown to the surety. (Rest., Security, § 124, subd. (1), com. C, pp. 327--328, 330.)

We first review the decisions relating to the creditor's duty of disclosure to the surety. We then explain that the evidence in the present case does not sufficiently support a finding that plaintiff's failure to inform defendant that the Nagayamas required a loan to pay their federal taxes constituted a breach of plaintiff's duty of disclosure which discharged defendant from liability on the third loan. ²

In all suretyship relations, the creditor owes to the surety a duty of continuous good faith and fair dealing. (County of Glenn v. Jones (1905) 146 Cal. 518, 520, 80 P. 695; Ely v. Liscomb (1914) 24 Cal.App. 224, 228, 140 P. 1086; Hamlen v. Rednalloh Co. (1935) 291 Mass. 119, 197 N.E. 149, 153, 99 A.L.R. 1230; First Citizens Bank & Trust Co. of Utica v. Sherman's Estate (1937) 250 App.Div. 339, 294 N.Y.S. 131, 139; Stearns, The Law of Suretyship (5th ed. 1951) § 2.11, at p. 22; 1 Story, Equity Jurisprudence (14th ed. 1918) § 448, at p. 430.) Thus, the creditor must not misrepresent or conceal facts so as to induce or permit the surety to enter or continue in the relationship in reliance on a false impression as to the nature of the risk. As with other contracts, a creditor's fraud, which may consist of intentional or negligent misrepresentation or active suppression of the truth, will discharge the surety as to any subsequently incurred liability. (Arant, Law of Suretyship and Guaranty (1931) § 28, at p. 75; 1 Brandt, The Law of Suretyship and Guaranty (3d ed. 1905) § 256, at p. 505; cf. 1 Corbin on Contracts (1963) § 6, at pp. 12--13.)

No general duty imposes upon the creditor the obligation to disclose to the surety such matters as the creditor knows might affect the surety's risk. ³ On the other hand, under some circumstances the creditor may be required voluntarily to make such a disclosure, and his failure to do so may discharge the surety. Whether the creditor owes the surety such a duty in turn depends upon the nature of the suretyship agreement (i.e., the nature of the risk the surety promises to assume) and the relationship between the particular creditor and surety. (Bank of Monroe v. Anderson Bros. Mining & R. Co. (1885) 65 Iowa 692, 22 N.W. 929, 933--934; Associated Indemnity Corporation v. Del Guzzo (1938) 195 Wash. 486, 81 P.2d 516, 526--527; London General Omnibus Company, Ltd. v. Holloway (1912) 2 K.B. 72, 78--79, 82--83; Hamilton v. Watson (1845) 12 Cl. & F. 109, 118--120, 8 Eng.Rep. 1339, 1343--1344; Note, Principal and Surety (1938) 36 Mich.L.Rev. 1217, 1218--1220.)

1. The duty of disclosure owed by the creditor to the surety at the inception of the relationship

The leading case imposing a duty upon the creditor voluntarily to disclose the facts to the surety, Railton v. Mathews (1844) 10 Cl & F. 934, 8 Eng.Rep. 993, involved a fidelity suretyship. Lord Cottenham stated 'it is the duty of the party acquiring the bond to communicate those circumstances * * * (which) the noncommunication, or, * * * the concealment of * * * would invalidate the obligation and release the surety * * *.' (10 Cl. & F. at p. 940, 8 Eng.Rep. at p. 995.) Lord Campbell expressed a broader rule, stating that, 'If the (employers) had facts within their knowledge which it was material the surety should be acquainted with, and which the (employers) did not disclose, * * * the concealment of those facts * * * discharges charges the surety; * * *' (10 Cl. & F. at p. 943, 8 Eng.Rep. at p. 996.)

The American cases, following the decision of the House of Lords in Railton v. Mathews, adopted as to fidelity bonds the broader rule expressed by Lord Campbell. That rule imposes an absolute duty upon the obligee to volunteer disclosure of all facts materially affecting the risk to the surety on a fidelity bond. (See, e.g., Park Paving Co. v. Kraft (1918) 262 Pa. 178, 105 A. 39, 40; Associated Indemnity Corporation v. Del Guzzo, supra, 81 P.2d at p. 526.) Irrespective of motive or intent, mere non-disclosure of facts known by the obligee which materially affect the surety's risk, such as prior dishonesty of the principal on the fidelity bond, therefore discharges the surety. (Railton v. Mathews, supra, 10 Cl. & F. at p. 943, 8 Eng.Rep. at p. 996; Harrison v. Lumbermen and Mechanics' Ins. Co. (1879) 8 Mo.App. 37, 40.) California follows this rule. (Guardian Fire, etc., Assurance Co. v. Thompson (1885) 68 Cal. 208, 209--210, 9 P. 1; West American Finance Co. v. Pacific Indemnity Co. (1936) 17 Cal.App.2d 225, 234, 61 P.2d 963.) ⁴

Although the American cases involving credit, as distinguished from fidelity, suretyships ⁵ often contain citations to and quotations from Railton and its progeny (see, e.g., American National Bank v. Donnellan (1915) 170 Cal. 9, 22, 148 P. 188; First Citizens Bank & Trust Co. of Utica v. Sherman's Estate, supra, 294 N.Y.S. 131, 139), these citations and quotations are mere dicta. Their actual holdings show that the cases implicitly follow the English line of decisions, explicitly rejecting the application of Railton to cases involving guaranties of credit. (London General Omnibus Company, Ltd. v. Holloway, supra, 2 K.B. 72, 78--79, 82--83, 88; Hamilton v. Watson, supra, 12 Cl. & F. 109, 118--120, 8 Eng.Rep. 1339, 1343--1344.) A creditor, such as a bank, does not, therefore, owe an absolute duty to the surety to disclose, without request by the surety, all facts within its knowledge which may materially affect the surety's risk. (Arant, op. cit. supra, § 28, p. 77; Stearns, op. cit. supra, § 7.15, pp. 218--220.)

We set forth the reasons for the differences in the nature of the duty of disclosure imposed in the case of the fidelity bond and that required in the instance of the creditor bond. First, in the case of a surety on a fidelity bond, the very act of offering or continuing the employment it self suggests that the employer trusts the employee. On the other hand, 'the bank or other creditor cannot reasonably be taken as affirming, by mere silence respecting earlier dealings, the financial ability of the person whom the proposed surety is asked to guarantee. * * * (T)he probable reason for requiring a guarantee is dissatisfaction with the customer's credit.' (London General Omnibus Company, Ltd. v. Holloway, supra, 2 K.B. 72, 87 (Kennedy, L.J.).)

Second, whereas on a fidelity bond the employer-obligee enjoys direct access to information concerning the employee-principal's performance, and in this respect occupies a far better position than the surety, a different situation prevails as to a creditor bond. A creditor such as a bank is usually in no better position than the surety to acquire information about the financial condition of the debtor. Particularly in those cases in which the surety assumes the risk at the debtor's request, rather than the creditor's, the creditor may reasonably assume that the surety will acquire from the debtor himself all information which it reasonably believes to be relevant to the risk. (Lee v. Jones (1864) 17 C.B. (N.S.) 482, 503, 144 Eng.Rep. 194, 202; Stearns, op. cit. supra, § 7.15, p. 218.)

Thus, the leading English case on the duty of disclosure owed by a bank to a surety that guarantees the credit of a bank customer, Hamilton v. Watson, supra, 12 Cl. & F. 109, 119, 8 Eng.Rep. 1339, 1344, holds that the bank does not owe a duty of disclosure of pertinent facts in the absence of an inquiry by the surety, unless the bank knows, and has reason to believe that the surety does not know, that the risk involved is other than that which the surety would reasonably expect. The prime example of a fact materially altering the risk which the creditor should reasonably believe is unknown to the surety would be...