U.S. Shoe Corp. v. Hackett, 85-2804

• Decision Date: 07 July 1986
• Docket Number: No. 85-2804,85-2804
• Citation: 793 F.2d 161
• Parties: The UNITED STATES SHOE CORPORATION, Plaintiff-Appellant, v. Patrick A. HACKETT and Rosemary H. Hackett, Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 161

793 F.2d 161

The UNITED STATES SHOE CORPORATION, Plaintiff-Appellant, v. Patrick A. HACKETT and Rosemary H. Hackett, Defendants-Appellees.

No. 85-2804.

United States Court of Appeals, Seventh Circuit.

Argued May 9, 1986.

Decided June 13, 1986.

Rehearing and Rehearing En Banc Denied July 7, 1986.

Gary P. Lantzy, Kohner, Mann & Kailas, Milwaukee, Wis., for plaintiff-appellant.

Michael A. Bowen, Foley Lardner, Milwaukee, Wis., for defendants-appellees.

Before POSNER and EASTERBROOK, Circuit Judges, and CAMPBELL, Senior District Judge. ^*

EASTERBROOK, Circuit Judge.

After Graebel's, Inc., became bankrupt in 1984, it owed $84,788 to The United States Shoe Corp. Shoe filed this diversity action to recover on a guaranty by Patrick and Rosemary Hackett, who are the officers, directors, and stockholders of Graebel's, Inc. The difficulty is that the guaranty, which the Hacketts signed in 1973 covers only credit extended to "HACKETT ENTERPRISES, INC., a Wisconsin Corporation, d/b/a GRAEBEL'S". In 1973 Hackett Enterprises and Graebel's, Inc., were separate corporations; they and two others (Mequon Shoe Corp. and Graebel's Fond du Lac Shoe Corporation, Inc.), all owned by the Hacketts, merged in 1976. Graebel's, Inc., was the surviving corporation, and it made all subsequent purchases in its own name. The district court granted summary judgment to the Hacketts, 601 F.Supp. 531 (E.D.Wisc.1985), concluding that the merger increased the risk of the guaranty, which discharged the Hacketts. We conclude that the Hacketts may not use new risk for which they were responsible to escape their guaranty, and that the grant of summary judgment was improvident.

The Hacketts and their corporations operated a chain of shoe stores in Milwaukee doing business under the trade name Graebel's. The Hacketts also sold shoes under other names, such as King Canvas; the Hacketts' firms ran occasional sales, such as one in a tent at the Experimental Aircraft Association Fly-In in Oshkosh, Wisconsin. The Graebel's name was used for the established stores. Between 1973 and 1976 Hackett Enterprises purchased shoes for all of the Hacketts' ventures. Hackett Enterprises would place the orders and direct delivery to the address where the shoes would be sold. Shoe would send the bill to Hackett Enterprises. In 1974, however, Mequon Shoe Corp. apparently purchased some shoes directly, and Shoe obtained a security interest in Mequon's inventory. Rosemary Hackett's affidavit, which describes the sale to Mequon, does not say how many of the purchases were made by Hackett Enterprises and how many by Mequon, although it says that "most" were made by Hackett Enterprises.

The district court thought that "the risk inherent in guarantying the obligations of 'Hackett Enterprises d/b/a Graebels' [sic] is nowhere near as great as that in guarantying the combined obligations of the four corporations merged into a new entity entitled 'Graebels [sic], Inc.' " (601 F.Supp. at 536). This view depended in part on the court's conclusion that "d/b/a GRAEBEL'S" is a term of limitation; we discuss this below. The proposition that a significant increase in risk discharges a guaranty is established in Wisconsin. Sage v. Strong, 40 Wis. 575 (1876). See Gritz Harvestore, Inc. v. A.O. Smith Harvestore Products, Inc., 769 F.2d 1225, 1230-34 (7th Cir.1985) (summarizing and applying Wisconsin law on this question). But no one can tell from the materials in the record whether there was a significant increase in risk, let alone whether the old risk was "nowhere near as great". Until 1977 Hackett Enterprises bought most of the shoes for all of the Hacketts' firms. We do not know how many shoes Mequon purchased directly; we do not know how many shoes Hackett Enterprises purchased for the use of outlets not doing business under the Graebel's trade name. For all we can tell 95% of all the purchases for the Hackett family corporations were made by Hackett Enterprises for the benefit of outlets doing business as Graebel's. The parties agreed at oral argument that critical records have been lost, so that precise measurement is impossible, but the record does not contain even a guess about the proportions. There is therefore no support for the district court's conclusion that the merger must have increased the risk a substantial amount.

A more fundamental point makes a guess on this score unnecessary, however. The principle that a big increase in risk discharges the guarantor is an implication of the fact that a guaranty is a commercial contract. The guarantor takes a risk in exchange for a benefit (here, the indirect benefit of appreciation in the value of the family's corporations). Unless the guarantor can estimate the size of the risk, he cannot tell whether the return is worthwhile. When events beyond the guarantor's control dramatically increase the risk, the assumptions on which the contract was founded are undercut. Usually a change in the terms of trade does not discharge a contract; an increase in the market price of coal does not relieve a seller of making deliveries contracted for at a lower price; the risk of a change in price influences the price fixed in the contract, and the contract apportions risk. But most guarantees allow the guarantor to walk away on notice. This one did; the Hacketts were free to revoke the guaranty at any time (although this would not terminate liability for goods already delivered). The principle that a substantial increase in risk avoids the guaranty rests on the assumption that guarantors would not ordinarily tolerate a big increase in the risk they face without seeking something in return. When there is such an increase, outside the guarantors' knowledge, courts treat the guaranty as if the right to revoke had been timely exercised. In Gritz, for example, the business was taken over by people hostile to the guarantor, and its franchisor then terminated the business relationship. This combination greatly increased the risk to which the guarantor was exposed, and the guarantor had no say in the increase.

If the party creating the new risk wants the guaranty to continue, it must take the initiative. The guarantor may consent, reaffirming the obligation. Thus a full statement of the rule is that "a material alteration in the contract between the creditor and the principal made after the execution of the guaranty contract and without the consent of the guarantor discharges the guarantor." FDIC v. Manion, 712 F.2d 295, 297 (7th Cir.1983); accord, Lakeshore Commercial Finance Corp. v. Drobac, 107 Wis.2d 445, 447, 319 N.W.2d 839, 840 (1982); Morley-Murphy Co. v. Van Vreede, 223 Wis. 1, 7, 269 N.W. 664, 666 (1936).

A guarantor may consent to the increased risk if he knows of the risk and proceeds heedless of it. Closer to the point, a guarantor may consent to the increased risk by creating it. Suppose in 1973, when the Hacketts signed the guaranty, they had been purchasing half of their requirements through Hackett Enterprises, Inc., and half through Mequon Shoe Corp., and suppose none of Mequon's purchases were subject to the guaranty. If in 1974 they funnelled all purchases through Hackett Enterprises, this would increase their exposure, but it would not discharge the guaranty. Or suppose the Hacketts suddenly applied the trade name Graebel's to all of their outlets, or quintupled the number of Graebel's stores they operated while maintaining separate King Canvas stores. Either would increase the risk; neither would discharge the guaranty, because in each case the Hacketts would know of and control the amount of risk. (The parties do not make anything of the fact that the corporations nominally made the decisions, perhaps because the Hacketts as managers caused them to do so, and the Hacketts as shareholders voted for the merger, so neither shall we.) When a guarantor is responsible for the increased risk, the guaranty remains in effect. It expands with the risk unless the guarantor expressly revokes the instrument. The Hacketts did not revoke their guaranty. The guaranty was designed to induce Shoe to sell its wares on credit to a closely-held family of corporations. Shoe sent no more merchandise than the Hacketts wanted to buy, and by ordering more they cannot avoid their promise to stand behind the corporations' debts.

The Hacketts offer a second excuse, that Hackett Enterprises "ceased to exist" in December 1976 when the four corporations merged. They agreed to stand behind the debts of Hackett Enterprises, not behind the debts of Graebel's, Inc. Corporate law does say that merged firms "cease to exist." Wisconsin has adopted the 1969 version of the American Bar Association's Model Business Corporation Act. See Wis.Stat. Sec. 180.67, which specifies the effect of mergers, and Sec. 11.06 of the 1984 version of the Model Act. But a merged firm "ceases to exist" only in the sense that it has no separate existence. It is sometimes misleading to talk of a firm as an "it." The corporation is just the legal identity of a complex set of contracts, and these contracts--directly or indirectly between people rather than legal constructs--are what matter. When the firm ceases to have a separate identity, the contracts live on. When Hackett Enterprises merged with Graebel's, Inc., both firms had contractual obligations and contractual entitlements. They owed money to suppliers such as Shoe, and they were owed money in return by customers. These rights and obligations, these contracts, survived the merger. So, too, if Marathon Oil Corp. had advantageous leases when it merged with United States Steel Corp., these leases would have survived the merger. The lessors, or the people with obligations to deliver crude oil to Marathon, could not have said: "Marathon has ceased to exist, so our obligations are at an end." The merger transferred all contracts to the surviving corporation; relations with outsiders went on as if nothing had happened.

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