U.S. v. Crain

• Decision Date: 17 January 1979
• Docket Number: No. 76-1574,76-1574
• Citation: 589 F.2d 996
• Parties: UNITED STATES of America, Plaintiff-Appellee, v. H. E. CRAIN and Ethel E. Crain, husband and wife, and Coconino County, Arizona, Defendants-Appellants.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 996

589 F.2d 996

UNITED STATES of America, Plaintiff-Appellee, v. H. E. CRAIN and Ethel E. Crain, husband and wife, and Coconino County, Arizona, Defendants-Appellants.

No. 76-1574.

United States Court of Appeals Ninth Circuit.

Jan. 17, 1979.

Moeller Henry & LaVelle (argued), Phoenix, Ariz., for defendants-appellants.

John F. Flynn, Asst. U. S. Atty. (argued), Phoenix, Ariz., for plaintiff-appellee.

Appeal from the United States District Court for the District of Arizona.

Before CHOY and SNEED, Circuit Judges, and KELLEHER ^*, District judge.

CHOY, Circuit Judge:

Harold and Ethel Crain appeal from the district court's summary judgment finding them liable on their personal guarantee of a Small Business Administration (SBA) loan and foreclosing the mortgage securing that guarantee. We affirm in part, and reverse and remand in part.

I

On January 12, 1968, the SBA loaned $100,000 to the Haining Lumber Company, Inc. Haining provided collateral for the loan. In addition, the loan was personally guaranteed by Harold Crain, then president of Haining, and his wife Ethel Crain, who owned 75% Of Haining's stock. The guarantee was secured by a mortgage on certain real property belonging to the Crains. The guarantee was executed on a standard SBA form, while the mortgage securing the guarantee was on a standard title company form adapted for use in Arizona. The guarantee provided that the SBA could proceed against the guarantors upon default of the principal debtor without pursuing any rights it might have against the debtor. ¹

Subsequent to the loan, Haining was the subject of a reorganization proceeding in the bankruptcy court. An arrangement was approved whereby Mr. Crain withdrew from the management of Haining. However, the Crains' guarantee remained in effect.

Following reorganization, Haining defaulted on its SBA obligations. On June 20, 1974, the United States commenced a suit on the guarantee in behalf of the SBA.

The Crains asserted as one ground of defense that the SBA had negligently permitted Haining's collateral to be dissipated, thus discharging the Crains' guarantee liability under Arizona law. The United States moved for summary judgment and the Crains countered with a similar motion of their own. On November 19, 1975, the parties stipulated that their respective motions for summary judgment be determined on the basis of the single issue of whether the SBA had any obligation to proceed against Haining's collateral prior to taking action on the Crains' guarantee.

The district court granted the Government's motion for summary judgment, expressly holding that federal rather than state law governs the interpretation of an SBA loan guarantee, and that the language of the guarantee did not require that the SBA move against collateral pledged by Haining prior to bringing an action on the Crains' guarantee.

II

The issue presented is whether guarantors of an SBA loan can assert state law defenses to the Government's claim on their personal guarantee.

Because this case involves the rights of the United States against private citizens with whom it has contracted rights based on a loan transaction authorized by Congress, See 15 U.S.C. § 636 federal law is controlling. The fact that, as here, no constitutional or federal statutory provision disposes of the issue does not change this. "A federal court sitting in a non-diversity case such as this does not sit as a local tribunal. . . . Federal common law implements the federal Constitution and statutes, and is conditioned by them." D'Oench, Duhme & Co. v. FDIC, 315 U.S. 447, 471-72, 62 S.Ct. 676, 686, 86 L.Ed. 956 (1942) (Jackson, J., concurring). The question thus turns on what the applicable federal law is.

The federal courts are generally free to draw upon any and all traditional sources in developing federal common law. United States v. Best, 573 F.2d 1095, 1101 (9th Cir. 1978). Often state law is an appropriate source. Textile Workers Union v. Lincoln Mills, 353 U.S. 448, 457, 77 S.Ct. 912, 1 L.Ed.2d 972 (1957); Royal Indemnity Co. v. United States, 313 U.S. 289, 296-97, 61 S.Ct. 995, 85 L.Ed. 1361 (1941); Board of Commissioners v. United States, 308 U.S. 343, 350-52, 60 S.Ct. 285, 84 L.Ed. 313 (1939); United States v. Best, 573 F.2d at 1102. Even when an "action arises under and is clearly determined by federal law, state law limiting the enforcement of a federal right is sometimes adopted as the federal rule." United States v. Haddon Haciendas Co., 541 F.2d 777, 783 (9th Cir. 1976).

As stated in Haddon, whether or not state law will be adopted as the federal common law rule depends on "whether the state law can be given effect without . . . conflicting with federal policy." Id. at 784, Quoting United States v. Stadium Apartments, Inc., 425 F.2d 358, 368 (9th Cir.) (Ely, C. J., dissenting), Cert. denied, 400 U.S. 926, 91 S.Ct. 187, 27 L.Ed.2d 185 (1970); See United States v. Yazell, 382 U.S. 341, 352-57, 86 S.Ct. 500, 15 L.Ed.2d 404 (1966); Clearfield Trust Co. v. United States, 318 U.S. 363, 367, 63 S.Ct. 573, 87 L.Ed. 838 (1943); United States v. MacKenzie, 510 F.2d 39, 41-42 (9th Cir. 1975) (en banc). ² Conversely, rejection of the state rule should be avoided where the adoption of a different federal rule would unduly interfere with the state's interests. United States v. Best, 573 F.2d at 1102; United States v. Haddon Haciendas Co., 541 F.2d at 785; United States v. MacKenzie, 510 F.2d at 41-42.

The United States urges that state law should not be adopted as federal common law in this case. The Government posits a strong public policy of promoting the security of federal investments and a need for uniform law governing the nationally-used guarantee contract involved in this case in support of its position.

In United States v. MacKenzie, a case involving the applicability of state law limiting the amount of deficiency judgments to federal foreclosures on mortgages securing SBA loans, this court pointed out that two federal interests were implicated in enforcing SBA loan contracts: protection of the federal fisc ³ and the congressional purpose in enacting the Small Business Act. ⁴ These same federal policies are at stake in the resolution of the question before us. ⁵

The Arizona rule that the Crains contend should be adopted as federal law in this case requires that a creditor look first to any security provided by the primary debtor and take such reasonable actions to preserve that security as circumstances require. The creditor's failure to act to protect the value of security given by the principal gives the guarantor a defense against enforcement of his obligation under Arizona law. See D. W. Jaquays & Co. v. First Security Bank, 101 Ariz. 301, 419 P.2d 85 (1966), and discussion of Arizona law Infra.

Adoption of these state law defenses will not adversely affect either of the federal policies involved in this case. Rather, recognition of guarantor protections provided by Arizona law will make it easier for the SBA to find sureties, facilitating SBA objectives. By encouraging private guarantors, the SBA is relieved of a certain amount of financial risk it would otherwise be forced to bear. Nor does the protection granted by Arizona law jeopardize the Government's interest in having its loans repaid. If the principal's collateral proves insufficient to meet the debt, the SBA can look to the guarantor for the deficiency. Furthermore, the rejection of Arizona's rule in the name of uniformity would unnecessarily introduce a lack of uniformity into debtor-creditor relationships in that state. No federal interest requires such an intrusion into state regulation of commercial transactions.

There are no "clear and substantial interests of the National Government, which . . . will suffer major damage if the state law is applied." United States v. Yazell, 382 U.S. at 352, 86 S.Ct. at 507. Thus, following Yazell, MacKenzie and Haddon, the district court should have adopted Arizona law as the proper common law rule.

III

Since the district court did not consider the effect of Arizona law in this case, the question arises whether this court may do so on appeal or whether, instead, a remand for this purpose is required.

If all necessary facts were of record and not in dispute, and the only remaining question was the effect of Arizona law, then this court could decide the case without remanding. Hansen v. Morgan, 582 F.2d 1214, 1217-18 (9th Cir. 1978); See Lundgren v. Freeman, 307 F.2d 104, 113-15 (9th Cir. 1962). However, if further exposition of facts or weighing of different facts in the record is necessary, remand is required. See Hansen v. Morgan, 582 F.2d at 1218.

The Crains' primary defense is based on the Arizona doctrine of equitable subrogation, which relieves the guarantor where the creditor has failed to act to protect the value of the security given by the primary debtor. See D. W. Jaquays & Co. v. First Security Bank, 101 Ariz. at 304-05, 419 P.2d at 88-89.

As an equitable defense, this doctrine may be applied despite any language in the guarantee contract; but in certain cases it may be waived, depending on what result is consistent with "justice and good conscience." Kilpatrick v. Superior Court, 105 Ariz. 413, 422, 466 P.2d 18, 27 (1970). Nonetheless, "(t) he right does not originate in contract, and it cannot lightly be destroyed by contract." D. W. Jaquays & Co. v. First Security Bank, 101 Ariz. at 305, 419 P.2d at 89.

Application of this equitable doctrine, and particularly whether this defense has been waived, requires a balancing of the equities dependent upon factual determinations not in the record before us. The parties conducted no discovery and there were no hearings or findings of fact on the issues of whether any collateral existed at the time of this action and whether the SBA in fact failed to act to preserve its value as security.

The Crains also claim certain statutory defenses, including a discharge of...