United States v. Stump Home Specialties Manufacturing, Incorporated
905 F.2d 1117 (1990)
Rule of Law:
A written modification to a loan agreement is enforceable against guarantors who have signed a general waiver authorizing such changes without notice. The modification is valid provided it is supported by consideration, which can be found when the modification is a condition of the loan itself or involves a mutual exchange of uncertain terms.
Facts:
- Stump Home Specialties Manufacturing, Inc. ('Stump') applied for a $270,000 loan from a bank, to be guaranteed by the Small Business Administration (SBA).
- The bank's loan officer agreed to a fixed 9.5% interest rate, but the bank's loan committee insisted on a variable rate of 1.5% over the bank's prime rate.
- At the loan closing, Stump's officers signed two promissory notes—one for the fixed rate and one for the variable rate—along with a loan agreement that stated a 9.5% fixed rate.
- Seven members of the Stump family, including two company officers and five non-managing members, signed a standard SBA guaranty form.
- The guaranty form 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'.
- After the closing, the SBA required the variable rate to be based on the New York prime rate instead of the bank's prime rate as a condition of its guaranty.
- The bank sent an amended agreement with the new variable rate term to Stump. The two officer-guarantors signed it, but the other five guarantors were not notified.
- Stump later defaulted on the loan when the variable interest rate had risen to 17.5%.
Procedural Posture:
- The United States, as assignee of the loan from the Small Business Administration, sued the Stump family guarantors in U.S. District Court.
- Following a bench trial, the district court (the court of first instance) awarded judgment to the United States for the unpaid loan principal plus interest.
- The guarantors, as appellants, appealed the district court's judgment to the U.S. Court of Appeals for the Seventh Circuit.
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Issue:
Are guarantors of a loan, who signed a guaranty permitting the lender to modify the loan's terms (including the interest rate) without notice, liable for the borrower's default after the interest rate was changed from a fixed rate to a variable rate, when the guarantors argue the modification lacked consideration?
Opinions:
Majority - Posner, Circuit Judge
Yes. The guarantors are liable because they waived their right to be discharged upon modification of the loan terms, and the modification was supported by consideration. Under Indiana law, a waiver of a guarantor's right to be discharged due to a material change in the guaranteed debt is valid and enforceable. The guarantors here signed a standard-form SBA guaranty that explicitly allowed the lender to modify the interest rate without notice. The court rejected the argument that changing the interest rate was equivalent to increasing the loan principal, reasoning that unlike an increase in principal which benefits both borrower and lender and invites collusion against the guarantor, a higher interest rate is a cost to the borrower, who has an incentive to resist. Furthermore, the modification was supported by consideration because the change to a variable rate was a necessary condition for the loan to be finalized; essentially, no variable rate meant no loan. Alternatively, the court found that even if viewed as a change from one variable rate to another, the substitution of one uncertain quantity for another constitutes sufficient consideration. The court ultimately characterized the change not as a true modification of a settled contract, but as the final step in completing the terms of the loan.
Analysis:
This decision strongly affirms the principle of freedom of contract, holding that explicit waiver clauses in guaranty agreements are strictly enforceable. It provides a significant precedent for lenders, confirming they can rely on such waivers to modify loan terms without obtaining consent from or even notifying every guarantor. Judge Posner's economic analysis distinguishes modifications of interest rates from modifications of principal, providing a rationale for why standard guaranty forms treat them differently. The opinion also signals a judicial willingness to look past the formal doctrine of consideration for contract modifications, suggesting that courts should instead focus on preventing coercive modifications through the defense of duress.
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