United States v. Stump Home Specialities Manufacturing, Inc.

United States Court of Appeals for the Seventh Circuit · Contracts

ContractsGuarantyContract modificationConsiderationChoice of lawSBA loanIndiana lawguaranty waiver

Facts

Stump Home Specialties obtained a bank loan guaranteed by the SBA, and at closing its officers signed both a fixed-rate note and a variable-rate note, while all seven family guarantors signed an SBA guaranty allowing the lender, without notice, to modify loan terms and interest rate but not to increase principal. The loan agreement itself stated a fixed 9.5 percent rate, but the bank preferred a variable rate and later, at the SBA's insistence, amended the agreement so the rate would be 1.5 percent over the New York prime rate; only the two officer-guarantors signed that amendment. When Stump defaulted in 1982, the applicable frozen rate under the amended agreement was 17.5 percent, much higher than 9.5 percent. The nonofficer guarantors argued they were discharged because the obligation had been modified without their consent and because the modification lacked consideration.

Issue

Whether guarantors who signed an SBA guaranty permitting the lender to modify loan terms and interest rate without notice remained liable after the interest provision was changed from the fixed rate stated in the loan agreement to a variable rate tied to the New York prime rate. Also, whether that change was unenforceable for lack of consideration.

Rule

As a general rule, state law governs disputes arising from SBA loan agreements. Under Indiana law, a guarantor may validly waive the right to discharge based on a material modification if the guaranty authorizes modifications without notice, except as limited by the guaranty's own terms; an exception for increases in principal does not bar changes in interest rate. A contract modification ordinarily requires consideration, but consideration is satisfied where the change completes a contingent bargain or where the substituted term carries sufficient mutuality and is not coercive.

🔒

See the holding & full analysis

Create a free KwikCourt account to unlock the rest of this brief — and practice the case.

The court's holding and reasoning
Doctrine tests, pitfalls & exam hypotheticals
10 practice questions + 4 AI-graded essays on this case

Free sample · practice this case

Test yourself

One of 10 multiple-choice questions for this case. Pick an answer to see why.

Prairie Lantern Toolworks, an Indiana corporation in Fort Wayne, borrowed from Lakeview Commercial Bank under a loan guaranteed by the SBA. After default, the United States sued a guarantor in federal court, and the guarantor argued that a freestanding federal common-law rule should govern whether a later interest-term change bound her, rather than Indiana contract law.

Which law should the court apply to decide the guarantor's liability?

Explanation. The majority held that, as a general rule, disputes arising from SBA loan agreements are governed by the relevant state's law as federal common law. Here that would be Indiana law, unless applying state law would unreasonably interfere with administration of SBA programs. The mere presence of the United States or the SBA does not create a general nationwide guaranty rule. (Derived from United States v. Stump Home Specialities Manufacturing, Inc. (n.d.).)