KEITH, Circuit Judge.
The Small Business Administration (SBA), an agency of the United States government, appeals from a judgment of the district court denying its claims against Duane G. Willis and Mary J. Willis. Plaintiff commenced this action on December 22, 1975, alleging that the defendants were liable to it pursuant to a guaranty executed in conjunction with an SBA loan. The guaranty was assigned to the SBA upon default of the primary debtor and performance by SBA pursuant to its own guaranty. Jurisdiction was invoked pursuant to 28 U.S.C. § 1345. The district court held that the SBA was not entitled to any monetary recovery because it had failed to dispose of collateral securing the loan in a commercially reasonable manner. We affirm Judge Robert B. Krupansky's decision.
The facts are relatively straightforward. On March 22, 1972, Opticron, Inc., a Delaware Corporation, together with Opticron International, Inc., and Opticron of Pennsylvania, Inc., (hereinafter collectively referred to as Opticron) executed a $325,000 promissory note in favor of the Union Commerce Bank of Cleveland, Ohio (UCB). The note was guaranteed up to 90 percent by the SBA. In conjunction with Opticron's execution of the note and as an inducement for the extension of credit, defendants Duane G. and Mary Jayne Willis signed a separate instrument in favor of the UCB and its successors and assigns unconditionally guaranteeing the prompt payment when due of the principal and interest owed on the note.
Opticron defaulted on the note. SBA loan officer Gordon Miller met on February 1, 1973, with representatives of Opticron, UCB and other interested parties regarding the financial position of Opticron. On February 7, 1973 the UCB requested payment from the SBA of 90 percent of the $325,000 loan pursuant to the SBA guaranty agreement.
The SBA subsequently took possession of the assets and operations of Opticron and placed a notice in the Business Opportunity Section of the Sunday Cleveland Plain Dealer, February 18, 1973, advertising a summary public auction sale to be held on Thursday, February 22, 1973, at the offices of Opticron. The notice contained a minimum bid requirement of $150,000.
On February 21, 1973, the SBA paid to the UCB the sum of $296,530, being payment in full of 90 percent of the $325,000 loan, plus 90 percent of the interest due on the loan. The February 22, 1973 auction did not take place as advertised. Apparently, questions were raised as to the legal sufficiency of the notice and so none of the parties present would place a bid. On March 13 and 14, and April 12, 1973, however, the public auction sales were held, and $47,456.63 was realized from the sale of Opticron's assets. Deductions from gross sales for rent, expenses and auctioneers' fees resulted in net proceeds of $41,115.47 from all auction sales.
In the meantime, Opticron had received two firm private offers to purchase its assets. On January 30, 1973, an offer from Will Ross, Inc. (Will Ross) to purchase all of the assets of Opticron as reflected on the latter's November 30, 1972 balance sheet for the sum of $200,000 cash was communicated by letter to Opticron's Board of Directors. On January 31, 1973, a prior offer from Marcrum Optical of Florida, Inc. (Marcrum) to purchase all assets as reflected on the January 30, 1973 balance sheet of Opticron for $210,000 was confirmed by letter. Marcrum offered to pay $100,000 in cash with the remaining $110,000 to be paid over a period of 10 years.
At the above-mentioned meeting on February 1, 1973, defendant Duane Willis communicated these two offers to the interested parties then present, viz., Gordon Miller of the SBA and a representative of the UCB. With the apparent concurrence of all present, a telegram dated February 2, 1973, was sent to Will Ross accepting its offer subject to the final agreement and concurrence of UCB.
Subsequent to the February 1, 1973 meeting, Miller informed Willis that a public sale was necessary to dispose of the assets collateralizing the promissory note. Thereafter, the aforementioned advertisement of the summary public auction ran in the Cleveland Plain Dealer on February 18, 1973.
Notwithstanding the receipt of $41,115.47 from the auction sales, the SBA seeks by this action to recover from defendant guarantors the full amount of the loan principal outstanding plus accrued interest; a total of $297,174.66 plus daily interest of $43.9071 from December 27, 1974. At trial, defendants asserted that the sale of Opticron's assets was not conducted in a commercially reasonable manner and that plaintiff had the burden of establishing the commercial reasonableness of the sales. The plaintiff countered by asserting that the defense of commercial reasonableness was not available to defendants and that, in any case, the burden of proof on that issue rested with
The Government presents four issues for decision on appeal: 1) whether unconditional guarantors can avail themselves of the defense of commercial reasonableness to defeat its alleged federal right of recovery; 2) assuming the defense is available to unconditional guarantors, whether the defendants are estopped to assert it; 3) whether defendants proved at the trial below that the sale of Opticron's assets was commercially unreasonable; and, 4) whether the district court erred in denying SBA any monetary recovery. These issues will be addressed in the order in which they have been set out above.
Availability of the Defense of Commercial Reasonableness
The Government makes two arguments in support of its contention that the defense of commercial reasonableness is unavailable to the defendants in this action. First, the Government argues that this case is controlled by federal law, which does not recognize the defense. The Government's second argument is three-pronged. First, it focuses upon the fact that the guaranty executed by the defendants made them "unconditional guarantors" of the indebtedness secured by the guaranty.
As a secondary component of the above argument, the Government urges that the agreement itself controls this case and that the fact of unconditional guaranty, coupled with other language contained in the agreement regarding the SBA's powers to deal with the collateral, conferred upon its discretion so broad that it placed upon defendants an absolute duty of repaying the loan regardless of any dereliction attributable to the SBA — i. e., that it relieved the SBA of any and all duties whatsoever to defendants in dealing with the collateral.
Finally, the Government contends that general principles of commercial law precludes the availability of the defense of commercial reasonableness in the instant case.
A. Applicable Law
Emphasizing that the alleged right of recovery is a federal one, the Government argues that this case is controlled by federal law and that there is no basis in federal law for defeating the SBA's right of recovery. In support of this contention the Government points to the SBA's choice of Law regulation, 13 C.F.R. § 101.1(d)(2). This regulation provides:
Additionally, the Government points to the note guaranteed by defendants, which provides in part:
The Government apparently would have this Court fashion its own federal common law rule as it is clearly empowered to do pursuant to the authority recognized by the Supreme Court in Clearfield Trust Co. v. United States, 318 U.S. 363, 63 S.Ct. 573, 87 L.Ed. 838 (1943). The issue before the Court in Clearfield, supra, was whether state or federal law was to govern the rights and duties of the United States in regard to the commercial paper it issues. The Supreme Court observed:
318 U.S. at 366-367, 63 S.Ct. at 575 (citations and footnote omitted). In reaching a decision as to the rule of law to be applied, i. e., the decision to fashion its own federal common law rule, the Court stated:
318 U.S. at 367, 63 S.Ct. at 575 (citation omitted). And commenting on the type of case which it has found appropriate for the fashioning of a federal common law rule, the Supreme Court stated twenty-three years later in United States v. Yazell, 382 U.S. 341, 86 S.Ct. 500, 15 L.Ed.2d 404 (1966):
382 U.S. at 354, 86 S.Ct. at 507.
This case also presents a situation where the Government's operations are on a vast scale, involving transactions which occur in several states. However, the factors which militated in favor of fashioning a new and different federal common law rule in the Clearfield Trust case, as opposed to adopting state law, are not as strong in the instant case. While this case presents a situation where the need for uniformity is clear, this need is met by adoption of the relevant provisions of the Uniform Commercial Code as the federal rule of decision.
Additionally, policy factors also militate in favor of adopting the UCC provision in question as the rule of decision in this case. Involved here is a uniform provision which imposes upon a creditor a duty of good faith in disposing of collateral entrusted to it. Its apparent purpose is to protect debtors from unnecessary loss upon sales of the collateral by their creditors following foreclosure.
Thus, unless we are inclined to the view that the Government, simply because it is the Government, is entitled to collect from its debtors regardless of its own capriciousness in disposing of collateral entrusted to it to secure indebtedness, there would appear to be no good reason for departing from state law in this case. Since we are inclined to no such view, we have concluded that, given the circumstances presented in this case, the UCC should apply as the federal rule of decision. After all, as the Supreme Court observed in Clearfield, supra, the Government does business on business terms. 318 U.S. at 369, 63 S.Ct. 573. This case provides no basis for creating an exception.
B. General Commercial Law Principles
The Government does not dispute the general availability of the defense of commercial reasonableness to primary debtors. It even appears to concede the availability of this defense to guarantors in some cases. However, the Government maintains that this defense is never available to guarantors in situations such as the one presented in the instant case.
In support of this contention, the Government draws first upon the fact that the guaranty executed by the defendants made them "unconditional guarantors" of the indebtedness secured. As such, the Government contends, defendants "have an absolute contractual responsibility to pay the debt at issue here." (Appellant's Br. at p. 50). The import of this argument appears to be that the defense of commercial reasonableness is unavailable to defendant simply by virtue of the fact that the guarantee was "unconditional." On the Government's theory, an unconditional guarantor assumes an absolute contractual obligation which, upon becoming operative, is dischargeable only by payment.
While this proposition does have a certain superficial appeal by virtue of its seemingly tautological logic, it fails to comport with the conventional meaning of the term "unconditional guaranty." In Pavlantos v. Garoufalis, 89 F.2d 203 (10th Cir. 1937), the Tenth Circuit defined and explained this term as follows:
89 F.2d at 206 (citations omitted and emphasis added).
The above-quoted definition and discussion make clear that the term "unconditional guaranty" has meaning only when contrasted with a "conditional guaranty" and that the significance of distinguishing between these lies primarily with the difference in the creditor's duty to proceed against the principal obligor before attempting to collect from the guarantor.
The issue in the instant case is whether and, if so, to what extent a secured party can collect a deficiency from guarantors after being charged with having needlessly
Second, the Government points to the language in the guaranty pertaining to its power in regard to the collateral upon default to support its contention for the unavailability of the defense of commercial reasonableness in the instant case. The Government emphasizes the language in the guaranty conferring upon the secured party "full power, in its uncontrolled discretion . . . to deal in any manner with the . . . collateral," including the power to realize on the collateral "at any public or private sale or sales." Additionally, the Government points to language providing that the obligations of the debtor "shall not be released, discharged or in any way affected, nor shall the debtor have any rights or recourse against the lender, by reason of any action lender may take or omit to take under the foregoing powers."
The import of this argument appears to be that the above-quoted language, in conjunction with the fact that the guaranty was unconditional, relieved the SBA of any duty whatsoever to defendants in dealing with the collateral. Carried to its logical extreme, the Government's view would permit it to collect the indebtedness from the guarantor even in a case where it had simply given the collateral away, or worse, destroyed it.
We reject this interpretation of the guaranty and hold that even the contractual obligations of unconditional guarantors are protected from unnecessary expense by the doctrine of commercial good faith. See Anderson, supra. To the extent the fair market value of Opticron's assets exceeded the amount for which they were actually sold, the deficiency pursuant to the note was clearly enlarged beyond what it might otherwise have been. And to the extent the SBA might reasonably have obtained a higher price for these assets, this enlargement of the deficiency was unnecessary.
In essence, we hold today that, as a matter of federal law, even the broad language quoted above will not be deemed to relieve the SBA of any and all responsibility to debtors in disposing of collateral securing its loans.
Moreover, a number of federal courts have permitted guarantors to invoke the defense of commercial reasonableness. See United States v. Terrey, 554 F.2d 685 (5th Cir. 1977); United States v. Whitehouse Plastics (5th Cir. 1974) 501 F.2d 692, cert.
The Government attempts to distinguish the above cases on two grounds. First, it argues that their holdings are limited to instances where there has been a failure by the secured party to comply with the relevant notice provisions of the UCC prior to sale. Their applicability being so limited, urges the Government, their holdings cannot be applied to cases where, as here, the crucial question concerns a public versus a private sale.
This distinction is without legal significance. The crucial question under consideration concerns "commercial reasonableness;" this remains so whether the factual context in which the issue is presented focuses upon proper notification prior to sale or the manner in which the sale is actually consummated. Having concluded that the standard to be applied is that of "commercial reasonableness," we hold that this requirement must be satisfied whether the facts involve a commercially reasonable notice prior to sale, or the commercial reasonableness of the sale itself.
Second, the Government argues that the above cases all involved actions by lenders to obtain deficiency judgments while the instant case is not one seeking a deficiency judgment, but rather, an action on a contract.
We are in agreement with the trial judge, that the distinction which the Government attempts to draw between this action and an action to obtain a deficiency judgment is one with neither factual support nor legal significance.
C. The Estoppel Argument
Section 9-504(3) provides in part:
The Government contends that, even assuming the availability of the defense provided in the above section to unconditional guarantors, the appellees are estopped from asserting the defense in the circumstances of this case by virtue of UCC § 9-507(1). Section 9-507(1) provides in pertinent part:
Comment No. 1 to § 9-507(1) provides in part by way of explanation:
The crux of the Government's argument here is that § 9-507(1) gives to the debtor and other secured parties the right to judicially test any suspect sale of collateral before its consummation. Since appellees were aware of both private offers to purchase Opticron's assets well in advance of the public sales, appellant asserts that their failure to even attempt to have the sales enjoined estops them from now complaining of the unreasonableness of those sales.
We agree with appellees that the "estoppel" argument advanced by the SBA is tantamount to the proposition that a debtor must always proceed affirmatively under § 9-507(1), rather than defend under § 9-504(3). We are of the opinion that § 9-507(1) provides a right to, rather than impose a duty upon, debtors. Invocation of its provisions as urged by appellant would fly in the face of every court decision affording
As the Court has determined that the UCC defense of commercial unreasonableness is available to defendants and that they are not estopped from asserting that defense in the instant case, we now turn to the consequences which follow upon these prior determinations.
Commercial Reasonableness of the Sale
A. Effect of Raising the Defense
As noted above, the defense of commercial reasonableness is available in this case and was raised by the defendants at the trial below. While courts differ as to the effect of asserting this defense, it appears that the great weight of authority holds that it has the effect of shifting the burden of proof on this issue to the secured party. 59 A.L.R.3d, p. 369 (1974); Vic Hansen & Sons, Inc. v. Crowley, 57 Wis.2d 106, 203 N.W.2d 728 (1973); Dynalectron Corp. v. Jack Richards Aircraft, supra, 69 Am. Jur.2d, Secured Transactions, § 623, pp. 520-531 (1966). This also appears to be the position taken by the courts of Ohio. See In re Frye, 9 UCC Rep.Ser. 913, 921 (S.D.Ohio 1970). We see no reason not to follow this authority as did the district court below.
The district judge made it clear to the Government at the outset of the trial below that it had the burden of proof on his issue. Yet, despite this notice, the Government's only proof regarding this issue at trial focused upon the reasonableness of the public sale which it conducted. Even in its briefs filed in connection with its appeal to this court, the Government still restricts its argument to the proposition that the auction was properly conducted. The entire thrust of the Government's proof and argument appears to be that proof that the collateral was properly sold in a recognized market by means of an accepted method of disposition, i. e. an auction sale, is also proof that the sale was commercially reasonable.
This Court cannot accept the Government's argument because it rests on the assumption that a properly conducted public sale is inherently reasonable, a premise which is clearly false. In Old Colony Trust Co. v. Penrose Industries Corp., 280 F.Supp. 698 (E.D.Pa. 1965), the Court stated:
280 F. Supp. at 712. At a later point, the court notes:
280 F. Supp. at 714-715 (footnote omitted). Finally, the court notes, and we agree:
280 F. Supp. at 715. In light of the above, we think it is clear that the Government did not have absolute discretion in choosing between a public and a private sale. Whatever discretion it had in choosing the method of sale was limited by its good faith duty to maximize the proceeds upon sale of the collateral. If the original choice of method was unreasonable, we think it matters little, if at all, that this unreasonable choice was executed in a reasonable and proper fashion.
Moreover, we are of the opinion that the Government's choice of a public sale as opposed to a private sale in the circumstances of this case was unreasonable. The evidence establishes that at the time the Government decided on the public sale, it had firm and outstanding offers of $200,000 and $210,000, respectively. The Government knew of these two offers at least 2½ months prior to its own sale and the $200,000 offer had been tentatively accepted with its apparent approval. Yet, despite the fact that the auctioneer hired to conduct the sale provided an estimate — although concededly only a guesstimate — of $45,000 for the assets upon public sale, the Government, without explanation or apparent good cause, announced and proceeded with the public sale.
And while price is not determinative, UCC § 507(2), the fact that the offers were five times greater than the proceeds realized upon the sale is at least probative on the question of commercial reasonableness. See Merchantile Financial Corp., supra at 801:
In light of these facts, we conclude that the Government failed to carry its burden and that the trial court was correct in holding that the sale was commercially unreasonable.
B. Effect of Breach
Having determined that the Government failed to carry out the duty imposed upon it by § 9-504(3), there still remains the question of the effect of this breach. The courts have differed. Some have held that failure to comply with the requirements of § 9-504(3) absolutely precludes recovery by the secured party in a subsequent action against the debtor for a deficiency. Camden National Bank v. St. Clair, 309 A.2d 329 (Me. 1973); Atlas Thrift Co. v. Horan, 27 Cal.App.3d 999, 104 Cal.Rptr. 315 (1972); Dynalectron Corp., supra. See also 2 Gilmore, Security Interests in Personal Property, Par. 44.9.4, p. 1264; Leasco Data Processing Equip. Corp. v. Atlas Shirt Co., 66 Misc.2d 1089, 323 N.Y.S.2d 13 (1971); Skeels v. Universal C.I.T. Credit Corp., 222 F.Supp. 696 (W.D.Pa. 1963) modified on other grounds, 335 F.2d 846 (3d Cir. 1964). This also appears to be the approach followed by Ohio courts. Miles v. N.J. Motors, Inc., 44 Ohio App.2d 351, 338 N.E.2d 784 (1975). Other courts have held that failure to meet the requirements of § 9-504(3) creates a presumption that the value of the collateral equalled the indebtedness secured, thereby extinguishing the indebtedness unless the secured party rebuts the presumption. United States v. Whitehouse Plastics (5th
In circumstances such as presented in this case, divergence in the law provides substance for federal choice. As noted already, Ohio courts appear to follow the first approach set out above. Miles v. N.J. Motors, Inc., supra. While we might well adopt the absolute bar rule applied by the Ohio courts, we, like the district court below, decline to do so out of our belief that the rebuttable presumption rule is the more enlightened and equitable.
Applying the rule to the facts of this case, we agree with the trial court that the Government cannot recover because it failed in its duty to rebut the presumption. The fact that two offers five times greater than the proceeds were made and that the Government's own original minimum bid requirement was $150,000 is sufficient to establish that, in all probability the assets' fair market value exceeded the price received upon actual sale. Yet, a review of the record of the trial below reveals that the Government failed to adduce any evidence tending to show that the fair market value of these assets was less than the indebtedness secured and if so, by what amount. Its entire presentation of testimonial evidence focused on establishing that the auction was properly conducted and that the sale was commercially reasonable by virtue of this fact alone.
The Government correctly notes that even a secured party who fails to dispose of collateral in a commercially reasonable manner has often been held entitled to recover the difference between the outstanding debt and the fair market value of collateral. But the Government would ignore that part of the rule followed in this case that before recovery is permitted, the secured party must 1) establish the fair market value of the collateral and, thereby, 2) rebut the presumption that the value of the collateral equalled the indebtedness secured. The Government failed to do either here and thus, we agree with the trial court that it was not entitled to any recovery.
As its final argument, the Government maintains that it is entitled to a judgment for $96,530, the difference between the $296,530 outstanding debt and $200,000. It argues that since the basis of the trial court's determination that the sale was commercially unreasonable was the fact that two private offers of $200,000 and $210,000, respectively, were made by prospective purchasers prior to the public sale and that since defendants offered no evidence to show that the collateral was worth more than $200,000 it is entitled to this amount at a minimum.
This Court cannot agree. The $200,000 figure which appellant would now select to represent the fair market value of the assets was introduced at trial not to establish fair market value per se, but rather, to show that the amount received upon the actual sale was substantially less than what might have been obtained in a sale conducted in a commercially reasonable manner. The introduction of this figure to suggest the inadequacy of the price actually obtained is not proof of the assets' actual value.
We have adopted as the rule in this case that where the secured party has disposed of the collateral in a commercially unreasonable manner, it rests with him to carry the burden of proof in rebutting the presumption that the fair market value of the assets equalled the indebtedness secured. Had sufficient evidence been adduced at trial, whether by appellant or defendants, to establish the fair market value of the assets in question, this court would not hesitate to permit appellant any benefit that it could derive therefrom. However, the fair market value of these assets was not established by the evidence of either party at trial.
For the foregoing reasons, the judgment of the district court is affirmed, the parties to bear their own costs.
Since Ohio has adopted the Uniform Commercial Code, Ohio Revised Code §§ 1301, et seq., appellees' contention that state law controls this case is, in essence, an argument for application of the UCC to the facts of this case. Thus, the import of appellees' contention is that the UCC § 9-504(3) commercial reasonableness defense is available in the instant case by virtue of having been made a part of Ohio's statutory law. See Ohio Rev. Code § 1309.47(C).
Upon our handling of the issue, the UCC is applicable to decide the outcome of this case as a matter of federal incorporation and not as a matter of Ohio state law. In other words, the operative authority for the application of the UCC in this case is federal, not state. See Mishkin, "Variousness of Federal Law: Competence and Discretion in the Choice of National and State Rules for Decision," 105 U.Pa.L.Rev. 797 (1959).
(Footnotes omitted). The requirements set out above appear to have been met in the instant case.