McENTIRE v. INDIANA NAT. BANK

MILLER, Presiding Judge.

Indiana National Bank (Bank) was victorious in its pursuit of a deficiency judgment on a guaranty when it was awarded summary judgment against guarantors Loyd McEntire (McEntire), Jerry Galbreath, and Ernest K. Jones. The trial court found the three individuals liable upon their unconditional guaranty to assure payments of an equipment lease executed by McEntire Drywall, Inc. (Drywall), which company petitioned for relief in bankruptcy before successful completion of its lease agreement. McEntire, the lone appellant, oppugns the result reached by the trial court, arguing the summary judgment was improper because of both incorrect applications of the law and the existence of material issues of fact. We agree and reverse and remand for further proceedings not inconsistent with our opinion herein.

ISSUES

McEntire raises the following as the points of dispute incorrectly resolved by the trial court:

FACTS

On July 9, 1980, the Bank and Drywall entered into an "Equipment Lease Agreement" whereby the company agreed to make sixty monthly payments of $175.88 for a telephone system priced at $7,106.00. Drywall also paid $1.00 for the option to purchase the equipment at the end of the lease for $710.60. At the same time the lease was executed, McEntire, Jerry Galbreath and Ernest K. Jones signed an unconditional guaranty upon liabilities of Drywall to the Bank, to the extent of $7,106.00.

In 1982, Drywall filed for bankruptcy, and the trustee in bankruptcy abandoned the telephone system to the Bank. The Bank, without notice to the individual guarantors or any attempt at advertisement, sold the system back to the original vendor at a private sale for $1050. The Bank then instituted suit against the guarantors for a deficiency judgment in the amount of $4,608.11. All the guarantors raised two defenses to the action, lack of notice of the sale and lack of commercial reasonableness of the sale itself. The Bank moved for summary judgment, granted by the court in the following terms:

Record, pp. 158-59. McEntire is the sole appellant before us, arguing for reversal.

DECISION

Summary judgment proceedings in this state are governed by Ind.Rules of Procedure, Trial Rule 56, which clearly states that

T.R. 56(C). If there are any doubts as to whether any issue of material facts exists with regard to the claim, a motion for summary judgment must be resolved in the nonmovant's favor. To determine if such doubts indeed exist, the evidence is to be construed liberally in the nonmovant's favor. Woodward Insurance, Inc. v. White (1982), Ind., 437 N.E.2d 59; Bridgewater v. Economy Engineering Co. (1984), Ind. App., 464 N.E.2d 14, trans. pending. Once having determined no issues of material fact exist, we must still determine that the trial court has correctly applied the law to those facts. Krueger v. Bailey (1980), Ind. App., 406 N.E.2d 665.

It is with this standard then that we review two of the trial court's conclusions — that this transaction is not subject to Article 9 of the Uniform Commercial Code and that even if Article 9 applies, McEntire is not protected thereunder.1 Under the circumstances and the issues presented herein, we must deal with both inquiries included in our standard of review because there is a genuine issue over material facts and the trial court incorrectly applied the law.

Application of Article 9 of the U.C.C.

The guaranty executed by McEntire very clearly covers the following of Drywall's obligations:

Record, p. 13. (Emphasis added.) When interpreting a guaranty, we follow the rules of construction applicable to any other contract. Thus, in the absence of ambiguity in the language used, we construe a guaranty's provisions as a matter of law. Goeke v. Merchants National Bank & Trust Co. of Indianapolis, (1984) Ind. App., 467 N.E.2d 760; Loudermilk v. Casey, (1982) Ind. App., 441 N.E.2d 1379. The terms of this particular guaranty very clearly contemplate the equipment lease agreement at issue herein and must have been so intended. However, our inquiry continues because the issue remains whether the guaranty comes within the ambit of the U.C.C. provisions regarding security agreements.

Indiana's version of the U.C.C. provides the following with respect to categorizing a purported lease as an actual security agreement:

IND. CODE 26-1-1-201(37). This statute clearly provides two ways of determining whether a lease in actuality is a conditional sale, a vehicle for securing an interest in an item the "lessee" is purchasing from the "lessor." The distinguishing difference between the two foci of I.C. 26-1-1-201(37) devolves upon the terms of any option to purchase included in the agreement.

Within the terms of subsection (b), if the lease provides an option whereby the lessee can purchase the property for no additional or for a nominal consideration, the lease is, as a matter of law, a security agreement. E.g., Bolen v. Mid-Continent Refrigerator Co., (1980) Ind. App., 411 N.E.2d 1255. However, unlike the situation in Bolen, where the consideration set forth was $1.00 and sales tax, we have no clear-cut evidence here that Drywall's option price on the telephone system, of $710.60, was "nominal consideration." We would have no problems if the sum here were very small in absolute terms, as in Bolen, but because $710.60 is not of such character, we can find it "nominal" only if it is insubstantial in relation to the fair market value of the telephone system at the time the option would have been exercised. See Matter of Marhoefer Packing Co., (7th Cir.1982) 674 F.2d 1139. We have no evidence in the record before us of what the fair market value of the equipment would have been at the time of the option, only the purchase price. (The matter may indeed have been introduced at the summary judgment hearing, but there is no transcript before us.) Therefore, we cannot say, as a matter of law, that the lease here is a security agreement as described in subsection (b) of I.C. 26-1-1-201(37). However, neither could the trial court declare it was not because the second inquiry remained to be resolved.

Under I.C. 26-1-1-201(37), subsection (a) provides for a determination upon the facts of each case that the option to purchase herein does not make the lease a security agreement. Matter of Marhoefer Packing Co., supra, 674 F.2d 1139. In contract law, the intention of the parties controls our decisions regarding the substance of agreements, and that intention is expressed by the clear language of the contract. See, e.g., Jenkins v. King, (1946) 224 Ind. 164, 65 N.E.2d 121; Citizens Bank & Trust Co. of Washington v. Gibson, (1984) Ind. App., 463 N.E.2d 276 trans. pending; R.R. Donnelley & Sons, Co. v. Henry-Williams, Inc., (1981) Ind. App., 422 N.E.2d 353. If that contract language is unambiguous, then construction of the agreement is a question of law for the court. E.g., Loudermilk v. Casey, supra, 441 N.E.2d 1379. These same rules of construction apply when deciding whether a lease is truly a rental agreement or is instead a security agreement. State Bank of Burleigh County Trust Co. v. All-American Sub, Inc., (1980) N.D., 289 N.W.2d 772. We have applied these very same rules to the lease herein and have found it to be a security agreement.

The facts of each agreement control any decisions we would make toward discerning whether two parties intended to enter into a security agreement. I.C. 26-1-1-201(37). And the facts that could be pertinent to each such determination would be difficult to catalog. However, the number present here is sufficiently overwhelming to indicate the Bank intended for Drywall to execute a security agreement for the purchase of the telephone equipment. The equipment lease here includes the following telltale provisions:

State Bank of Burleigh County Trust Co. v. All-American Sub, Inc., supra, 289 N.W.2d 772; J. WHITE & R. SUMMERS, UNIFORM COMMERCIAL CODE § 22-3 (1980). Under these circumstances, we are compelled to say, as a matter of law, the parties intended to enter into a security agreement. The trial court's declaration to the contrary was incorrect, thus making his conclusion that Article 9 of the U.C.C. did not apply erroneous.

Guarantor as "Debtor" and Entitled to Notice

Indiana's version of Article 9 of the U.C.C. is found at IND. CODE 26-1-9-101 et seq. McEntire's argument that he was entitled to notice of the Bank's sale of the equipment devolves upon two provisions of Article 9, I.C. 26-1-9-105(d) and I.C. 26-1-9-504(3). I.C. 25-1-9-504(3) mandates what notice shall be sent regarding a secured party's disposition of collateral after default upon the agreement:

(Emphasis added.) The telephone equipment was not perishable, and there was no evidence it would have declined rapidly in value or that it was customarily sold on a recognized market. Therefore, the Bank was required to send reasonable notice of the sale to the debtor. The question remains whether McEntire was such a "debtor," entitled to notice.

"Debtor" for purposes of secured transactions is defined at I.C. 26-1-9-105(1)(d):

Under Indiana law, a guaranty is an independent contract to assume liability for performance of a duty or payment of a debt if the primary obligor defaults in performance or payment. Cargill, Inc. v. Buis, (7th Cir.1976) 543 F.2d 584; Indiana University v. Indiana Bonding & Surety Co. (1981), Ind. App., 416 N.E.2d 1275; Davis v. B.C.L. Enterprises, Inc. (1980), Ind. App., 406 N.E.2d 1204. Thus, upon default of his principal, a guarantor becomes primarily liable on the debt, subject to the type of guaranty executed (conditional or unconditional) and to conditions contained in the agreement itself. Indiana University v. Indiana Bonding & Surety Co., supra; Bowyer v. Clark Equipment Co. (1976), 171 Ind.App. 431, 357 N.E.2d 290. A guarantor then indeed "owes payment or other performance of the obligation secured," irrespective of his ownership of or rights in the collateral. This state of affairs qualifies a guarantor for the status of "debtor" within the terms of I.C. 26-1-9-105(1)(d). By adopting this view, we are also aligning ourselves with the majority of jurisdictions who have also addressed the issue. See, e.g., Ford Motor Credit Co. v. Lototsky (E.D.Pa. 1982), 549 F.Supp. 996; National Acceptance Co. of America v. Medlin (N.D.Ill. 1982) 538 F.Supp. 585; Commercial Credit Corp. v. Lane (M.D. Fla. 1979) 466 F.Supp. 1326; First Alabama Bank of Montgomery, N.A. v. Parsons (1980), Ala. Civ. App., 390 So.2d 640; Walter E. Heller & Co. v. Wilkerson (1980), Colo. App., 627 P.2d 773; Barnett Bank of Tallahassee v. Campbell (1981) Fla.App., 402 So.2d 12; Barbree v. Allis-Chalmers Corp. (1982), 250 Ga. 409, 297 S.E.2d 465; Liberty Bank v. Honolulu Providoring Inc. (1982), 65 Haw. 273, 650 P.2d 576; Commercial Discount Corp. v. Bayer (1978), 57 Ill.App.3d 295, 14 Ill.Dec. 647, 372 N.E.2d 926; Clune Equipment Leasing Corp. v. Spangler (1981), Mo. App., 615 S.W.2d 106; DeLay First National Bank & Trust Co. v. Jacobson Appliance Co. (1976), 196 Neb. 398, 243 N.W.2d 745; Chase Manhattan Bank v. Natarelli (1977), 93 Misc.2d 78, 401 N.Y.S.2d 404; see also First National Bank of Denver v. Cillessen (1980), Colo. App., 622 P.2d 598 (co-signers); Savings Bank of New Britain v. Booze (1977) 34 Conn.Sup. 632, 382 A.2d 226 (accommodation maker); First National Bank & Trust Co. v. Kunes (1973) 230 Ga. 888, 199 S.E.2d 776 (indemnitor); T & W Ice Cream Inc. v. Carriage Barn, Inc. (1969), 107 N.J.Super. 328, 258 A.2d 162 (accommodation endorser); O'Hara v. First National Bank of Fort Worth (1980), Tex.Civ.App., 613 S.W.2d 306 (accommodation maker); Rhoten v. United Virginia Bank (1980) 221 Va. 222, 269 S.E.2d 781 (co-maker).

Concurrent with a guarantor's assumption of the status of "debtor" runs the protection of such debtor under I.C. 26-1-9-504(3). This protection includes the debtor's entitlement to reasonable notification of the disposition of the collateral. This principle is adhered to by most of the above-cited cases from other jurisdictions but was probably best explained in the seminal case of Chase Manhattan Bank v. Natarelli, supra, 93 Misc.2d 78, 401 N.Y.S.2d 404. In that case, the New York Supreme Court explained that one of the U.C.C.'s goals was to make distinctions along functional rather than formal lines, and thus, a guarantor should be considered a debtor within Article 9 and be similarly protected despite having only a conditional interest in the collateral. The court went on to say that requiring reasonable notice be sent to guarantors imposes no undue burden upon secured parties nor unduly prejudices them inasmuch as guaranties are executed at the request of and for the benefit of those same secured parties.

We are aware of authority that denies guarantors the right to notice under these circumstances. These cases either refuse to equate a guarantor with a debtor or refuse to find I.C. 26-1-9-504(3) applicable to debtors who do not own the collateral. See First National Park Bank v. Johnson (9th Cir.1977), 553 F.2d 599; A.J. Armstrong, Inc. v. Janburt Embroidery Corp. (1967), 97 N.J.Super. 246, 234 A.2d 737 (accommodation parties).2 We believe the realities of commercial dealings require we adhere to the majority position rather than making fine distinctions based merely upon semantics. Our result is that the trial court here erred in ruling McEntire is not a debtor. He became a debtor upon the company's default and was entitled to notice of the Bank's disposition of the equipment.

Waiver

The Bank urges that, regardless of McEntire's characterization as "debtor" and his entitlement to notice, he waived such notice by the terms of the guaranty. We disagree.

IND. CODE 26-1-9-501(3) does not allow the debtor to waive his right to notice of sale. It states:

(Emphasis added.) Nor can the debtor waive this right by provision in the security agreement. Hall v. Owen County State Bank, (1977) 175 Ind.App. 150, 370 N.E.2d 918. We believe the same is applicable to McEntire who purportedly waived his right to notice in the guaranty. Under the terms of I.C. 26-1-9-501(3), he cannot waive this right for virtually the same reasons he was entitled to notice in the first place, the U.C.C. prizes function over form. If we were to find otherwise, a secured party could avoid the protection afforded debtors by the mere expedient of requiring a guaranty be executed with each security agreement. Such result would then hinge upon semantics rather than actualities. We again follow the majority when we decide that McEntire could not waive his right to notice. See, e.g., Ford Motor Credit Co. v. Lototsky, supra, 549 F.Supp. 996; Commercial Discount Corp. v. King, (N.D.Ill. 1981) 515 F.Supp. 988; Commercial Credit Corp. v. Lane, supra, 466 F.Supp. 1326; Barnett Bank of Tallahassee v. Campbell, supra, 402 So.2d 12; Clune Equipment Leasing Corp. v. Spangler, supra, 615 S.W.2d 106; Savings Bank of New Britain v. Booze, supra, 34 Conn.Sup. 632, 382 A.2d 226 (accommodation maker); contra, United States v. Kurtz (E.D.Pa. 1981), 525 F.Supp. 734, affd. (3rd Cir.1982), 688 F.2d 827, cert. denied (1982) 459 U.S. 991, 103 S.Ct. 347, 74 L.Ed.2d 387 (interpreting California law); National Acceptance Co. of America v. Wechsler (N.D.Ill. 1980), 489 F.Supp. 642; Vickers v. Chrysler Credit Corp. (1981) 158 Ga.App. 434, 280 S.E.2d 842; Continental Leasing Corp. v. Lebo (1970), 217 Pa.Super. 356, 272 A.2d 193.3

The Bank argues that the nature of McEntire's guaranty, as unconditional, requires that we find him absolutely liable without regard to the disposition of the collateral and cites authority in support thereof. E.g., Fireman's Fund Insurance Co. v. Joseph J. Biafore, Inc., (3d Cir.1975) 526 F.2d 170; Paul Revere Protective Life Insurance Co. v. Weis, (E.D.Pa. 1981) 535 F.Supp. 379; Continental Leasing Corp. v. Lebo, supra, 217 Pa.Super. 356, 272 A.2d 193. With all due respect to the courts in those cases, we believe they erred in their interpretation of the function of an unconditional guaranty.

Federal courts have defined "unconditional guaranty" in the following terms:

Pavlantos v. Garoufalis, (10th Cir.1937) 89 F.2d 203, 206; United States v. Willis, (6th Cir.1979) 593 F.2d 247; Joe Heaston Tractor & Implement Co. v. Securities Acceptance Corp., (10th Cir.1957) 243 F.2d 196; U.S.A., Etc. v. Chatlin's Department Store, Inc., (E.D.Pa. 1980) 506 F.Supp. 108. The practical ramification of the distinction with the term "conditional" is that the unconditional guarantor automatically becomes the primary obligor upon default of his principal and is not entitled to notice thereof. See Bowyer v. Clark Equipment Co., supra, 171 Ind.App. 431, 357 N.E.2d 290. He therefore does not wish to protect himself by relying on the solvency of his principal. Id. Confusion seems to arise, however, by the very nature of a guaranty, not between the two kinds.

There is no question a guarantor may waive notice of treatment, release, or sale of collateral while the terms of the security agreement are still in effect. Carney v. Central National Bank of Greencastle, (1983) Ind. App., 450 N.E.2d 1034. But a distinction must be made between the waiver of pre-default disposition of collateral when the guarantor is still only secondarily liable and post-default treatment of collateral when the guarantor is actually facing primary liability and is entitled to fair treatment in the reduction of that liability. See Commercial Discount Corp. v. King, supra, 515 F.Supp. 988. It is this post-default disposition that is protected by the terms of Article 9 and which we deem may not be waived. We fail to see how the fact that McEntire contracted to become absolutely liable under his unconditional guaranty can in any way alter the unwaivable mandate for notice under I.C. 26-1-9-501(3).4 See United States v. Willis, supra, 593 F.2d 247 (defense of commercial reasonableness); Commercial Discount Corp. v. King, supra, 515 F.Supp. 988; Walter E. Heller & Co., v. Wilkerson, supra, 627 P.2d 773 (defense of commercial reasonableness under Illinois law).

Commercial Reasonableness

For the same reasons we have held McEntire entitled to reasonable notification of the disposition of the collateral, so is he entitled to raise the defense of commercial reasonableness. I.C. 26-1-9-504(3). As this is a question of fact, Hall v. Owen County State Bank, supra, 175 Ind.App. 150, 370 N.E.2d 918, it would not have been amenable to summary judgment. Regardless of whether McEntire had been entitled to notice, this error is cause for reversal.

Our decision to reverse does not bar the Bank's action for a deficiency judgment. Instead, the Bank must simply hurdle the two defenses erected by McEntire while it presents its case. First, it has the burden of proving that the sale was held in a commercially reasonable manner. After having established that point, and as a consequence of having failed to notify McEntire, it must then prove "that the reasonable value of the collateral at the time of the sale was less than the amount of the debt." Id. 370 N.E.2d at 928. (This must be established by credible objective evidence other than the opinions of the Bank's employees. Id.) To this end, we

Reverse and remand for proceedings not inconsistent with this opinion.

CONOVER and YOUNG, JJ., concur.