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U. S. A. EX REL. SBA v. CHATLIN'S DEPT. STORE

July 21, 1980

U. S. A. on Behalf of its Agency, the SMALL BUSINESS ADMINISTRATION
v.
CHATLIN'S DEPARTMENT STORE, INC., et al.



The opinion of the court was delivered by: GILES

MEMORANDUM AND ORDER

The United States, on behalf of its agency the Small Business Administration ("SBA"), brings this action for mortgage foreclosure to collect on a deficiency judgment obtained under a guaranty agreement executed by the individual defendants, Lewis and Irene Chertok, as security for a loan. The SBA has moved for summary judgment pursuant to Rule 56, Fed.R.Civ.P.

 On June 29, 1976, Chatlin's Department Store, Inc. ("Chatlin's") executed a $ 330,000 promissory note in favor of Girard Bank. The SBA guaranteed 90 percent of the loan balance in the event of default by the borrower. Defendants executed a guaranty agreement to secure the note.

 When Chatlin's defaulted, the SBA, after honoring its guaranty commitment to Girard Bank, was assigned the promissory note, defendant's guaranty agreement, and a mortgage document previously executed by defendants. The SBA then conducted a public auction sale of Chatlin's assets which allegedly brought a return of $ 11,000. The SBA now seeks to recover the remaining amount due upon the loan, alleged to be approximately $ 300,000.

 Defendants maintain that the SBA violated a duty imposed by the Pennsylvania Uniform Commercial Code ("UCC"), 12A P.S. § 9-504(3) to dispose of Chatlin's assets in a commercially reasonable manner and that the UCC governs the rights and obligations of the SBA in this action. Section 9-504(3) reads, in pertinent part, as follows:

 
(3) Disposition of the collateral may be by public or private proceedings and may be made by way of one or more contracts. Sale or other disposition may be as a unit or in parcels and at any time and place and on any terms but every aspect of the disposition including the method, manner, time, place and terms must be commercially reasonable....

 In moving for summary judgment, the SBA asserts that its rights and liabilities are governed by an unconditional guaranty agreement which must be construed in accordance with federal law, as contrasted to state commercial law. Further, the SBA claims that even if the defense of commercial reasonableness were available to them, defendants waived their right to assert it upon execution of unconditional guaranty agreement. Finally, it contends that the sale of Chatlin's assets was commercially reasonable in any event.

 For the reasons set forth below, this court holds that the duty imposed by Section 9-504(3) of the UCC does govern the sale of assets and therefore, the guaranty agreement did not release the SBA from its obligation to conduct the sale of Chatlin's assets in a commercially reasonable manner. Inasmuch as there remains a significant factual dispute as to the commercial reasonableness of the sale of the assets of the primary obligor, the motion for summary judgment must be denied.

 I.

 The SBA contends that defendants have an absolute duty to repay the debt because of the default of Chatlin's. Defendants argue that state commercial law provides an affirmative defense. While the court agrees with the SBA that specific language in the promissory note *fn1" provides that federal law is controlling in this case, the question remains as to what substantive federal rule applies. See, United States v. Willis, 593 F.2d 247 (6th Cir. 1979), United States v. Conrad Pub. Co., 589 F.2d 949 (8th Cir. 1978).

 In Willis, a corporation executed a promissory note in favor of a bank which was guaranteed up to 90 percent by the SBA. The defendants signed a separate instrument unconditionally guaranteeing prompt payment of the note. When the corporation defaulted on the note, the SBA paid back 90 percent of the loan and took possession of the corporate assets. After conducting a public auction sale of the assets, the SBA sought to recover from the individual guarantors the full amount of the loan. The defendant asserted that the sale of the corporate assets was not commercially reasonable, citing Section 9-504(3) of the Ohio Uniform Commercial Code. As in the instant case, the government there also claimed that the defense was unavailable under federal law since the guarantors had signed an unconditional guaranty agreement. In holding for the guarantors, the court stated that there was no substantive federal law in accordance with which the rights of the parties could be determined. Therefore, the court adopted the state commercial law as the federal rule of decision. Citing the Supreme Court in Clearfield Trust Co. v. United States, 318 U.S. 363, 63 S. Ct. 573, 87 L. Ed. 838 (1943) where the Court held "in the absence of an applicable Act of Congress it is for the federal courts to fashion the governing rule according to their own standards", the Willis court stated:

 
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. The Uniform Commercial Code has been enacted and is operative in 49 states (Louisiana excepted) and the District of Columbia. Moreover, it is the culmination of years of exhaustive study and effort, the purpose of which was to simplify, clarify, modernize and make uniform the laws of various jurisdictions concerning commercial practices and transactions.

 Willis, 593 F.2d at 253 (footnotes omitted).

 In Conrad, defendants had also executed an unconditional guaranty agreement which was subsequently assigned to the SBA. For the same reasons as in Willis, the Eighth Circuit Court of Appeals adopted Section 9-504(3) of the North Dakota UCC to allow the defense of commercial reasonableness stating, "(t)he UCC has become the source of federal common law in the area of commercial transactions, and, as such, it would be inappropriate to fashion a specialized ...


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