Unpublished Disposition, 865 F.2d 265 (9th Cir. 1988)

No. 87-3581.

United States Court of Appeals, Ninth Circuit.

Before WALLACE and REINHARDT, Circuit Judges, and CHARLES L. HARDY^* , District Judge.

MEMORANDUM^** 

The primary issue in this case concerns the proper method of analysis of a surety contract under Oregon law. Although Oregon law is concededly unclear on this issue, we conclude that the district court erred in applying a subjective, rather than an objective, standard of materiality. We reverse and remand for the proper application of Oregon law.

In October 1979, McCulloch & Sons, Inc. entered into a loan agreement for $200,000 with the United States National Bank of Oregon (USNB), 90% of which was to be guaranteed by the Small Business Administration (SBA). The final loan agreement, processed by the SBA and forwarded to all the parties, included two items crucial to this appeal: a $100,000 line of credit running for the life of the loan and a requirement that the principals of McCulloch & Sons guarantee the full payment. The original loan application, prepared by Colin Ackerson, made no mention of the first item. Shortly after the signing of the loan agreement, USNB, without prior notice to the sureties, sought permission from the SBA to alter the line of credit, limiting it to a renewable annual line. Ackerson and the McCullochs were not informed of the change. In March 1981, Colin Ackerson received a letter from Susan Clark, assistant manager of USNB, noting that McCulloch & Sons were losing money and bringing his attention to the altered line of credit arrangement. Ackerson did not respond. Six months later, USNB terminated the line of credit and, four weeks after that, McCulloch & Sons collapsed.¹ 

Under Oregon surety law, if, "without the surety's consent, the principal and creditor modify their contract ... the compensated surety is discharged if the modification materially increases his risk ..." See Lloyd Corp. v. O'Connor, 258 Or. 33, 37-38, 479 P.2d 744, 746 (1971). The decision in this case turns on the question of the definition of a material modification under Oregon law.

At trial, the district court determined that the four McCulloch defendants would not have executed the guarantees and the mortgages had the line of credit been omitted from the contract. Consequently, the court released them from their obligations as sureties. However, because the court found that the Ackersons did not rely on that particular provision of the agreement, as evidenced by the application and their tacit acquiescence in the March 1981 letter, the United States was permitted to foreclose on the mortgages executed by them. In essence, the court applied a subjective standard of materiality in assessing liability against appellants.

An analysis of a surety contract involves a two-step process. First, the scope of risk assumed by the surety must be assessed. This is an interpretation question, resting on normal contract principles which include, in cases of ambiguity, subjective judgments. Equitable Savings & Loan v. Jones, 522 P.2d 217, 221 (Or.1974). Second, there is an analysis of whether changes in the contract materially altered these risks. This appears to be a factual question, turning on the objective differences between the original contract and the contract as performed.

As to the first part of the inquiry, the court below concluded that the scope of the guarantee provisions must be guided by some flexible notion of party intent, not by a concept of strict technical compliance. See Bank of the Northwest v. Brattain, 698 P.2d 536, 537-38 (Or.Ct.App.1985). We agree, but the district court took this equitable principle too far. The district court assumed that since Mr. Ackerson did not immediately protest when he learned that USNB had altered the line of credit, the credit line was not a viable part of the guaranty contract. This reasoning is incorrect and unsupported by Oregon case law. In cases involving ambiguous guarantee provisions, the subjective intent of the parties will control. See Calamari & Perillo, Contracts Sec. 3.10 (1987). However, before subjective analysis is applied to the contract, there must be some ambiguity. In Brattain, the court analyzed an ambiguous section of the surety contract in light of the entire document and the intent of the parties. In the present case, however, paragraph 9 is crystal clear in its meaning; the section calls for a line of credit that is to last for the life of the loan. We do not believe that Oregon law permits courts to delete plain language from the contract. The district court erred in taking some precatory language from an Oregon case and using it to render void certain sections of the surety contract that are unambiguous, clear to the parties, and indisputably part of the surety contract.

While the dissent apparently agrees that paragraph 9 is a part of the surety contract for purposes of analysis, we part ways on the interpretation of the materiality of the change. The test for a material change in Oregon is what "a careful and prudent person undertaking the risk would have regarded as substantially increasing the chances of loss." Fassett v. Deschutes Enterprises, 686 P.2d 1034, 1037 (Or.Ct.App.1982) (quoting Lloyd Corporation v. O'Connor, 479 P.2d 744 (1971). Although the Oregon courts appear not to have been entirely consistent in their formulation of materiality, our survey of Oregon law convinces us that the objective prudent person standard enunciated in O'Connor has been adopted by most Oregon courts.²  This test of a careful and prudent person appears to represent the epitome of an objective standard, turning not on the particular beliefs of the parties but on an established norm. See Samuelson v. Promontary Investment Corp., 736 P.2d 207, 210 (Or.Ct.App.1987) (citing Fassett and O'Connor) . By articulating a test that focused on the Ackerson's reliance on paragraph 9, the district court deviated from Oregon's objective test. On remand, the lower court should determine whether an ordinary, prudent person would have viewed the change as substantially altering the terms of the contract.³ 

The district court's form of analysis makes for a rather odd pattern. All six defendants signed the same contract. The deviations from the contract were exactly the same for each of the defendants, yet four won and two lost. In the absence of some waiver or other postcontract analysis, we find this outcome both unusual and unprecedented in Oregon law. Consequently, we reverse for the correct application of the governing principles of Oregon law.⁴ 

WALLACE, Circuit Judge, concurring and dissenting:

The critical issue which divides us in this case is whether the Bank's modification of the surety agreement was material. The majority and I view Oregon law differently. This is not necessarily our fault--as the majority concedes. Oregon law is less than clear on this issue. The majority applies an objective test of materiality. I dissent because I believe that Oregon law requires a subjective test.

In Equitable Savings & Loan Association v. Jones, 268 Or. 487, 491-92, 522 P.2d 217, 219 (1974) (Equitable Savings), the Oregon Supreme Court provided guidance on the materiality standard. It stated:

What constitutes a material alteration is probably best cast in the following statement:

" * * * Probably what is meant is that an unauthorized alteration in the contract will release the surety where it changes the nature of the contract, thus changing the real meaning and legal import of the surety's obligation and placing him in a position different from that which he occupied before it was made.... (Footnotes omitted)"

Id.; see also Fassett v. Deschutes Enterprises, Inc., 69 Or.App. 426, 432, 686 P.2d 1034, 1037 (Fassett) (a material change is one that a careful and prudent person undertaking the risk would have regarded as substantially increasing the chance of loss), rev. denied, 298 Or. 150, 690 P.2d 506 (1984). The Equitable Savings materiality standard requires us to examine the surety's belief as to the nature of the underlying contract in order to determine whether the alteration placed the surety "in a position different from that which he occupied before [the alteration] was made." Equitable Savings, 268 Or. at 491-92, 522 P.2d at 219; see also Bank of the Northwest v. Brattain, 73 Or.App. 261, 263, 698 P.2d 536, 537-38 (1985) (Brattain) (examine the intention of the parties when analyzing a guaranty contract). Although not absolutely clear, review under the Oregon materiality standard requires assessment of the subjective belief of the surety as well as an objective reading of the document. See Samuelson v. Promontory Investment Corp., 85 Or.App. 315, 320-21, 736 P.2d 207, 210 (1987) (Samuelson) (because a surety agreed to guarantee loans at up to 18% interest, but with no interest "floor," a subsequent modification of the underlying agreement setting a retroactive 16% floor was not material; the floor did not exceed the outer limit of the risk the surety originally agreed to accept); see also Equitable Savings, 522 P.2d at 219; Fassett, 686 P.2d at 1037-38; Brattain, 698 P.2d at 537-39.

The district court's citation of Brattain evinces its use of this form of analysis. The district court concluded that it was necessary to examine the loan application leading up to the execution of the guaranty and mortgages in order to determine Colin Ackerson's intent in executing them. Thus, the district court relied on the original loan application, in which Colin Ackerson offered his personal guarantee, secured by the two mortgages, without an accompanying line of credit. In addition, the district court found probative in determining his earlier intent the fact that, when the Bank notified Colin Ackerson in March 1981 that continuation of the credit line was contingent upon the Company's return to a positive net worth position, he did not invoke paragraph 9 of the bank agreement, which provided the line of credit for the loan.

Because the district court focused on extrinsic evidence of what Colin Ackerson said and did in executing the guaranty and the mortgages, we should review for clear error. See Miller v. Safeco Title Insurance Co., 758 F.2d 364, 367 (9th Cir. 1985). We should accept the district court's findings as to Colin Ackerson's intent unless we are " 'left with the definite and firm conviction that a mistake has been committed.' " Anderson v. Bessemer City, 470 U.S. 564, 573 (1985), quoting United States v. United States Gypsum Co., 333 U.S. 364, 395 (1948). "Where there are two permissible views of the evidence, the factfinder's choice between them cannot be clearly erroneous." Id. at 574.

I do not believe that the district court clearly erred. I conclude that the district court found that although the underlying agreement was altered, Colin Ackerson did not view the change as materially increasing his risk because he thought he was accepting the risk of guaranteeing the loan from the outset without a line of credit. This analysis of the materiality of a change was appropriate under Oregon law. Samuelson, 85 Or.App. at 320-21, 736 P.2d at 210.

While I would affirm as to Colin Ackerson, I agree that the judgment cannot stand as to Doris Ackerson, but for a different reason. Doris Ackerson argues that there was insufficient evidence to sustain a judgment against her because (1) there was no evidence that she knew of the March 1981 letter from the Bank stating that the Company was continuing to lose money and that the Bank's ability to continue to provide an operating line of credit depended on the Company's ability to recover its losses and return to a positive net worth position, and (2) there was no evidence tending to establish that Colin Ackerson was acting as her agent in executing the guaranty. See Young v. Neill, 190 Or. 161, 220 P.2d 89, 94 (1950) (an agency relationship between a husband and wife must be proved, not presumed, though it may be implied from the circumstances); Durham v. Warnberg, 62 Or.App. 378, 660 P.2d 208, 211 (1983) (same).

I am unable to review her contentions. The district court made no findings of fact or conclusions of law concerning Doris Ackerson. The opinion does not even mention her. Therefore, I would vacate the judgment against Doris Ackerson and remand for findings and conclusions.