Camp v. First Financial Federal Savings & Loan Ass'n , 299 Ark. 455 ( 1989 )

Robert H. Dudley, Justice.

Appellant, Worth Camp, Jr., co-signed a $25,000 promissory note payable to appellee, First Financial Federal Savings and Loan Association. The purpose of the transaction was to establish a line of credit for an inventory of used cars to be resold by Rusty Jones, a used car dealer who was the other co-signer. The note was renewed three (3) times and, during that time, the amount of the note was increased to $50,000. Jones defaulted, suit was filed, and judgment was entered against Jones and appellant, jointly and severally, in the amount of $52,180, plus interest at the rate of 12 % and attorneys’ fees of $5,218. Jones is not involved in this appeal. We reverse the judgment against appellant.

The facts concerning the execution of the note are not in dispute. Jones applied to appellee for a loan in order to open a used car business. Appellee refused to make a loan to Jones. Jones, a family friend of appellant Camp, asked appellant if he would cosign a note. Appellant agreed, and the two of them then completed a credit application for appellee. Appellee agreed to make a $25,000 loan if both co-signed the note. The loan was approved because of appellant’s financial worth. Appellant neither owned nor acquired an interest in the used car business, nor did he receive any of the proceeds of the loan. Appellant, an attorney, did represent Jones in the formation of his business and charged Jones a reasonable fee for his work.

Ark. Code Ann.§4-3-415(l)(1987) defines an accommodation party as “one who signs the instrument in any capacity for the purpose of lending his name to another party to it.” The comment to this section provides in part that the “essential characteristic is that the accommodation party is a surety, and not that he has signed gratuitously.” Thus, an accommodation party may appear on the instrument as a co-maker. See J. White and R. Summers, Uniform Commercial Code, % 13-12, at 516 (2d ed. 1980). Under the facts of this case, appellant is an accommodation party and a surety.

Sureties may have simple contract defenses. See Comment to Ark. Code Ann. § 4-3-415(1) (1987). One of the defenses involves the creditor’s failure to disclose facts which materially increase a surety’s risk. A number of courts have adopted Section 124(1) of the Restatement of Security (1940), to define the creditor’s duty to disclose. Sumitomo Bank of California v. Iwasaki, 70 Cal. 2d 81, 88, 73 Cal Rptr. 564, 571, 447 P.2d 956, 963 (1968); accord, Maine National Bank v. Fontaine, 456 A.2d 1273 (Me. 1983); First National Bank of Arizona v. Bennett Venture, Ltd., 130 Ariz. 562, 564, 637 P.2d 1065, 1067 (App. 1981); First National Bank & Trust of Racine v. Notte, 97 Wis. 2d 207, 213, 293 N.W.2d 530, 536 (1980); Watkins Products, Inc. v. Stadel, 214 N.W.2d 368 (N.D. 1973). We also adopt the section which provides:

§ 124. Non-Disclosure by Creditor.

(1) Where before the surety has undertaken his obligation the creditor knows facts unknown to the surety that materially increase the risk beyond that which the creditor has reason to believe the surety intends to assume, and the creditor also has reason to believe that these fácts are unknown to the surety and has reasonable opportunity to communicate them to the surety, failure of the creditor to notify the surety of such facts is a defense to the surety.

Comment (b) to that section states that:

Among facts that are material are the financial condition of the principal, secret agreements between the parties, or the relations of third parties to the principal. If the surety requests information, the creditor must disclose it. Where he realizes that the surety is acting or is about to act in reliance upon a mistaken belief about the principal in respect of a matter material to the surety’s risk, he should afford the surety the benefit of his information if he has an opportunity to do so.

In this case, the original note was executed on August 2, 1984, and the renewals were executed on January 25, 1985, September 11,1985, and March 15,1986. The appellant testified thaton August 15, 1985, just beforetheSeptember 1985 renewal, the loan officer of appellee “advised me the note was coming up for renewal and he advised me that the interest had been paid.” Appellee offered no evidence to the contrary. In truth, interest payments were four (4) months delinquent. Appellant testified that he would not have executed the September 11, 1985, renewal if he had known that interest was not current. The trial court did not find that these facts constituted a sufficient defense, but that appears to be because that court, faced with a case of first impression, applied the wrong standard of duty. It held that “the evidence shows that the plaintiff [appellee] did not administer this loan in bad faith or cause any fraudulent misrepresentations with regard thereto to be made, and that the actions of the bank in administering this loan did not impair the collateral in question.” It was not necessary for the surety to prove bad faith or fraudulent misrepresentation. Instead, he had to prove only the elements set forth in Section 124.

Appellee’s conduct toward appellant was even more egregious in a different regard. All of the witnesses agreed that appellee would not make the loan to Jones alone. Appellee’s president testified that “the loan would not have been made without Mr. Camp as the co-borrower.” However, once appellant signed as a co-maker, and the loan limits were practically reached, the appellee began making side loans, or personal loans, to Jones. For example, when $24,861 of the guaranteed $25,000 line of credit had been reached, appellee made a side loan to Jones of $3,250. When $48,019 of the $50,000 guaranteed line of credit had been reached the appellee made side loans to Jones of almost $10,000. These side loans to Jones amounted to $25,038, and were repaid from cars which were mortgaged to appellee. Yet, all parties understood that the loans which appellant co-signed were to be repaid by sale of the car inventory. Appellant knew nothing of the side loans and naturally thought that Jones’ used car business was making payments only on the loans which he cosigned. The trial court again applied the wrong standard and held that although appellee “did loan additional sums to the Defendant Jones without the knowledge of Mr. Camp, these loans evidenced by ‘side notes’ were not in violation of any duty to Mr. Camp nor do they fall within the concept of bad faith by the Plaintiff [appellee].”

Both of these actions, the failure to disclose and the secret side loans, materially increased the surety’s contemplated risk, and the creditor was aware of the surety’s ignorance of the facts. Yet, the creditor, appellee, chose to misrepresent the truth about the currency of the interest payments and to secret the side loans.

As a result of the actions, the surety assumed a risk well beyond that which he intended. The appellee was aware of the facts, and although given the opportunity, failed to communicate them to the surety. Such actions by a creditor discharge a surety. Accordingly, the judgment is reversed and the complaint is dismissed.

Reversed and dismissed.

Hickman, J., not participating. Hays, J., dissents.