Wallace G. Frederick v. United States

GODBOLD, Circuit Judge:

The trial court granted summary judgment for the plaintiff, the United States, and dismissed defendant's counterclaim. We reverse.

The suit arose out of a $100,000 loan made by the Small Business Administration (SBA) on March 16, 1960, to Frederick Dredging Company, Inc. (“the company” or “the corporation”). The debt was evidenced by a note executed for the corporation by Wallace G. Frederick (hereinafter “Frederick”) as president; the note was not executed by Frederick individually. As security the corporation gave a mortgage on real estate located in Alabama and various personal property.¹ Frederick, individually, signed the usual SBA guaranty form, guaranteeing punctual payment of the note when due and agreeing that upon failure of the company to pay the note, whether due by acceleration or otherwise, he would, upon written demand of SBA, pay SBA the amount due and unpaid. As security for performance of the guaranty Frederick assigned to SBA life insurance with a cash surrender value of approximately $4,000.

The corporation became delinquent, and on March 16, 1962, SBA declared the note in default and accelerated. The United States then filed suit in the District Court for the Western District of Louisiana, against the company only.² On May 28, 1962, default judgment was entered against the company for a total of $102,720.69, consisting of a principal sum of $97,654.74, accumulated interest as of March 15, 1962, of $4,073,04, advances of $986.81 for preservation and care of collateral, interest of $7.10 as of March 15, 1962, on advances made for preservation of collateral, plus interest after March 15, 1962, at 5% % per an-num on the principal amount until paid. The judgment recited that it was “with full recognition of complainant’s special mortgage, lien and privilege upon the following described property,” then listed various items of personal property including a dredge and a tug. The judgment directed that the described property be seized and sold by the United States Marshal for the Western District of Louisiana, “at public auction with appraisement, for cash, to the highest bidder,” and the amount realized be credited pro tanto on the amount of the judgment and if not sufficient to discharge the judgment the unpaid balance would be enforceable against any property of the defendant.

On February 4,1964, the United States began the present action. First it sued, on the note itself, in the United States District Court for the Southern District of Texas against “Wallace G. Frederick, d/b/a Frederick Dredging Company, Inc.,” as alleged maker. The complaint recited execution of the note by the named defendant and default thereon, and claimed unpaid principal and interest of $44,-759.13, plus interest from default on October 1, 1962, until paid.

Subsequently a First Amended Complaint was filed,³ and attached as exhibits were a copy of the note and the guaranty; this pleading set out a claim on the guaranty against Frederick in his individual capacity, alleging that although requested he had failed and refused to pay the remaining principal and interest due on the note in accordance with his guaranty, to plaintiff’s damage in the amount of $44,759.13, plus interest at % per annum from date of default, to wit, October 1, 1962. Judgment was prayed against Frederick alone for said sum, with interest from the date of default.⁴

Plaintiff moved for summary judgment. The motion was submitted on the basis of the First Amended Complaint to which the note and guaranty were attached, additional exhibits (to the motion) consisting of a certified copy of the Louisiana judgment and an affidavit of an employee of SBA,⁵ interrogatories and answers thereto (none of which is here material, except in one minor respect indicated below), and the sworn First Amended Answer and Counterclaim of Frederick.

Pursuant to Rule 54(b) the Court granted summary judgment for the United States on its claim but held the action could proceed as to Frederick’s counterclaim.

A. The Motion for Summary Judgment

In his sworn First Amended Answer and Counterclaim defendant denied that the United States was entitled to recover the sum of $44,759.13 with interest at 5y2% per annum from October 1, 1962. As grounds for the denial he set out that on or about July 25, 1962, the United States Marshal for the Western District of Louisiana levied under a writ of execution upon property mortgaged to SBA and sold the same to an agent of the SBA for $44,100, that the property foreclosed on had been appraised for approximately $299,000 when the loan was made, and said amount was then accepted by SBA as the fair market value thereof. Frederick charged that the purchase for $44,100 was “unconscionable and tainted with fraud” and that the purchase was void because of fraud and conspiracy of the Marshal and SBA. On the basis of the same allegations Frederick counterclaimed for damages against the United States.

The matters before the Court on the motion did not remove all material issues of disputed fact. Frederick admitted the note was due and payable and that he executed the guaranty. What is missing is proof by plaintiff of the amount of damages to which it is entitled. While defendant’s pleadings could have been more artful it is plain he was denying under oath that he owed the sum sued for. Detailed allegation of operative facts, which were also asserted as the basis of a counterclaim, did not eliminate Frederick’s denial. If the sworn Answer did nothing else it clearly put in issue the statement in the SBA affidavit that no part of the debt had been paid except as fully credited.

To recover, whether by summary judgment or trial on material issues, the government must prove the amount due and unpaid on the note and hence due by the guarantor, unless the amount is admitted (and here it was not). The United States claimed $44,759.13 with interest from October 1, 1962, which as best we can tell, though this is not clear, is asserted as the date of default on the guaranty as opposed to default on the note. Even if we assume that effect is to be given the Louisiana judgment as judicially establishing the amount of, and the elements of, the principal’s indebtedness so as to be binding on Frederick,⁶ there is no explanation of how the total of $102,720.67 awarded was reduced to alleged unpaid principal of $44,759.13, as of December 15, 1964. It is not possible to tell how the interest of $6,429.58 referred to in the affidavit was calculated or from what date, and whether it included all, some, or none of the interest of $4,073.04 awarded by the court in Louisiana; this is especially confusing because the Louisiana suit claimed acceleration arising from default on March 16, 1962, and the Texas suit claims default on October 1, 1962.^6a There was no information of what had happened concerning the advances for preservation of collateral (and interest thereon) awarded in the Louisiana judgment.⁷ Of course, the major factual deficiency was that nothing was stated concerning payment on the debt after it was reduced to judgment except the conclusionary statement in paragraph 4 of the affidavit that nothing had been paid except what had been fully credited — the form, date, amount and source of such payments were unrevealed, as well as whether the “payments” referred to were payments before judgment, realizations on security after judgment, or both. Presumably at least part of the credits arose from a sale which the Marshal was authorized by the judgment to hold. But authority to make a sale is not proof that the sale occurred, or of the amount of or application of the proceeds. The only facts before the Court of the proceeds of a sale consist of the statement in defendant’s First Amended Answer, that the sale was for $44,100 and was to SBA. Applying this amount to the total of the Louisiana judgment leaves a balance of $58,620.69. Applying it solely to the principal recited in the judgment, leaves a principal balance of $53,554.24. And, as set out above, it is not possible to follow the calculations of interest. Even without the denial by Frederick we are unable to see how summary judgment could be entered for a liquidated amount with any assurance of its correctness, considering the confusing and conflicting figures.⁸

The United States asserts that Frederick is making a collateral attack on the Louisiana judgment and that the burden was on him to put in the present record all the record of the Louisiana suit. This misses the mark. In the first place the evidentiary effect, if any, of the Louisiana judgment against Frederick depends on a showing by the government of more than it has here shown about the Louisiana case. Second, the guarantor’s obligation is to pay only what is unpaid. The United States sued for such net amount, the amount was denied under oath, and the United States has not proved the net amount. It cannot shift to Frederick responsibility for its offering a part only of the Louisiana record, which part, to the extent it has any evidentiary effect against Frederick, shows only the gross amount of the principal’s debt and nothing as to the net unpaid balance.

We conclude that the summary judgment was erroneously granted.

B. The Counterclaim

After the grant of summary judgment the United States moved to dismiss the counterclaim, asserting sovereign immunity, and alternatively moved to transfer the cause to the Western District of Louisiana. The counterclaim was then limited by the defendant to an amount not in excess of the government’s claim against him. The District Judge granted the motion to dismiss on three grounds: (1) sovereign immunity — that the counterclaim related to a claim of tort at the foreclosure sale, while the government’s claim had been purely contractual, citing United States v. Finn, 239 F.2d 679 (9th Cir., 1956), United States v. Patterson, 206 F.2d 345 (5th Cir., 1953) and related cases; (2) that defendant had not made claim with the General Accounting Office as required by 28 U.S.C.A. § 2406; (3) that no allegations showed the defendant was owner of any cause of action for tort at the foreclosure sale, that such a cause would belong to the corporation only and should have been disposed of in the foreclosure suit.

The guaranty gives wide powers to SBA to deal with the collateral assigned as security for its performance, including the right to purchase the security, but states “such powers [are] to be exercised only to the extent permitted by law.” A guarantor, who is in broad terms a type of surety, has a beneficial interest in collateral held by the creditor for the principal debt, and the creditor must exercise good faith in preserving, applying and disposing of the security and the proceeds, not only for the sake of the creditor’s security but in recognition of the guarantor’s obligation. Misapplication of security is a defense to the guarantor in an action against him on his obligation. The guarantor cannot compel the creditor to go against the security (and the guaranty so states), but once the creditor does so he must do so without negligence and with due regard for the guarantor’s interest in preservation of it and disposition of it for a proper value, for had the creditor not gone after the security the value of it would be subject to the guarantor’s rights as subrogee of the creditor.⁹ If a creditor irregularly or negligently sells security so that it produces less than its value the guarantor may sue the creditor for improperly preserving or applying the collateral, or, if sued, may set off the full value of the security against the amount otherwise due. Dilbert v. Wernicke, 214 F. 673 (6th Cir., 1914); Denson v. Gray, 113 Ala. 608, 21 So. 925 (1897); 72 C.J.S. Principal and Surety §§ 197-199, 206, 289-291, 299 (1951); 38 C.J.S. Guaranty § 81 (1943).

The guarantor’s interest in the collateral exists in any ease. But in addition this guaranty included in its definition of collateral for the performance thereof all collateral assigned by the corporation for the payment of the note.

If the United States mishandled the security, as claimed by defendant, it violated not only a duty imposed by law but also a duty imposed by the guaranty agreement itself.¹⁰

What the defendant complains of is purchase by the government for its own account at an inadequate price. The rights of SBA to purchase at the sale, and its obligation as a mortgagee purchasing the security, depend upon the terms of the mortgage itself, the type of sale, and questions of choice of law, all of which cannot be answered on the fragmentary information before us. At this time it is sufficient to say that the mortgagee, if it conducts the sale, has as a minimum a duty to the mortgagor to conduct the sale openly and fairly, and, regardless of who conducts the sale, a duty not to purchase the property for a price so inadequate as to show bad faith. This is the minimum duty; the duty may be higher when a trial court has before it data on which to ascertain the applicable standard.

This brings us to consideration of sovereign immunity and whether appellant should have sought a credit from the General Accounting Office before asserting his counterclaim. We are concerned with the interplay of the doctrine of sovereign immunity, 28 U.S.C.A. § 2406 and Fed.R.Civ.P. 13.

Rule 13 provides for “counterclaims and cross-claims.” A counterclaim under this rule is a claim of one party against an opposing party. It includes common law recoupment and set-off, which is statutory. Common law re-coupment was equitable in nature, resting on the principle that it was equitable to settle in one action all claims growing out of the same contract or transaction; it was for defensive use only, and a defendant could not use it as the basis for an affirmative judgment in his favor. Under most statutes set-off at law is a demand asserted to diminish or extinguish plaintiff’s demand, which arises out of a transaction different from that sued on, and generally must be liquidated and emerge from a contract or judgment. 3 Moore, Federal Practice, f 13.02 at 8-9 (2d ed. 1966).

Rule 13 counterclaims include recoupment and set-off. The “arising out of the same transaction” requirement (which at common law the defendant had to meet to establish his right to assert the claim) has significance in distinguishing between the compulsory counterclaim of Rule 13(a), which must be pleaded if arising out of the same transaction or occurrence else it will be barred, and the permissive counterclaim of Rule 13(b), which does not arise out of the same transaction or occurrence and may be, but need not be, pleaded.

The distinction between recoupment and set-off has significance where a defendant sued by the United States asserts a claim as to which the government has made no statutory waiver of its sovereign immunity. 3 Moore, Federal Practice, f[ 13.02 at 9 n. 1. (2d ed. 1966).

Both 13(a) and (b) are qualified by 13(d) in cases against the United States. United States v. Lashlee et al, 105 F.Supp. 184 (W.D.Ark., 1952). Rule 13(d) provides:

“Counterclaim Against the United States. These rules shall not be construed to enlarge beyond the limits now fixed by law the right to assert counterclaims or to claim credits against the United States or an officer or agency thereof.”

Thus a defendant is either compelled by 13(a), or permitted by 13(b), to counterclaim against the sovereign within the limits to which the sovereign immunity has been given up by the United States by other provisions of law. The waiver can be by statutory consent to be sued¹¹ or by the institution of the particular action. Our conclusion is that when the sovereign sues it waives immunity as to claims of the defendant which assert matters in recoupment — arising out of the same transaction or occurrence which is the subject matter of the government’s suit, and to the extent of defeating the government’s claim but not to the extent of a judgment against the government which is affirmative in the sense of involving relief different in kind or nature to that sought by the government or in the sense of exceeding the amount of the government’s claims;¹² but the sovereign does not waive immunity as to claims which do not meet the “same transaction or occurrence test” nor to claims of a different form or nature than that sought by it as plaintiff nor to claims exceeding in amount that sought by it as plaintiff.¹³ In re Monongahela Rye Liquors, Inc., 141 F.2d 864 (3rd Cir., 1944); United States v. Ringgold, 8 Pet. 150, 8 L.Ed. 899 (1834). Cf. Bull v. United States, 295 U.S. 247, 55 S.Ct. 695, 79 L.Ed. 1421 (1935); United States v. Macdaniel, 7 Pet. 1, 8 L.Ed. 587 (1833); 3 Moore, Federal Practice, jf 13.28 at 75-76 (2d ed. 1966). This ties in with the distinction made in Rule 13 itself. As defined in 13(e), a counterclaim may diminish or defeat the recovery sought by the opposite party — this far the government’s waiver goes. It may also, but need not, “claim relief exceeding in amount or different in kind from that sought in the pleading of the opposing party.” The government does not go so far as to waive its immunity to this kind of claim.

We do not understand Lacy v. United States, 216 F.2d 223 (5th Cir., 1954) to establish a rule in this circuit that in the absence of statutory waiver a sovereign does not waive sovereign immunity to any extent by filing suit. There the government sought an injunction to require defendant to remove structures from a transmission line easement of the TYA; defendant sought damages for trespass and an injunction compelling the United States to move the line, affirmative relief different in nature and exceeding in scope that sought by the government and not merely reducing the plaintiff’s claim. United States v. Finn, supra, and United States v. Patterson, supra, relied upon by the trial court, also involved attempts by defendants to seek affirmative relief which was not to reduce or extinguish the government’s recovery but to establish an independent right to. recovery from the government.

Defendant’s counterclaim here arises from the same transaction or occurrence.¹⁴ Defendant is sued on the guaranty; the status of the parties created by that contract imposes on the plaintiff a duty to the guarantor to deal properly with the security hypothecated by the creditor.

We turn now to the effect of § 2406.¹⁵ As we construe this section, it has no application where the sovereign already has laid aside its immunity by statute or by filing suit. A claim which otherwise qualifies to be filed as a compulsory counterclaim against the government is not subject to § 2406. United States v. Frank, 207 F.Supp. 216 (S.D. New York 1962). Section 2406 does have application where the claim is asserted as a permissive counterclaim under Rule 13(b). See full discussion in United States v. Lashlee, 105 F.Supp. 184 (W.D.Ark., 1952).¹⁶

It would be anomalous to hold that a defendant, in court in an action he did not bring, is required to plead a counterclaim against the government because it is compulsory under Rule 13 (a) but that once pleaded his counterclaim is subject to dismissal on the ground he had not, before being sued, taken affirmative action to seek an administrative “credit” of the General Accounting Office.¹⁷ The anomaly would be even more pronounced where the defendant is, as here, a secondary obligor, partially insulated by the primary obligor and the security, and might never be called on to pay.¹⁸

These conclusions of the scope of § 2406 are consistent with its purpose of preventing the government from being surprised by claims it has not had time to consider administratively. Cox and Deck v. United States, 6 Pet. 172, 31 U.S. 172, 8 L.Ed. 359 (1832); United States v. Heard, 32 F.Supp. 39, 41 (W.D.Va., 1940). So long as the same transaction or occurrence is involved surprise is minimized.

The counterclaim was improperly dismissed.

The records, briefs and oral argument are contradictory as to the extent to which the government has by court order, or agreement, or otherwise, either cooperated or refused its cooperation, or made available to defendant, or refused to make available to him, information in its files relating to the alleged Louisiana sale, credits given on the note, and like data. We have no doubt that the guarantor is entitled to such information either by voluntary disclosure by the government or under appropriate orders of the court within applicable rules of discovery.

Reversed and remanded.

1 . The mortgage is not in the record. Also there appears to have been a supplemental chattel mortgage given by the corporation in October, 1960, on additional personal property, but the record' does not disclose the nature of the property or what, if anything, has been done to realize on this collateral.

2 . The only evidence of the Louisiana proceeding in the record is a copy of the judgment, made an exhibit to the motion for summary judgment; we are able to determine the relief sought only to the extent revealed by the judgment.

3 . In its application for leave to file the First Amended Complaint the government stated as its reason “to include in the subject action the liability of the Defendant, Wallace G. Frederick, as guarantor of the promissory note set forth in the Original Complaint.”

4 . Questions of change of parties and service of process, arising from the amended complaint being against Frederick individually, are not before us, since Frederick appeared and answered. The United States took judgment against the individual only.

5 . Material parts of the affidavit stated:

“2. That on March 16, 1960, Wallace G. Frederick became indebted to the United States, by and through Small Business Administration, in the amount of $100,000.00, as evidenced by promissory note dated March 16, 1960, executed by Frederick Dredging Company, Inc., and delivered to Small Business Administration, said note being secured by the guaranty of Wallace G. Frederick, a copy of said guaranty being attached hereto and marked Exhibit ‘A.’

“3. That Wallace G. Frederick is justly and truly indebted to the United States under and by virtue of said promissory note, as of December 15, 1964, in the following amounts:

Unpaid principal balance $44,759.13

Accrued interest on loan as

of December 15, 1964 6,429.58

Total $51,188.71

Interest accrues after December 15, 1964, at the daily rate of $6.8382.

“4. That no part of said debt has been paid except as has been fully credited to said debt.”

6 . There is considerable doubt on this record that the Louisiana judgment binds the guarantor in those respects. A judgment against a principal conclusively establishes against a surety the fact of, and amount of, the principal’s liability, except against defenses of fraud or collusion, if obtained in a suit of which surety had full knowledge and opportunity to defend. (While there are technical differences between a guarantor such as Frederick and a surety, they do not produce a different result here.) Unless it is shown that the surety had such knowl- \ edge and opportunity the judgment is at the most only prima facie evidence, at the least only some evidence to be considered by the jury, of the fact of and amount of the surety’s indebtedness. Lake County v. Massachusetts Bonding and Insurance Co., 75 F.2d 6 (5th Cir., 1935); 2d appeal, 84 F.2d 115 (1936); Seaboard Surety v. Westwood Lake, Inc., 277 F.2d 397 (5th Cir.), cert. denied, 364 U.S. 821, 81 S.Ct. 55, 5 L.Ed.2d 50 (1960); Hopkins v. National Surety Co., 154 La. 61, 97 So. 297 (1923). Cf., authority that a default judgment against the principal does not affect the surety in any respect. Fusz v. Trager, 39 La. Ann. 292, 1 So. 535 (1887) ; Allison v. Thomas and Rosenfeld, 29 La.Ann. 732 (1877). Plaintiff has shown no knowledge or opportunity by Frederick to defend the Louisiana case; whether service on the corporation was obtained by serving him, or whether he was still connected with the corporation when it was sued, is not revealed by the record. All these are questions appropriate for a trial, with a full record of the Louisiana case available.

6a . But the government’s answers to interrogatories said both note and guaranty were “accelerated” on March 16, 1962.

7 . The record also is silent as to what realization, if any, has been made on other security given by the corporation and the separate security given by Frederick securing his performance of the guaranty.

8 . Hamlin v. Hamlin, 237 F.Supp. 299 (N.D.Miss., 1964) held summary judgment inappropriate to decide whether recited consideration in a deed was so grossly inadequate as to charge the United States with notice thereof, or to decide whether the recited value or the alleged actual value was the true value.

9 . The guaranty recognizes the right of the guarantor to be subrogated to “collateral” (including the security given by the corporation) when SBA has been paid in full.

10 . While regularity of the sale is not before us, we point out that 28 U.S.C.A. § 2005 requires appraisal before a judicial sale if required by state law and not otherwise provided by the court. Whether the sale is a judicial sale or an execution may depend on whether confirmation is required. Weir v. United States, 339 F.2d 82 (8th Cir., 1964); 33 C.J.S. Executions § 196 (1942). We do not know whether confirmation was here required. If the sale was judicial Louisiana law requires appraisal before sale. LSA-C.O.P. art. 2332. We do not know whether the “appraisement” referred to in the judgment occurred. In briefs and pleadings the parties variously refer to the sale as an “execution sale” and an “order of foreclosure.”

11 . For example, the consent of the government to be sued given by the Federal Tort Claims Act is a consent to the defendant’s asserting his tort claim as a counterclaim. 3 Moore, Federal Practice, H13.29 (2d ed. 1966, Supp.1965); United States v. Harms, 96 F.Supp. 1022 (D.Colo., 1951) ; United States v. Rosati, 97 F.Supp. 747 (D.N.J., 1951).

12 . The trial judge recognized this waiver of sovereign immunity but held defendant’s claim was a set-off, sounding in tort only, and that the claim was the property of the corporation in any event.

13 . A claim as to which sovereign immunity is not waived could be one within the-usual statutory definition of set-off, or it could be so different in origin or nature as to be outside the scope of set-off also.

14 . United States v. Houff, 202 F.Supp. 471, (W.D.Va.), aff’d 312 F.2d 6 (4th Cir., 1962) and United States v. Fyles, 253 F.Supp. 386 (D.Vt., 1965), are actions on SBA loans in which claims were made by the defendants similar to those here. Both courts treated the claims as affirmative defenses rather than the subject of counterclaims, which further indicates the right of Frederick to raise in this case the matters he complains of.

15 . 28 U.S.C.A. § 2406: “In an action by the United States against an individual, evidence supporting the defendant’s claim for a credit shall not be admitted unless • he first proves that such claim has been disallowed, in whole or in part, by the General Accounting Office, or that he has, at the time of the trial, obtained possession of vouchers not previously procurable and has been prevented from presenting such claim to the General Accounting Office by absence from the United States or unavoidable accident.”

16 . There are other cases holding § 2406 not applicable where the defendant appears to assert a defense which is not in form a claim but establishes that the liability asserted by the United States does not exist. United States v. Pusey, 47 F.2d 22 (9th Cir., 1931) was a suit to recover a refund on estate taxes paid. The Court allowed the defendant to prove that the original assessment had been erroneous, Norton v. United States, 81 F. 819 (5th Cir., 1897) construing a statute similar to § 2406, held that an argument that the money whose return was sued for had never come into the hands of the defendant was not a “claim for credit” hence the statutory process need not be observed.

Some eases construe § 2406 in a bookkeeping sense. United States v. Du Perow, 208 F. 895 (N.D.Ohio, 1913) suggests it applies only where defendant has dealt with the government in such a way that it is reasonable to expect the existence of an “account” with the government. Norton v. United States, supra, suggests “claim for credit” refers to a claim which is ordinarily represented by a “voucher.”

17 . In United States v. Houff, supra, and United States v. Fyles, supra, no question was raised of compliance with § 2406.

18 . Where § 2406 is applicable we doubt that failure of a defendant to have complied should cause peremptory dismissal of a counterclaim. We recommend for use in appropriate cases the procedure followed by Judge Bootle in United States v. Farmers Seed and Feed Company, 181 F.Supp. 475 (M.D.Georgia, 1959), of agreeing to withhold judgment for a reasonable length of time to permit defendant to bring himself in compliance with § 2406, or some other procedure giving the defendant time to act while protecting the government against surprise.