Security Bank, N.A. v. Mudd

No. 84-295
IN THE SUPREME COURT OF THE STATE OF MONTANA
1985

SECURITY BANK, N.A.,
Plaintiff and Appellant,
-vs-
JOSEPH E. MUDD,
Defendant and Respondent.

APPEAL FROM: District Court of the Thirteenth Judicial District,
In and for the County of Yellowstone,
The Honorable Charles Luedke, Judge presiding,

COUNSEL OF RECORD:

For Appellant:
Herndon, Harper & Munro; James Edmiston argued,
Billings, Montana

For Respondent :
Joseph E. Mudd argued, Bridger, Montana

Submitted: January 21, 1985
Decided: March 14, 1985

Filed:
Mr. Justice Fra.nk B. Morrison, Jr. delivered the Opinion of
the Court.
Security Bank, N.A. (Bank) brought an action in the
District Court of the Thirteenth Judicial District, County of
Yellowstone, to recover under a contract of guaranty executed
by defendant, Joseph E. Mudd. Both Mudd and George Balback,
the loan officer involved, were deposed. The case was then
submitted to the court upon the depositions, the court file
and the attorneys' briefs. The court held that Bank failed
to notify Mudd of changes in the underlying note which mate-
rially increased defendant's risk under the guaranty, dis-
missed Bank's complaint and awarded Mudd costs and reasonable
attorney's fees. The District Court stayed its jud.gment at
Rank's request, pending this appeal.
Prior to the summer of 1979, Coral Bemis owned and
operated an employment agency in Kalispell, Montana. That
summer, with Joseph Mudd acting as her attorney, Bemis sold
the Kalispell business. She accepted a $25,000 contract
receivable, due in one year, September 25, 1980.
Wishing to open an employment agency in Billings, Mon-
tana, Bemis sought financinq in that city, to no avail. Mudd
then offered to contact an acquaintance of his, the Vice
President. of Security Bank, on Bemis' behalf. That contact
enabled Bemis to obtain an interview with George Balback, a
loan officer at Rank. Following that interview, Balback
contacted Mudd to inquire about Bemis' $25,000 contract
receivable. Balback apparently requested Mudd to guarantee a
note for Bemis and Mudd agreed. Bank subsequently issued a
note to Bemis for $16,000, with a 1 3 % percent interest rate.
The note was secured by the $25,000 contract receivable and
stock certificates of the corporation, and guaranteed by
Mudd .
 At either Mudd's or Bank's request (both sa-y it was upon
the request of the other), Bemis was not told Mudd guaranteed
her note.
The contract of guaranty signed. by Mudd was continuing
and unconditional. It stated in relevant part:
"FOR VALUE RECEIVED and in consideration of credit
now or hereafter extended to Coral L. Bemis, ...
undersigned ... guarantees:
" (1) The payment to Bank upon demand of all sums
of money now or hereafter owed by Debtor to Rank,
together with interest thereon;
" (2) The payment of all costs and expenses, in-
cluding attorneys' fees incurred by Rank in connec-
tion with the collection of the indebtedness of
Debtor.

"This Guaranty shall be a continuing one and under-
signed hereby expressly waives presentment, demand,
protest, and notice of protest on any and a.11 forms
of such indebtedness, and also, notice of accep-
tance of this Guaranty, acceptance on the part of
said Bank being conclusively presu.med by its
request for this Guaranty and receipt of the same
by it. Undersigned consents to the extension of
the time of payment of any obligation guaranteed by
this Guaranty without notice to undersigned."
Late in 1979, Mudd helped Bemis and Veronica Sherman
incorporate as C.L. Bemis, Inc. Mudd. agreed to become the
silent owner of 2 percent of the business, with Bemis and
Sherman each owning 49 percent.
In January 1980, Bemis received an early payment of
$20,'7OO as full satisfaction of the $25,000 Kalispell con-
tract. Ralback applied $13,500 to the $l6,OOO note and
released the remaining money to Bemis for use in her new
employment agency. Bemis did not inform Mudd of this trans-
action. Balback cannot recall whether he did or not. In
fact, Balback ca.n.notrecall the specifics of any conversation
he might have had with Mudd, but is certain he kept Mudd.
informed of Bemis ' subsequent financial difficulties. Mudd
contends he made several inquiries to Bank about the note and
was told that a large portion of it had been paid in January
1980. He further c o n t e n d s Bank n e v e r t o l d him o f Bemi.sl

financial dif f icul t i e s .

O F e b r u a r y 11, 1980, R e m i s l o r i g i n a l n o t e had a b a l a n c e
n

o f $2,500, p l u s a c c r u e d i n t e r e s t . O t h a t d a t e , t h e n o t e was
n

i n c r e a s e d by $2,000 and changed by Bank and B e m i s t o a re-

volving note, with i n t e r e s t t o accrue a t 1 7 percent.

O March 2 1 ,
n 1980, Bemis e x e c u t e d a n o t h e r n o t e i n t h e

name o f C . L . Bemis, Inc., d / b / a B r y a n t Bureau, i n t h e amount

of $5,000. T h i s c o r p o r a t e n o t e was g u a r a n t e e d by V e r o n i c a

and David Sherman. The g u a r a n t o r s were s u b s e q u e n t l y r e l e a s e d

when Veronica p a i d t h e m a j o r i t y o f t h e n o t e and t r a n s f e r r e d

t h e remaining $450 d e b t t o B e m i s i n d i v i d u a l l y .

On September 16, 1980, t h e n o t e , which i s t h e s u b j e c t o f

t h i s appeal-, was e x e c u t e d by Bemis i n t h e amount o f $5,250.

T h i s n o t e s t a t e s t h a t t h e money was advanced f o r renewal o f

Note No. 13384C, the original $16,000 note. The $5,250

consists of:

(1) $2,500 -- the remaining balance on the original

$16,000 n o t e ;

(2) $2,000 -- an a d d i t i o n a l advance made on t h e o r i g i -

n a l $16,000 n o t e ;

(3) $300 -- accrued interest on the original $16,000

n o t e ; and

(4) $450 -- r o l l e d from t h e c o r p o r a t i o n ' s n o t e .

Bemis defaulted on t h e $5,250 note and Rank demanded

payment from Mudd. Upon Muddts r e q u e s t , Bank obtained a

judgment on the note against Bemis on April 8, 1981.

However, Bemis then filed f o r b a n k r u p t c y and. Bank d i d n o t

recover. Defendant t h e r e a f t e r r e f u s e d t o honor t h e g u a r a n t y

and t h i s a c t i o n was b r o u g h t June 29, 1981.

In i t s appeal of t h e dismissal of its action against

Mudd, Bank r a i s e s t h e f o l l o w i n g i s s u e s :
 1. Whether the District Court erred in holding Bank
was under a duty to notify the guarantor that (a) it had
received payment upon a contract receivable, which payment
possibly may have been sufficient to pay off a line of cred-
it; and (b) it was not using that security to ful.ly satisfy
the primary oblj.ga.tion.
2. Whether under a contract of unconditional and
continuing guaranty, a partial release of collateral by Bank
was sufficient under Montana law to exonerate the guarantor
from his obligation to pay the debt of the primary debtor.
Our resolution of the first issue renders issue number
.two moot.
The District Court, relying on Sumitomo Bank of Califor-
nia v. Iwasaki (Cal. 1968), 447 P.2d 956, held Bank had a
duty to notify Mudd, as guarantor of the note, when it deter-
mined not to totally discharge Bemis' note upon receipt of
the collateral and when it extended further credit to Bemis.
Sumitomo involved numerous extensions of credit under the
original note. The California Court held that each extension
of credit created a new suretyship contract. Sumitomo, 447
P.2d at 964. The Court then applied a test from the Restate-

- -of Security for when
ment ' creditor has a duty, at the
outset of an obligation, to d.isclose facts it knows about the
debtor to the surety to determine whether the surety should
be released. The elements of that test are:

1. The creditor has reason to believe those facts
materially increase the risk beyond that which the surety
intends to assume;
2. The creditor has reason to believe the facts are
unknown to the surety; -
and
3. The creditor has a reasonable opportunity to cornmu-
nicate the facts to the surety. &statement - Security
of

S 124 (1) (1941) .
 We approve the District Court's use of the Restatement

- Security's test in this instance as release of the
of
collateral. without full payment of the note similarly created
a new suretyship contract. Further, we find the District
Court did not abuse its discretion in determining, under the
facts of this situation, that all three elements of the test
were met.
There is sufficient credible evidence to support the
trial judge's findings regarding the second and third ele-
ments of the test.
Regarding element number two, it is undisputed that Bank
knew Bemis did not know Mudd had guaranteed her loan. There-
fore, it was reasonable for the trial judge to find that
creditor (Bank) had reason to believe that surety/guarantor
(Mudd) did not know the collateral had not been used to
totally discharge the note. There is no evidence Rank so
informed Mudd and there was no reason for Bemis to tell Mudd
of the partial release.
With respect to the third element, Fudd repeatedly
stated in his deposition that despite numerous inquiries
concerning the note, he was never told of the note's true
status. Mudd remembered the details of the discussions. In
contrast, Balback's statements in his deposition regarding
his discussions with Mudd over the use of the coll-ateral are
rather vague and uncertain. There is sufficient evidence to
support the trial judge's finding that despite numerous
opportunities to do so, creditor (Bank) had never told
surety/guarantor (Mudd) the true facts.
The first element of the test is not so easily resolved.
No changes to the note resulted in an obligation greater than
the $16,000 Nudd originally agreed to assume. Moreover, the
guaranty was both unconditional and continuing. However,
Pludd knew that the $25,000 contract receivable was going to
be used as collateral when he signed. Bemis' note as
guarantor. The trial judge did not abuse his discretion in
finding that the contract receivable was inextricably linked
with the guaranty and that Mudd had the right to assume that
Bank would use the money from that contra.ct receivable to
satisfy the note, or notify him otherwise. The Bank's
failure to do so materially increased Mudd's risk beyond that
which he intended to assume.
The District Court therefore correctly held that Bank
was under a duty to notify Mudd that it did not totally
discharge Bemis' note upon receipt of the collateral. When
Bank failed to so notify Mudd, he was released a.s guarantor
of Eemis' note.
The decision of the Distri rt is affirmed.

c
We concur:

hie£ Justice
/