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First Wisconsin Financial Corp. v. Yamaguchi

decided: February 24, 1987.


Appeal from the United States District Court for the Northern District of Illinois, Eastern Division, No. 82 C 3624, Harry D. Leinenweber, Judge.

Author: Easterbrook

Before CUMMINGS, CUDAHY, and EASTERBROOK, Circuit Judges.

EASTERBROOK, Circuit Judge. Tomkenco, Inc., borrowed money from First Wisconsin Financial Corp. against the security of Tomkenco's assets and receivables. The contract between Tomkenco and First Wisconsin created a "Loan Account Ledger". When Tomkenco presented First Wisconsin with evidence that it had sold goods and created receivables, First Wisconsin would advance 80% of the amount of the receivables. The ledger would be updated with a specific entry, identified by Tomkenco's customer. The loans would be summed, and each month Tomkenco would receive a statement of the debit balance. The whole balance was due on First Wisconsin's demand. Tomkenco sent the customers' checks directly to First Wisconsin, which credited the particular item in the ledger and applied any excess to remaining debt not reflecting customers' paper (for example, debt secured by Tomkenco's inventory and equipment). Thomas Yamaguchi and Kenneth Kuzmenko, the principal stockholders and managers of Tomkenco, personally guaranteed Tomkenco's debts to First Wisconsin.

First Wisconsin started lending money to Tomkenco in May 1979. During the fall of 1980 Kuzmenko began to fabricate documents showing that Tomkenco had sold goods and received customers' paper. First Wisconsin loaned money against this worthless paper. Although First Wisconsin sometimes checked with customers to learn whether the purported sales had occurred, Kuzmenko enlisted Edward Gavney, an employee of UNA Corp., to "verify" fictitious sales to Bohler Brothers, a division of UNA. First Wisconsin did not catch on until the end of June 1981, by which time Tomkenco had obtained about $213,000 in loans against the bogus documents. Tomkenco was liquidated, more than $250,000 in debt to First Wisconsin, which tried to collect on its guaranties. By then Kuzmenko had vanished, leaving Yamaguchi as First Wisconsin's logical target.

Yamaguchi, however, was no longer an officer of Tomkenco. He quit on January 31, 1981, and sold all of his stock to Kuzmenko. He informed First Wisconsin of the change and requested a "release" of any accrued liability on this guaranty. First Wisconsin declined to "release" Yamaguchi unless someone invested $50,000 more in Tomkenco, an additional "equity cushion" that would improve First Wisconsin's position. Neither Kuzmenko nor Yamaguchi produced the money. On April 2, 1981, Yamaguchi's lawyer sent this letter to First Wisconsin:

As you know Mr. Yamaguchi has resigned as an officer and director of Tomkenco, Inc., effective on January 31, 1981. We were under the impression that First Wisconsin was intending to release Mr. Yamaguchi from his guarantee upon delivery to you of certain documentation from Mr. Yamaguchi. I understand that now you are not able to do that. However, on behalf of Mr. Yamaguchi, I am requesting that you release Mr. Yamaguchi from all liabilities incurred by Tomkenco on or after January 31, 1981, the effective date of his resignation. This is, in effect, a revocation of the guaranty effective on January 31, 1981. Could you please acknowledge receipt of this letter by giving us a written acknowledgment of Mr. Yamaguchi's release.

Despite a reminder from Yamaguchi's lawyer, First Wisconsin never replied in writing to this letter or asked for clarification. First Wisconsin concedes, however, that it received the letter.

After Kuzmenko's fraud had been exposed, First Wisconsin filed this diversity action against Kuzmenko, Yamaguchi, and UNA, seeking to make good its loss. The parties agree that Wisconsin law applies. The facts concerning Yamaguchi are undisputed, and both parties moved for summary judgment, which Judge Aspen granted in 1983. Judge Aspen concluded that the letter of April 2 revoked Yamaguchi's guaranty, but as of April 2 rather than January 31. On April 2 Tomkenco owed First Wisconsin about $404,000. After that date, Tomkenco paid First Wisconsin some $554,000, and borrowed $407,000. First Wisconsin argued that these payments should be applied to the particular items of customer paper against which money had been lent. Under this approach Yamaguchi was liable for $404,000 less payments attributable to paper written before then. Judge Aspen disagreed, concluding that although First Wisconsin had lent against security, the parties' arrangement was a single open-account loan. Payments and new advances on a single loan usually are accounted for under the first-in, first-out (FIFO) method. The application of FIFO accounting extinguished Yamaguchi's debt. Tomkenco paid about $554,000 after April 2, more than enough to cover the balance of $404,000 on that date. The court therefore entered summary judgment for Yamaguchi. Other parties remained in the case, however, and Judge Aspen declined to enter a partial final judgment under Fed. R. Civ. P. 54(b).

First Wisconsin eventually caught up with Kuzmenko, and the case was set for trial in May 1986 before Judge Leinenweber, to whom the case had been transferred. The parties settled on the eve of trial. First Wisconsin then tried to amend its complaint to add a claim of fraud against Yamaguchi, contending that not until the deposition of Kuzmenko in November 1985 did First Wisconsin have reason to believe that Yamaguchi had participated in the deceit. Judge Leinenweber declined to allow the amendment, and at last the court entered a judgment "final" and appealable under 28 U.S.C. § 1291. First Wisconsin contests the denial of leave to amend, but this was within the district judge's discretion. See Bohen v. City of East Chicago, 799 F.2d 1180, 1184-85 (7th Cir. 1986). By its own account, First Wisconsin did not try to amend the complaint for six months after learning of Yamaguchi's complicity. First Wisconsin explains that it waited because it did not want to risk a postponement of the trial scheduled for May 1986. This damns rather than justifies the delay, however; First Wisconsin concedes that it tried to split this case and, for its own convenience, obtain two trials. District courts are entitled to protect themselves, and other litigants whose cases would be affected, against such strategic conduct.

This leaves two questions of substance: the effect of the letter of April 2, and the choice of the accounting method. We agree with the district court that the letter of April 2 revoked the guaranty but do not believe that FIFO accounting is appropriate in a case of this character.

After Yamaguchi left Tomkenco, he was exposed to liability based on the debt outstanding on January 31. He promptly opened negotiations for relief. These foundered, and the letter of April 2 deals with liability for future transactions. It asks for "release" from liability for all transactions " after " January 31 and continues: "This is, in effect, a revocation of the guaranty effective on January 31, 1981." First Wisconsin contends that it interpreted this letter as another effort to negotiate a release from the liability accrued as of January 31, but the subjective interpretations of one party to a communication do not detract from the force it objectively carries. The letter acknowledged that First Wisconsin was not going to let Yamaguchi avoid any accrued liability; Yamaguchi then asked to be let out of any new liability effective January 31. To achieve this goal Yamaguchi needed two things: a "release" of the exposure created between January 31 and April 2, and no liability thereafter -- in other words, a revocation of the guaranty. The letter used both words.

Under Wisconsin law any clearly communicated revocation of a guaranty is effective. Bremer v. Rufener, 186 Wis. 195, 202 N.W. 206 (1925); Klatte v. Franklin State Bank, 211 Wis. 613, 618, 248 N.W. 158, 160 (1933). Clarity is important to commercial transactions. The beneficiary of a guaranty relies on the undertaking in supplying credit. Unless the lender can determine the extent of its protection through objective criteria, the risk of doing business will go up, and with it the rate of interest charged for loans. Uncertainty thus injures honest, reliable debtors. Wisconsin's law honors only "definite and unequivocal notice" of revocations of guaranties. Bremer, 186 Wis. at 198, 202 N.W. at 207. Just as it is undesirable to expose lenders to needless risk of loss by allowing revocations that do not alert lenders to the change of liability, it is also undesirable to allow foibles of expression to expose guarantors to continuous liability. Guarantors need certainty, too, to plan affairs to decide what to charge for the guaranty, cf. United States Shoe Corp. v. Hackett, 793 F.2d 161, 162 (7th Cir. 1986). It will be harder or more costly to obtain guaranties (and therefore more difficult to launch new businesses) if every guaranty carries the risk that a jury subsequently will decline to let the guarantor off. Perfection is too much to demand in any notice, just as opacity offers too little warning to support revocation.

There are three possible sources of ambiguity in the letter. First, the letter was sent while the parties were negotiating for release of the liabilities predating January 31; second, the letter seeks to "revoke" effective two months before it was sent and therefore combines elements of revocation and release; third, the critical sentence contains the modifier "in effect". None of these, however, so clouds the picture that summary judgment is inappropriate. The existence of other ongoing negotiations could not have obscured (in the mind of an objectively reasonable reader) the significance of this letter; Yamaguchi explicitly put pre-January 31 obligations to one side and addressed subsequent liabilities. First Wisconsin now says that it is sure that Yamaguchi did not want to revoke his guaranty, because had First Wisconsin though Yamaguchi was doing any such thing it would have stopped extending credit to Tomkenco, bringing the fraud to light at once. As we must take the case, however, Yamaguchi had no knowledge of the fraud and no interest in Tomkenco, so he would not have cared whether First Wisconsin made further loans. The existing customer paper appeared to cover Tomkenco's debts. If First Wisconsin had nay doubt whether Yamaguchi was pulling out, it had only to ask; yet First Wisconsin did not ask for clarification. The letter was designed to its purpose. It requested a release, a remedy not available unilaterally, and declared a revocation, a result within Yamaguchi's sole control. The muddle created by the statement that the revocation was "in effect" created as of January 31 does not obscure Yamaguchi's desire to be liable for no new debts of Tomkenco. No modestly careful reader of this letter could fail to appreciate that Yamaguchi was not going to accept liability for Tomkenco's future debts.

On to the accounting method. Wisconsin follows the method for attribution of payments described in Restatement of Security § 142 (1941) and Restatement (Second) of Contracts §§ 259-60 (1981). See Moser Paper Co. v. North Shore Publishing Co., 83 Wis. 2d 852, 857-58, 266 N.W.2d 411, 415 (1978); Crown Life Insurance Co. v. LaBonte 111 Wis. 2d 26, 330 N.W.2d 201 (1983). Under this approach a payment is applied as the debtor directs; if the debtor does not direct, it is applied as the creditor chooses, provided the creditor promptly informs the debtor; if neither debtor nor creditor communicates a choice, the court selects an equitable method of application. Both the Restatement (Second) of Contracts § 260(2) and the Wisconsin cases express a preference for the FIFO method when the court must choose. See State v. J.C. Penney Co., 48 Wis. 2d 125, 147, 179 N.W.2d 641, 652 (1970); Marshall & Ilsley Bank v. Hackett, Hoff & Thiermann, 213 Wis. 426, 431, 250 N.W. 866, 868 (1933); Hannan v. Engelmann, 49 Wis. 278, 5 N.W. 791 (1880). All of this is qualified in the Restatement (Second) of Contracts § 260(1) by a concern that the method recognize the interests of third parties -- often guarantors, who may furnish funds for the payment of specific accounts. Funds furnished by ...

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