Appeal from the United States District Court for the Northern District of Illinois, Eastern Division, No. 84 C 4579, James B. Moran, Judge.
Cudahy, Ripple, and Manion, Circuit Judges.
Eastern Illinois Trust & Savings Bank ("Eastern") sued the Small Business Administration (the "SBA") for damages based on the SBA's refusal to abide by its agreement to purchase from Eastern 90 % of three SBA-guaranteed loans that had lapsed into default. The SBA responded that Eastern had violated their agreement, thus releasing the SBA from its guaranty obligations; the SBA also counterclaimed for the amount it had paid to purchase one defaulted loan. After a bench trial the district court concluded that Eastern's actions did not materially breach the guaranty agreement and that, therefore, the SBA was required to honor its guarantees of the three loans. The SBA appeals. We affirm.
The SBA operates a guaranteed loan program that assists small businesses in obtaining financing on reasonable terms when money is unavailable from other sources. See 15 U.S.C. § 631 et seq. Participating banks normally enter into a guaranty agreement with the SBA, setting out procedures and requirements for the guaranteed loan program. When a qualified borrower applies to a bank for an SBA-guaranteed loan, the bank must obtain authorization from the SBA to proceed with the loan. After SBA approval, the bank lends its own funds to the borrower and services the loan pursuant to the guaranty agreement. If the borrower defaults, the bank may demand that the SBA purchase its share of the outstanding balance -- typically, and in this case, 90 % of the balance.
In 1978 Eastern and the SBA entered into a standard guaranty agreement. This agreement prescribed terms and conditions of SBA-guaranteed loans and incorporated by reference all applicable rules and regulations of the SBA. One standard condition imposed by SBA regulations is a cap on the interest rate that a participating bank may charge for a guaranteed loan. 13 C.F.R. § 122.8. Another condition permits the SBA to refuse to purchase its share of a guaranteed loan in cases where a participating bank has not "substantially complied" with SBA requirements. 13 C.F.R. § 120.202-5.
The guaranty agreement itself, executed by Eastern and the SBA and incorporated in each of the four loans at issue here, prohibited Eastern from charging any fees or commissions in connection with a loan, unless paid for actual services rendered.*fn1 SBA regulations require that any such fee or commission accepted as payment for services rendered must be disclosed to the SBA. See C.F.R. §§ 120.104, 120.303. These provisions presumably operate to prohibit a participating bank from evading ceilings on interest rates by charging points or making side loans to borrowers.
In each of the four loans at issue here, however, Eastern made a secondary loan to the borrower, not disclosed to the SBA, that resulted in interest payments higher than those prescribed by the guaranty agreement. See, mem. op. 631 F. Supp. 1393, slip op. at 3-6 (N.D. Ill. 1986). It is undisputed that these side loans violated terms of the guaranty agreement. The crux of this case is the question whether Eastern's conduct in connection with the four loans nonetheless constituted substantial compliance with SBA requirements such that the SBA must honor its guaranty obligations.
Eastern sought $880,363.00 plus interest, costs and attorney's fees, after the SBA refused to purchase its usual share of these defaulted loans. The SBA sought a return of the $364,468.25 it earlier paid to purchase one guaranteed loan before learning of Eastern's prohibited side loans.
Eastern violated the terms of its guaranty agreement with the SBA. The question whether the violation was a material breach of the agreement, or rather whether Eastern substantially complied with the agreement, is a question of general federal law. See United States v. Kimbell Foods, Inc., 440 U.S. 715, 726-27, 59 L. Ed. 2d 711, 99 S. Ct. 1448 (1979); First Nat'l Bank v. Small Business Admin., 429 F.2d 280, 286-87 (5th Cir. 1970); cf. Clearfield Trust Co. v. United States, 318 U.S. 363, 367, 87 L. Ed. 838, 63 S. Ct. 573, 575 (1943) ("Application of state law . . . would subject the rights and duties of the United States to exceptional uncertainty. . . . [leading] to great diversity in results by making identical transactions subject to the vagaries of the laws of the several states."). The question whether or not a particular breach of a contract is "material" is a question of fact requiring detailed attention to all of the circumstances. See, e.g., Sahadi v. Continental Illinois Nat'l Bank & Trust Co., 706 F.2d 193, 196 (7th Cir. 1983); Restatement (Second) of Contracts § 241. Assuming that the trial court applied the appropriate legal standards, we review its findings of fact under the clearly erroneous standard. Fed. R. Civ. P. 52(a).
We believe that the district court did apply appropriate legal standards in this case. As noted, the materiality of a breach invokes an all-the-circumstances test, and several specific factors have been recognized as relevant to this analysis. The district court cited Sahadi and the factors listed there, but also noted that, since the SBA, a government agency, was a party, special attention must be paid to potential non-financial damage that might flow from a breach. The district court cited four issues affecting materiality:
(1) Whether the breach operated to defeat the bargained-for objective of the parties; (2) whether the breach caused disproportionate prejudice to the non-breaching party; (3) whether custom and usage considers such a breach to be material; and (4) whether the allowance of reciprocal ...