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February 7, 1989

JAMES ABDNOR, Administrator, U.S. Small Business Administration, LEWIS F. MATUSZEWICH, and LEWIS F. MATUSZEWICH, P.C., Defendants

Suzanne B. Conlon, United States District Judge.

The opinion of the court was delivered by: CONLON

Plaintiff Heritage Bank & Trust Company ("Heritage") sues the United States Small Business Administration ("SBA") and SBA Administrator James Abdnor for alleged breach of a loan guaranty. Heritage sues its former attorneys, Lewis F. Matuszewich and Lewis F. Matuszewich, P.C. (collectively, "Matuszewich"), for alleged breach of a duty to properly advise Heritage in connection with the SBA guaranty application. Jurisdiction is based on 15 U.S.C. § 634(b)(1) and on principles of pendent jurisdiction. All parties move for summary judgment.


 On October 6, 1980, Heritage and the SBA entered into a loan guaranty agreement ("the guaranty agreement"). Amended Complaint para. 5. Under the agreement, the SBA agreed to guarantee certain loans made by Heritage that had been approved in advance by the SBA. Id. The guaranty agreement provided that loan applications had to comply with the SBA's rules and regulations. SBA Facts para. 2. Part 120 of Title 13, Code of Federal Regulations (13 C.F.R. § 120.5 (1982)), provides that the SBA will not guarantee loans made for the purpose of financing the purchase of assets from the lender or an associate of the lender. *fn1" Id. at para. 3.

 On October 4, 1982, Heritage applied to the SBA for a 90 percent guaranty of a loan to Kautzmann Steel Company, Inc. ("Kautzmann"). Id. at para. 5. The principal amount of the loan was $ 550,000. Id. The loan proceeds were to be used by Kautzmann to acquire the assets of the Beverly Steel Corporation ("Beverly Steel"). Id. The president and controlling shareholder of Beverly Steel, William Parker ("Parker"), was also a member of Heritage's board of directors. Id. at para. 6. Under the terms of the purchase agreement, Parker would continue to own Beverly Steel's premises and, in addition, issue a note in the amount of $ 300,000 as part of Kautzmann's financing package. Heritage Facts para. 22; SBA Facts para. 15.

 Parker's continuing interest in Beverly Steel and his role as a Heritage board member caused Heritage to question whether its loan application complied with SBA regulations. SBA Facts para. 6. At issue was whether Heritage should disclose Parker's role as a Heritage board member. Id. Matuszewich concluded that Parker's role as a board member did not jeopardize Heritage's application. Heritage Mem. Ex. 4 at 122-28. Therefore, Heritage did not inform the SBA that Parker was a member of its board. *fn2" SBA Facts para. 20.

 The SBA initially denied Heritage's loan application because inadequate cash flow from Beverly Steel's operations created a risk that Kautzmann would default on the loan. Heritage Facts paras. 19, 20. However, the SBA agreed to reconsider the application if Heritage and Kautzmann reduced the size of the loan, increased Kautzmann's equity in the acquisition and agreed to other changes in the acquisition financing. Id. at para. 21.

 Kautzmann and Heritage agreed to meet the SBA's demands. Id. at para. 22. The acquisition price was reduced from $ 850,000 to $ 750,000; Kautzmann's note payable to Parker was reduced from $ 300,000 to $ 250,000; the loan and requested SBA guarantee was reduced from $ 550,000 to $ 500,000; and Kautzmann agreed "to inject $ 50,000 of equity into the Company." Id.

 On January 25, 1983, the SBA approved Heritage's revised application, and agreed to guarantee 90 percent of the Kautzmann loan. Id. at para. 24. On March 5, 1985, however, Kautzmann defaulted on the loan and filed a voluntary petition for bankruptcy. Amended Complaint para. 7. Heritage notified the SBA of Kautzman's default and requested that it repurchase 90 percent of the loan pursuant to the guaranty agreement. Id. at para. 8. The SBA refused. The SBA claimed that the guaranty agreement was void because Heritage had not complied with SBA regulations requiring Heritage to disclose Parker's identity as a board member.


 Under Fed.R.Civ.P. 56, a motion for summary judgment will be granted only if there are no material facts in dispute and the movant is entitled to judgment as a matter of law. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247, 91 L. Ed. 2d 202, 106 S. Ct. 2505 (1985); Silverman v. Ballantine, 694 F.2d 1091, 1093 (7th Cir. 1982). A party responding to a motion for summary judgment must set forth specific facts supporting the existence of a genuine issue for trial. Powers v. Dole, 782 F.2d 689, 694 (7th Cir. 1986); Posey v. Skyline Corp., 702 F.2d 102, 105 (7th Cir. 1983). All reasonable factual inferences must be viewed in favor of the non-movant. Hermes v. Hein, 742 F.2d 350, 353 (7th Cir. 1984); Korf v. Ball State Univ., 726 F.2d 1222, 1226 (7th Cir. 1984). However, a bare contention that an issue of fact exists is insufficient to create a factual dispute. Posey, 702 F.2d at 105.

 The issue in Heritage's breach of contract claim is whether Heritage failed to meet a condition precedent when it opted not to disclose Parker's board membership in its SBA application. *fn3" The SBA claims that Heritage was required to disclose this information under SBA regulations applicable to the guaranty agreement. SBA Facts paras. 1-3; SBA Mem. at 8. Heritage claims that failure to disclose this information was not a material breach of the guaranty agreement because Heritage substantially complied with the remaining application procedures. Heritage Mem. at 3. Heritage further contends that the SBA had constructive notice of Parker's board membership because a copy of Heritage's annual report containing this information was on file with the SBA. Heritage Facts para. 11; Heritage Reply Mem. at 2. Finally, Heritage claims that SBA regulations did not require disclosure of Parker's identity as a board member because Parker was not a party to the Kautzmann loan. Heritage Mem. at 9-10.

 Heritage's argument that it was not required to disclose Parker's board membership is without merit. SBA regulations provide that the SBA will not guarantee a loan if the proceeds are used to finance the purchase of property from a bank director, unless the lender first discloses the director's identity on its SBA application. 13 C.F.R. § 120.5(a) (1982); Eastern Illinois Trust & Savings Bank v. Sanders, 826 F.2d 615, 616 (7th Cir. 1987); First Nat'l Bank of Louisa, KY v. United States, 6 Cl. Ct. 241, 243 (1984). Here, the loan proceeds were used to finance Kautzmann's acquisition of Beverly Steel's assets. Heritage does not deny that Parker controlled Beverly Steel and was indirectly if not directly a party to the sale. This means that the loan proceeds were ...

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