## Facts

- Stump Home Specialties Manufacturing, Inc. (Stump), a small family-owned business in Indiana, sought a bank loan backed by a Small Business Administration (SBA) guaranty.
- The SBA approved the loan on the basis of a fixed interest rate of 9.5%.
- After the bank disbursed the loan proceeds, the bank sought and obtained SBA approval to change the interest-rate term to a variable rate: 1.5% over the New York prime rate.
- Over time, prime rates increased substantially; by the time Stump defaulted in 1982, the interest rate had risen to 17.5%.
- Several Stump family members executed personal guaranties in connection with the SBA-guaranteed loan.
- When Stump defaulted, the SBA honored its guaranty to the bank and the loan was assigned for collection to the United States.
- The United States sued Stump and the individual guarantors to recover the unpaid balance of principal and accrued interest.
- After a bench trial in the Northern District of Indiana, the district court entered judgment for the United States for roughly $222,000 in unpaid principal and about $253,000 in interest.
- On appeal, the Stumps challenged liability on multiple contract-law grounds, including an argument that the post-disbursement interest-rate modification was unenforceable for lack of consideration.

## Issues

1. In a suit by the United States to enforce obligations arising from an SBA-guaranteed loan, should the court apply a free-standing federal common law of contracts or incorporate the relevant state’s law (here, Indiana law) as the federal rule of decision under *United States v. Kimbell Foods, Inc.*?
2. Under the governing law, was the SBA-approved post-disbursement change from a fixed 9.5% rate to a variable prime-based rate enforceable against the borrower and guarantors, despite arguments that the modification lacked consideration?
3. Did the interest-rate change discharge or otherwise limit the guarantors’ liability?

## Decision

- The Seventh Circuit held that, under *Kimbell Foods*, the relevant state’s law—Indiana law—supplies the federal rule of decision for disputes concerning SBA loan terms and related guaranties, absent a demonstrated conflict with SBA program needs.
- Applying Indiana law, the court rejected the Stumps’ contract defenses, including the contention that the interest-rate modification was unenforceable for lack of consideration.
- The court concluded that the guarantors remained liable under their guaranties notwithstanding the SBA-approved move from a fixed to a variable rate.
- The Seventh Circuit affirmed the district court’s judgment for the United States.

## Legal Principles

- In litigation arising from SBA-guaranteed lending, federal courts generally apply state commercial and contract law as incorporated federal common law, following *United States v. Kimbell Foods, Inc.*, unless using state law would unreasonably interfere with federal program operation.
- Courts should not create a separate federal body of commercial contract rules for ordinary loan and guaranty disputes when state law can supply workable rules.
- Under state contract principles, a loan-term modification approved by the SBA and implemented by the lender does not automatically become unenforceable merely because it changes the economic consequences of the deal; defenses such as lack of consideration must be evaluated under the governing state doctrine.
- Guarantors are not released solely because the borrower’s cost of borrowing increases after a rate change; discharge depends on whether, under state law, the change is the type of alteration that legally relieves a surety or guarantor of responsibility.

## Conclusion

*United States v. Stump Home Specialties Manufacturing* held that, in an SBA-guaranteed loan enforcement action, Indiana law applies as the federal rule of decision under *Kimbell Foods* and that the SBA-approved post-disbursement conversion from a fixed 9.5% interest rate to a variable prime-based rate did not defeat enforcement or discharge the family-member guarantors; the Seventh Circuit therefore affirmed judgment for the United States for the unpaid principal and accrued interest.


United States v. Stump Home Specialties Manufacturing, 905 F.2D 1117 (1990).