WALCUTT v. CLEVITE CORP

SCILEPPI, J.

The three individual plaintiffs and the deceased (hereinafter collectively referred to as plaintiffs) were, with one minor exception, sole stockholders of several corporations engaged in the manufacture and sale of phonograph needles and related items. In February, 1959 plaintiffs sold their stock-holdings in those corporations to defendant Clevite Corporation in exchange for shares of Clevite stock. As part of the transaction, plaintiffs entered into separate written agreements not to compete with Clevite for 10 years, and plaintiff Lowell Walcutt further agreed to consult and advise with respect to the phonograph needle business, as requested, during that period. In return for these latter promises, Clevite agreed to pay Lowell Walcutt $20,000 per year and the remaining plaintiffs $10,000 each per year, payments to be made in equal quarter-annual installments. The agreements were made assignable but expressly provided that Clevite was to remain liable for the payments if the assignee defaulted.

In September, 1960 Clevite entered into an agreement with defendant Richmond to sell the assets of plaintiffs' former corporations. Among other provisions, Richmond agreed to form a corporation to which all of the assets, including plaintiffs' agreements, were to be transferred. The consideration was to be paid by the new corporation part in cash and part by the assumption of certain liabilities, including the obligations under the plaintiffs' agreements. Clevite also agreed to deliver certain warranties at the closing.

Thereafter Richmond caused Walco Electronics Company, Inc. (Walco) to be formed as a New Jersey corporation, and became its president and sole stockholder. The closing occurred on September 23, 1960, at which time plaintiffs' noncompetition agreements were assigned to and assumed by Walco. In addition, Richmond personally executed a written guarantee to Clevite that Walco would make the payments as they would become due to plaintiffs, and that, if Walco defaulted, Richmond would make the payments himself. Subsequent to the closing, Walco paid each plaintiff the $2,500 quarterannual installment due on September 30, 1960. Walco did not pay Lowell Walcutt the balance of the installment due him on that date, nor did it make payments on any installments due plaintiffs thereafter.

Shortly after the closing, a dispute arose between Walco and Clevite, and in February, 1961 Walco instituted an action against Clevite in the Federal District Court for the Southern District of New York demanding $400,000 damages on two alternative causes of action, one for fraud and the other for breach of warranty arising out of the sale. None of the plaintiffs is a party to that action, which is still pending.

In May, 1961 plaintiffs commenced the instant action against Clevite and Richmond to recover through the quarter ending March 31, 1961 the unpaid installments due under their noncompetition agreements. The suit against Clevite is based directly on the noncompetition agreements and, against Richmond, on his personal guarantee to Clevite. Walco, as a foreign corporation not doing business in New York, was not amenable to process and consequently is not a party to this action.

Richmond's answer, inter alia, asserted as affirmative defenses and setoffs that Clevite made fraudulent representations to Richmond and Walco concerning the inventory transferred, and that, relying upon such representations, Walco and Richmond were thereby "induced to have Walco purchase the said inventories and other assets". It is further alleged that as a result both Walco and Richmond were damaged in a sum far exceeding plaintiffs' claims. Similar affirmative defenses and setoffs are included in paragraphs relating to breaches of warranty given by Clevite to Walco and Richmond. Special Term granted summary judgment in favor of plaintiffs against both Clevite and Richmond and in favor of Clevite on its cross claim over against Richmond under section 264 of the Civil Practice Act. The Appellate Division unanimously affirmed and we granted leave to appeal.

We are all in agreement that summary judgment was properly granted against Clevite. Accordingly, our inquiry will be directed to whether Special Term erred in finding that no triable issue was raised by Richmond's defenses.

We note initially that plaintiffs' claims against Richmond arise out of a transaction entirely separate from the sale of their business to Clevite. Richmond made no agreement with plaintiffs. His undertaking was part of the subsequent sales agreement between Clevite and Walco, and was merely to guarantee that Walco's obligations to Clevite would be met. Plaintiffs' claims, therefore, are based upon the theory that they are third-party beneficiaries of Richmond's guarantee to Clevite, and, as such, are subject to all the equities between the parties to that agreement ( Detmer Woolen Co. v. Van Horn, 59 Misc. 163).

Before this court, Richmond argues that he was personally induced to enter into his contract of guarantee by virtue of Clevite's fraud upon him. Doubtless, a fraud so committed by a creditor upon a guarantor would enable the latter to disaffirm, and such disaffirmance, in turn, would defeat the rights of third-party beneficiaries of the contract. The difficulty with this argument is that nowhere in his answer does Richmond assert that he was induced to enter into his contract of guarantee because of Clevite's misrepresentations. The fraud is alleged only as the inducement to Walco's purchase of the assets. As a result, Richmond's belated assertion of personal fraud is unavailing, and we must look solely to those defenses raised below to determine if a triable issue exists.

Stripped to its essentials, Richmond's defense is that Clevite grossly exaggerated its inventory on the sale to Walco, with the result that Walco received $400,000 less in inventory than it had bargained for. These averments of inventory shortage present, in essence, the defense of partial failure of consideration, regardless of the terminology employed in the answer. Thus narrowed, the question for determination becomes whether a guarantor, when sued alone, may avail himself of the defense of a partial failure of consideration arising out of the main contract.

The situation is readily distinguishable from cases in which the rule was fashioned that a guarantor when sued alone by the creditor cannot avail himself of an independent cause of action existing in favor of his principal as a defense or counterclaim ( Ettlinger v. National Sur. Co., 221 N.Y. 467; Gillespie v. Torrance, 25 N.Y. 306; Lasher v. Williamson, 55 N.Y. 619; Elliott v. Brady, 192 N.Y. 221). The reasons underlying this rule are extensively discussed in both the Ettlinger and Gillespie cases ( supra), and may be summarized by the proposition that a guarantor may not take upon himself the election of remedies which rightfully belongs solely to his principal. Thus, a guarantor may not interpose his principal's defense of fraud since by so doing he would deprive the principal of his independent right to affirm or disaffirm ( Ettlinger v. National Sur. Co., supra.) Likewise, he may not assert his principal's claim of breach of warranty since "he might thus bar a large claim in canceling a small one" ( Gillespie v. Torrance, supra, p. 311). In all of these instances the claim is deemed to be an independent cause of action existing in favor of the principal, which he alone may or may not assert in what he deems to be his best interest.

There can be no doubt that a guarantor, when sued alone by the creditor, can successfully resist by showing that the creditor, on his part, totally failed to perform his obligations to the principal. In other words, the guarantor may always assert a total failure of consideration. This is because the guarantor is not liable unless the principal is bound (4 Williston, Contracts [rev. ed.], § 1213). By the same reasoning, the guarantor should be liable for no more than is his principal where there is a partial failure of consideration. By asserting such partial failure of consideration the guarantor does not avail himself of an independent claim belonging to the principal nor does he arrogate to himself a right of election which his principal enjoys. Where the consideration fails, either partially or entirely, neither the principal nor the guarantor is accountable for anything which has not been received. The question posed here has never before been squarely presented to this court. It has, however, been held below that a surety, when separately sued, may interpose as a partial defense the creditor's nonperformance of all the obligations of the contract toward the principal ( Forsythe v. United States Fid. Guar. Co., 130 Misc. 569). And this court has had occasion, in dicta, to remark that "an indorser or surety may always, where the contract has not been assigned, show a failure, partial or total, of consideration of his principal's contract which he is called upon to perform" ( Gillespie v. Torrance, 25 N.Y. 306, 308-309, supra). We hold, therefore, that Richmond's defense of partial failure of consideration was properly asserted, thereby raising a triable issue which precluded summary judgment.

We need not, however, rest our determination solely upon the above ground. All the papers submitted to us leave little doubt that Richmond and Walco are truly one and the same. It was Richmond who took part in every step of the negotiations leading to the purchase of the phonograph needle business from Clevite. Walco was merely a corporation formed at the last minute to take title to the assets. Richmond was and still is its president and sole stockholder. Any fraud which was committed on Walco to induce its purchase must perforce have been committed on Richmond. And, by the same token, any defense interposed by Richmond must be deemed to have had the implied consent of Walco. When the principal's defense is asserted against the creditor under these same conditions, it is perfectly proper (Restatement, Security, § 133).

The judgment should be modified by reversing that portion which granted summary judgment in favor of plaintiffs as against Richmond and in favor of Clevite on its cross claim against Richmond, and, as so modified, affirmed.

FULD, J. (concurring).

I agree for modification on the ground that sufficient appears from the affidavits in opposition to the summary judgment motion to create a triable issue of fact as to whether the defendant Richmond, the president and sole stockholder of the purchasing corporation (Walco), was fraudulently induced to enter into his contract of guarantee. As long as the record discloses " facts sufficient to require a trial" (Rules Civ. Prac., rule 113; italics supplied), it matters not that the answer or the supporting papers may be imperfectly or defectively framed. (Cf. Curry v. Mackenzie, 239 N.Y. 267.)

FOSTER, J. (dissenting).

I dissent and vote to affirm the judgment in its entirety. From the entire record before us, it seems clear that Richmond, sued alone as the guarantor, asserts certain affirmative defenses and setoffs which do not raise triable issues of fact relating to the personal contract of guarantee. This is not a case of any alleged failure of consideration and thus a discharge of the principal debt, for the pleadings and affidavit of Richmond are in terms of allegations of damages resulting specifically from alleged fraud and breaches of warranty committed upon the purchaser of the assets, Walco, with retention of the benefits from the sale including the Walcutts' noncompetition agreements ( Gillespie v. Torrance, 25 N.Y. 306).

As noted in the majority opinion, Walco alone brought suit in the Federal court against Clevite for $400,000 damages on these same two causes of action, fraud and breach of warranty. In effect, Richmond seeks a portion of the same relief in this case as an individual and guarantor of Walco by seeking a dismissal of the complaint by means of a setoff to the extent of the Walcutts' and Clevite's claims. Nowhere does Richmond assert in his answer and in the facts presented in his affidavit that his claim of fraud or misrepresentation is pleaded essentially as a personal defense, thereby raising a triable issue of fact as to the discharge of liability on the contract of guarantee. (See, e.g., Howe Mach. Co. v. Farrington, 82 N.Y. 121, 125; Spencer Co. v. New York Review, 282 App. Div. 659.)

The question then squarely becomes whether a triable issue exists over Richmond's attempt to offset Walcutts' and Clevite's claims by interposing a "portion" of the damages allegedly incurred as a result of the sale of the business. (Cf. Crown Worsted Mills v. Sheinman, 5 A.D.2d 810, affd. 5 N.Y.2d 811.) While it is true that the Walcutts as third-party beneficiaries have a right to recover subject to the equities between the parties to the agreement, the damages incurred and the relief demanded by Richmond are not personal to him as the guarantor. These defenses and setoffs belong to Walco, as a separate entity not a party to this action, and they cannot be used by the surety here when he sued as the surety and not as the sole stockholder of Walco. Richmond obviously recognized that these indivisible causes of action belong to the corporation, as evidenced by the language of the pleadings here and by the Federal court action brought by Walco alone. To allow a setoff here would mean the splitting of causes of action not belonging to Richmond (cf. Psaty Fuhrman v. Continental Cas. Co., 278 App. Div. 159, 162-163). I do not think it can be fairly implied here that Richmond pleads or avers a personal defense, calling for damages or cancellation, in the inducement of his personal guarantee.

Where the surety is sued alone, as here, since Richmond's corporation, Walco, is not a party, the rule is clear that the surety cannot avail himself of claims of his principal against creditors. (See, e.g., Gillespie v. Torrance, 25 N.Y. 306, supra; Lasher v. Williamson, 55 N.Y. 619; Elliott v. Brady, 192 N.Y. 221; City of New York v. Fidelity Deposit Co., 253 App. Div. 676, 678.) Furthermore, this rule is usually applied where the creditor's breach of warranty or fraud is pleaded as a defense, as it is in this case. It has been specifically held that such claims are personal to the principal and cannot be made by the surety ( Gillespie v. Torrance, 25 N.Y. 306, 312, supra; Ettlinger v. National Sur. Co., 221 N.Y. 467, 469-470; Elliott v. Brady, 192 N.Y. 221, 225-226, supra). "It has also been said that the principal's claim may exceed that of the creditor and that, if the surety were permitted to assert the claim, the court would be placed in the unsupportable position of granting a judgment for such excess to the surety, who is not entitled to it, or to the principal, who is not a party to the action. The additional argument has been advanced that, if the surety were permitted to try the principal's claim for breach of warranty, the courts judgment as to whether there was in fact a breach, and the amount of damages, would be conclusive on the principal, who was not a party to the action." (Stearns, Law of Suretyship [Elder's Rev., 5th ed.], § 7.21, p. 234.)

I agree with the courts below that no competent proof placed any fact in issue in this case and consequently summary judgments were properly granted in favor of the Walcutts against Clevite and Richmond, and in favor of Clevite over against Richmond.

Chief Judge DESMOND and Judges DYE and VAN VOORHIS concur with Judge SCILEPPI; Judge FULD concurs in a separate opinion; Judge FOSTER dissents in an opinion in which Judge BURKE concurs.

Judgment modified in accordance with the opinion herein and, as so modified, affirmed, with costs to appellant Richmond against Walcutt and Clevite Corporation, and with costs to Walcutt against Clevite Corporation.