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July 24, 1991


The opinion of the court was delivered by: Robert L. Carter, District Judge.

In 1978, Tarra Hall Clothiers, Inc. ("Tarra Hall"), a New York-incorporated garment manufacturer, received two direct loans totalling $1 million from the Economic Development Administration ("EDA"), an agency within the United States Department of Commerce, under an economic assistance program established by the Trade Act of 1974, 19 U.S.C.A. §§ 2101 et seq. (West 1980 & Supp. 1991) (the "Trade Act"). It is undisputed that defendant Joseph E. Krieger, president and 100% shareholder of Tarra Hall, executed two notes evidencing these loans, and that he and his wife, defendant Sally Krieger, executed personal guarantees of the total amounts due under the notes. The undisputed facts also show that in 1980, Tarra Hall defaulted on both notes, and that in 1982, the EDA exercised its option to accelerate the maturity dates of the two notes, made written demands upon Tarra Hall for the outstanding principal amounts plus accrued interest, and demanded payment from the Kriegers pursuant to the personal guarantees. The EDA thereafter referred the matter to the United States Department of Justice for litigation, and in March, 1986, the United States Attorney for the Southern District of New York commenced the instant action pursuant to 28 U.S.C. § 1345 to enforce the guarantees against the Kriegers.

Joseph Krieger counterclaimed against the United States for breach of contract, alleging that, when the EDA agreed to provide the two direct loans to Tarra Hall, the EDA also agreed to provide a 90% guarantee of another loan for Tarra Hall from a commercial lender. Joseph Krieger claimed that Tarra Hall accepted the two direct loans and that he and his wife signed the personal guarantees for these direct loans in reliance on the EDA's alleged agreement to provide the guarantee on the commercial loan. He further alleged that the EDA later breached this agreement, and that its breach resulted in damages to both Tarra Hall and himself.

The United States now moves for summary judgment on its claim against the Kriegers pursuant to Rule 56, F.R.Civ.P., and for dismissal of Joseph Krieger's counterclaim pursuant to Rule 12(b)(1), F.R.Civ.P., for lack of subject matter jurisdiction. The Kriegers cross-move for summary judgment on the United States' claim, and, in the alternative, seek a court order enforcing a proposed settlement agreed upon by the parties in April, 1987.


A. Background

Central to each side's summary judgment motion is the threshold issue of whether the personal guarantees upon which the Kriegers are presently being sued are enforceable. The Kriegers contend that the EDA obtained the personal guarantees from them for collateral purposes, and that the EDA thereby violated its own regulation specifically authorizing resort to personal guarantees "only when necessary to assure continued interest and effort of the borrower's owners or management on behalf of the borrower." 13 C.F.R. § 315.62(a)(1)(i) (1977) [hereinafter the "EDA regulation"]. They assert that the personal guarantees are therefore illegal contracts, are contrary to public policy, and cannot be enforced against them.

Alternatively, the Kriegers argue that the EDA's "extraction" of personal guarantees from them without making a preliminary finding that such guarantees were "necessary" within the meaning of the EDA regulation, constituted agency action that was both "in excess of statutory authority" and "arbitrary and capricious." They assert that the guarantees must therefore be set aside pursuant to the Administrative Procedure Act. 5 U.S.C.A. § 551 et seq. (West 1977 & Supp. 1991).

Finally, Sally Krieger contends that even if the personal guarantees may have been obtained from her husband in accordance with the EDA regulation's mandate that such guarantees be required only when necessary to assure management's continued interest and effort, and may therefore be enforceable against him, the guarantees from her could not possibly have been authorized under the regulation's mandate since she was neither an officer nor a shareholder of Tarra Hall. Therefore, she asserts, the guarantees cannot be enforceable against her.

As an initial matter, the court notes that the Kriegers failed to plead the affirmative defenses of illegality and invalidity of the personal guarantees in their answer to the United States' complaint, see Rule 8(c), F.R.Civ.P., and that, in the five years that have passed since the filing of the complaint, the Kriegers also failed to seek to amend their answer, see Rule 15(a), F.R.Civ.P., so as to include these affirmative defenses in the pleadings. These procedural defects raise two difficulties for the court.

First, due to the mandatory language of Rule 8(c), F.R.Civ.P., failure to plead an affirmative defense such as illegality generally results in waiver of that defense and its exclusion from the case. United States ex rel. Maritime Admin. v. Continental Illinois Nat. Bank & Trust Co., 889 F.2d 1248, 1253 (2d Cir. 1989); Satchell v. Dilworth, 745 F.2d 781, 784 (2d Cir. 1984). Second, technically speaking, the Kriegers' failure to plead the affirmative defenses of illegality and invalidity constitutes failure to "place in issue" the validity of the personal guarantees. This has serious ramifications for the legal standards to be applied in the parties' cross-motions for summary judgment, since, generally, "[a]n obligee as plaintiff in an action against a guarantor has the burden of proof of all the essential elements of the cause of action which he has alleged, including the execution and existence of the contract on which he sues, [and] that it is supported by consideration. . . ." 63 N YJur.2d § 372 at 492 (1987 & Supp. 1990).*fn1 Only where the validity of the guarantee contract has been placed in issue is the contract's validity also an essential element to be proved by the plaintiff obligee. Id.; cf. Celotex Corp. v. Catrett, 477 U.S. 317, 322-23, 106 S.Ct. 2548, 2552-53, 91 L.Ed.2d 265 (1986) (summary judgment is mandated where a party fails to make a showing sufficient to establish the existence of an element essential to that party's case, and on which that party will bear the burden of proof at trial).

Nevertheless, under both federal and New York law, it is not absolutely necessary to plead the illegality of a contract which is also contrary to public policy. See, e.g., Kaiser Steel Corp. v. Mullins, 455 U.S. 72, 77, 102 S.Ct. 851, 856, 70 L.Ed.2d 833 (1982), quoting McMullen v. Hoffman, 174 U.S. 639, 19 S.Ct. 839, 43 L.Ed. 1117 (1899) ("no court will lend its assistance in any way towards carrying out the terms of an illegal contract"); Attridge v. Pembroke, 235 A.D. 101, 256 N YS. 257 (1932); Metz v. Woodward-Brown Realty Co., 182 A.D. 60, 169 N.Y.S. 299 (1918). In other words, the court may, sua sponte, "step in and deny the right to any relief [under an agreement] without reference to the state of the pleadings, whenever it becomes apparent that the agreement is antagonistic to the interests of the public." 21 N.Y.Jur.2d § 142 at 548-49 (Lawyers' Co-op 1982 & Supp. 1991). In their summary judgment motion, the Kriegers have raised the claim that the personal guarantee contracts are contrary to public policy.

In addition, even under circumstances not involving defenses based on public policy, courts have held that failure to plead the affirmative defense of illegality does not necessarily compel a judicial determination of waiver where the failure did not prejudice the plaintiff. See, e.g., Allied Chem. Corp. v. Mackay, 695 F.2d 854, 855 (5th Cir. 1983); Steinberg v. Columbia Pictures Indus., Inc., 663 F. Supp. 706, 715 (S.D.N Y 1987) (Stanton, J.). In this case, the United States appears not to have been prejudiced by the Kriegers' failure to plead their defenses of illegality and invalidity. It has had an adequate opportunity to respond to these challenges. See Allied Chem. Corp., supra, 695 F.2d at 856; cf. Continental Illinois Nat. Bank and Trust Co., supra, 889 F.2d at 1253 (defendant should have been permitted to amend pleading to assert additional defense, where question of whether defense had to be specifically pleaded was fairly close one, and plaintiff had already been alerted to defense by pleading of codefendant). What is more, nowhere in its opposition to the Kriegers' summary judgment motion does the United States even mention, let alone object to, the Kriegers' failure to plead these defenses. See, e.g., Canal Ins. Co. v. Earnshaw, 629 F. Supp. 114, 119 (D.Kan. 1985).

B. Statutory Procedures and Regulations Under the Trade Act

In response to increased import competition, Congress enacted the Trade Act in order to, inter alia, "assist industries, firms, workers, and communities to adjust to changes in international trade flows. . . ." 19 U.S.C.A. § 2102(1)(4). As part of the Trade Act, Congress established the "Adjustment Assistance to Firms" program ("loan program") to provide technical and financial assistance to United States firms in their efforts to make such economic adjustments. Id. §§ 2341 et seq. Since it was under this loan program that the EDA provided its two direct loans to Tarra ...

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