diff --git a/modelopt/torch/quantization/utils/core_utils.py b/modelopt/torch/quantization/utils/core_utils.py
index 3d1e017b3a5..ce7cc06eb3f 100644
--- a/modelopt/torch/quantization/utils/core_utils.py
+++ b/modelopt/torch/quantization/utils/core_utils.py
@@ -953,6 +953,10 @@ def fsdp2_aware_weight_update(root_model, modules_to_update, reshard=True):
     Returns:
         None
     """
+    # Assigned only once setup below completes; the finally block keys off
+    # this so a setup failure (e.g. a CUDA OOM raised by unshard()) propagates
+    # instead of being replaced by an UnboundLocalError. See issue #1859.
+    fsdp_param_mapping = None
     try:
         if isinstance(root_model, FSDPModule):
             # Get FSDP root module, if none is returned, then the update is not made to a submodule of an FSDPModule
@@ -995,7 +999,10 @@ def fsdp2_aware_weight_update(root_model, modules_to_update, reshard=True):
     finally:
         from modelopt.torch.quantization.qtensor.base_qtensor import QFSDPParam, QTensorWrapper
 
-        if isinstance(root_model, FSDPModule):
+        # fsdp_param_mapping is None when setup did not complete (nothing was
+        # unsharded or mapped) — skip the update so the original error from
+        # the try block is not masked by an UnboundLocalError here.
+        if isinstance(root_model, FSDPModule) and fsdp_param_mapping is not None:
             # Update FSDPParam list
             for module in modules_to_update:
                 for param_name, param in module.named_parameters():
diff --git a/tests/unit/torch/quantization/test_utils.py b/tests/unit/torch/quantization/test_utils.py
index 933c553ce12..e593c52da8b 100644
--- a/tests/unit/torch/quantization/test_utils.py
+++ b/tests/unit/torch/quantization/test_utils.py
@@ -13,14 +13,19 @@
 # See the License for the specific language governing permissions and
 # limitations under the License.
 
+from contextlib import nullcontext
+from unittest import mock
+
 import pytest
 import torch
+from torch.distributed.fsdp import FSDPModule
 
 from modelopt.torch.quantization.utils import (
     convert_quantization_axis_to_reduce_axis,
     reduce_amax,
     reduce_block_amax,
 )
+from modelopt.torch.quantization.utils import core_utils
 from modelopt.torch.quantization.utils.layerwise_calib import LayerActivationCollector
 
 
@@ -59,6 +64,47 @@ def test_reduce_block_amax(block_sizes, test_input, expected_scales):
     torch.allclose(scales, expected_scales)
 
 
+@pytest.mark.parametrize("failure_point", ["module_discovery", "unshard"])
+def test_fsdp2_aware_weight_update_preserves_setup_error(monkeypatch, failure_point):
+    """A failure during setup (e.g. a CUDA OOM raised by ``unshard()``) must
+    propagate to the caller, not be replaced by an ``UnboundLocalError`` from
+    the ``finally`` block referencing variables that were never assigned.
+
+    Regression test for https://github.com/NVIDIA/Model-Optimizer/issues/1859.
+    """
+    root_model = mock.MagicMock(spec=FSDPModule)
+    module = torch.nn.Linear(4, 4)
+
+    def _raise_oom(*args, **kwargs):
+        raise RuntimeError("CUDA out of memory (simulated)")
+
+    if failure_point == "module_discovery":
+        monkeypatch.setattr(core_utils, "_get_enclosing_fsdp_module", _raise_oom)
+    else:  # the reported scenario: discovery succeeds, unshard() OOMs
+        monkeypatch.setattr(core_utils, "_get_enclosing_fsdp_module", lambda m, r: root_model)
+        fake_fully_shard = mock.MagicMock()
+        fake_fully_shard.state.return_value._fsdp_param_group.is_sharded = True
+        monkeypatch.setattr(core_utils, "fully_shard", fake_fully_shard)
+        monkeypatch.setattr(core_utils, "enable_fake_quant", lambda m: nullcontext())
+        root_model.unshard.side_effect = _raise_oom
+
+    with pytest.raises(RuntimeError, match="out of memory"):
+        with core_utils.fsdp2_aware_weight_update(root_model, module):
+            pass  # setup fails before the body runs
+
+    if failure_point == "unshard":
+        root_model.unshard.assert_called_once()
+
+
+def test_fsdp2_aware_weight_update_non_fsdp_body_error_passthrough():
+    """For a non-FSDP root model the context manager is a no-op wrapper and
+    must transparently propagate errors raised in the body."""
+    module = torch.nn.Linear(4, 4)
+    with pytest.raises(ValueError, match="body failure"):
+        with core_utils.fsdp2_aware_weight_update(module, module):
+            raise ValueError("body failure")
+
+
 @pytest.mark.parametrize("fp8_dtype", [torch.float8_e4m3fn, torch.float8_e5m2])
 @pytest.mark.parametrize("axis", [None, 0, 1, (0, 1)])
 def test_reduce_amax_fp8(fp8_dtype, axis):