Posts in Guarantors

January 04, 2013
Must Banks Provide Advice To Their Customers During Loan Transactions?

When making a commercial loan, do lenders have a fiduciary duty to their Indiana borrowers or guarantors?  The Indiana Court of Appeals, in Paul v. Home Bank, 953 N.E.2d 497 (Ind. Ct. App. 2011), said no.

The loans.  Paul dealt with two loans to a borrower for the development of a hotel.  The first loan involved a promissory note, assignment of leases, a mortgage and a set of guaranties signed by the individual investors, who were also physicians.  The second loan, executed the same date, was a line of credit and also involved a promissory note, a mortgage and a set of guaranties signed by the same individuals.  The borrower defaulted on both loans, and the bank obtained a summary judgment permitting a sheriff’s sale of the mortgaged property.  Since the sheriff’s sale satisfied only the first (larger) loan, the bank moved for summary judgment against the guarantors to collect the debt owed on the second loan. 

The “confusion defense.”  The guarantors filed their own summary judgment motion making all sorts of arguments, only one of which I will discuss today.  The guarantors asserted they should prevail because “they are not lawyers, and [the bank] failed to advise them as to the meaning of the [guaranties].”  The guarantors thought the guaranties executed for the first loan released the guaranties for the second loan.  The guarantors believed the documents meant one thing and faulted the bank for not advising them that the documents said something else.  I have labeled this the “confusion defense.”

No fiduciary duty.  The Court dismissed the guarantors’ argument and relied upon the following well-settled Indiana law applicable to the relationship between banks and customers:

[A] business or “arm’s length” contractual relationship does not give rise to a fiduciary relationship.  That is, the mere existence of a relationship between parties of bank and customer or depositor does not create a special relationship of trust and confidence.  In the context of mortgagor/mortgagee relationship, mortgages do not transform a traditional debtor-creditor relationship into a fiduciary relationship absent an intent by the parties to do so.  Absent special circumstances, a lender does not owe a fiduciary duty to a borrower. 

The “special circumstances” are “when one party has confidence in the other party and is ‘in a position of inequality, dependence, weakness, or lack of knowledge.’”  The evidence must show that the dominant party improperly influenced the weaker party so as to gain an “unconscionable advantage.” 

Big boys shouldn’t cry.  Applying Indiana law to the facts in Paul, the Court noted that the guarantors were physicians who “embarked upon a sophisticated business venture . . . [and] cannot now complain because they failed to read the [guaranty] or seek the advice of legal counsel before signing [it].”  In Indiana, one is presumed to understand the document he signs and cannot be released from its terms due to his failure to read it.  The Court affirmed the summary judgment in favor of the bank. 

Paul is another illustration of the enforceability of solid loan documents.  In Indiana, a well-written guaranty is tough to beat.  If you click on the “Guarantors” category to the left, you will see several posts that address a number of defenses that were roundly rejected in Indiana cases.  Certainly there are circumstances when a guaranty may not be enforceable or a guarantor may be released, but those cases are rare. 

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Posted at 05:53 PM in Guarantors , Promissory Notes  |  Permalink

November 20, 2012
“Collection” Vs. “Payment” Guaranties: Dearth Of Indiana Law

The other day, one of my transactional partners and I were discussing whether a particular written instrument constituted an enforceable guaranty.  He raised an issue that admittedly I have not yet litigated, namely whether the instrument was a “guaranty of collection” as opposed to a “guaranty of payment.” 

No Indiana cases.  One of our associates, Justin Kashman, briefly looked into the issue and turned up no Indiana state or federal opinions discussing the difference between the two guaranties under Indiana law.  I, too, conducted my own research and could not find any decision defining the two guaranties, or otherwise comparing or contrasting them.  My trusty Black’s Law Dictionary also fails to delineate between a payment guaranty and a collection guaranty.  In the final analysis, according to our research, these do not appear to be terms of art in Indiana.

Other states.  Our limited research into other states, however, confirmed what my partner believed – that the law generally recognizes two types of guaranties, depending upon the language used.  For example, Kentucky classifies a guaranty as either one for payment — an absolute guaranty — or one for collection — a conditional guaranty.  A guaranty is an absolute guaranty when it is subject to no conditions and contains an absolute promise to pay the outstanding indebtedness guaranteed.  The guaranty involved in KMC Real Estate Investors v. RL BB Fin., 968 N.E.2d 873 (Ind. Ct. App. 2012) was an absolute guaranty, as it expressly stated that "[t]his is a guaranty of payment, not of collection . . . ."  The guaranty went on to say that "Guarantor therefore agrees that Lender shall not be obligated prior to seeking recourse against or receiving payment from Guarantor, to do any of the following . . . , all of which are hereby unconditionally waived by Guarantor: (1) take any steps whatsoever to collect from Borrower . . . ." 

The distinction.  As noted in KMC, when a guaranty is absolute, "the guaranty may proceed against the guarantor at once on default of the principal. The guarantor's liability is dependent upon the same rule of law by which the liability of one who has broken his contract is determined."  If, on the other hand, the guaranty is found to be one of collection, then “the guarantor undertakes only to pay the debt upon the condition that the guarantee [lender] shall diligently prosecute the principal debtors without avail.  And this means the prosecution of a suit against the principal debtor to judgment and execution.”  Getty v. Schantz, 100 F. 577 (7th Cir. 1900).  Since the guaranty in KMC was absolute – a payment guaranty - the lender had the right to immediately enforce the guaranties and did not need to first exhaust its remedies against the borrower or execute on its collateral.

Given my experience, the standard guaranty we see in commercial mortgage loans is a payment/absolute guaranty.  Nevertheless, despite the absence of Indiana cases interpreting collection/conditional guaranties, I’m confident that with appropriate language this type of limited guaranty would be upheld by the Indiana courts.  So, if you draft or negotiate guaranties, or if you enforce or defend them, you should remain mindful of the classification.  The nature and extent of the guarantor's liability exposure will dramatically affect the dynamics of any particular Indiana commercial foreclosure case.

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Posted at 04:44 PM in Guarantors  |  Permalink

September 07, 2012
Indiana District Court Examines “Material Adverse Change” Default Provision

The most common loan default is for non-payment.  But there are many other events that can trigger a default.  Indeed loan documents, including guaranties, typically contain a multitude of default-related provisions.  One provision that we often see, but rarely apply, looks something like this:

Insecurity.  Lender determines in good faith that a material adverse change has occurred in Guarantor’s financial condition from the conditions set forth in the most recent financial statement before the date of the Guaranty or that the prospect for payment or performance of the Debt is impaired for any reason.

Greenwood Place v. The Huntington National Bank, 2011 U.S. Dist. LEXIS 78736 (S.D. Ind. 2011) (rt click/save target as for .pdf) addresses a similar material adverse change (“MAC”) clause. 

Summary judgment.  In Greenwood Place, Southern District of Indiana Judge Tanya Walton Pratt issued a ruling on a motion for summary judgment filed by a lender against two borrowers based on the theory that there had been a “material adverse change in the financial condition of” the guarantor of the loans.  The opinion did not quote the entire clause, but it was clear that the subject loan agreement provided that “any material adverse change in the financial condition of” the guarantor constituted an event of default.  (Note that an alleged default occurred even though the loan payments were current.) 

The change.  Since the execution of the loan agreement, the guarantor’s cash had been almost completely depleted, his net worth had decreased by 60%, his equity in real estate had diminished by 80%, and he had unpaid judgments against him for several million dollars.  According to the Court, “to be sure, [guarantor] has experienced an adverse change in his financial condition.”  But, “whether this change has been material . . . is a more difficult question.”

The Court’s struggle.  The Court conceded that “at first blush, it would appear that this change has been material as that word is used in common parlance.”  Nevertheless, the Court noted that the loan documents did not define “any material adverse change.”  Evidence from six witnesses suggested different definitions.  Although the lender urged the Court to accept a “know it when you see it” interpretation, the Court was “uncomfortable” with applying such an approach at the summary judgment stage.  “Materiality,” noted the Court, is an “inherently amorphous concept.”  The guarantor still had a sizeable net worth that, based on certain assumptions, could be enough to absorb any liability stemming out of the underlying loans.  “This cushion creates questions as to whether the adverse change in [guarantor’s] financial condition is, in fact, material.” 

Ambiguous.  The Court denied the lender’s motion for summary judgment:

Given the “sliding scale” nature of materiality, coupled with the lack of a definition or objective standard found in the [loan agreement], the Court cannot help but find that the term is ambiguous because reasonable people could come to different conclusions about its meaning.  . . .  [T]herefore, “an examination of relevant extrinsic evidence is appropriate in order to ascertain the parties’ intent.”

Essentially, the Court held that the issue of materiality was a question of fact for trial. 

What we learned.  The Court’s analysis of the relevant financial conditions provides a road map for prosecutors (or defenders) of similar defaults.  The Court’s opinion does not question the fundamental validity or enforceability of MAC provisions.  The opinion does, however, raise the question of whether such a provision can form the basis for a pre-trial disposition of the case:  “when it comes to materiality, it’s all relative.”  The implication is that every case (financial condition) is different, and facts may need to be weighed.  On the other hand, Greenwood Place does not go so far as to proclaim that summary judgment should be denied in every case.  The opinion merely demonstrates how difficult summary judgment might be to achieve. 

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Posted at 09:39 AM in Guarantors , Mortgages , Promissory Notes  |  Permalink

August 31, 2012
Guarantor Strikes Out With Defenses To Guaranty

Defenses to liability under a guaranty are few and far between in Indiana.  General Electric Capital v. Delaware Machinery, 2011 U.S. Dist. LEXIS 53897 (S. D. Ind. 2011) (.pdf) illustrates this. 

Set up.  The General Electric opinion dealt with a lender’s motion for summary judgment against a guarantor.  In 2003, the lender and the borrower entered into a master lease agreement that obligated the borrower to make payments on certain equipment in eighty-three monthly installments.  The lender obtained a guaranty in connection with the master lease agreement.  In 2009, the borrower failed to make lease payments, so the lender accelerated the amounts due and filed suit against the guarantor.  The Court concluded that, under the unambiguous language of the guaranty, the guarantor was liable to the lender for the borrower’s obligations.  (The opinion quotes the operative language of the guaranty.) 

The guarantor asserted three arguments as to why, despite the language in the guaranty, he should not be liable: 

Fraudulent inducement.  The guarantor’s first argument was that the lender fraudulently induced him to enter into the guaranty through representations that the master lease agreement would constitute a lease agreement, and not a purchase or security agreement.  The lender countered that fraudulent inducement based on misrepresentations “of the legal effect of a document” are not recognized in Indiana.  Indiana law generally recognizes fraudulent inducement as a defense to a contract, but one exception to the rule is:

when the representation at issue, though false, relates to the legal effect of the instrument sued on.  Every person is presumed to know the contents of the agreement which he signs, and has, therefore, no right to rely on the statements of the other party as to its legal effect.

Since the alleged characterization of the subject contract was a question as to the contract’s legal effect, the guarantor had no right to rely on the alleged misrepresentations of the lender.  Strike one.

Judicial estoppel.  The guarantor’s second defense was that the lender was judicially estopped from claiming damages for more than the amount claimed in the complaint.  In Indiana, “judicial estoppel prevents a party from pursuing a theory incompatible with its original theory in the same litigation.”  The opinion sets out three factors to be considered by courts, including whether the party’s later position was “clearly inconsistent” with its earlier position.  In its complaint, the lender stated that “at present, the amount due . . . totals not less than $279,074.43.”  In its subsequent motion for summary judgment, the lender sought over $415,000.00.  The operative language in the lender’s complaint was “at present.”  The guarantor could not show that the lender’s current position was “clearly inconsistent” with its position in the complaint.  Strike two. 

Indemnification.  The guarantor’s third contention was that he should not be liable due to the lender’s failure to perfect its security interest.  According to the guarantor, “this amounts to seeking indemnification for [lender’s] own negligence in failing to perfect.”  (Evidently, the equipment was not available as a source of recovery.)  The guarantor argued that, had lender perfected its interest, the lender could have sold the subject equipment for in excess of $500,000.00 and therefore covered all of the lender’s alleged damages.  The Court focused on the language of the guaranty, which provided that guarantor’s obligations were not affected by the borrower’s “failure to . . . perfect and maintain a security interest in, or the time, place and manner of any sale or other disposition” of the equipment.  Thus the express terms of the guaranty entitled the lender to recover damages regardless of its failure to perfect its security interest.  Strike three.

Language in guaranties usually rules the day.  That certainly was the case in General Electric.  The defenses asserted by the guarantor, although creative, ultimately did not defeat the lender’s summary judgment motion.

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Posted at 02:56 PM in Guarantors  |  Permalink