Legal Alerts

Understanding the Extent of Commercial Guaranties

Lindquist Gets Real: Real Estate Tips from Lindquist & Vennum

In February 2013, we wrote about a pair of Michigan decisions concerning so-called "bad boy" guaranties common in non-recourse financing, and in particular CMBS financing that potentially expanded the scope of such guaranties in ways that were perhaps not intended by the parties nor foreseen by the guarantors.

We have found that parties to more traditional guaranties also sometimes do not understand the scope and extent of their guaranties. This can be a pitfall for individuals involved in commercial real estate development. Over time, an individual who is a managing member or principal of a real estate entity might end up executing personal guaranties on multiple loans with the same bank. Without vigilance, this can unwittingly create a circumstance in which the guarantor is responsible for liabilities that he did not intend.

The typical bank "form" guaranty says the following: "For good and valuable consideration, Guarantor absolutely and unconditionally guarantees full and punctual payment and satisfaction of the Indebtedness of Borrower to Lender...."

The key is the expansive definition of "Indebtedness": "...all of the principal amount outstanding from time to time and at any one or more times, accrued unpaid interest thereon and all collection costs and legal expenses related thereto..., now existing or hereafter arising or acquired, that Borrower... owes or will owe to Lender." Distilled to its essence, this means that if an individual signs a guaranty for a credit line, for example, and if that same lender thereafter makes a real estate loan to the same borrower, or acquires such a loan from another lender, the guarantor is potentially personally liable for that second loan as well. So long as there is "Indebtedness" from the borrower to that lender, the guarantor is potentially liable.

This liability continues "in full force until all the Indebtedness incurred or contracted before the receipt by Lender of any notice of revocation...."

The language in bold is critically important, yet often overlooked or forgotten. It is the responsibility of the guarantor to provide written notice to the lender of revocation of a guaranty at the end of the loan--typically when the loan is paid in full and retired.1 After the guaranteed loan is paid, the guarantor should deliver a written revocation of the guaranty. If there is no revocation, the guaranty continues to apply to any "Indebtedness." In other words, the guarantor could find himself unwittingly guaranteeing other loans by the lender to the borrower.

This is an important but, in our experience, often overlooked calendar item that is often a pitfall for the unwary. In some manner, everybody who signs a guaranty should create some form of calendar reminder to consider providing notice of revocation of the guaranty at a time that coincides with the maturity of the loan.

Here is a fact pattern we have seen more than once: client goes to his bank and takes out a one-year credit line for his business. Banker asks for a personal guaranty. Client agrees to guarantee the line for the first year. Banker agrees and produces a set of loan documents using one of the common bank loan document software programs such as Laser Pro. Neither banker nor client read the documents carefully because these are "standard" loan documents.

At the end of year one, the line renews automatically, and it renews again at the end of year three. The guarantor does not furnish a written revocation of the guaranty at any time. During year three, the business takes out a term loan to purchase equipment for the business and retire the credit line. A year later the business takes out a mortgage loan to purchase real estate. Two years later the business falls on hard times and both the mortgage loan and equipment loan are in default. Bank hires a lawyer who writes a letter to the client "reminding" him that he has a personal guaranty for both the equipment loan and the mortgage loan. "How can that be? I guaranteed a line of credit for one year only?!"

Unfortunately, the guaranty that the client actually signed was a continuing guaranty in the form discussed above. In deposition, the banker testifies that the bank would not have made either of the other two loans without the personal guaranty, and the bank’s internal credit review shows the existence of the personal guaranty as an item of additional security for the two term loans.

There may be some defenses to personal liability under that scenario depending on various possible facts that might exist, or there may not. The trick, though, is to avoid that argument altogether by remembering to revoke the guaranty when you think its purpose is done.

1 Do not do this during while the loan is outstanding. This would constitute an event of default of the loan.

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