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Guarantors May Not Be Liable for Loan Balance Where Guaranty is Not Absolute and Unconditional

July 13, 2012

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The recent case of GECCMC 2005-C1 Plummer Street Office Limited Partnership v. NRFC NNN Holdings, LLC, (2012) 204 Cal.App.4th 998 is good news for guarantors who sign a guaranty agreement that is less than "absolute" and "unconditional". This California Court of Appeal case shows that courts are inclined to strictly interpret the terms of guarantees against the lender where the guaranty agreement includes conditions on the guaranty obligation.

In NRFC NNN Holdings, LLC, the trial court held in favor of the lender in an action on a $44 million commercial loan guaranty. The guaranty was a "non-recourse" loan (meaning that under normal circumstances, the lender may not collect against the borrower personally, but must satisfy the loan balance through foreclosure of the property securing the debt or deed-in-lieu). However, in this case, the loan became "recourse" - meaning that the lender could proceed against the borrower (and in this case, the guarantor) personally if the borrower engaged in acts of "misconduct". An affiliate of the borrower signed a guaranty agreement guaranteeing the debt on similar terms.

The loan was secured by two commercial properties in Chatsworth, California, which were leased out to Washington Mutual Savings and Loan. Unfortunately, Washington Mutual Savings and Loan went out of business, stopped paying the rent, and abandoned the property, leaving the borrower without income to pay the debt. The lender ultimately foreclosed on the property and sought a deficiency judgment against the guarantor for $42 million plus attorney's fees and costs, on the theory that the borrower engaged in "misconduct" (thereby making the loan a "recourse" loan) because the lease with Washington Mutual Savings and Loan was effectively terminated by reason of Washington Mutual's non-payment of rent and abandonment. The lender relied on a provision of the promissory note evidencing the loan which provided that a termination of Washington Mutual's lease without the lender's consent constituted "misconduct".  In addition, the guaranty agreement expressly provided that:

"the Loan shall be fully recourse to Guarantor, and Guarantor hereby unconditionally and irrevocably guarantees payment of the entire Loan, if … without the prior written consent of [lender, the Washington Mutual lease] is terminated or cancelled, or the term of [the lease]… is surrendered."

The trial court determined that the Washington Mutual lease was terminated without the lender's consent and awarded the lender approximately $43 million in damages and costs. The guarantor appealed. 

The Court of Appeal disagreed with the trial court and reversed the decision in favor of the guarantor.  Despite the clear language in the guaranty stating that the loan would be recourse against the guarantor if the lease was terminated, cancelled or surrendered, the court (strictly construing the language against the lender) held that the parties intended that the recourse language only applied where the borrower committed a "bad boy act" (e.g. misconduct) that posed a particular risk to the lender. In the present case, Washington Mutual's failure was virtually unforeseeable by the borrower and guarantor and certainly not contributed to by their bad acts.

This is good news for guarantors seeking to get out of the obligation to pay on a guaranty that is conditional by its express terms. This case demonstrates that even when the language under the guaranty appears to be clear and purports to bind the guarantor to pay the lender for the debt, courts may be inclined to interpret provisions of the guaranty in favor of the guarantor in finding that the guarantor is not responsible for the obligation. This may be particularly applicable to cases where fairness dictates that the guarantor not be responsible. 

The take-away here is that, just because a guaranty seems to be clear on its face, it may be worthwhile to have an attorney review the guaranty and consider the circumstances surrounding the breach of the loan obligation, before conceding the guaranteed obligation to the lender.  In light of this case, a prudent lender would consider compromising (settling the obligation for less) if there is a favorable fairness argument to be made by the guarantor.

For more information, please contact:

Derek Ridgway

925-746-8484 Direct Phone
925-746-8493 Fax

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