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Guarantor Wargame: Rights of Equitable Contribution

Guarantor Defense Wargame.jpg

At Hackard Law, we're devoted to protecting client interests, and that includes years of defending guarantors against lender lawsuits. One of the main ways we keep our skills sharp in guarantor litigation is through war games - formulating  potential cases and seeing how they play out, whether on the courtroom battlefield or through an outside compromise settlement. The following is just one hypothetical example of when a bank and a group of borrowers clash over the status of a guaranty:

I. Typical Scenario

a. The Borrower. In 2005 various individuals formed a California limited liability company called Big Borrower, Limited Liability Company ("Big Borrower"). Ownership of the membership interests of Big Borrower is reflected in the chart below.

b. Guarantors. The members of Big Borrower and the Trustees of their respective related Revocable Inter Vivos Trusts each signed individual guaranties titled "Commercial Guaranty" that the "Guarantor absolutely and unconditionally guarantees full and punctual payment and satisfaction of the Indebtedness of Big Borrower to Lender." The amounts of the guaranties are equal to the outstanding balance of the Indebtedness to the Lender, Little Bank. Each Guarantor waived the right to require the Lender to "proceed against any person, including Borrower, before proceeding against Guarantor." There is no contractual agreement between the Guarantors or members of Big Borrower to allocate contributions among them for the satisfaction of Big Borrower's Indebtedness. The Guarantors are reflected in the chart below.

MEMBERS AND GUARANTORS OF BIG BORROWER, LLC

Member

Percentage Interest

Guarantors

Financial Status

Abe and Alphina Acacia

35%

Abe and Alphina Acacia, Trustees of the Acacia 2004 Revocable Inter Vivos Trust

Abe Acacia, Individually

Alphina Acacia, Individually

Solvent

Bob and Brandi Birch

20%

Bob Birch and Brandi Birch, Trustees of the Birch 1994 Revocable Inter Vivos Trust

Bob Birch, Individually

Brandi Birch, Individually

Solvent

Cherry Chaparral

10%

Cherry Chaparral, Individually

Solvent

Dagney and Darla Douglas

15%

Dagney Douglas and Darla Douglas, Trustees of the Douglas Family Revocable Inter Vivos Trust

Dagney Douglas, Individually

Darla Douglas, Individually

Solvent

Festus Fescue

20%

Festus Fescue, Individually

Bankrupt

II. The Birch Guarantors' Concerns.

a. Disproportionate Burden. Big Borrower has now defaulted on its Indebtedness to the Lender, Little Bank. The Birches are concerned that they, in order to protect themselves, will be forced to pay a disproportionate share of any settlement with the Lender.

b. Rights of Contribution from Other Guarantors. Given Big Borrower's default and the Lender's indication that the loan and guaranties will soon be assigned to the Special Assets division of the Lender; the Birches want to know their rights against other Guarantors.

III. Summary of California Law - Equitable Contribution Between Guarantors

a. Guarantors' Proportionate Liability for Contribution. Civil Code Section 1432 provides that a party to a joint or joint and several obligation, "who satisfies more than his share of the claim against all, may require a proportionate contribution from all the parties joined with him." (See also Civ. Code § 2848.) The "proportionate contribution" concept set forth in Civil Code section 1432 is applicable here.

b. Right of Action. An action to enforce the right of contribution is governed by equitable principles. (Overholser v. Glynn (1968) 267 Cal.App.2d 800, 807.) Although an express or implied agreement allocating contribution among the parties usually will be honored (Booth v. Friedman (1927) 82 Cal.App. 174, 178-179), in the absence of such an agreement, the allocation of contribution "rests upon principles of equity and natural justice." (Blankenhorn-Hunter-Dulin Co. v. Thayer (1926) 199 Cal. 90, 96; see also 14 Cal.Jur.3d (1999), pt. 2, Contribution and Indemnification, § 3, p. 11.)

c. The Equity of Contribution. In Jans v. Nelson (2000) 83 Cal.App.4th 848 the Appellate Court concluded that in a circumstance in which all limited partners executed guaranties of a partnership debt and there were no other express agreements concerning rights of contribution, equity required the proportionate obligation for contribution to be based upon the ownership interest of the various guarantors. Those who own the right to "the benefit [of the partnership's business activity] must take the burden." (Civ. Code, § 3521.) The legitimate expectations of owners of differing interests in a limited partnership are not equal; "equality of liability among persons whose respective situations are not equal is inequitable."

IV. Conclusions

a. "Fair Share" Contribution Should Be Based On Equity. Each Guarantor's "fair share" contribution must be proportionate to their ownership interest in the limited liability company. Employing these ratios without removing the insolvent Guarantor from the equation, the "fair share" would be as follows: Abe and Alphina Acacia, 35%; Bob and Brandi Birch, 20%; Cherry Chaparral, 10%; Dagney and Darla Douglas, 15%; and Festus Fescue, 20%.

b. "Fair Share" Must Take Into Account Insolvent Guarantors. Solvent limited liability company members who have guaranteed a debt of the limited liability company have an equitable duty of contribution when a fellow guarantor has satisfied the guaranteed debt.   When the member has guaranteed the limited liability company debt in his or her role as a member, the Guarantor's duty of contribution is presumed to be limited by his or her proportionate share of ownership of the limited liability company. In calculating the solvent member's ownership interests, the ownership interests of any insolvent members must be disregarded.   Thus, absent some other agreement among the co-guarantors, a solvent member's equitable contribution will be proportionate to his or her adjusted percentage of ownership.   For these purposes this is the member's "fair share" of the debt. Employing these ratios and removing the insolvent Guarantor, Festus Fescue, from the equation, the "fair share" would be as follows: Abe and Alphina Acacia, 43.75%; Bob and Brandi Birch, 25%; Cherry Chaparral, 12.5%; Dagney and Darla Douglas, 18.75%;

c. Public Policy and Application of the Rule. A member who has signed a guarantee in his or her role as a member and who then has fully or partially satisfied the guaranteed debt has a right of contribution from solvent members who also have guaranteed the debt. The right of the Guarantor to contribution is limited to the amount by which the Guarantor's actual payment of the guaranteed debt exceeds his or her fair share.

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