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At Hackard Law, our top priority is protecting client interests, and that means successfully defending guarantors against lender lawsuits year in, year out. One of the primary ways to keep our skills sharp in guarantor litigation is by conducting legal war games - formulating potential cases and seeing how they play out, whether on the courtroom battlefield or through achieving an outside compromise settlement. The following case is just one hypothetical example of when borrowers and a lender "come to blows" over the status of a guaranty. Just remember, good legal counsel backed by experience is worth its weight in gold in such situations:
I. Typical Scenario
Two business associates banded together in 2006 to purchase an office building for the price of $10,000,000.00. They formed a Limited Liability Company (LLC) to own and operate the building. The LLC paid $2,000,000.00 toward the purchase and borrowed $8,000,000.00 from a bank. The bank loan was secured by a senior mortgage (trust deed) on the property. The associates personally guaranteed the LLC's debt to the bank. The LLC has no assets other than the building. The tenant in the building exited in early 2012. The LLC did not have funds to pay on the mortgage. The guarantors paid on the mortgage through May 2012 but quit paying because they saw that their personal liquidity was rapidly eroding. Notices of default were recently served by the bank on the borrower and the guarantors.
II. Scenario Specifics
a. The Borrower. In 2006 Abe and Brandi, his co-owner in a real estate development company, formed a California limited liability company called Build N' Borrow, Limited Liability Company ("Build N' Borrow"). Ownership of the membership interests of Build N' Borrow is reflected in the chart below. The Borrower has no other assets than the office building.
b. The Bank. The bank is Lawsoota Bank ("Lawsoota"). Lawsoota is a large multi-state regional lender.
c. Guarantors. The members of Build N' Borrow, their respective spouses and the Trustees of their related Revocable Inter Vivos Trusts each signed an individual guaranty, titled as a "Commercial Guaranty." The terms of the guaranties include provisions that the "Guarantor absolutely and unconditionally guarantees full and punctual payment and satisfaction of the Indebtedness of Build N' Borrow to the bank." The amounts of the guaranties are equal to the outstanding balance of the Indebtedness to the Lender, Lawsoota. The Guarantors are reflected in the chart below.
d. The Commercial Guaranty. The Commercial Guaranty includes certain waivers, including: (1) The guarantors agreed to waive any rights they might have pursuant to California Code of Civil Procedure §§ 580a[i] and 726,[ii] subdivision (b), and Civil Code Section 2856.[iii] The Guaranty also provides that the amount of the guaranteed obligation may be reduced only by the price for which the collateral is sold at foreclosure sale, even if the collateral is worth more than the sale price.
e. The Emotional Strain. The guarantors have an acute awareness that Lawsoota is now looking to them for payment of the mortgage. Lawsoota has asked the guarantors to post additional assets as security for its loan to Build N' Borrow. Lawsoota has also requested a sizable principal pay down. The guarantors and their spouses are jittery. They are experiencing a prolonged ordeal and feel that they have been thrashing about for a less painful resolution than that proposed by the bank.
f. The Landscape of Guarantor Defense. The basic principles of guarantor defense encompass a plethora of timing, factual and legal issues. Knowledge of all the features of the landscape - the post-default, the pre-litigation and litigation terrain - lessens and possibly neutralizes the lender's advantages. Guarantor defense tactics can mirror those of a fighter pilot - altitude (time) can be traded for speed (quick resolution) and vice versa. Loan extensions can be sought for time, or deeds in lieu of foreclosure, coupled with full or partial deficiency waivers, can be sought for speed of resolution. Either tactic supports the overall goal of preventing the economic meltdown of the guarantor.
MEMBERS AND GUARANTORS OF BUILD N' BORROW, LLC
Abe and Alphina Acacia
Abe and Alphina Acacia, Trustees of the Acacia 2004 Revocable Inter Vivos Trust
Abe Acacia, Individually
Alphina Acacia, Individually
Bob and Brandi Birch
Bob Birch and Brandi Birch, Trustees of the Birch 1994 Revocable Inter Vivos Trust
Bob Birch, Individually
Brandi Birch, Individually
III. Lawsoota Bank's Security
a. Build N' Borrow Building. Build N' Borrow owns a 120,000 square foot office building located in California. Lawsoota made a loan to Build N' Borrow in 2006 in the original principal amount of $8,000.000.00. In early 2012, the tenant exited the building. Build N' Borrow has now defaulted on its Indebtedness to Lawsoota. The guarantors are not currently paying the borrower's obligation to Lawsoota.
b. Security from Guarantors. Abe's guaranty obligation to Lawsoota guarantees the debt of Build N' Borrow. Abe gave a deed of trust on his property at Lake Tahoe to secure his debt (guaranty to Lawsoota). The deed of trust on Abe's Lake Tahoe property clearly references Build N' Borrow's debt to Lawsoota and Abe's guaranty of the debt. It is a valid secured obligation.
IV. Post-Default Negotiations
a. Special Assets. Lawsoota's special assets specialist, Max Dollars, recently contacted Abe and Brandi. Max indicated that he wanted to meet with Abe and Brandi "yesterday" and talk about how "they" (the bank, Abe and Brandi) can move forward together.
b. Likely Issues at the Bank Meeting.
i. Max will start with the simple points that the borrower owes the bank, the guarantors guaranteed the borrower's debt, and the bank wants its money. That is, the bank wants the loan brought current.
ii. An express or implied threat of litigation usually follows the "bring the loan current" speech.
iii. Workout options are then explored or explored at a later meeting. The constellation of workout options includes:
1. Extending or shortening the loan maturity date;
2. Capitalizing or forgiving interest;
3. Increasing default interest rates;
4. Changing payment times;
5. Providing for additional principal reductions;
6. Requiring additional collateral for the loan from the borrower and/or guarantors;
7. Requiring lender liability waivers;
8. Confirming the existing provisions and amounts owed on the loan; and
9. Inserting jury trial waivers, judicial reference provisions and/or arbitration provisions into the loan documents.
IV. Workout options generally require updated financial statements. Borrowers and guarantors must take care in providing these statements for a number of reasons:
1. The statements are a road map to the guarantors' assets. If the lender does sue on the guaranties, the lender will have the list of the guarantor's assets that it will seek to attach.
2. Any inaccuracies in the financial statements will be seized upon by lender's counsel in litigation or in a bankruptcy proceeding. Lender's counsel will often argue that the inaccuracy constitutes fraud.
V. General Principles of Workout Negotiations
a. Pre-Negotiation Agreements. Some banks will want pre-negotiation agreements. The proposed agreements can be a lender's effort to secure borrowers' and guarantors' concessions before any negotiations begin. Counsel for borrowers and guarantors must be extremely vigilant in protecting their clients' rights that can otherwise be bargained away before negotiations begin.
b. Non-Performing Promissory Notes Are Generally Not Traded For Another Promissory Note. A bank will not want to trade one promissory note for another of lower value. Banks will readily counsel that they will not trade a non-performing asset for another note secured only by a guarantor's promise.
VI. Liability of Guarantors
a. Liability of a Guarantor (Surety). A guarantor is often titled a surety in guaranty agreements and/or statutory law. A deficiency judgment can be recovered from a surety, but the surety, in the absence of contrary agreements, can require the beneficiary (the bank) to exhaust the security of the borrower before attempting recovery of the judgment from the surety. The surety may be entitled to reimbursement from the borrower.
b. Most Bank Commercial Guaranty Documents Have Extensive Waivers of Statutory Rights of Sureties. While statutes and case law provide guarantors many defenses to enforcement and collection on their guarantees, most commercial guaranty agreements signed by guarantors have waivers of specific defenses. California law generally provides that guarantor waivers may include:
i. The waiver of the guarantor's rights of subrogation, reimbursement, indemnification and contribution and any other rights and defenses that are or may become available to the guarantor by reason of Civil Code §§ 2787 through 2855;
ii. The waiver of any rights or defenses that the guarantor may have in respect of its obligations as a guarantor by reason of an election of remedies by the creditor; and
iii. The waiver of any rights or defenses that the guarantor may have because the principal's obligation is secured by real property, including any rights or defenses based on the application of the Code of Civil Procedure §§ 580a, 580b, 580d or 726 to the principal's obligation.
VII. Bank Negotiations
a. Guarantors Negotiating Alone. Guarantors who, without counsel, negotiate with banks on their guaranties might do a fantastic job . . . then again, they may not. Special asset bank employees are often heard to say, "Let's keep the lawyers out of this." Very confident or uninformed guarantors might readily agree. The bank's lawyers are really not "out of this." They work closely with special assets negotiators on a general level and, when needed, on very specific levels. Unrepresented guarantors usually lack experience in resolving bank guaranties and may lack the judgment to identify "traps for the unwary."
b. Experienced Counsel. Experienced counsel for guarantors can help. The presence of experienced counsel brings to mind the adage that "good judgment comes from experience and experience from bad judgment." Experienced counsel will be aware of the lender-guarantor negotiation landscape. He or she has seen it before. This experience at its best can help facilitate resolution. Lacking resolution, experienced counsel can identify and prepare the guarantor for the defense of probable lender-initiated litigation.
a. Emotional Strain for Guarantors.
b. Lawsuit May Be Filed.
c. Complexities Abound.
i. Issues between co-guarantors.
ii. Statutory rights waivers exist in most guaranty agreements.
iii. The guarantor's rights can be lost even before negotiations.
d. Experience Counts.
i. Experience is critical when the Guarantor becomes the Defendant in a lawsuit.
ii. Knowledge and understanding of the difficult "road ahead" helps alleviate fear and anxiety.
[i] Code of Civil Procedure § 580a governs the computation of fair market value of property for which a money judgment is sought for the balance due upon an obligation secured by a deed and trust. This section provides that the court may render judgment for not more than the amount by which the entire amount of the indebtedness due at the time of the sale exceeds the fair market value of the real property.
[ii] Code of Civil Procedure § 726 (b) relates to actions for foreclosure of mortgages, providing that the amount of the judgment is to be the difference between the sale price of the property and the fair market value, but in no event greater than the difference between the amount of the debt and the sale price.
[iii] Civil Code § 2856 permits guarantors or other sureties to waive certain rights and defenses, including the protections afforded by Code of Civil Procedure § 580a and 726.