Utah Bar Journal

What is a Guaranty?
The guaranty is a contract, in its essence a very simple one: It is an agreement, made in advance, to pay the debt of someone else. In a commercial loan context, the guaranty provides the lender with recourse against the guarantor in the event the borrower defaults under its loan obligations. Guaranties are within the Statute of Frauds, see Utah Code Ann. § 25-5-4(1)(b) (1953), and so must be in writing and signed by the guarantor in order to be enforceable.

Protective Clauses and Waivers
The primary purpose of a guaranty can be served by a couple of simple sentences. So, one asks, why does the typical commercial loan guaranty agreement go on for page‑after‑single-spaced-page? Why this thick, sedimentary layering of verbiage overlaying so simple a concept? The answer is that all of that language is to account for the multitude of judicial defenses and exceptions that have evolved over the centuries as guarantors – and their astute and creative counsel – have marshaled every available argument against having to pay the debt of someone they believed would never default when they originally gave the guaranty. All the protective clauses, waivers, and “if-then’s” are merely intended to bring the rights of the parties back to the place where the lender can require the guarantor to pay if the borrower does not.

Many forms used by commercial banks and their law firms employ quite general language that waives the more basic defenses, but neglects the detailed, explicit waivers that are required to protect the lender without overloading the document with over-reaching jargon, and yet also lets the guarantors know where they stand.

Consideration
Because it is a contract, a guaranty agreement must be supported by consideration, i.e., a benefit or promise given by the creditor from the guarantor in exchange for the guaranty. See Bray Lines, Inc. v. Utah Carriers, Inc., 739 P.2d 1115, 1117 (Utah Ct. App. 1987). For most commercial loan agreements, consideration is simply not a problem. The consideration flowing between a lender and a borrower is obvious. With guaranties, however, the consideration can be a little less obvious. Although consideration separate from the extension of the loan itself is unnecessary where the guaranty is given as part of the same transaction as the principal debt, see Boise Cascade Corp., Bldg. Materials Distrib. Div. v. Stonewood Dev. Corp., 655P.2d 668, 669 (Utah 1982), problems can arise when a guaranty is delivered after the loan is made. If the guaranty is signed after the loan transaction is closed, it opens the potential for a lack‑of‑consideration defense. See Yoho Auto., Inc. v. Shillington, 784 P.2d 1253, 1255 (Utah Ct. App. 1989). Where the guaranty is executed after the closing, the lender should document that the loan was made in anticipation of the guarantor’s guaranty of the primary loan transaction, which would not have been made absent the guarantor’s undertaking. See U.S. v. Lowell, 557 F.2d 70, 72 (C.A. Mich. 1977). Alternatively, the lender can close a loan using a demand note, replacing it with a term note after the guarantor signs the guaranty, with the change in terms itself being the consideration for the guaranty. Where the guaranty agreement is used for additional security to prop up a shaky loan, the loan documents should be amended and restated, explicitly stating that the guaranty agreement is given to induce and enable the loan modification.

One more thing about consideration deserves mention: Section 3-408 of the Uniform Commercial Code provides that “no consideration is necessary for an instrument or obligation thereon given in payment of or as security for an antecedent obligation of any kind.” U.C.C. § 3-408 (1990). So, if the guaranty of an antecedent debt is embodied in a negotiable instrument, no consideration is required. See State Bank of Greeley v. Owens, 502 P.2d 965, 966 (Colo. App. 1972).

Guarantee of Payment, or Collection?
A guaranty of payment requires the guarantor to pay the obligee, even before the obligee seeks to enforce against the primary obligor. By contrast, a guaranty of collection requires the creditor to pursue collection efforts against the primary obligor, before going against the guarantor. Collection guaranties are, therefore, conditional in nature. A collection guaranty can require the creditor to sue the primary obligor, foreclose on collateral, and exhaust available legal remedies, all before requiring the guarantor to pay anything. If the guaranty is of collection only, therefore, it is vital for the lender to make sure that the collection guaranty states in no uncertain terms the extent to which the creditor must pursue the primary obligor before the guarantor becomes immediately liable. See Strevell-Paterson Co., Inc. v. Francis, 646 P.2d 741, 743 (Utah 1982).

Amendments and Modifications
It is important to remember this: If the lender materially alters the loan agreement, the guarantor may be discharged. See Clark v. Walter-Kurth Lumber Co., 689 S. W.2d 275, 278 (Tex. App. 1 Dist. 1985). The expressed rationale for this common law rule varies, but tends toward the view that the guarantor agreed to guarantee a certain loan with a certain risk and that it is unfair to require the guarantor to guarantee a different loan, particularly where the modification increases the guarantor’s exposure. Thus, a well-drafted guaranty agreement should include a provision to the effect that the guaranty will not be affected by any relaxation of the lender’s rights under the loan agreement, by any modifications, or by adjustments in the amount or timing of payments due the lender. See Westcor Co. Ltd. P’ship v. Pickering, 794 P.2d 154, 156 (Ariz. Ct. App. 1990). Even instances where the guarantor is plainly not prejudiced may, if not consented-to by the guarantor, result in discharge. This sometimes merciless application of the rule makes it critical that the guarantor consent to all material changes, even to forgiving part of the guaranteed debt. See Capital Bank v. Engar, 545 So.2d 317 (Fla. App. 3 1989).

Likewise, any release of collateral for the loan or the discharge of any co-guarantor will, absent consent, discharge the guarantor’s guaranty. See Speight, McCue & Assocs., P.C. v. Wallop, 153 P.3d 250, 256 (Wyo. 2007). This is because a guarantor, who pays the borrower’s debt to the creditor, may become subrogated to the rights of the creditor in the collateral, and the guarantor also has contribution rights against co-guarantors of the same debt (this concept will be discussed in greater detail below). Release of collateral or the discharge of a co-guarantor may prejudice those subrogation and contribution rights and will be enough to discharge the guarantee obligation.

Another circumstance deserving the draftsman’s attention is where the creditor fails to perfect (or to renew) a security interest. Accordingly, the well-drafted guaranty agreement will also have language giving the lender the right to deal with both collateral and co-guarantors without releasing the guarantor, or will provide that the guarantor’s obligations will be unaffected by impairment of collateral, inadvertent or otherwise. In every case, the lender’s counsel should carefully document every modification, extension, or collateral release or substitution relating to a guaranteed loan.

Invalidity
It is also standard for the commercial guaranty agreement to have a clause stating that the guaranty will not be affected by the invalidity of the primary obligation. This responds to the reasoning that says if the guarantor must pay what the primary obligor “owes” or what is “payable,” and if that debt is not legally due, then no guaranty obligation arises. Therefore, if for some reason the primary obligor is not really obliged to pay, then this provision is designed to provide that the guaranty nonetheless remains enforceable against the guarantor.

Subrogation
Once the guarantor pays anything toward the primary obligor’s debt, the guarantor acquires the rights of a subrogee. See Aetna Cas. & Sur. Co. v. Goergia Tubin Co., 1995 WL 429018 (S.D.N.Y. 1995). The guarantor can assert rights in the collateral, or can claim contribution from co-guarantors. If the obligation has been paid in full, none of this matters. However, if the lender is still owed money, the subrogation rights can be a terrific source of confusion, expense and vexation, as the lender, the subrogee, the debtor, and co-guarantors each jostle for advantage. Accordingly, the well-drafted guaranty agreement will have a provision waiving rights of subrogation until the guaranteed obligation is paid in full.

Foreclosure
The Utah Supreme Court ruled in Machock v. Fink, 137 P.3d 779 (Utah 2006), that a guarantor who has guaranteed a loan secured by real property is entitled to the same protections the primary obligor enjoys under the Trust Deed Act, such as the “single-action” rule, see Utah Code Ann. § 78-37-1 (2002), and the anti-deficiency rule, see id. § 57-1-32 (Supp. 2007). Accordingly, where the debt is secured solely by real property, the guarantor must receive the same notices and opportunities to cure afforded the trustor under a trust deed, and the lender must proceed against the real estate collateral before commencing an action against the guarantor. See Surety Life Ins. v. Smith, 892 P.2d 1, 3 (Utah 1995).

Likewise, where the debt is secured by personal property, the guarantor falls within the definition of a “debtor” in Article 9 of the Uniform Commercial Code, see U.C.C. § 9-102(28) (1990), and is entitled to all of the notices owed to the primary obligor. Failure to give the guarantor notice of dispositions of collateral can preclude the secured party from obtaining a deficiency judgment. See Strevell-Paterson Co., Inc. v. Francis, 646 P.2d 741, 743 (Utah 1982).

Specialized Types of Guaranties
There is a whole menagerie of specialized types of commercial loan guaranties. What follows is a sampling of some of the most useful – and inventively named:

Full or Limited Payment/Duration
Obviously, the lender prefers a guarantee of the entire debt – every red farthing – the primary obligor owes. Also called a “hell-or-high-water” guaranty, this agreement assures the obligee that the guarantor will pay all the obligations of the debtor, no matter how or when they arise, and without conditions.

Sometimes, however, a guarantor will negotiate for a limit on the amount he is willing to stand for. For example, with accruals of interest, default interest, late fees, and attorney fees, the guarantor may want certainty on the topside of his obligation to the obligee. Sometimes the guarantor is simply not inclined to guarantee the totality of the primary obligor’s debt. For example, a limited guaranty can guarantee only a specified amount or percentage of the obligation; only the principal of the debt; only the debtor’s operating expenses or the debt service; only costs of collection, or a deficiency, or only for a limited period of time. Where the guaranty is limited as to time, care must be taken to ensure that obligation’s termination point is clearly delineated, that is, the limited duration guaranty should say that the obligee must send a claim or file a lawsuit against the guarantor within six calendar months after the primary obligor fails to pay or respond to a judgment, and only at that point does the time period begin to run.

Reducing or “Burn-Down” Guaranties
This type of guaranty provides that the guarantor’s potential liability will be reduced (or will disappear entirely) upon the occurrence of something other than the mere passage of time. For example, the guaranty could reduce in amount or proportion, if and when the primary obligor reaches certain revenue goals, sells a certain asset, perfects a patent, or some other occurrence. For purposes of drafting, it is imperative that the extraneous condition reducing the guaranty obligation be objective and relatively easy to ascertain, to avoid a dispute over whether the triggering event has actually taken place and the obligation has thus been reduced.
Reducing guaranties are not uncommon in construction loans, where the lender is willing to look only to the primary obligor’s credit and the value of the real property collateral, once the realty has been improved by the completion of construction. Until then, the lender wants the guarantor to have plenty of incentive to finish the project. Thus, the agreement should specify that the guaranty will not be reduced until the improvements are substantially complete in accordance with plans and specifications approved by the lender; a certificate of occupancy has been issued; or, a certain proportion of net leasable space has actually been leased.

Joint, or Joint and Several
Occasionally, a guarantor will bargain for only joint liability with a co-guarantor, as contrasted with joint and several liability. Where the guaranteed obligation is joint, the obligee must join all co-guarantors in a single action if he hopes to recover from them all. See Othridge v. First Nat. Bank of Gainesvill, 458 W.E. 2d 887, 890 (Ga. App. 1995). On the other hand, where the obligation is joint and several the obligee can proceed against less then all of the co-guarantors (or only one) for recovery of the entire guaranteed obligation. See Finagin v. Arkansa Dev. Fin. Auth., 139 S.W.3d 797, 803 (Ark. 2003).

Springing or “Exploding” Guaranty
Related to the reducing guaranty is the exploding guaranty, one where the guaranty of the entire debt (or some agreed-upon amount) becomes effective if the primary obligor breaches certain specific covenants or takes or allows someone else to take certain actions. These covenants usually involve a falsity of the borrower’s warranties and representations made in connection with the lender’s credit extension or the bankruptcy of the primary obligor. Obviously, the exploding guaranty is most useful where the guarantor controls the primary obligor; it is designed to motivate the guarantor to intercede for the lender’s benefit.

“Carve-Out” Guaranty
A carve-out guaranty is used where the loan is non-recourse except on occurrence of the specified events the lender wishes to discourage – such as bankruptcy, false representations or financial reporting, the wrongful transfer of collateral, or misappropriation of rents, security deposits, reserve accounts or insurance proceeds – in which event the guarantor’s obligation becomes concurrent with the primary obligor’s. Most commercial banks and insurance companies do not make non-recourse loans, but carve-out guaranties are frequently used in securitized secured loans to single-asset/single-purpose entities, which typically have few assets other than the collateral for the loan. Where there is no recourse, the lender’s chief concern is that the borrower properly maintain the collateral and preserve its value, and refrain from bad acts such as fraudulent statements to the lender, misappropriation of insurance proceeds, failure to pay taxes, etc.

“Good-Guy Guaranty”
A perennial concern of lenders is that the repossession and disposition of the collateral be quick and painless. This worry can be abated by using a variation called a good-guy guaranty, where the guarantor is automatically released if and when the obligor transfers clear title to the collateral to the lender.

“Snap-Back” Guaranty
Once a guaranty has terminated and the guarantor is released, a snap-back agreement reinstates the guaranty if certain conditions or occurrences arise. For example, snap-back provisions can be used to resurrect a guaranty obligation that has been released by payment, if the lender is subsequently required to disgorge payments received to a bankruptcy trustee exercising the avoidance powers of 11 U.S.C. § 365.

“Upstream/Downstream/Cross-Stream” Guaranties
Upstream guaranties are the guaranties of a subsidiary’s obligations by a parent entity, and downstream guaranties are the reverse. A cross-stream guaranty is one affiliate’s guarantee of the debt of another affiliate of the same parent entity. The draftsman should carefully examine whether there is consideration for these kinds of guaranties as well as the potential ramification of the primary obligor’s bankruptcy. Because the parent entity’s equity interest in the subsidiary increases with payment of the subsidiary’s debts, downstream guaranties offer less risk to the lender than either upstream or cross-stream guaranties.

Conclusion
The guaranty agreement deserves more attention than it often gets in the commercial loan transaction, where it can be effectively tailored to meet the desires of the guarantor while still ensuring that the lender has a guaranty that will meet its needs quickly and without protracted litigation.