By: Jack Easterbrook
Question: if a person signs a loan guaranty and it contains a long waiver section in which the signer gives up defenses (and the guaranties all have these sections, right?), is the guaranty still enforceable if the lender breaches the loan agreement? That is, can the lender claim that the guarantor is obligated to pay under the guaranty even though the lender was a cause of the defaults in the loan? That was the question in the DelPonti* case and the court came down on the side of the guarantors. (The case citation and the pertinent facts of the case are discussed below.)
What are the takeaways?
The court in the DelPonti case described two things the lender apparently did, which affected its rights under the guaranties taken from the borrower’s principals:
First, the court said the lender failed to honor approved payment applications (requests for advances) from the borrower on a construction loan. This is a reminder that the lender needs to be very careful that its loan documents thoroughly describe the conditions borrowers must satisfy to obtain advances. Stopping an advance without proper cause under the loan documents may jeopardize the lender’s ability to enforce its guaranties.
Second, in a subsequent loan workout the lender told the guarantors they would be exonerated if they did certain things in connection with the construction project, but later changed its position and tried to enforce the guaranties. The lesson is obvious: the lender needs to be careful about its communications with the borrower and the guarantors but if there is an agreement, stick to it!
Finally, while the guarantor may waive all of its defenses under the terms of the guaranty, the DelPonti court says that the lender continues to have a duty of good faith and fair dealing under the loan documents. The lender, according to the court, cannot sidestep that duty and use the broad waiver language in the guaranty to ensure repayment of a loan. This outcome actually seems rather consistent with the long standing trend in the courts to strictly construe loan documents and demand lender good faith. The DelPonti case addresses an area that the California courts had not previously discussed but the holding likely is not a surprise to those following the issue and familiar with the history of lender liability litigation.
Details of the DelPonti Case:*
The lender in the DelPonti case (a predecessor bank taken over by California Bank & Trust) made a construction loan in the amount of $6 million to an LLC developing a townhome project and took the personal guaranties of the principals. As the first phase of the project was nearing completion, the lender failed to honor requests for advances from the borrower which resulted in the first phase not being completed and sold. This triggered loan defaults by the borrowing LLC. The DelPonti case does not elaborate on the specifics of this; it states, however, that the trial court, after reviewing the evidence, found that lender’s failure to honor the payment applications (for loan advances) was a breach of the loan agreement by the lender. Subsequently the parties entered into a workout agreement, which was spelled out in an email from the lender. The lender agreed to exonerate the guarantors if they performed certain tasks related to the construction project. The guarantors did these things but the lender nevertheless foreclosed on the real estate collateral and pursued the guarantors for the deficiency.
The lender did not dispute the factual findings of the trial court but argued on appeal that even if the guarantor had such defenses, they were waived in the guaranty. The court discussed at length California Civil Code Section 2856, which is broad in scope and provides that a guarantor may waive the rights and defenses that would otherwise be available to the guarantor, including defenses that may exist because the loan is secured by real estate collateral.
The court said that the question of whether the waivers in a guaranty can be enforced under such circumstances had not previously been addressed in California. The lender’s argument, however, did not sway the court, which held that a guarantor’s waiver of defenses is limited to legal and statutory defenses expressly set out in the agreement. The court would not extend this to include “the predefault waiver of the Bank’s own misconduct.”
A Win for Long Guaranty Forms ?
When opining on the waiver’s effectiveness, the court emphasized that “a guarantor’s waiver of defenses is limited to legal and statutory defenses expressly set out in the agreement…” This suggests one additional point of interest to those concerned about the length of commercial loan documents: those long waiver provisions in the guarantees actually serve a purpose if a dispute arises! If a defense otherwise available to a guarantor is not expressly set out in the waiver portion of the guaranty, the courts are likely to narrowly construe the matter and interpret it to the benefit of the guarantor.
*California Bank & Trust v. DelPonti , 232 Cal.App.4 th 162 (2014)
The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.
Understanding Debt Financing and Loan Transactions
Debt financing is a specialized, complex area that goes to the heart of a company’s business, whether that business is real estate, low tech, or high tech. Loan transactions directly affect cash flow, and therefore are the lifeblood of any enterprise. For the lender, such as a bank, financial institution or private lender, it is critical to contain risk through careful structuring of loan documents. The lender also needs to know the pitfalls and optimal strategies if it encounters a problem loan or needs to consider whether or how to enforce its rights under loan documents, which may include foreclosing on its collateral. If a guarantor is involved, additional issues concerning scope, waiver and limitations on recourse will arise and must be properly structured and understood. On the other side of the transaction, sophisticated borrowers need to know if or in what situations the provisions in a loan document, promissory note, deed of trust or some other agreement will trigger a loan default and put the borrower at risk. And, of course, the guarantor issues mentioned above also come into play.
Strategy Law has deep expertise in all manner of debt financing, loan documentation and credit transactions, including structuring complex new debt financing transactions, securing loans with business assets, real estate assets or other unique collateral, developing creative borrowing bases, preparing complex loan documents, addressing the requirements of parties to intercreditor agreements, subordination agreements and guarantees, and addressing problem loans and workouts. This latter area may involve forbearance agreements, negotiation of restructured transactions, litigation, and representing creditors in bankruptcy.
Our experience extends to asset based loans, commercial lines of credit and term debt, venture financing, construction financing, commercial mortgage-backed securities deals and project financing.
Because of our work in the area of problem loans, Strategy Law has deep experience with the bankruptcy process, which it deals with strictly from a creditor’s perspective. We have represented lenders and other parties in interest seeking to enforce their rights after a bankruptcy petition is filed by a borrower, including obtaining relief from the automatic stay in bankruptcy, arguing “first day” orders, conducting evidentiary hearings and trials in bankruptcy court, defending bankruptcy preference claims, and purchasing assets out of bankruptcy.
The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.
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