Indiana Commercial Foreclosure Law

Indiana Guaranties Enforced In Note/Renewal Context

As previously posted here, there can be obstacles, under Indiana law, to obtaining a quick and inexpensive judgment against a guarantor.  Fortunately for lenders, on April 30, 2009 the Indiana Court of Appeals decided TW General Contracting Services v. First Farmers Bank and Trust, 2009 Ind. App. LEXIS 735 (Ind. Ct. App. 2009) (.pdf), which should help in overcoming some of those obstacles.

The players.  TW General Contracting involved the standard cast of characters in a commercial loan:  a lender, a borrower and a handful of guarantors.  The guarantors argued that their initial personal guaranties should not apply to the subsequent promissory notes. 

The loans and renewals.  Here is a summary of the relevant loan transactions with the borrower:

 05/11/05 Note #1 delivered; guarantors each signed a guaranty

 06/13/06 Note #1 renewed by Note #2

 03/06/07 New Note (#3) delivered

 06/01/07 New Note (#4) delivered; Note #1 renewed by Note #5

 09/21/07 Note #1 renewed by Note #6

The lawsuit against the borrower and the guarantors concerned defaults on three notes – Note #6 (renewal of Note #1), Note #3 (new note) and Note #4 (another new note).  Guaranties were only signed in connection with Note #1, however, back on May 11, 2005.

Material alteration?  In the plaintiff lender’s motion for summary judgment, the defendant guarantors asserted that the execution of the three new notes materially altered the guaranties and, as such, the lender’s claims had no merit.  For more about the “material alteration” defense, please click on my prior posts of 01/10/09 and 03/23/07.  In support of their theory, the guarantors submitted an affidavit from one of the guarantors stating/contending:

 ● The guarantor did not intend to personally guarantee the new notes.
 ● The new notes were unrelated to the 2005 obligations.
 ● The guarantor informed the lender that the new notes were for an independen project and that he would not personally guarantee the 2007 loans.
 ● The guarantor did not intend or contemplate that the 2005 guaranties would be applicable to the subsequent notes.
 ● The loans of 2005 had been satisfied and the accounts closed.
 ● It was the guarantor’s understanding that personally guaranteeing further loans would require the signing of a new guaranty.
 ● The new notes were not within the scope of what was contemplated by the guaranties when they were executed.
 ● The guarantor never consented to guaranteeing the new notes and was never given any consideration for doing so.

In short, the guarantors argued that “material alterations as a result of [Notes #6, #3 and #4] were not within their contemplation when they executed the guaranties.”  The Court of Appeals, in a pro-lender opinion, slammed the door shut on the guarantors.

Language fatal.  In its detailed and thoughtful opinion, the Court sliced and diced the language in various provisions in the guaranties.  The terms showed the guarantors “entered into unmistakable, very expansive guaranties to ‘induce’ the Lender to make loans to [borrower], the S-Corporation in which they are sole shareholders.”  The subsequent notes were signed by at least one of the four guarantors, albeit in their corporate (not individual) capacity.  “As such, the additional obligations to [borrower], and in turn the Guarantors, could not have come as a complete surprise . . ..”  The Court of Appeals was emphatic in its decision: 

  pursuant to the clear, extremely global language of the Guaranties,
  these additional obligations could hardly be characterized as
  material alterations but rather as a logical continuation of the
  mutually beneficial lender-borrower-guarantor arrangement.

Bullet dodged.  The circumstances in TW General Contracting were not unique.  These renewal/new note scenarios, which rely on prior guaranties, are out there.  Fortunately for lenders, the Court of Appeals’ opinion in TW General Contracting establishes strong legal precedent enabling lenders to overcome the “material alteration” defense.  Perhaps not all guaranties will have such definitive language, but the case’s fundamental holding should be of great help to lenders in their motions for summary judgment.

Even though the Court of Appeals affirmed the trial court’s summary judgment in favor of the lender, it is still advisable, when renewing notes or making subsequent notes, to have a new guaranty signed or at least to have a signed document (our firm uses a “Consent and Confirmation of Guaranty”) acknowledging that the prior guaranty remains in force.   

“Material Alteration” Defense Rejected In Indiana Guaranty Enforcement Action

Today we build upon my March 23, 2007 post entitled “Liability Of Guarantors Or Accommodation Parties When The Original Obligation Is Materially Altered.”  That post discussed Keesling v. T.E.K. Partners, 2007 Ind. App. LEXIS 358 (Ind. Ct. App. 2007), where the Indiana Court of Appeals held that the guarantor was released from liability.  Confronted with a different set of facts, on December 10, 2008 Magistrate Judge Nuechterlein of the Northern District of Indiana ruled the opposite way, concluding that the defendant guarantor did not provide sufficient evidence to establish a release.  Conn-Selmer, Inc. v. Bamber, 2008 U.S. Dist. LEXIS 99921 (N.D. Ind. 2008) (ConnSelmer.pdf).  Keesling and Conn-Selmer are good reads for secured lenders who may be struggling with a guarantor’s contention that the underlying loan transaction was materially altered so as to release the guarantor from liability.

The parties.  Selmer Company was the lender.  The defendant/borrower was Woodwind, and the defendant/guarantor was Bamber.  Selmer Company provided credit to Woodwind.  Bamber executed a personal guaranty in favor of Selmer Company to cover repayment of the credit.  The security agreement between Selmer Company and Woodwind stated that the “guaranty shall, without further consent of or notice to the undersigned, pass to, and may be relied upon and enforced by any successor or assignee of [Selmer Company] and any transferee or subsequent holder of any indebtedness, liability or obligation.”  After the execution of the underlying security agreement and guaranty, Selmer Company changed ownership several times.  Plaintiff Conn-Selmer was the party that ultimately sued Bamber.

Guarantor’s contention.  Bamber did not dispute execution of the personal guaranty or the terms and conditions of the guaranty.  Rather, he argued that, since the liabilities under the security agreement had changed over time, he was relieved from liability under the guaranty. 

Basic rule.  Magistrate Judge Nuechterlein noted that, in Indiana, it is a general rule that:

when the principal and obligee cause a material alteration of the underlying obligation without the consent of the guarantor, the guarantor is discharged from further liability.  A material alteration which will effect a discharge of the guarantor must be a change which alters the legal identity of the principal’s contract, substantially increases the risk of loss to the guarantor, or places the guarantor in a different position.

Insufficient evidence of lack of consent.  The Court decided the Conn-Selmer case in the context of a motion for summary judgment filed by plaintiff Conn-Selmer.  In response to Conn-Selmer’s motion, Bamber was compelled to provide evidence of the material alteration and whether it was without his consent.  While the Keeling decision analyzed, and rested upon, the “material alteration” element of the defense, the Conn-Selmer decision centered upon the “lack of consent” element:

Bamber offers documentation of a few communications made between Bamber and the various successors of the Selmer Company memorializing agreed changes to the credit repayment rates and deadlines.  However, three of these documents addressed Dennis Bamber personally, and one was drafted by Dennis Bamber himself.  Further, each appears, in substance, to confirm agreements made between the Selmer Company and Dennis Bamber, on behalf of Woodwind.  As such, Bamber cannot argue that he was not privy to any changes made to the underlying security agreement.  Indeed, these documents attest that Bamber was simultaneously fulfilling both roles as “obligee” on the debt, in his professional role as head of Woodwind, and as “guarantor” under the ongoing security agreement.  Consequently, Bamber cannot, and indeed does not, argue that he did not consent to any asserted changes made to [the] security agreement.  Because lack of consent is a necessary element to relieve Bamber of liability under the personal guaranty, this Court concludes that Bamber has not provided sufficient evidence to establish release from liability under the guaranty.

Bamber was unable to prove that any material alteration of the underlying obligation was without his consent so as to discharge him from personal liability.  One of the lessons for secured lenders who may be pursuing a guaranty enforcement action in Indiana is to review your files for evidence showing that the guarantor consented to any alterations to the note/security agreement.  Armed with any such evidence, you should be able to defeat the material alteration defense as Conn-Selmer was able to.

Guarantor Contribution Claims And The Meaning Of “Joint And Several Liability”

If by chance you want to learn about contribution claims between guarantors, I recommend reading the September 29, 2008 opinion in Balvich v. Spicer, 2008 Ind. App. LEXIS 2117 (Ind. Ct. App. 2008) (Balvich.pdf).  The Court details Indiana’s laws of contribution, including the applicable statute of limitations.  Although contribution does not directly concern secured lenders, the related concept of joint and several liability does. 

Contribution, generally.  A suit for contribution involves the partial reimbursement of one who has discharged a common liability.  “The doctrine of contribution rests on the principle that where parties stand in equal right, equality of burden becomes equity.”  The right of contribution “operates to make sure those who assume a common burden carry it in equal portions.”  As a basic example, if one of three guarantors paid a lender $100,000 to satisfy a deficiency judgment, then that guarantor could sue the other two guarantors to recover their pro rata portion of the $100,000.

Joint and several liability, defined.  As I read through the Balvich case, it occurred to me that it might be useful to explain what “joint and several” liability means.  If you deal with commercial foreclosures, you may be familiar the “joint and several” terminology in the context of a judgment against multiple guarantors.  When a court enters a money judgment against more than one guarantor, one will see language like:

Lender hereby is granted judgment in its favor and against the defendants, Guarantor I, Guarantor II, and Guarantor III, jointly and severally, with regard to the Guaranties, in the amount of . . ..

There were multiple guarantors in Balvich.  The Court of Appeals, relying upon Indiana Trial Rule 54(E), noted generally that a judgment against two or more persons, jointly and severally, permits “enforcement proceedings jointly or separately against different parties or jointly or separately against their property.”  The all-important Black’s Law Dictionary defines “joint and several liability” as:

A liability is said to be joint and several when the creditor may sue one or more of the parties to such liability separately, or all of them together at his option.  A joint and several . . . [promissory] note is one in which the obligors or makers bind themselves both jointly and individually to the obligee or payee, so that all may be sued together for its enforcement, or the creditor may select one or more as the object of his suit . . ..

Significance of joint and several liability to secured lenders.  In a case of joint and several liability among multiple guarantors, lenders can pick and choose which guarantors to go after for the entire amount owed.  For example, if there are three guarantors, but investigation discloses that two of them are judgment proof, one can opt to chase only the solvent guarantor for all of the unpaid debt.  Plaintiff lenders in Indiana would not be required to sue all three, and lenders would not be limited to a recovery of a specific co-guarantor’s pro rata portion. 

Jurisdiction Over Out-Of-State Guarantors

In what state can a commercial lender bring its case against an out-of-state guarantor of an Indiana loan?  Judge David Hamilton of the Southern District of Indiana helps answer this question in Automotive Finance v. Aberdeen Auto Sales, 2007 U.S. Dist. LEXIS 60136 (S.D. Ind. 2007) (AutomotiveOpinion.pdf), in which he denied a motion to dismiss filed by a Mississippi defendant/guarantor in an Indiana commercial collection action. 

The status.  Plaintiff lender (Automotive Finance) filed an Indiana federal court foreclosure case against defendant borrower (Aberdeen), a Mississippi entity, for breach of an auto dealer floor-plan financing contract intended to support Aberdeen’s Indiana operations.  In addition to naming Aberdeen as a defendant, the lender named a Mississippi citizen who had guaranteed the deal.  The guarantor (Mitchell) filed a motion to dismiss for lack of personal jurisdiction, asserting that the lender could only sue her in Mississippi to pursue damages based on the guaranty.

The issue.  One of the questions in the case was whether Mitchell’s guaranty of an Indiana debt was sufficient to justify the exercise of specific jurisdiction over her in Indiana.  Mitchell’s only tie to Indiana was that she signed the guaranty – in Mississippi.  She did not communicate with anyone in Indiana or travel to Indiana in connection with the deal.  She received no compensation from the business borrower for the floor-plan financing.  “If the court has jurisdiction over Mitchell, it must be based on the guaranty for the benefit of [borrower], which Mitchell admits she signed.”  Id. at 4. 

The guaranty.  The language of the guaranty was somewhat unique.  Mitchell explicitly agreed in the guaranty to submit to the personal jurisdiction of Indiana.  The guaranty also provided that it shall be governed by Indiana law.  (It also should be noted that Mitchell was a director and/or officer of the borrower.)

The jurisdiction lesson.  Indiana extends its personal jurisdiction to the full extent of the due process clause of the Fourteenth Amendment.  Under applicable constitutional principles and Indiana case law, Judge Hamilton held that the court could exercise personal jurisdiction over the Mississippi guarantor: 

  Plaintiff and the defendants entered into a substantial and
  long-term commercial financing relationship in which a
  lender in Indiana extended credit to a borrower in Mississippi,
  with guaranties from other Mississippi residents, including
  Mitchell.  As part of the guaranty, Mitchell agreed to jurisdiction
  and venue in Indiana.  Based on the clear terms of the guaranty,
  Mitchell obviously had “fair warning,” . . . that she could be sued
  in Indiana with respect to this transaction.  She could reasonably
  anticipate that she would be “haled into court” in Indiana in
  disputes arising out of the guaranty.  The guaranty itself told her
  that she was agreeing to precisely that possibility.  She also
  agreed that if she filed suit herself relating to the guaranty, she
  would file it in Marion County [Indianapolis], Indiana.

Id. at 5.  Judge Hamilton further reasoned that, because the borrower was subject to jurisdiction in Indiana, Mitchell’s guaranty was presumably “an essential term of [lender’s] agreement to extend $100,000 in credit to a corporation whose creditworthiness was uncertain.”  Id. at 7.  From the perspective of the lender, Judge Hamilton concluded, it made “good sense” to secure the agreement of all parties to the transaction so that any lawsuit arising from it could be heard in one venue with all interested parties, including guarantors.  Without such an agreement, credit would be more difficult and expensive to obtain.  Id. 

The upshot.   Automotive Finance is a favorable decision to creditors with Indiana deals involving out-of-state guarantors.  Depending upon the facts of the particular case, Judge Hamilton’s opinion supports the notion that, even though guarantors may have little-to-no contacts with Indiana, the mere fact that the individual guaranteed a loan for an Indiana project may be sufficient to subject that individual to jurisdiction here. 

Normally, it’s in the best interests of lenders to avoid the need to file suits in multiple states for the same debt.  Secured lenders are thus advised to utilize the language mentioned in the Automotive Finance guaranty – that is, have the guarantor stipulate to personal jurisdiction and venue in Indiana (or wherever the loan collateral is).  Without such an express statement, winning the jurisdictional battle may be more difficult. 

IRISH V. WOODS: Which Surety Was Left Holding the $500,000 Bag?

A secured lender’s primary source of recovery when a project goes bad usually is the loan collateral.  Secondary sources could be the assets of a guarantor, a surety or an accommodation party, labels that often are used interchangeably to describe a person who signed a loan document but who did not directly benefit from the loan.  (See, March 23, 2007 post, Liability of Guarantors or Accommodation Parties when the Original Obligation Is Materially Altered).  The April 24, 2007 decision by the Indiana Court of Appeals in John T. Irish v. F. Lawrence Woods, 2007 Ind. App. LEXIS 786 (IrishOpinion.pdf) addresses some general rules applicable to these secondary sources and also provides a good suretyship vocabulary lesson. 

Backdrop.  Plaintiff Irish and defendant Woods formed LLC.  Lender Old National Bank loaned LLC about $500,000.  Both LLC and Irish were named borrowers on the note, but Irish did not directly benefit from the loan.  Only LLC did.  Woods guaranteed the note and, interestingly, also signed a separate guaranty of Irish’s debt under the note.  LLC defaulted but evidently was judgment proof.  Irish settled with Old National for the total amount due by purchasing the note.  Irish then sued Woods for the debt, claiming Woods was liable as the guarantor of the note.  Irish also asserted a contribution claim against Woods based on the guaranty of Irish’s obligation under the note. 

7 things to know about Indiana suretyship law. 

1. A borrower is a “principal obligor” – here, the LLC.  Id. at 6.

2. When a party places a signature on a note solely for the benefit of another party, and without receiving any direct benefit, he or she is an “accommodation party” – here, Irish.  Id. 

3. An accommodation party is considered a “surety.”  When the term surety refers to a person, it is a person who is liable for the payment of a debt, or performance of a duty, of another person.  Id.  (The words “guaranty” and “guarantor” are synonyms for “suretyship” and “surety.”  Id. at 7, n.4.)   

4. The liability of an accommodation party only is relevant in the event of a default by the accommodated party.  Ind. Code § 26-1-3.1-419(e).  In such event, the accommodation party’s suretyship status allows him to seek reimbursement from the accommodated party.  As a party with recourse against another party, the accommodation party’s suretyship status is equivalent to that of a “secondary obligor.”  Id.

5. A “cosuretyship” occurs when two secondary obligors agree that, as between themselves, each should perform part of its secondary obligation or bear part of the cost of performance.  The test of cosuretyship is a common liability for the same debt or burden.  Id. at 8-9.

6. A “subsuretyship” occurs if two secondary obligors agree that, as between themselves, one (the ‘principal surety’ – here, Irish) rather than the other (the ‘subsurety’ – here, Woods) should perform or bear the cost of performance.  Id. at 9.

7. Whether a particular party is a cosurety with, or a subsurety to, another party affects rights of contribution.  The right of contribution operates to make those who assume a common burden bear it in equal proportions.  In a cosuretyship, one cosurety is entitled to contribution from the other cosureties so that all cosureties bear the burden in equal, or otherwise agreed to, proportions.  With regard to subsuretyships, if the principal surety performs on the obligation, it is not entitled to contribution from a subsurety.  But, if the subsurety performs on the principal obligation, the subsurety is entitled to reimbursement from the principal surety.  Id.

The upshot.  The lender, Old National, was well-served by having Irish co-sign the note.  Even though the direct beneficiary of the loan (the LLC) defaulted, Old National evidently still recovered the debt from Irish, an accommodation party.  There was no need for Old National to pursue the guarantor, Woods.  Because Irish anted up, Woods got off scot-free.

Irish, as principal surety, “purchased” the note for the amount of his liability and then sought to enforce the guaranty of Woods, the subsurety.  But a principal surety cannot “purchase” his own debt and unilaterally create liability for a subsurety, who would not otherwise be liable.  Id. at 13.  The Court also determined that Woods, as guarantor of the note, only was secondarily liable.  Irish, as principal surety, was primarily liable for the cost of performance on the note.  In other words, in what may have been a close call for the Court, the judges ruled that the note’s co-signor (Irish) was on the hook but that the note’s guarantor (Woods) was not.

LIABILITY OF GUARANTORS OR ACCOMMODATION PARTIES WHEN THE ORIGINAL OBLIGATION IS MATERIALLY ALTERED

On February 28, 2007, the Indiana Court of Appeals decided a case about the personal liability of guarantors/accommodation parties in Keesling v. T.E.K. Partners, 2007 Ind. App. LEXIS 358.  If you’re a lender that modifies deals, or enforces loans that have been reworked, Keesling is instructive.

Background.  In Keesling, an Indiana commercial foreclosure case, there were multiple parties to an installment note and mortgage related to the development of a residential neighborhood.  Three entities and four individuals in their personal capacities signed the original note of $300,000.  (There were no guaranties.)  When the note came due, there was approximately $50,000 left to be paid.  Some, but not all, of the original parties entered into a second note that took into consideration the balance remaining of the original note and about another $50,000.  The parties to the second note ultimately defaulted, and the plaintiff assignee, who held the note and mortgage, sued everyone, including the original signatories.  The defendants relevant to this article did not know about or consent to the execution of the second note.  They contended that they merely were accommodation parties on the original note and that, because the second note constituted a material alteration of the original obligation, they should be discharged from further personal liability under either note.  The Court agreed.

Guarantor vs. accommodation party.  The Indiana Court of Appeals labeled the individuals who signed the original note in their personal capacity as “accommodation parties” pursuant to the definition in Indiana’s UCC, Article 3.1:  I.C. 26-1-3.1-419.  An accommodation party, according to the Indiana UCC, is someone who signs an instrument for the purpose of incurring liability on the instrument without being a direct beneficiary of the value given for the instrument.  Keesling at 7.  As a practical matter, particularly for purposes of enforcement, an accommodation party essentially is the same as a guarantor, the primary difference being that a guarantor signs a separate instrument – a guaranty.  (Also, accommodation parties, sometimes called co-makers or co-borrowers, may have available to them common law surety defenses - a topic I’ll tackle another day.)  The Court in Keesling concluded that the subject defendants signed the original note but were not direct beneficiaries of the value given for the instrument.  So, the Court deemed them to be accommodation parties, although the opinion also referred to them as guarantors and applied general guaranty law.   

Material alteration.  The Court noted that, generally, a guaranty is a promise to answer for the debt and default of another.  When parties cause a material alteration of an underlying obligation, without the consent of the guarantor, the guarantor is discharged from further liability.  Indiana defines a material alteration as a “change which alters the legal identity of the principal’s contract, substantially increases the risk of loss to the guarantor, or places the guarantor in a different position.”  Keeling at 6-7.

The Keesling illustration.  The plaintiff basically tried to characterize the second note as a refinance of the original note.  Not so fast, said the Court.  The second note purported to add accounts payable of other parties, and it capitalized interest due on the original note.  “In itself, this capitalization of interest was a material alteration.”  Id. at 10-11.  So, the second note not only added new debt but increased the total principle draws beyond the original amount of the note.  Significantly, the alterations occurred without the knowledge or consent of the parties alleged to be personally liable.  The Court held that the alterations were material and that the defendants were “not chargeable with the second note, a new agreement which did not include their signatures.”  Id. at 13.  The Court also discharged the defendants from any liability as to the original note. 

Morals of the story.  If as a lender you intend to refinance or modify the original deal, each and every party you want to answer for the debt should sign off on the new loan documents.  This is particularly true if you materially alter the original obligation.  The lesson is a simple one and, maybe to most of you reading this, an obvious one – get the guarantors to sign another guaranty or get the accommodation parties to sign the second note.  Lenders should view the matter as an entirely new transaction. 

On the flip side, if you’re a lender who acquired, perhaps through an assignment, a loan that has been modified in some fashion, as was the case in Keesling, you should research and identify all individuals that might be deemed accommodation parties or guarantors.  Because your institution may not have originally documented the transaction, obtain all the loan papers and study the deal’s history.  If there was not a material alteration of the original debt, missing signatures or guaranties may not be fatal.  To maximize your financial recovery, you should consider the possibility of pursuing anyone who signed any of the loan documents prepared throughout the life of the deal.

ALLEGED GUARANTORS NEED NOT PROVE A NEGATIVE

In my January 16 post, The Commercial Lender's 8-Item Care Package for its Foreclosure Attorney, I recommend (as item number one) that all applicable loan documents be provided to outside counsel.  This would include any guaranty that was a part of the loan transaction.  As most of you reading this blog know, it is not uncommon for some business loans to have a personal guaranty, which specifically requires an individual to guarantee the financial obligations undertaken by the business.  In other words, the guarantor becomes secondarily liable for the business debt and, as such, will invariably be named as a defendant in the foreclosure suit.   

Although it may seem obvious, the plaintiff lender has the burden of proving the existence of the guaranty.  Without such evidence, a claim against a guarantor will fail, which is exactly what happened in a February 16, 2007 ruling by United States Magistrate Judge Andrew P. Rodovich for the Northern District of Indiana in Case No. 2:97 cv 276, United Consumers Club, Inc. et. al. v. Mark Bledsoe, et. al., 2007 U.S. Dist. LEXIS 11489.  Although the case involved the breach of a franchise agreement, not a promissory note, the holding applies with equal vigor to lenders:

If [plaintiff] is to maintain a claim based upon the execution of a written instrument, their initial burden of providing evidence of the document's existence cannot be shifted by requiring [defendants/alleged guarantors] to prove its non-existence....  [T]here is no evidence before the court that [defendants/alleged guarantors] signed a personal guaranty.  Accordingly, summary judgment is proper in favor of [defendants] on [plaintiff's] claim for breach of the personal guaranty.

The opinion does not specify whether someone lost the guaranty or whether there never was a guaranty in the first place.  The obvious point is - if as a lender you want to sue on a guaranty, you need to produce the written instrument, preferably to your attorney before suit is even filed.  Simply alleging a guaranty existed won't cut it - alleged guarantors are not required to prove a negative in order to prevail.