Indiana Commercial Foreclosure Law

Criminal Bank Fraud As A Collection Tool?

Secured lenders caught up in loan defaults typically pursue the contract-based remedies of damages and foreclosure designed to make lenders whole for their actual losses (unpaid principle balance, interest and attorney fees).  In Klinker v. First Merchants Bank, 964 N.E.2d 190 (Ind. 2012), a lender sought statutory-based treble damages for alleged criminal acts of fraud by a guarantor.  It was an aggressive strategy, but was it worth it?

Default.  Klinker involved a used car dealership that borrowed money from a lender to purchase cars under a floor-plan agreement.  The terms of the loan, which the dealership’s principle guaranteed, required the borrower to pay money to the lender whenever it sold a car.  Also, the borrower could not transfer title without the lender’s consent.  When the lender audited the dealership, it learned that thirty-one cars for which the lender had loaned money were gone.  The borrower had failed to turn over any sale proceeds for the thirty-one cars.   

CVCA.  What was unique about Klinker was the lender’s claims under Ind. Code § 34-24-3-1, known as the Indiana Crime Victims’ Compensation Act (“CVCA”).  The CVCA permits one who suffers a pecuniary (monetary) loss as a result of certain property crimes to bring a civil action against the person who caused such loss.  The victim can recover up to three times its actual damages.  Although a criminal conviction is not required, the plaintiff must prove each element of the underlying crime, including criminal intent. 

Claim 1.  The lender’s CVCA action asserted two fraud claims based on I.C. §§ 35-43-5-4 and 8, which are criminal statutes.  Under the first, the lender could obtain summary judgment only if undisputed facts showed (1) the guarantor (2) concealed, encumbered or transferred property (3) with the specific intent to defraud the lender.  The guarantor transferred financed vehicles without the lender’s knowledge and thus concealed them from his creditor.  This constituted a breach of contract, but did “not lead inescapably to a finding of criminal fraud.”  This is because the lender also must demonstrate undisputed facts showing that the guarantor acted with the requisite “mens rea – the specific intent to defraud.”  There must have been undisputed facts to establish that, when the guarantor made the challenged transfers, “his conscience objective was to cause injury or loss” to the lender by deceit.

Mens rea.  When judgment creditors bring proceedings supplemental to set aside fraudulent conveyances, fraudulent intent may be inferred from the “8 badges of fraud,” about which I have written previously.  In Klinker, the lender designated evidence that established three badges of fraud, but summary judgment was inappropriate due to the absence of the mens rea element:

summary judgment is almost never appropriate where the claim requires a showing that the defendant acted with criminal intent or fraudulent intent.  . . .  This is particularly so for CVCA claims.  The CVCA provides a punitive remedy if the claimant can prove that the defendant violated a penal statute, and, as a punitive measure, it should be strictly construed and applied only where the challenged conduct is clearly proscribed.  Moreover, because CVCA claims combine criminal and civil law, they implicate the state constitutional policy favoring jury intervention in both criminal trials and civil trials.

The Court concluded that “drawing all reasonable inferences in favor of the non-moving party, it is possible that the trier of fact could find a simple breach of contract here instead of criminal fraud, regardless of how strong the badges of fraud may be.”

Claim 2.  As to the second claim, to be entitled to summary judgment the lender must show undisputed facts establishing that (1) the guarantor (2) knowingly (3) executed or attempted to execute (4) a scheme or artifice (5) to obtain the lender’s money or other property (6) by means of false or fraudulent pretenses, representations, or promises, and (7) that the lender is a state or federally chartered or federally insured financial institution.  In Indiana, “a person engages in conduct ‘knowingly’ if, when he engages in the conduct, he is aware of a high probability that he is doing so.”  I.C. § 35-41-2-2(b).  “The fraudulent-conveyance badges of fraud (circumstantial evidence) are not relevant in this context – other circumstantial evidence must be presented.”  In addition to the “knowingly” problem, the lender in Klinkler had a fatal timing issue with this particular claim.  The alleged misrepresentations occurred after the guarantor had obtained the loans.  The fraudulent activity must have been done at the time of execution.

No summary judgment.  The Indiana Supreme Court reversed the trial court’s summary judgment for the lender.  The result reveals at least one drawback of the lender’s aggressive loan enforcement approach - CVCA cases virtually guarantee a trial.  This means that the case will be lengthier and more expensive.  As illustrated by Klinker, although CVCA claims are available to lenders in Indiana, the pursuit of such claims almost certainly will slow down the collection process.

Judgment Deemed Satisfied After Defendant Guarantor Utilizes Strawman To Purchase It

In commercial foreclosure actions, creative parties and counsel often reach unique settlements that satisfy the needs of both the lender and the borrower or guarantor(s). The case of TacCo v. Atlantic Limited Partnership, 937 N.E.2d 1212 (Ind. Ct. App. 2010) shows such creativity in action. TacCo is a lesson in satisfaction of judgments and the strawman defense, but the more interesting facet of the case is the maneuvering between co-guarantors over their shared exposure to a $3.2MM judgment.

Players. I’ll label the key players in TacCo as follows: Lender, Borrower, Strong Guarantor, Strawman and Weak Guarantor. “Strong” and “weak” signify that one of the co-guarantors seemingly had the financial capacity or willingness to pay the debt, while the other did not. Lender initiated a commercial mortgage foreclosure action against Borrower, Strong Guarantor and Weak Guarantor. The suit resulted in a judgment for $3.2MM.

Post-judgment settlement. Before the sheriff’s sale, Lender and Strong Guarantor entered into a settlement agreement that centered on Lender’s sale of the judgment for $1.5MM in cash, a $1.5MM promissory note and a $250,000 letter of credit. On paper, the settlement was conditioned upon Strong Guarantor’s ability to locate a purchaser of the judgment, which purchaser ended up being Strawman. Lender obtained the cash and promissory note, and Strawman obtained an assignment of the judgment. Strawman then submitted a credit bid at the sheriff’s sale for $1.5MM and acquired the subject property.

Purpose. Lender got paid off, but Weak Guarantor was not a part of the deal. Although Weak Guarantor and Strawman submitted conflicting evidence and theories, it appears that the settlement was structured to deliver Strong Guarantor the real estate and to expose Weak Guarantor to judgment enforcement (collection) efforts by Strawman.

Post-settlement motion. After the settlement occurred, Weak Guarantor filed a motion for entry of satisfaction of judgment. See, Ind. Trial Rule 67(B) . Weak Guarantor asserted that the judgment had been paid in full. Strawman contended that the judgment still existed and that, as the assignee of the judgment, it could collect the entire $1.7MM+ deficiency from Weak Guarantor.

Judgment satisfaction rules. The legal issue was whether the intent of the post-judgment settlement transaction was to extinguish the judgment against Strong Guarantor. The Court in TacCo outlined the applicable Indiana legal principles:

1. Payment of a judgment by one of the judgment debtors (defendants) is a satisfaction of the judgment, notwithstanding the fact that an assignment of the judgment is made to such debtor or to someone else.
2. Where a strawman is used by a co-debtor to purchase an assignment of a judgment, the judgment is deemed to have been purchased by one of the joint judgment debtors.
3. The controlling fact in such a case is the payment by one legally bound to pay, and the fact that an assignment is made to him or to someone else is not of controlling importance.
4. If one whose duty is to pay the debt makes the payment, then an assignment will not keep the debt alive.

Judgment satisfied. Without regurgitating all of the detail here, the Court in TacCo followed the money, evaluated the actors’ involvement and concluded that Strawman and Strong Guarantor essentially were the same entity. Here is how the Court of Appeals in TacCo applied the rules to reach its conclusion:

We conclude that the evidence presented to the trial court showed that [Strong Guarantor] made payment to [Lender] to purchase the Consent Judgment and assigned the judgment to [Strawman]. . . . Here, [Strong Guarantor] was a party legally bound to pay the judgment, and the evidence showed that it was the party who made payment to [Lender] for purchase of the judgment. The fact that an assignment of the judgment was made to [Strawman] does not change the fact that such payment resulted in a satisfaction of the judgment. The trial court did not abuse its discretion when it found that [Strong Guarantor] used [Strawman] as its strawman to purchase the Consent Judgment and deemed that the judgment had been satisfied.

Result. The upshot was that the judgment no longer existed, and Weak Guarantor’s exposure to the full $1.7MM+ deficiency disappeared. Strawman thus could not enforce the judgment against Weak Guarantor.

Arguably, Strong Guarantor still might have a contribution claim against Weak Guarantor for a pro rata portion of the deficiency ($850,000+), but the Court did not address that issue. In the end, the settlement structure in TacCo was a creative design for Strong Guarantor that didn’t quite work.

Indiana Guaranties: Right Of Contribution Clarified

My October 10, 2008 post discussed the right of contribution among guarantors and the Court of Appeals’ opinion in Balvich. In Small v. Rogers, 2010 Ind. App. LEXIS 2117 (Ind. Ct. App. 2010), a guarantor’s contribution effort failed. Why? If you are a co-guarantor or represent a co-guarantor, you’ll want to know the answer.

Guarantor payments. The Small case involved a dispute between Guarantor 1 and Guarantor 2, both of whom guaranteed two distressed commercial loans. In his workout dealings with the two lenders, Guarantor 1 decided to bring all of the accrued and unpaid interest current. In turn, he demanded that Guarantor 2 reimburse him for Guarantor 2’s pro-rata share of such payments. Since Guarantor 2 refused, Guarantor 1 filed suit seeking contribution.

Guarantor 2’s contention. Guarantor 2 asserted that Indiana’s right of contribution did not apply because (a) the payments that Guarantor 1 made were less than Guarantor 1’s pro rata portion of the full guaranteed debt and (b) the payments did not result in either guarantor’s release from liability.

Contribution law. Here are some well-settled Indiana rules set out in Small:

1. Contribution involves the partial reimbursement of one who has discharged a common liability. (“Discharge” means “any method by which a legal duty is extinguished; esp., the payment of a debt or satisfaction of some other obligation.”)
2. The right of contribution operates to make sure those who assume a common burden carry it in equal portions.
3. In order to be entitled to contribution, the claimant must have first paid the debt or more than his proportionate share of the debt.

Applying rule #3. The Court in Small noted that the two debts had a combined balance of $5.4MM and, furthermore, that Guarantor 1’s payments totaled only $88,000. Since Guarantor 1 “paid only a portion of the amounts due under the promissory notes and far less than his proportionate share of the debts owed . . . [the Court could not] say that the right of contribution [applied] in this case.”

Balvich distinguishable. The Small opinion addressed the Balvich case that I cited in my 2008 post. Guarantor 1 asserted that Balvich permitted him to recover his pro rata portion of the payments made in excess of his pro rata share. The Small Court noted a handful of distinguishing factors, one being that, in Balvich, unlike in Small, a judgment had been entered against all guarantors, jointly and severally. Further, the Court explained that, in Balvich, the plaintiff guarantor’s payment resulted in a satisfaction (resolution) of the judgment and thus a release of all guarantors:

In Balvich, the banks reduced the co-guarantors’ debt to two judgments. The [plaintiffs] subsequently paid more than their proportionate share of the judgments, thereby satisfying the judgments. Unlike in Balvich, the debt owed by [Guarantor 1 and Guarantor 2] has not been reduced to a judgment. Thus, there can be no satisfaction of the judgment, and therefore, no discharge of the debt. Rather, in this case, the debt still exists. [Guarantor 1] did not discharge the debt, either by paying the debt or a judgment on the debt. Furthermore, the amounts paid by [Guarantor 1] do not constitute more than his proportionate share of the more than $5,000,000.00 of debt incurred.

Timing. I understand why Guarantor 1 filed the contribution claim. He alone made sizeable payments that presumably benefitted Guarantor 2. Guarantor 1 simply wanted Guarantor 2 to pay his fair share. But according to Small, there is a difference between a payment and a payoff/settlement. The Court reasoned that to rule in Guarantor 1’s favor would be to sanction claims for contribution upon each and every payment made toward a debt until the debt is discharged. According to Small, contribution rights do not materialize until the debt goes away, but “this is not to say that the amounts paid toward a debt cannot, or will not be credited to the party asserting the right of contribution once the guaranteed debt is discharged." The opinion suggests that Guarantor 1's claim was, at best, premature.

The key appears to be that guaranty-based payments need to fund a final resolution of the defaulted loan, either through a prejudgment settlement/release or a post judgment satisfaction. Small’s lesson is that lawsuits for contribution can’t be made piecemeal, or, in other words, they can’t be based on partial debt-related payments. Guarantors beware.

(I’m left wondering whether the result in Small was fair. I see both points of view. Perhaps this is a topic for another day. Email or post a comment with your opinion.)

To Be Enforceable, An Indiana Mortgage Must Adequately Describe The Debt It Purports To Secure

It’s pretty rare to read a case in which a court renders a commercial mortgage invalid.  But that’s what happened in SPCP v. Dolson, 2010 Ind. App. LEXIS 1852 (Ind. Ct. App. 2010) (.pdf).  Secured lenders beware:  if your mortgage contains an inaccurate and materially misleading description of the debt, you will lose your foreclosure remedy.

Purported mortgagor was a surety.  In SPCP, the alleged mortgagor, Holland, owned real estate that she leased to Dolson, a company that operated a pub.  The lease provided that Holland and Dolson could participate in a mortgage loan related to the real estate.  In fact, a lender, SPCP, made a $700,000 loan to Dolson.  The Dolls (officers in Dolson) and Thompson (Mrs. Doll’s father) guaranteed the loan.  Holland co-signed a mortgage with Dolson in favor of SPCP.  Holland did not, however, review or sign the underlying promissory note.   

Mortgages 101.  The SPCP opinion outlined the basic statutory requirements for a valid mortgage in Indiana (Ind. Code § 32-29-1-5).  A mortgage must recite both (1) the date for repayment and (2) one or more of:  (a) the sum for which it is granted; (b) the notes or evidences of debt; or (c) a description of the debt sought to be secured.  Mortgages must also be dated and signed, sealed and acknowledged by the grantor. 

Debt description.  With regard to the accuracy of the debt description, Indiana cases say:

literal accuracy in describing the debt secured by the mortgage is not required, but the description of the debt must be correct, so far as it goes, and full enough to direct attention to the sources of correct information in regard to it, and be such as not to mislead or deceive, as to the nature or amount of it, by the language used.  . . .  A reasonably certain description of the debt is required so as to preclude the parties from substituting debts other than those described for the mere purpose of defrauding creditors.

SPCP refined this summary of the law into a two-part test:  (1) whether the debt description was inaccurate and (2) whether the inaccuracy was sufficiently material to mislead or deceive the grantor/mortgagor as to the nature or amount of the debt. 

The inaccuracy.  The mortgage signed in SPCP secured debt “incurred under the terms of ‘a’ Promissory Note dated December 27, 2001 executed by Dolson, the Dolls and Thompson and maturing December 27, 2021.”  This accurately described the date of execution of the subject note and the maturity date but inaccurately described the identity of the note’s makers.  Thompson did not execute the note.  He signed a guaranty.  The Court held that the mortgage’s description of the debt was inaccurate. 

Materially misleading.  Moreover, the Court, in affirming the trial court’s summary judgment for Holland, concluded that the inaccuracy was sufficiently material so as to mislead Holland.  The Court articulated three reasons for its decision, all of which centered on the role of Thompson:

     1. Release.  After Dolson defaulted on the loan, SPCP settled with Thompson for $550,000 and released him from liability.  Holland, in agreeing to the mortgage, acted only as a surety pledging collateral to secure the loan of Dolson.  If Thompson had been liable on the note as a primary obligor (a maker), and not a guarantor, then any release of Thompson would, under Indiana law, have released Holland and her real estate.  Because Thompson was only a guarantor and thus a co-surety with Holland, the release of Thompson did not have that effect. 

     2. Subrogation.  Thompson’s status as guarantor, instead of co-maker of the note, changed Holland’s recourse against Thompson.  Under Indiana law, sureties have the right to complete reimbursement and subrogation from makers.  As only a co-surety, Thompson, at most, was exposed to Holland for Holland’s pro-rata contribution to the debt.  Thus the loan structure increased Holland’s risk of loss.  (I discussed suretyship law on 5-23-07.)

     3. Detrimental reliance.  Holland testified it was her understanding that her real estate would be subject to foreclosure only if the Dolls and Thompson failed to pay the debt.  Holland therefore relied to her detriment on the mortgage’s inaccurate description of Thompson as a co-maker.  Holland claimed that she would not have signed the mortgage had she known that Thompson was only a guarantor. 

Over the last few years, I have seen a handful of cases like SPCP in which the mortgagor was not the borrower but merely a pledgor of real estate.  In those cases, unlike SPCP, the language in the mortgage clearly connected the mortgage with the note.  The loan documents in SPCP lacked that clarity, and the alleged mortgagor was able to seize on the inaccuracy to save her commercial real estate from foreclosure.

Indiana Only Requires The Guarantor To Sign A Guaranty

Secured lenders pursuing guaranty enforcement actions sometimes face resistance from guarantors despite clear and well-written guaranties.  Guarantors may go to great lengths to avoid a judgment.  The recent Indiana Court of Appeals case of Grabill Cabinet Company, Inc. v. Sullivan, 919 N.E.2d 1162 (Ind. Ct. App. 2010) (.pdf ) appears to be one of those cases, but the ultimate decision favors creditors.

What happened.  Plaintiff Supplier sued defendant Individual, who was once a manager and member of LLC.  In 2006, LLC submitted a credit application to Supplier, and Individual signed a guaranty of the LLC debt owed to Supplier.  Individual signed in her personal capacity.  Individual subsequently assigned her interests in LLC and resigned from the company.  A couple years later, LLC ordered product from Supplier for which LLC failed to pay.  This resulted in a lawsuit in which Supplier named Individual as a defendant based upon her guaranty. 

General guaranty law.  The Court’s opinion has a nice summary that defines a guaranty and a continuing guaranty, as well as an outline of the general rules applicable to the liability of a guarantor.  If you or your counsel need to learn more about the basics of guaranties, click on the .pdf of the decision I’ve provided above.

The defense.  Individual’s primary defense was that Supplier needed to sign the guaranty in order for it to be valid and enforceable.  She also argued that the guaranty should have been automatically terminated upon her disassociation with LLC.  The trial court bought the argument.  The Court of Appeals didn’t. 

The Statue of Frauds.  The Court found no Indiana case law supporting the proposition that, for a guaranty to be valid, it must be signed by the primary debtor and/or the creditor.  The Court focused upon Indiana’s Statute of Frauds, Ind. Code § 32-21-1-1(b), which states in pertinent part:

  A person may not bring any of the following actions unless the
  promise, contract, or agreement on which the action is based, or
  a memorandum or note describing the promise, contract, or
  agreement on which the action is based, is in writing and signed
  by the party against whom the action is brought or by the party’s
  authorized agent:

   (2)  An action charging any person, upon any special promise, to answer for the debt, default, or miscarriage of another.

The holding.  The Court concluded:  “although the Statute of Frauds requires a guaranty to be in writing, only the ‘party against whom the action is brought’ need sign it, and that requirement has been met here.”  The Court also found the language in the guaranty to be consistent with the outcome.  The Court was, indeed, emphatic that, for a guaranty to be valid and enforceable, a guaranty need not be signed by anyone other than the guarantor. 

Of interest.  Supplier initiated its collection action on August 10, 2008.  The date of the Court of Appeals decision reversing the trial court was January 14, 2010, almost one-and-a-half years after the filing of the case.  The case still needed additional trial court proceedings to adjudicate Supplier’s damages.  My point – bear in mind that Indiana collection cases, including mortgage foreclosure actions, are like any other lawsuit, which can be full of unexpected delays and expense.

Impairment Of Collateral Defense Denied

If your financial institution is seeking to collect a business debt from a guarantor that is asserting an “impairment of collateral” defense, the recent decision by the Northern District of Indiana in LEAF Funding v. Brogan, 2009 US Dist. LEXIS 65203 (N.D. Ind. 2009) (Leaf.pdf) should help you understand the defense and help you convince the guarantor that the defense may not apply. 

The situation.  Plaintiff LEAF, equipment lessor (lender), sued defendant Brogan, equipment lessee, for breach of a medical equipment lease.  Dines, also a named defendant, was the guarantor of the lease.  Brogan had defaulted on the lease for a failure to make payments.  LEAF had been unable to repossess the equipment, as allowed under the lease, because Brogan’s landlord had changed the locks to Brogan’s plant.  And a court order arising out of a separate state court lawsuit froze all of Brogan’s assets, which order contributed to LEAF’s inability to repossess the equipment.

The argument.  Dines’ only contention in response to LEAF’s motion for summary judgment was that LEAF impaired the collateral (the equipment) when LEAF “failed to take timely possession of and to promptly liquidate the leased property after Dines made two phone calls to LEAF requesting that LEAF make arrangements to come and retrieve the Equipment.”  Dines sought to be discharged from liability.

The defense, generally.  LEAF identified several Indiana points of law applicable to the defense:

 The guarantor’s liability [could be] discharged if the facts establish that the creditor’s conduct unjustifiably impaired the collateral securing the debt.

 The guarantor has the burden of proving the impairment (damage/loss of value), and impairment to the collateral is a necessary element of the defense.

 When a creditor releases or negligently fails to protect security put in his possession by the principal debtor, the surety is released to the extent of the value of the security so impaired.

Indiana case law focuses on the conduct of the creditor.  The creditor (the plaintiff) must have acted improperly and caused harm to the collateral.  Absent a reduction in value of the collateral attributable to the creditor, the defense will not apply.  The Court also cited to the UCC at Ind. Code § 26-1-3.1-605(g), which says that impairing value of an interest in collateral includes:

 (1)  failure to obtain or maintain perfection or recordation of the interest
 in collateral;
 (2)  release of collateral without substitution of collateral of equal value;
 (3)  failure to perform a duty to preserve the value of collateral owed,
 under IC 26-1-9.1 or other law to a debtor or surety or other person
 secondarily liable; or
 (4)  failure to comply with applicable law in disposing of collateral.

No discharge.  While some Indiana cases suggest that the guarantor’s debt can be fully discharged upon proof of the defense, in actuality Indiana law provides that the guarantor will only be released “to the extent of the value of the security so impaired.”  Indiana favors a “pro tanto [for so much] approach that measures the amount of the impairment at the time of default” as opposed to allowing for a complete discharge of any liability.

Not applicable in LEAF.  After taking inventory of Indiana’s rules and policies applicable to the impairment of collateral defense, the Court in LEAF concluded that the defense should fail and that Dines remained jointly and severally liable to LEAF for the damages resulting from Brogan’s breach.  The inaccessibility of the collateral was not the result of actions taken or caused by LEAF, which was unable to repossess the equipment due to circumstances outside of its control.  Moreover, the lease specifically provided that Brogan had an obligation to deliver the equipment to LEAF upon default.  LEAF had no duty to retrieve the equipment at Brogan’s request.  Finally, none of the UCC § 605(g) elements were present in LEAF. 

Guarantors in lien enforcement cases may try to duck or delay collection efforts by asserting the impairment of collateral defense when, in my view, the defense should only apply in very limited circumstances in which the plaintiff/lender/creditor has actually caused harm to the collateral while the collateral was in its possession or control. 

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.