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.