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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.)