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“Collection” Vs. “Payment” Guaranties: Dearth Of Indiana Law

The other day, one of my transactional partners and I were discussing whether a particular written instrument constituted an enforceable guaranty.  He raised an issue that admittedly I have not yet litigated, namely whether the instrument was a “guaranty of collection” as opposed to a “guaranty of payment.” 

No Indiana cases.  One of our associates, Justin Kashman, briefly looked into the issue and turned up no Indiana state or federal opinions discussing the difference between the two guaranties under Indiana law.  I, too, conducted my own research and could not find any decision defining the two guaranties, or otherwise comparing or contrasting them.  My trusty Black’s Law Dictionary also fails to delineate between a payment guaranty and a collection guaranty.  In the final analysis, according to our research, these do not appear to be terms of art in Indiana.

Other states.  Our limited research into other states, however, confirmed what my partner believed – that the law generally recognizes two types of guaranties, depending upon the language used.  For example, Kentucky classifies a guaranty as either one for payment — an absolute guaranty — or one for collection — a conditional guaranty.  A guaranty is an absolute guaranty when it is subject to no conditions and contains an absolute promise to pay the outstanding indebtedness guaranteed.  The guaranty involved in KMC Real Estate Investors v. RL BB Fin., 968 N.E.2d 873 (Ind. Ct. App. 2012) was an absolute guaranty, as it expressly stated that "[t]his is a guaranty of payment, not of collection . . . ."  The guaranty went on to say that "Guarantor therefore agrees that Lender shall not be obligated prior to seeking recourse against or receiving payment from Guarantor, to do any of the following . . . , all of which are hereby unconditionally waived by Guarantor: (1) take any steps whatsoever to collect from Borrower . . . ." 

The distinction.  As noted in KMC, when a guaranty is absolute, "the guaranty may proceed against the guarantor at once on default of the principal. The guarantor's liability is dependent upon the same rule of law by which the liability of one who has broken his contract is determined."  If, on the other hand, the guaranty is found to be one of collection, then “the guarantor undertakes only to pay the debt upon the condition that the guarantee [lender] shall diligently prosecute the principal debtors without avail.  And this means the prosecution of a suit against the principal debtor to judgment and execution.”  Getty v. Schantz, 100 F. 577 (7th Cir. 1900).  Since the guaranty in KMC was absolute – a payment guaranty - the lender had the right to immediately enforce the guaranties and did not need to first exhaust its remedies against the borrower or execute on its collateral.

Given my experience, the standard guaranty we see in commercial mortgage loans is a payment/absolute guaranty.  Nevertheless, despite the absence of Indiana cases interpreting collection/conditional guaranties, I’m confident that with appropriate language this type of limited guaranty would be upheld by the Indiana courts.  So, if you draft or negotiate guaranties, or if you enforce or defend them, you should remain mindful of the classification.  The nature and extent of the guarantor's liability exposure will dramatically affect the dynamics of any particular Indiana commercial foreclosure case.

How Should A Junior Lender/Mortgagee Respond To An Indiana Foreclosure Suit?

One of our bank clients, which has a home equity line of credit portfolio, recently asked me to give a presentation on how best to deal with foreclosure suits filed by senior lenders (first mortgagees).  Whether junior mortgages are residential or commercial, the basic plan of attack in Indiana is the same:

 1. Email Summons and Complaint filed by senior mortgagee, together with scan of the bank’s loan documents, to foreclosure counsel.  Advise foreclosure counsel of the manner of service of process (certified mail or hand delivery) and date of receipt.

 2. Foreclosure counsel will file an appearance and a motion for extension of time with the court.  Nothing else typically will be due with the court until 50 – 53 days after the date of service of process.

 3. During the 50 – 53 day window, the bank should do the following:

a. Order an appraisal or broker price opinion, and determine the fair market value of the mortgaged property.

b. Create an estimate of the senior mortgagee’s entire indebtedness, including unpaid principal balance, accrued interest, late fees, delinquent real estate taxes, per diem interest and attorney fees/litigation costs.  The complaint will list many of these figures.

c. Create an estimate of carrying costs associated with owning the real estate, including real estate taxes, hazard insurance premiums, maintenance/repair costs, utility expenses and attorney fees/litigation expenses for foreclosure. 

d. Create an estimate of liquidation expenses, including broker fees and closing costs.

e. Determine the bank’s own estimated indebtedness, including unpaid principal balance, accrued interest, per diem interest and late fees.

 4. Before the close of the 50 – 53 day window, the bank should determine whether it would ultimately net any money if it were to acquire the mortgaged property at the sheriff’s sale and then liquidate it.  The question is whether the value of the mortgaged property exceeds the senior mortgagee’s indebtedness, the carrying costs and the liquidation expenses.  Here is a basic formula:  Fair Market Value - (Senior Debt + Carrying Costs + Liquidation Expenses) = Equity.

 5. If the calculation in #4 shows insufficient equity, then the bank should consider instructing foreclosure counsel to file a disclaimer of interest and motion to dismiss.  (The exception to this would be if the bank desires to collect the debt from other assets of the borrower or a guarantor.)  The case might end here.

 6. If the calculation in #4 shows sufficient equity, then the bank should advise foreclosure counsel of its debt figures in #3(e) above and instruct counsel to file an answer to the complaint and a cross claim against the borrower (and guarantor, if applicable).

 7. The bank or foreclosure counsel next should order a title commitment to be effective through the date of the filing of the complaint, and ensure all lien holders are named in the case.

 8. Foreclosure counsel will monitor the lawsuit and obtain judgment/foreclosure decree for the bank.

 9. After the entry of judgment but before the sheriff’s sale, the bank should revisit the equity analysis in #4.  The bank – the junior lender - must decide if it is prepared  to pay off the senior mortgagee’s judgment so that the bank can credit bid its own judgment at the sale. 

 10. The junior lender should communicate its decision regarding #9 to foreclosure counsel, with bidding instructions, if any. 

 11. As applicable, foreclosure counsel will attend the sheriff’s sale, tender a cash deposit sufficient to pay the senior mortgagee’s judgment in full and submit a credit/judgment bid on behalf of the bank, which will acquire title to the property if it’s the winning bidder.  If the bank is outbid, then it will receive cash in the amount of its credit bid (and a refund of the deposit). 

Perhaps the most important thing to bear in mind is that the process requires junior mortgagees to bring enough cash to the sheriff’s sale to pay off the credit (judgment) bid of the senior mortgagee.  A junior lender cannot submit its own credit bid or obtain title to the real estate unless it first outbids the senior lender with cash.  Hence the significance of the analysis in #4. 

Is The Citimortgage Opinion Flawed For Not Requiring Proof Of Assignment Documents?

This is my final post about the Indiana Supreme Court’s opinion in Citimortgage v. Barabas, 2012 Ind. LEXIS 802 (Ind. 2012).  Here are my other three:  10-26, 10-19, 10-12.  The Court’s decision to grant Citimortgage’s motion to intervene was understandable in that it preserved the senior lien.  Based upon the Court’s ruling, a logical outcome would have been to set aside the trial court’s judgment and resulting sheriff’s sale.  But that’s not what happened. 

Result.  The Court didn’t simply remand the case to the trial court - to the prejudgment stage - for further proceedings with Citimortgage as a party.  The Court dispensed with a “do over” and instructed the trial court to amend its judgment “to provide that ReCasa took the [real estate] subject to Citimortgage’s lien.”  What I believe this means is that the litigation (for now) is over but that Sanders, the third-party purchaser, owns the real estate subject to the Citimortgage lien (of an undetermined amount).  Junior mortgagee ReCasa didn’t lose – Sanders did

Absence of proof.  A more curious aspect of the Court’s analysis was the fact that there was no hard evidence of Citimortgage’s lien.  From what I can tell in reviewing all of the Citimortgage opinions, there was no proof of the date upon which Citimortgage acquired the lien or, in other words, when Citimortgage became Irwin’s assignee.  The Court appears to have assumed, based perhaps on the 2009 mortgage assignment, that Citimortgage was the mortgagee at the time ReCasa filed the suit in 2008.

Against the grain.  Setting aside the trial court’s judgment is one thing, but it’s an entirely different matter to effectively grant Citimortgage its own judgment.  This outcome seems to cut against law that has developed in this country over the last several years mandating that lenders/mortgagees actually prove that they hold the mortgage at the time of the filing of a foreclosure claim.  As I noted back in November of 2007, a famous opinion from a federal court in Ohio emphatically held that an institution filing a foreclosure suit must have proof that it owned the note and held the mortgage on the date of the filing of the foreclosure complaint.  This means that the real party in interest must produce, and typically must include as exhibits in its pleadings, chain of assignment documents linking the original lender/mortgagee to the holder of the debt at that time.  Without such documentation, the party lacks standing to file a lawsuit or, in the case of a junior lien holder, to assert a claim in a lawsuit, which is what Citimortgage did.  In the Ohio case, District Judge Boyko lectured:  “unlike Ohio State law and procedure, as the Plaintiffs perceive it, the federal judicial system need not, and will not, be forgiving in this regard.”  In footnote 3, he flatly rejected plaintiff’s “judge, you just don’t understand how things work” argument. 

Seemingly, the Indiana Supreme Court bought the “judge, you just don’t understand how things work” argument in Citimortgage.  Or, to be fair, perhaps the Court knows how things work.  Either way, a compelling contrast exists between Judge Boyko’s uncompromising order dismissing plaintiffs’ cases and the Indiana Supreme Court’s pragmatic decision recognizing Citimortgage’s purported lien.