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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.