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Employee/Guarantor Of Equipment Supply Contract Pays Price For Bankrupt Employer’s Default

Lesson.  If you are an employee signing a contract for your company, be wary of any kind of personal guarantee provision built into the paperwork.  You might get stuck with your employer’s debt.

Case cite.  Smith v. M&M Pump, 41 N.E.3d 1026 (Ind. Ct. App. 2015). 

Legal issues.  Was Smith a valid guarantor, even though he did not personally benefit from the contract?  Did his company’s pending bankruptcy insulate Smith from liability?  Was Smith on the hook for collection costs, too?

Vital facts.  While Smith was employed as a superintendent for Lily, a coal mining company, he signed a credit agreement with M&M to supply mining equipment to Lily.  The agreement had a paragraph stating that Smith would act as a guarantor in the event of a breach of contract by Lily.  (The provision is quoted in the opinion.)  Lily later defaulted and ultimately filed for bankruptcy protection.  M&M pursued Smith individually for the company’s debt.   

Procedural history.  The trial court entered summary judgment in favor of M&M and against Smith, who appealed. 

Key rules. 

  • If a guarantee is made contemporaneously with the underlying contract, then “consideration” sufficient to create the contract is sufficient to support the guarantee.  In other words, it is not necessary for a guarantor to derive any benefit from the principal contract for legal consideration to exist. 
  • In Indiana, a person is presumed to understand the document he signs and cannot be released due to his failure to read it. 
  • Creditors are not required to wait until completion of a debtor’s bankruptcy to pursue a guarantor. 
  • Generally, guarantors are liable for attorney fees and collection costs where the underlying contract contemplates such damages, regardless of any specific reference to such costs in the guarantee provision. 

Holding.  The Indiana Court of Appeals affirmed the summary judgment.  A proper yet harsh result for Smith, no doubt.

Policy/rationale.  Even if Smith did not know what he was signing, his mistake would not preclude summary judgment.  The Court concluded that Smith signed an “[unambiguous] personal guarantee clause.”  The fact that Smith claimed he got nothing from the deal was immaterial under the law.  Further, guarantors owe the debts of their principals regardless of whether the principal can or cannot pay.  Creditors “are not required to wait” on the outcome of any claim against the principal.  Finally, because the credit agreement awarded collection costs to M&M, Smith guaranteed payment of such costs, even though the guarantee clause did not specifically reference them.  The bottom line is that Smith promised in writing to pay the debt of his employer/company.  There was no way around it.

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