Indiana Court Holds That Contract For Purchase Of Loan Was Not Breached
An Award Of Unpaid Interest And Late Fees Due Under An Absolute Guaranty Is Not Discretionary

Indiana Court of Appeals Denies Guarantor’s “Material Alteration” Defense

Lesson. While it still is advisable for lenders to have guarantors sign off on any loan modifications, such paperwork may not always be required. Indiana courts will look closely at both the nature of the alterations and any waiver/consent language in the guaranty when deciding whether to absolve guarantors of liability.

Case cite. Shoaff v. First Merchs. Bank, 2022 Ind. App. LEXIS 395 (Ind. Ct. App. 2022)

Legal issue. Whether a guarantor was released from liability based on alleged “material alterations” of the original obligation.

Vital facts. Borrower defaulted on a $600k loan, and Lender sued Guarantor for the debt. The Shoaff opinion quotes verbatim important provisions of the guaranty upon which the Court relied, so please review for more facts. Over a five-year period, Borrower’s underlying obligation was modified “multiple times,” which included:

(1) a series of new notes being issued for the debt; (2) a new loan number being provided; (3) [a co-guarantor] signing a new guaranty; (4) the alteration of the payment of the debt from a revolving line of credit to a term note; (5) a change in the manner in which the debt was to be repaid (altered to required monthly payments); and (6) multiple changes in the form and amount of the interest rate.

Lender notified Guarantor “as a courtesy” about many, but not all, of these modifications.

Procedural history. The trial court granted summary judgment in favor of Lender. Borrower appealed.

Key rules. Shoaff provides an impressive summary of Indiana guaranty law, including how the rules operate within the summary judgment context. As it relates to Guarantor’s key defense, Indiana common law provides that “when parties cause a material alteration of an underlying obligation without the consent of the guarantor, the guarantor is discharged from further liability whether the change is to [the guarantor’s] injury or benefit.” A “material alteration” is:

a change which [1] alters the legal identity of the principal's contract, [2] substantially increases the risk of loss to the guarantor, or [3] places the guarantor in a different position. The change must be binding.

“[T]he legal identity of the principal's contract … is best understood to mean whether the obligation itself—rather than the instrument which records it—has meaningfully changed.” On this point, the Court cited to a legal encyclopedia, American Jurisprudence 2d, for authority:

even without an express term in a guaranty allowing it, a modification of the underlying obligation generally does not revoke a continuing guaranty; the guarantor is only discharged if the modification, other than an extension of time, creates a substituted contract or imposes risks on the secondary obligor fundamentally different from those imposed pursuant to the original one.

Holding. The Indiana Court of Appeals affirmed the summary judgment for Lender.

Policy/rationale. Guarantor contended that Borrower’s underlying obligation had been “materially altered” such that Guarantor was released from the debt. The Court disagreed. A distinctive aspect of Shoaff is the Court's reliance on language in the guaranty that Guarantor “prospectively consented” to the alterations and waived notice of them:

The only changes were to the structure of the loan, the dates associated with its repayment, and the manner in which it was to be repaid. Those changes do not fit any of the three categories of materiality, and clearly fall within the language of the [guaranty], demonstrating that [Guarantor] contemplated their possibility and prospectively consented to them.

Moreover, the Court did not view the loan modifications as imposing “fundamentally different risks” on Guarantor, even though Guarantor may end up paying more than he expected to pay when he signed the guaranty. Such changes, the Court reasoned, were “in degree, not in kind.” Guarantor “assumed” such risks of paying interest, late fees and future debts by virtue of the language in the guaranty. In a nod to a strict reading of the operative contract language, the Court concluded:

the underlying obligation—guaranteed by [Guarantor]—was not materially altered. Regardless, any alterations were contemplated by the parties to the Agreement, and prospectively consented to by [Guarantor].

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I represent parties involved in disputes arising out of loans that are in default. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at [email protected]. Also, don’t forget that you can follow me on Twitter @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.