Lender’s Email Committing To Future Loan Modification Does Not Prevent Foreclosure

Lesson. In Indiana, borrowers generally cannot use oral statements of lenders to contradict or alter the written terms of a promissory note.

Case cite. Cent. Mkt. of Ind. v. Hinsdale Bank N.A., 207 N.E.3d 1215 (Ind. Ct. App. 2023)

Legal issue. Whether Lender’s pre-closing email committing to a post-closing loan modification precluded summary judgment for Lender in loan enforcement action.

Vital facts.

This case arose out of an SBA loan for the purchase of a grocery store. Lender’s loan was secured by a mortgage, personal guaranties, and a security interest on all of Borrower’s assets. Due to financial difficulties with the store, Borrower defaulted on the loan, and Lender filed suit seeking to recover on the approximate $1.8 million debt.

A complicating factor to this otherwise straightforward case surrounded a guaranty executed by a son of one of the owners/members of Borrower (“Son”). Son was reluctant to sign off. The loan officer, after speaking to Lender’s president, sent the following email to the father:

Please tell [Son] there is nothing to worry about. I have spoken to [president] and he assured me that within three months of this closing, the bank will refinance and transfer the loan to [another guarantor]. This refi will get you some working capital and also absolve [Son] of the SBA's guaranty. It's just a matter of three months or at most four months. After the initial closing, the SBA is no [longer]in [the] picture and the bank has more leeway in these matters.

If you want, I can speak to [Son] personally. Also please ask [Son] to sign the [l]ease and reassignment of rents, and some additional documents that were sent to you to forward him for his signatures. Have you forwarded them to [Son] yet[?] Hopefully he will sign off on those once he knows that we will get him off the loan/SBA guaranty within 3-4 months. You also have to finalize some details in [Son's] life insurance. We will need the policy to close.

(the “Email”). These representations were not incorporated into the loan documents, however. The refinance never occurred.

Procedural history. Lender filed a motion for summary judgment that the trial court granted. Borrower appealed.

Key rules. Indiana Code Section 26-2-9-4 bars enforcement of oral "credit agreements" unless they (l) are in writing; (2) set forth all material terms and conditions of the credit agreement; and (3) are signed by the creditor and the debtor.

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

Policy/rationale. In response to the summary judgment motion, Borrower filed an affidavit from Son showing that Lender reneged on its promise to remove Son as guarantor upon refinancing. Borrower’s defense theory was fraudulent inducement. The Court concluded that the Email “fell short” of the requirements of I.C. 26-2-9-4 because it did not mention the promissory note’s terms and was only a discussion about a possible future modification of Son’s guaranty. Thus, neither Son’s affidavit nor the Email created an issue of fact precluding summary judgment. Note: the Hinsdale Bank case dealt only with Lender’s action against Borrower. Lender was not enforcing Son’s guaranty at the time. Had Son been a party, the opinion suggests the outcome would have been the same, which is to say the Email may not have absolved Son from personal liability.

Related posts.

• Is The Label “Indiana Lender Liability Act” A Misnomer?
• Alleged Oral Release Of Mortgage Rejected
• Indiana’s Lender Liability Act Once Again Protects Bank From Borrower’s Claims
• ILLA Saves Bank From Alleged Misrepresentation That Loan Was “A Go”

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Part of my practice involves representing parties in loan-related disputes. 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.

Estate Could Not Recover Alleged Debts Of Decedent’s Son Under “Open Account” Theory

Lesson. To collect a debt that is not otherwise documented in a promissory note or credit agreement, make sure there is evidence of a promise, either express or implied, for the debtor to pay the balance to the creditor.

Case cite. Meyer v. Meyer 205 N.E.3d 215 (Ind. Ct. App. 2023)

Legal issue. Whether a mother’s payment of various bills and debts for her son could later be recovered by her estate.

Vital facts. Estate sued Brian, one of the sons of the decedent (Laverne), to collect a debt. Estate asserted that Brian not only had a promissory note with Laverne but also an “open account” with an amount due of another $22K. Brian did not dispute that he owed about $5K on the promissory note, but he contested the other amounts, which appeared on a list of “bills paid” on behalf of Brian by Laverne.

Procedural history. Following an evidentiary hearing, the trial court entered judgment against Brian for about $27K. Brian appealed the amount of the judgment.

Key rules. Estate bore the burden of proving that Brian promised to repay the money that Laverne provided to him. At issue in Meyer was something called an “open account.” In Indiana:

For a mutual and open account to exist, there must be a mutual relationship, that is, there must be reciprocity of dealing. A mutual open account is an open account where there are items debited and credited on both sides of the account rather than simply a series of transactions always resulting in a debit to one party and a credit to the other party; each party to a mutual account occupies both a debtor and a creditor relation with regard to the other party. Thus, an account is generally not considered mutual if all the items are on one side.

The Court also examined a separate, albeit similar, principle under Indiana law called “account stated”:

An account stated is an agreement between the parties that all items of an account and balance are correct, together with a promise, express or implied, to pay the balance. An agreement that the balance is correct may be inferred from delivery of the statement together with the account debtor's failure to object to the amount of the statement within a reasonable time."

Holding. The Indiana Court of Appeals agreed with Brian and reversed the trial court with instructions to reduce the judgment to $5,292.12 based only on the note.

Policy/rationale. Brian argued that, although Laverne in fact paid certain bills of his, there was no evidence that he promised to repay her. There was also no evidence that the list of bills tendered to the trial court was ever delivered to Brian. With specific regard to Estate’s “open account” theory, the Court concluded that there “was no reciprocity of dealing between Laverne and Brian.” The Court recognized Brian’s assertion that all the subject transactions were “on one side of the ledger.”

Related posts.

• Claim “On An Account” Vs. Enforcement Of A Loan: Comments On Proposed Amendment to Indiana Trial Rule 9.2(A)
• Indiana’s Statute Of Limitations For “Open Account” Claims: Supplier’s Case Too Late

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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.

Individual’s Credit Card Authorization To Cover Company’s Unpaid Invoices Opened Door To Personal Liability

Lesson. Personal guaranties come in all shapes and sizes. The document need only evidence a conditional promise to answer for the debt of another upon the debtor/borrower’s failure to pay.

Case cite. Innovative Water Consulting LLC v. SA Hosp. Acquisition Grp. LLC, 2023 U.S. Dist. LEXIS 3178 (S.D. Ind. 2023)

Legal issue. Whether an individual’s credit card authorization form signed in conjunction with a company contract constituted a personal guaranty of the company’s debt.

Vital facts. Plaintiff alleged that Defendant company breached a services contract related to COVID test kits. Another of the defendants (Alleged Guarantor) purportedly signed a personal guaranty of the contract by completing a “Credit Card Authorization Form” (Authorization) allowing Plaintiff to charge his credit card for any outstanding invoices. The Authorization, which Alleged Guarantor signed above the line “Customer Signature,” stated:

I, [Alleged Guarantor], authorized representative of [Defendant company] and authorized signer of the credit card reference [sic] above (the "Card") authorize [Plaintiff] to process payment[s] due from [Defendant company] to [Plaintiff] via such Card. Such authorization shall apply to any payments due. I understand that the Card may be saved in [Plaintiff’s] records and periodically charged for any invoice exceeding its due date by 10 (ten) days due [Plaintiff] from [Defendant company], unless/until [Defendant company] provides written notice of de-authorization to [Plaintiff’s] Account Manager, at least three (3) business days before any payment becomes due.

Plaintiff later billed Defendant company for delivered test kits, but the company failed and refused to pay. Alleged Guarantor did not provide Plaintiff with a written notice of de-authorization of the Authorization. Plaintiff’s subsequent efforts to charge Alleged Guarantor’s credit card were declined.

Procedural history. Alleged Guarantor filed a Rule 12(b)(6) motion to dismiss Plaintiff’s claim against him.

Key rules. To prevail, Plaintiffs must show: (1) the existence of a guaranty agreement; (2) a breach of that agreement; and (3) damages.

In Indiana, "[a] guaranty is a conditional promise to answer for the debt or default of another person, such that the guarantor promises to pay only if the debtor/borrower fails to pay." No specific words are required to form a binding guaranty. A guaranty "must consist of three parties: the obligor, the obligee, and the surety or guarantor."

To determine whether a person signs in his personal or official capacity, courts “must interpret the [relevant document] as it would any other contract under Indiana law.”

Holding. The U.S. District Court for the Southern District of Indiana dismissed, without prejudice, Plaintiff’s claim against the Alleged Guarantor. Notably, the Innovative Water Consulting opinion did not arise out of a trial or even a summary judgment motion, but rather a preliminary pretrial motion to dismiss that merely challenged the allegations in the complaint. Although the Court dismissed the complaint, it was seemingly on a technicality related to the damages allegations. The Court permitted the Plaintiff to file an amended complaint to address the deficiency, and the case against the Alleged Guarantor continues today.

Policy/rationale. The takeaway from the Court’s decision is that the Alleged Guarantor may end up being on the hook. Ultimately, any ambiguity regarding the Authorization has to be resolved through summary judgment or trial, however.

The Alleged Guarantor’s first argument was that he signed the Authorization on behalf of Defendant company only. However, “references to the guarantor's official title are not conclusive of the capacity in which he signed.” The Court cited to Indiana precedent and reasoned that, because Defendant company was already obligated under the contract, the Court could “reasonably infer” that Alleged Guarantor signed in his personal capacity.

The Alleged Guarantor’s second contention was that the face of the Authorization itself disproved the notion that he agreed to answer for his company’s debt. Neither the word “guaranty” nor the phrase “personally guaranteed” appeared on the Authorization. The Court was unwilling to accept that position, however, at least at the pleadings stage:

Here, drawing all reasonable inferences in [Plaintiff's] favor, the Authorization appears to contain [Alleged Guarantor's] conditional promise to answer for [Defendant company’s] overdue payments, and it identifies the three necessary parties: [the obligor, the obligee, and the guarantor].

The Alleged Guarantor’s final point was that the parties to the Authorization did not sign the “guaranty” in writing as required by the underlying contract, which provided that “all waivers and amendments to this Agreement must be signed in writing by each party.” The Court rejected this theory on the basis that the Authorization was not a waiver or amendment to the underlying contract but rather a separate agreement.

Related posts.

• Lender Prevails In Interpretation Of Limitation Provision In Guaranty
• Indiana Only Requires The Guarantor To Sign A Guaranty

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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.

Indiana Court Discusses Test For Recovery Of Attorney's Fees In Action Against Guarantor

Lesson. An arbitrary “partial” award of attorney fees to a lender may be reversible error. Trial courts must assess what is a reasonable amount of attorney’s fees, taking into account all services rendered up to the entry of such an award.

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

Legal issue. Whether a trial court’s award of attorney’s fees was unreasonable (too low).

Vital facts. This is my third post about Shoaff. Please review my first and second posts for more information about the liability and damages issues in Lender’s suit against Guarantor.

Procedural history. The trial court granted summary judgment for Lender, but Lender cross-appealed the court’s award of attorney fees.

Key rules. Last week’s post dealt with non-discretionary contract damages. “Unlike the calculations of interest and late fees, the trial court's discretion with respect to attorney's fees is, generally speaking, unfettered by everything except for reasonableness.”

“The determination of reasonableness of an attorney's fee necessitates consideration of all relevant circumstances.” Indiana courts may, but are not required to, consider things like hourly rate, result achieved, and difficulty of the issues.

Holding. The Indiana Court of Appeals reversed the trial court and remanded the case for an assessment of a reasonable amount of fees for “all services rendered in pursuit of the debt” owed by Guarantor to and through the date of the order granting such fees.

Policy/rationale. Lender asserted that the trial court abused its discretion when it limited its award of attorney’s fees to the date of the initial summary judgment entry. Lender sought fees for the subsequent litigation that included additional motions and a second award of damages. The Court noted that “reasonable attorney's fees are guaranteed by the [guaranty].”

The Shoaff opinion stated that the trial court’s failing was its “unexplained” decision to limit fees up to a certain date. That decision was “arbitrary,” rendering the award of fees unreasonable. The Court threaded the discretionary/reasonableness needle as follows:

The trial court is free to evaluate [Lender’s] submissions for the fee amount and assess whether that amount itself is reasonable, and the trial court may, in its discretion, conclude that the amount either is or is not reasonable. But to award partial fees, reasonable or not, is to ignore the plain meaning of the [guaranty], and therefore constitutes an abuse of discretion.

As stated last week, the rules and outcome in Shoaff should apply to actions to enforce promissory notes as well as guaranties.  

Related posts.

• Attorney Fee Awards in Indiana
• Unsettled: Recoverability Of Attorney’s Fees For In-House Counsel
• Indiana Attorney Fee Liens In Commercial Cases

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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.

An Award Of Unpaid Interest And Late Fees Due Under An Absolute Guaranty Is Not Discretionary

Lesson. Contract language is a court’s road map for calculating a lender’s damages, including accrued interest and late fees, which are not discretionary.

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

Legal issue. Whether a trial court has discretion in awarding damages for unpaid interest and late fees due under a guaranty.

Vital facts. This is my second post about Shoaff. Please review last week’s post for background about this lender v. guarantor litigation dealing with an absolute (unconditional) guaranty. The underlying loan documents provided for the recovery of accrued interest and late fees upon default.

Procedural history. The trial court granted summary judgment for Lender, but upon Guarantor’s appeal, Lender cross-appealed the ruling on damages.

Key rules. Indiana recognizes two kinds of guaranties. The first is an absolute or unconditional guaranty:

An absolute guaranty is an unconditional undertaking on the part of the guarantor that the person primarily obligated will make payment or will perform, and such a guarantor is liable immediately upon default of the principal without notice…. An absolute guaranty, unlike a conditional one, casts no duty upon the creditor or holder of the obligation to attempt collection from the principal debtor before looking to the guarantor….

The second type of guaranty is a conditional guaranty, which “is an undertaking to pay or perform if payment of performance cannot be obtained from the principal obligor by reasonable diligence….”

Rules applicable to other contracts govern guaranties. Indiana courts “must give effect to the intentions of the parties, which are to be ascertained from the language of the contract in light of the surrounding circumstances."

Generally, the nature and extent of a guarantor's liability depends upon the terms of the contract, and a guarantor cannot be made liable beyond the terms of the guaranty. Nevertheless, the terms of a guaranty should neither be so narrowly interpreted as to frustrate the obvious intent of the parties, nor so loosely interpreted as to relieve the guarantor of a liability fairly within their terms.

A lender’s damages are contractual in nature, and "[t]he rules governing the interpretation and construction of contracts generally apply to the interpretation and construction of a guaranty contract." Damages must be supported by the evidence.

“Readily ascertainable” damages means that “the trier of fact need not exercise its judgment to assess the amount."

Holding. The Indiana Court of Appeals reversed the trial court’s damages award and remanded the case for a correct calculation of interest and late fees consistent with the Court’s opinion.

Policy/rationale. Lender argued that the trial court did not compute its damages correctly. At issue were accrued interest and late fees that, according to the Court, were “calculable and readily ascertainable.” This means that the trial court's discretion (such as a reasonableness standard) should not have been implicated.

In Shoaff, the trial court did not take into account all of the variables needed to accurately calculate Lender’s losses. First, the trial court's computation of interest employed a flat 5% rate instead of the fluctuating interest rate called for in the loan documents. Second, the trial court assessed only one late fee, but the loan documents required a fee for each of the several late payments in question. The Court of Appeals reasoned that the trial court improperly exercised “some discretion” regarding the “methodology for calculating interest and late fees,” and thus “abused that discretion by adopting an approach that did not comply with the unambiguous terms of the [loan documents].” The Court’s reasoning should apply with equal vigor to any loan documents, not just guaranties.

Related posts.

• “Collection” Vs. “Payment” Guaranties: Dearth Of Indiana Law
• Lender Prevails In Interpretation Of Limitation Provision In Guaranty

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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.

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].

Related posts.

• Indiana Court Releases Mortgage On Parents' Farmland Based On Material Alteration Of Kids' Loan
• “Material Alteration” Defense Rejected In Indiana Guaranty Enforcement Action
• Liability Of Guarantors Or Accommodation Parties When The Original Obligation Is Materially Altered

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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.

Forged Power Of Attorney In Set Of Loan Documents Did Not Render Personal Guaranty Unenforceable

Lesson. A properly-executed promissory note and personal guaranty should overcome alleged defenses associated with other flawed loan documents.

Case cite. Nextgear Capital Inc. v. Premier Grp. Autos LLC 2022 U.S. Dist. LEXIS 89317 (S.D. Ind. 2022)

Legal issue. Whether a forged power of attorney signed in connection with floorplan financing rendered a personal guaranty of the loan unenforceable.

Vital facts. Floorplan financing “is when an automobile dealer establishes a line of credit with a lender to purchase vehicles before selling them to a customer….” Once the dealer sells the vehicle, it repays the money to the lender. In Nextgear, Borrower entered into a contract for floorplan financing with Lender. The contract involved a promissory note, security agreement and two personal guaranties. Borrower “floored” its first vehicle with Lender on April 16, 2019.

On April 18, 2019, a sales executive for Lender went to Borrower’s office to meet with the two guarantors, who were also representatives of Borrower, for the purpose of obtaining a power of attorney (POA) required to service the loan. Upon arriving, the sales executive met with someone he believed was one of the guarantors, who signed the POA. The sales executive, who was a notary, examined a photocopy of the individual’s driver’s license and notarized the POA. Borrower proceeded to floor ten more vehicles.

Lender’s policy of obtaining a POA was limited to having one signed by Borrower, not any guarantors. The promissory note and guaranties confirmed this. In this instance, for some reason Lender got signatures on POAs from what Lender believed were both guarantors, presumably signing as agents of Borrower.

Later in 2019, the parties agreed to increase the line of credit. In connection with this, Borrower made a 150k payment to Lender, which credited Borrower’s account for that amount. Immediately following that payment, Borrower floored several more vehicles. Shortly thereafter, Borrower’s 150k payment was rejected for insufficient funds. At that point, Borrower’s loan balance was about 355k. Further, Borrower began paying operational expenses upon the sales of vehicles rather than paying Lender as required. Lender declared Borrower to be in default.

Also, Lender later discovered that the person who signed one of the POAs was not in fact a guarantor. The actual guarantor contended that the sales executive may not have properly notarized the POA or otherwise assisted with the forgery.

Procedural history. Lender sued Borrower and guarantors for breach of contract, specifically for claims related to the promissory note and guaranties. The guarantor identified on the forged POA (“Guarantor”) filed multiple counterclaims that included forgery and indemnification. Lender filed a motion for summary judgment.

Key rules.

When interpreting contracts like promissory notes and guaranties, an Indiana court’s analysis “starts with determining whether the contract's language is ambiguous.” If the language is unambiguous, courts then apply the contract’s “plain and ordinary meaning in light of the whole agreement, 'without substitution or addition.'"

Indiana’s right to indemnification arises through a contract, by a statutory obligation, or may be implied at common law. "In the absence of any express contractual or statutory obligation to indemnify, such action will lie only where a party seeking indemnity is without actual fault but has been compelled to pay damages due to the wrongful conduct of another for which he is constructively liable."

Holding. The U.S. District Court for the Southern District of Indiana granted summary judgment in favor of Lender. This post focuses on some of the counterclaims/defenses of Guarantor surrounding the forged POA.

Policy/rationale.

Were the promissory note and guaranty unenforceable against Guarantor due to the POA being forged? No. Importantly, Guarantor did in fact execute the guaranty. “[Guarantor contends that due to the forged POA allegedly from him, [his co-guarantor] was able to substantially increase the line of credit and increase the amount of money [Lender] now seeks from [Guarantor]. [Guarantor] argues that even if he is liable based on signing the guaranty, it should be limited to the amount of money that was provided in the first thirty days after execution of the promissory note.” The Court rejected the defense because the promissory note only required a POA to be signed by Borrower. Since the co-guarantor signed the POA on behalf of Borrower, and since Guarantor did not need to co-sign, the forgery on the separate POA was inconsequential.

Another of Guarantor’s defenses rested on the theory of indemnification. He claimed that his liability was derivative of the sales executive’s “wrongful conduct in assisting with the forgery” of his POA. “But for [the forger], [co-guarantor] would not have drawn on the line of credit, thus leading [Guarantor] to be liable.” The Court reiterated that the forged POA was not required to extend credit to Borrower. Further, the sales executive’s actions did not cause Guarantor to sign his guaranty.

Related posts.

• Guarantor Strikes Out With Defenses To Guaranty
• Forgery Defense Must Be Raised Immediately
• Indiana District Court Examines “Material Adverse Change” Default Provision

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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.

Indiana Court Releases Mortgage On Parents' Farmland Based On Material Alteration Of Kids' Loan

Lesson. Sometimes a lender will loan money to a borrower that is secured with collateral, such as a mortgage, pledged by a third party. These third parties are known as sureties. If a lender materially changes the terms of the original loan without the knowledge or consent of the surety, then the surety’s collateral will be released.

Case cite. Brooks v. Bank of Geneva, 97 N.E.3d 647 (Ind. Ct. App. 2018); reaffirmed, 103 N.E.3d 197 (Ind. Ct. App. 2018)

Legal issue. Whether a mortgage pledged by third parties was released when the terms of the borrower’s loan were altered.

Vital facts. A bank granted a loan to a married couple (borrowers) for their dairy farm.  The couple gave the bank a mortgage on real estate they owned.  For the purpose of partially securing the couple’s debt, the wife’s parents also granted a mortgage to the bank on farmland they owned. Importantly, the parents were not personally liable for the underlying debt. 

Over the next year or so, the bank issued four other loans to the borrowers that were secured by their own real estate. The parents were unaware of these additional loans. About a year after that, the bank, again without the parents’ knowledge, agreed to change the terms of the original promissory note to permit semi-annual payments instead of monthly payments. Over the following couple of years, the borrowers began selling off their mortgaged real estate, as well as their farm equipment and cattle, to pay off the four loans that were not secured by the parents’ real estate. The sale proceeds “greatly exceeded” the amount of the original note secured in part by the parents’ farmland. Subsequently, the borrowers defaulted under the original note.

Procedural history. The bank filed a collection lawsuit against both the borrowers and the parents and specifically sought to foreclose on the parents’ farmland. The bank filed a motion for summary judgment, which the trial court granted. The court decreed that the parents’ property should be sold to satisfy the borrowers’ debt. The parents appealed.

Key rules. One who mortgages his land to secure the debt of another is a “surety” to the debtor (the borrower). Indiana law is well settled that a surety’s collateral “is released by any action of the creditor [the lender] which would release a surety, such as the extension of the time of the payment of the debt, the acceptance of a renewal note, or the release of other security.”

A surety is similar to a guarantor. In Indiana, if a borrower and lender “make a material alteration in the underlying obligation without the consent of the guarantor, the guarantor is discharged from further liability.” The test for “material alternation” is “one that changes the legal identity of the debtor’s contract, substantially increases the risk of loss to the guarantor, or places the guarantor in a different position.”

The nature of the “alteration” is irrelevant and can even benefit the surety. If the alteration entails “either a change in the physical document or a change in the terms of the contract between the debtor and creditor that creates a different duty of performance on the part of the debtor,” then such change will be deemed material and will discharge the surety from liability.

Holding. The Indiana Court of Appeals reversed the trial court’s summary judgment for the bank and, in doing so, found that the parents’ mortgage had been released. The Court reaffirmed its opinion on rehearing.

Policy/rationale. The Court reasoned that the bank materially altered the subject promissory note two ways and did so without the parents’ knowledge or consent:

    First, the payment terms went from monthly to semi-annually. Even though the accommodation may have helped the borrowers’ cash flow and did not change the amount of the debt, the parents were entitled to know about it and protect themselves accordingly.

    Second, and perhaps more importantly, the bank had released the borrowers’ mortgage on four other parcels of land. By doing so, the bank placed the parents “in a much more perilous position” as the holders of the only remaining real estate to secure the loan.

Related posts.

• IRISH V. WOODS: Which Surety Was Left Holding the $500,000 Bag?
• Mortgage On Wife’s Real Estate Discharged Post-Divorce Following Material Alteration Of Underlying Debt Owed By Ex-Husband’s Business
• “Material Alteration” Defense Rejected In Indiana Guaranty Enforcement Action

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My practice includes representing lenders, borrowers and guarantors in contested commercial mortgage foreclosure cases. 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.

Guarantor Loses Procedural Battle Over Whether He Can Be Sued In Both the United States and Brazil

Lesson. When negotiating guaranties, or litigating rights under them, know that courts will slice and dice the language within the guaranty in order to determine the parties’ intent and reach an appropriate outcome. Every word can be important.

Case cite. 1st Source Bank v. Neto, 861 F.3d 607 (7th Cir. 2017).

Legal issue. Whether language in a guaranty allowed for parallel litigation in the United States (Indiana) and Brazil.

Vital facts. 1st Source was an Indiana federal court collection action by a lender against a guarantor arising out of a $6 million loan to purchase an airplane. Defendant, who resided in Brazil, personally guaranteed the loan. The Seventh Circuit’s opinion interpreted the guaranty’s so-called choice-of-law and venue provision, which stated:

This guarantee shall be governed by and construed in accordance with the laws of the state of Indiana .… In relation to any dispute arising out of or in connection with this guarantee the guarantor [i.e., the defendant guarantor] hereby irrevocably and unconditionally agrees that all legal proceedings in connection with this guarantee shall be brought in the United States District Court for the District of Indiana located in South Bend, Indiana, or in the judicial district court of St. Joseph County, Indiana, and the guarantor waives all rights to a trial by jury provided however that the lender [i.e., the plaintiff lender] shall have the option, in its sole and exclusive discretion, in addition to the two courts mentioned above, to institute legal proceedings against the guarantor for repossession of the aircraft in any jurisdiction where the aircraft may be located from time to time, or against the guarantor for recovery of moneys due to the lender from the guarantor, in any jurisdiction where the guarantor maintains, temporarily or permanently, any asset. The parties hereby consent and agree to be subject to the jurisdiction of all of the aforesaid courts and, to the greatest extent permitted by applicable law, the parties hereby waive any right to seek to avoid the jurisdiction of the above courts on the basis of the doctrine of forum non conveniens.

The guarantor defaulted under the guaranty, and the lender sued to collect in both Indiana federal court (where the lender was located) and in a court in Brazil (where the airplane and other of the guarantor’s assets were located).

Procedural history. The guarantor, in the Indiana case, sought “antisuit injunctive relief” to prevent the lender from suing him in Brazil. The trial court denied the guarantor’s motion, and the guarantor appealed to the Seventh Circuit, which issued the opinion that is the subject of today’s post.

Key rules. Generally, in Indiana, “courts interpret a contract so as to ascertain the intent of the parties.” When courts find a contract to be clear, they will require the parties to perform “consistently with the bargain they made, unless some equitable reason justifies non-enforcement.”

International forum-selection clauses are prima facie valid. The resisting party can only call into question the agreement’s validity if enforcement is unreasonable under the circumstances, which exception has been held to apply to three circumstances: (1) if the clause was the result of fraud, undue influence or overweening bargaining power, (2) if the selected forum “is so gravely difficult and inconvenient that the complaining party will for all practical purposes be deprived of its day in court” or (3) if enforcement would contravene strong public policy of the forum in which the suit is brought, declared by statute or judicial decision.”

Holding. The Seventh Circuit Court of Appeals affirmed the District Court’s decision.

Policy/rationale. The guarantor had five contentions in support of his position, all of which the Court rejected. First, the clause did not limit venue to Indiana. Second, the clause did not limit the suit to either Brazil or Indiana. Third, the guarantor’s “judicial estoppel” argument had no merit. Fourth, the clause did not violate public policy. Finally, the Court found that the Brazil suit was not “vexatious or duplicative” of the Indiana action. In the final analysis, the Court carefully studied the words in the operative guaranty provision, and the Court’s interpretation of those words carried the day. For more detail on the Court’s analysis, or to better understand how a court might interpret your guaranty provision, please review the Court’s opinion (link above).

Related posts.

• Lender Prevails In Interpretation Of Limitation Provision In Guaranty
• Guaranty of Subsequent Debt

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I represent both lenders and guarantors in commerical loan enforcement actions. 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.

Indiana’s Statute Of Limitations For “Open Account” Claims: Supplier’s Case Too Late

Lesson. The deadline for creditors to file suit on an “open account,” including a guaranty of an “open account,” is six years.

Case cite. Ganz Builders v. Pioneer Lumber, 59 N.E.3d 1025 (Ind. Ct. App. 2016)

Legal issue. Whether a creditor’s claims against a debtor and a guarantor were barred by the statute of limitations.

Vital facts. In 1996, the defendant debtor, a builder, signed an application for a line of credit with the plaintiff creditor, a supplier. The debtor also signed a credit account agreement. The debtor’s president signed a personal guaranty agreement in connection with the arrangement. The last charge against the account was February 21, 2006. In November of 2012, the creditor filed its complaint against the debtor and the guarantor for a failure to make payments under the terms of the agreements.

Procedural history. The parties filed cross-motions for summary judgment against one another related to liability under the agreements and defendants’ statute of limitations defense. The trial court granted summary judgment for the creditor.

Key rules.

• Indiana’s statute of limitations for actions on accounts and contracts not in writing is six years pursuant to Ind. Code 34-11-2-7. I.C. 34-11-3-1 governs the accrual date: “an action brought to recover a balance due upon a mutual, open, and current account … is considered to have accrued from the date of the last item proved in the account on either side.”
• I.C. 34-11-2-9 controls actions based upon promissory notes and other written contracts for the payment of money. Although this statute also has a six-year limitation period, the accrual date is different. See my 3/9/09 post.
• An action upon a contract in writing, other than for the payment of money, must be commenced within ten years. I.C. 34-11-2-11.
• Indiana case law is settled that a written credit card application and/or agreement does not constitute a written contract or a promissory note. Rather, “the contract creating the indebtedness is formed only when the customer accepts the bank’s offer of credit by using the card.” This type of arrangement is materially different than a promissory note or installment loan. As such, Indiana treats a credit card relationship as an “open account” as opposed to being governed by a written contract per se. For more, see my 9/27/10 post.
• The Court in Ganz cited to Black’s Law Dictionary to define an open account as: “an account that is left open for ongoing debit and credit entries by two parties and that has a fluctuating balance until either party finds it convenient to settle and close, at which time there is a single liability.”

Holding. The Indiana Court of Appeals reversed the trial court’s decision and held that the creditor untimely filed its claims against both the debtor and the guarantor.

Policy/rationale. In Ganz, there were fluctuating balances resulting from a series of transactions, and the creditor kept the account open in anticipation of future purchases. The Court thus concluded that the credit arrangement was in the nature of an open account, like a credit card, as opposed to one based upon a written contract or a promissory note – both of which have different statutes of limitations and accrual triggers.

The accrual date under I.C. 34-11-3-1 – “date of the last item proved in the account on either side” – meant the last charge to, or the last payment made on, the account. In Ganz, the last activity at issue was February 21, 2006, meaning that the latest the creditor could file a claim was February 21, 2012. November of 2012 was too late.

Regarding the guarantor, the Court basically approached the two defendants the same. The separate written guaranty still fell under the open account analysis, according to the Court. Although the accrual date arguably may have been slightly different, the same six years applied, so the guarantor, too, prevailed on the defense.

Related posts.

• Indiana’s Statute Of Limitations For The Enforcement Of Promissory Notes – 6 Years
• Credit Card Debt's 6-Year Statute Of Limitations Held To Commence When Account Due

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I frequently represent creditors and debtors in business-related collection actions. 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.

Lender Prevails In Interpretation Of Limitation Provision In Guaranty

Lesson. When negotiating a damages limitation in a payment guaranty, consider whether the limited amount guaranteed arises before or after any post-default credits, such as proceeds from the sale of mortgaged property. Then, capture the intent as clearly as possible in the langauge of the guaranty itself.

Case cite. Broadbent v. Fifth Third, 59 N.E.3d 305 (Ind. Ct. App. 2016).

Legal issue. Whether a payment guaranty was ambiguous as it related to the limitation on the amount of liability.

Vital facts. In connection with a sizable commercial mortgage loan, the defendant executed a payment guaranty, which had a limitation provision stating in relevant part: “Guarantor shall be limited to fifty percent (50%) of the outstanding balance of principal and accrued interest under the Note; provided … that any reduction … shall be applied first to that portion of the Liabilities not guaranteed by Guarantor….” Following a default, the total debt amount was about $7.5MM, and the lender pursued the guarantor as part of the loan enforcement action. In the process, the parties agreed to a receiver’s sale of the mortgaged real estate resulting in an agreed-up credit against the debt in the amount of $4.4MM. The factual dispute ultimately surrounded whether the guarantor’s 50% liability applied before or after the credit for the sale proceeds.

Procedural history. The trial court granted summary judgment for the lender and concluded that the guarantor owed 50% of the debt before the credit.

Key rules. It is well-settled in Indiana that “a guaranty is a conditional promise to answer for a debt or default of another person, such that the guarantor promises to pay only if the debtor/borrower fails to pay.”

Generally, the nature and extent of a guarantor’s liability depends upon the terms of the contract, and a guarantor cannot be made liable beyond the terms of the guaranty. Nevertheless, the terms of a guaranty should neither be so narrowly interpreted as to frustrate the obvious intent of the parties, nor so loosely interpreted as to relieve the guarantor of a liability fairly within their terms.

If a guaranty is unambiguous, extrinsic evidence (such as an affidavit) of a party’s understanding of the guaranty (i.e. intent) is not to be considered.

Holding. The Indiana Court of Appeals affirmed the trial court’s ruling.

Policy/rationale. The guarantor argued that the limitation provision in the guaranty was ambiguous because it did not state “when” the “outstanding balance” was to be determined. He submitted an affidavit stating that his intent was that any liability was to be determined after all payments on the debt had been applied. The Indiana Court of Appeals agreed with the trial court that the relevant provision was unambiguous on the key issue. The “when” was ten days after the maturity date and upon written demand. Looking at the guaranty as a whole, the Court found that the language clearly required the guarantor to pay 50% of the accelerated debt. The Court went on to discuss precisely how the damages against the guarantor were to be calculated, including when and how to apply the $4.4MM credit, which was to be applied first to the portion not guaranteed.

Related posts.

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

Employee/Guarantor Of Equipment Supply Contract Pays Price For Bankrupt Employer’s Default
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I frequently represent lenders and guarantors in loan enforcement actions. 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.

Settlement Agreement Between Lender And Guarantors Did Not Release The Contribution Rights Of The Guarantors

Lesson. Be mindful of language in settlement agreements with lenders. Don’t unwittingly release contribution claims among guarantors unless that’s the objective.

Case cite. New v. T3 Investments, 55 N.E.3d 870 (Ind. Ct. App. 2016).

Legal issue. Whether a mutual release within a settlement agreement between a lender, on the one hand, and a borrower and several guarantors, on the other hand, resulted in a waiver of rights of contribution among the guarantors.

Vital facts. New was a commercial mortgage foreclosure matter. The heart of the case surrounded the liability of the guarantors of the loan. At issue was a “Settlement and Mutual Release Agreement” entered into by the lender, the borrower and the guarantors. The Court’s opinion sets out the relevant portions of the agreement, including the release provision. The borrower/guarantors breached the agreement by failing to pay the lender, so the lender’s claims later were reduced to a judgment. After a sheriff’s sale, an $865,315.95 deficiency remained, and one of the guarantors – T3 – paid the deficiency in full. T3 then filed an action for contribution against the other five guarantors seeking their pro-rata share of the deficiency payment. Those guarantors asserted that the prior settlement agreement had language that operated to release them from liability. T3 contended that the settlement agreement dealt only with the bank and did not demonstrate that the guarantors bargained for any benefits and detriments with respect to each other.

Procedural history. New was an appeal to the Indiana Court of Appeals following the trial court’s summary judgment in favor of T3.

Key rules.

• The doctrine of contribution “rests on the principle that, where parties stand in equal right, equality of burden becomes equity.” Contribution ensures “those who assume a common burden carry it in equal portions.” A party who pays a debt is entitled to receive contribution from any party having the same joint and several liability.
• Generally, the right of contribution only can be destroyed by an agreement between the obligated parties.
• A release is a contract and is interpreted according to contract law. Contract formation requires an offer, acceptance and consideration. Consideration generally is where there is a benefit accruing to the promisor or a detriment to the promisee. Consideration “consists of bargained-for exchange.” A release must be supported by consideration.

Holding. The Court of Appeals affirmed the trial court’s summary judgment in favor of T3. The remaining guarantors were obligated to pay T3 their pro-rata portion of the deficiency judgment.

Policy/rationale. Although the language in the “mutual release” provision in the settlement agreement was very broad and arguably cut against T3’s position, the Court found that there was no “bargained-for” exchange among the guarantors related to any release among them. The guarantors negotiated collectively with the lender. The bargained-for exchange concerned only the loan and the lawsuits filed by the lender. The settlement agreement spelled out how to resolve only those claims. The guarantors in the agreement did not settle among themselves. In short, the mutual release contained within the settlement agreement was not applicable to T3’s contribution claim.

Related posts.

• Indiana Guaranties:  Right Of Contribution Clarified
• Guarantor Contribution Claims And The Meaning Of "Joint And Several" Liability
• Claim For Contribution Against An "Accomodation Party" Fails
• Effectiveness Of A Release In An Indiana Forbearance Agreement
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I represent parties, including guarantors, in commercial mortgage foreclosure disputes. 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.

Does A Deed-In-Lieu Of Foreclosure Automatically Release A Borrower From Personal Liability?

A deed-in-lieu of foreclosure (DIL) is one of many alternatives to foreclosure.  For background, review my post Deeds In Lieu Of Foreclosure: Who, What, When, Where, Why And How.  Today I discuss the Indiana Court of Appeals’ opinion in GMAC Mortgage v. Dyer, 965 N.E.2d 762 (Ind. Ct. App. 2012), which explored whether a DIL in a residential mortgage foreclosure case released the defendant borrower from personal liability. 

Deficiency.  In GMAC Mortgage, the borrower sought to be released from any deficiency.  The term “deficiency” typically refers to the difference between the fair market value of the mortgaged real estate and the debt, assuming a negative equity situation.  Exposure to personal liability arises out of the potential for a “deficiency judgment,” which refers to the money still owed by the borrower following a sheriff’s sale.  The amount is the result of subtracting the price paid at the sheriff’s sale from the judgment amount.  (For more on this topic, please review my August 1, 2008, June 29, 2009 and March 9, 2012 posts.) 

DIL, explained.  GMAC Mortgage includes really good background information on the nature of a DIL, particularly in the context of residential/consumer mortgages.  According to the U.S. Department of Housing and Urban Development (HUD), a DIL “allows a mortgagor in default, who does not qualify for any other HUD Loss Mitigation option, to sign the house back over to the mortgage company.”  A letter issued by HUD in 2000 further provides:

[d]eed-in-lieu of foreclosure (DIL) is a disposition option in which a borrower voluntarily deeds collateral property to HUD in exchange for a release from all obligations under the mortgage.  Though this option results in the borrower losing the property, it is usually preferable to foreclosure because the borrower mitigates the cost and emotional trauma of foreclosure . . ..  Also, a DIL is generally less damaging than foreclosure to a borrower’s ability to obtain credit in the future.  DIL is preferred by HUD because it avoids the time and expense of a legal foreclosure action, and due to the cooperative nature of the transaction, the property is generally in better physical condition at acquisition.

Release of liability in FHA/HUD residential cases.  The borrower in GMAC Mortgage had defaulted on an FHA-insured loan.  The parties tentatively settled the case and entered into a DIL agreement providing language required by HUD that neither the lender nor HUD would pursue a deficiency judgment.  The borrower wanted a stronger resolution stating that he was released from all personal liability.  The issue in GMAC Mortgage was whether the executed DIL agreement precluded personal liability of the borrower under federal law and HUD regulations.  The Court discussed various federal protections afforded to defaulting borrowers with FHA-insured loans, including DILs.  In the final analysis, the Court held that HUD’s regulations are clear:  “A [DIL] releases the borrower from all obligations under the mortgage, and the [DIL agreement] must contain an acknowledgement that the borrower shall not be pursued for deficiency judgments.”  In short, the Court concluded that a DIL releases a borrower from personal liability as a matter of law. 

Commercial cases.  In commercial mortgage foreclosure cases, however, a lender/mortgagee may preserve the right to pursue a deficiency, because the federal rules and regulations outlined in GMAC Mortgage do not apply to business loans or commercial property.  The parties to the DIL agreement can agree to virtually any terms, including whether, or to what extent, personal liability for any deficiency is being released.  The point is that the issue of a full release (versus the right to pursue a deficiency) should be negotiated in advance and then clearly articulated in any settlement documents.  A release is not automatic. 

GMAC Mortgage is a residential, not a commercial, case.  The opinion does not provide that all DILs release a borrower from personal liability, and the precedent does not directly apply to an Indiana commercial mortgage foreclosure case. 

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I represent parties in loan-related litigation.  If you need assistance with such a 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.

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.

Related posts.

• Fried Tomato Grower, Part II: Lack of Consideration
• Attorney Fee Awards in Indiana
• Indiana Only Requires The Guarantor To Sign A Guaranty

Mortgage On Wife’s Real Estate Discharged Post-Divorce Following Material Alteration Of Underlying Debt Owed By Ex-Husband’s Business

Lesson.  Lenders are well served to get the signatures of all parties to a loan, including all guarantors and mortgagees, if the loan is renewed or modified.  Otherwise, there is a risk that the guarantor or even a mortgage could be released.

Case cite.  First Federal Bank v. Greenwalt, 42 N.E.3d 89 (Ind. Ct. App. 2015).

Legal issue.  Whether a mortgage was discharged due to a material modification of the guaranteed indebtedness. 

Vital facts.  Husband and Wife granted a mortgage in the amount of $300,000 on two properties they owned to secure a promissory note executed by Husband’s business.  Following a divorce, Wife got Property 1, and Husband got Property 2.  Thereafter, Husband’s business and Lender consolidated debts and renewed the note multiple times without Wife’s knowledge.  The debt amount increased to nearly $450,000.  Husband later sold Property 2 and gave about $110,000 in net proceeds to Lender.  Ultimately, Husband was discharged of his debts in a Chapter 7 bankruptcy proceeding.  Lender then sought to foreclose on Property 1 to satisfy the remaining debt owed by Husband’s business.

Procedural history.  The trial court granted summary judgment for Wife, and Lender appealed.

Key rules.  In Indiana, one who mortgages her land to secure another’s debt is called a surety.  Indiana does not distinguish guarantors from sureties.  A surety’s collateral can be released by a creditor’s actions “such as the extension of the time of payment of the debt, the acceptance of a renewal note, or the release of other security.”  When a principal “alters the terms of the contract without the consent of the surety, the surety is discharged, even if the alteration is to the benefit of the surety.”  To result in a discharge, the alteration “must be a change which alters the legal identity of the principal’s contract, substantially increases the risk of loss to the guarantor, or places the guarantor in a different position.”  

Holding.  The Court of Appeals affirmed the trial court’s summary judgment in favor of Wife.

Policy/rationale.  Wife originally was a surety for Husband’s business’s debt, but she contended that Property 1 was no longer subject to Lender’s mortgage.  Lender argued that there had been no material alteration to the debt but, if there had been, the debt that existed at the time of any material obligation was not discharged.  The First Federal Bank opinion thoroughly outlined the complex facts and applicable law, including the Keesling case (see post below).  The Court concluded that the alteration of the loan terms between Lender and Husband’s business constituted material alterations of the underlying obligation guaranteed by Wife such that both Wife, as a surety, and Property 1 were discharged.    

Related posts. 

• Sheriff’s Sales Of Separate Tracts: Principal’s Real Estate First, Surety’s Second
• “Material Alteration” Defense Rejected In Indiana Guaranty Enforcement Action
• IRISH V. WOODS: Which Surety Was Left Holding the $500,000 Bag?

Note Sale Will Not Release Guarantor

The Indiana Court of Appeals opinion in Riviera Plaza v. Wells Fargo, 2014 Ind. App. LEXIS 208 (Ind. Ct. App. 2014), discussed whether the “material alteration” defense, sometimes asserted by guarantors seeking dismissal, applies when a loan is transferred from one lender to another.

The defense.  My 01-10-09 post talks about “material alteration” in detail.  The general rule is that, when the lender and borrower cause a material alteration of the underlying obligation -  without the consent of the guarantor - the guarantor is discharged from further liability.  The nature of the alteration must be “a change which alters the legal identity of the principal’s contract, substantially increases the risk of loss to the guarantor, or places the guarantor in a different position.” 

Assignment a material alteration?  In Riviera, the guarantor asserted that the sale and assignment of the underlying mortgage loan from the prior lender to the plaintiff lender constituted a material alteration that released the guarantor of his obligation under the guaranty.  The guarantor argued that he did not consent to the transfer and cited to the Keesling case about which I wrote on 03-23-07.  The Court in Riviera, however, stated that Keesling “is easily distinguishable from the instant matter.”  Simply put, “the assignment of the Loan Documents did not alter [the borrower’s] obligation under the terms of the Note.”  The Court in Riviera also pointed to language (see my 8-26-15 post) in the subject guaranty that suggested an assignment of the guaranty does not constitute a material alteration. 

Fail.  The guarantor’s defense failed.  Here is what the Court in Riviera said:

[I]n light of the language contained in the Guaranty expressly providing that the Loan Documents could be assigned to another lender with or without notice to [the guarantor] and that the Guaranty shall follow the Note and Mortgage in the event the Note and Mortgage were assigned by [the original lender], we conclude that the assignment of the Loan Documents did not constitute a material alteration which would release [the guarantor] from his obligation under the Guaranty and preclude recovery by [the plaintiff lender/assignee].

The argument asserted by the guarantor was clever but, in the end, lacked merit.  In a loan sale, with regard to the guarantor, really the only thing materially altered is the party to whom payments must be made.  The obligation itself remains unchanged in such transactions.  Plus, the law does not require a guarantor or a borrower to consent to the sale in the first place.  They are not parties to such transactions.       

In addition to prosecuting and defending commercial foreclosure cases, I assist clients with the purchase and sale of mortgage loans.  If you would like to discuss such a transaction, please contact me or my partner Rob Inselberg, who is a whiz at negotiating and papering these deals. 

When Buying A Loan, Is A Separate And Distinct Assignment Of The Guaranty Required?

When an assignee (buyer) of a mortgage loan needs to enforce that loan in court, the assignee must establish that it is in fact the lender/mortgagee or, in other words, the current owner of the loan.  See my standing-related posts from 10-25-13 and 12-19-14 for more on this idea.  Today I specifically address the assignment of a guaranty.

No assignment.  As the buyer of a loan, or counsel for the purchaser of a loan, one of the closing documents probably should include a separate and distinct assignment of any guaranties.  With that in hand, there will be zero doubt about your ability to enforce the guaranty.  I have been involved in cases, however, where no such assignment exists.  Instead, there only is a broad assignment of all loan documents or perhaps only assignments of the promissory note and mortgage.  This was the backdrop in Riviera Plaza v. Wells Fargo, 2014 Ind. App. LEXIS 208 (Ind. Ct. App. 2014), a case in which the guarantor of a commercial mortgage loan appealed the trial court’s judgment against him on the basis that the plaintiff assignee, Wells Fargo, did not produce an assignment of the guaranty.  The guarantor asserted that the record was devoid of evidence showing that there had been a valid assignment of the guaranty to Wells Fargo.

Evidence.  In Riviera, there existed an assignment of mortgage, an allonge to the promissory note and a bill of sale of the loan documents from the original lender to Wells Fargo.  The bill of sale mentioned guaranties.  Wells Fargo also had a general assignment of loan documents that referenced the note and mortgage and “all claims secured thereby.”  Finally, the language in the guaranty in Riviera, which language is fairly common, indicated that the guaranty “shall follow the note and security instrument . . .”.  (Read the opinion for a more expansive quote from the guaranty.)

Chain of title established.  The Indiana Court of Appeals found in favor of Wells Fargo with respect to the chain of title defense asserted by the guarantor: 

In light of the language in the assignment referring to all “claims secured thereby,” . . . the language of the Guaranty indicating that the Guaranty “shall follow the Note and Security Instrument,” and [the guarantor’s] failure to object to the substitution of Wells Fargo as the real party in interest and plaintiff on the amended complaint, we conclude that the trial court did not err in determining the Wells Fargo held a valid assignment of the Guaranty.

Not required.  The Court’s holding in Riviera generally is consistent with my understanding of the law, which is that guaranties follow the note and mortgage and that a separate and distinct assignment of guaranties is not required.  Again, if you are involved on the front end, a separate assignment is preferable.  But if you’re litigating with loan documents that lack such an assignment, usually you can find supporting language in the guaranty itself, coupled with language like “and all claims secured thereby” in some other assignment document, which will be sufficient to demonstrate that the assignee holds the guaranty.  Plus, barring a prior release of the guarantor, why wouldn’t the guaranty automatically follow the note and mortgage?

Guaranty of Subsequent Debt

Can a guaranty cover a promissory note executed in the future?  The United States District Court for the Northern District of Indiana, in Barbara v. Pringle, 2013 U.S. Dist. LEXIS 167024 (.pdf), said yes.

Structure.  The plaintiff lender in Barbara, a private individual, loaned the defendants millions of dollars in a series of promissory notes spanning several years.  However, only a single guaranty agreement was signed. 

Defense.  The defendant guarantors contended that the guaranty was ambiguous.  Specifically, they argued that the guaranty did not apply to the promissory notes that postdated it.  In reaching a result similar to that discussed in my May 2, 2014 post, the Court concluded that the guaranty did, in fact, unambiguously apply to all of the subsequent notes. 

Outcome.  The outcome turned on the guaranty’s definition of obligations:  “each guarantor undertook to personally guarantee the obligations . . . the guaranty applied to ‘all obligations’ of whatever type . . . .”  The guaranty covered obligations to the lender “now or hereafter existing or due or become due.”  The Court held that the guarantors’ “not only guaranteed the obligations in force at the time of the agreement, but also those that would arise between the parties later.”  The Court’s conclusion was consistent with Indiana law, which is settled on the idea that a guaranty can apply to debt incurred in future transactions. 

Words.  Please note that the language in the document backed up the result.  Most guaranties contain broad language that contemplates future debt, and such terms are enforceable.  But not all guaranties are the same.  Negotiate up front accordingly. 

Guarantor Wins Res Judicata Battle, Loses Deficiency War

This follows up last week’s post regarding Weinreb v. Fannie Mae, 993 N.E.2d 223 (Ind. Ct. App. 2013).  This week, I delve into what Weinreb tells us about naming guarantors in foreclosure suits and pursuing defenses that don’t work.   

Procedural history.  Weinreb involved the personal liability of a defendant guarantor for a deficiency judgment.  In a prior lawsuit, the lender obtained a $7.8MM judgment on a promissory note and a decree of foreclosure on a mortgage, which proceedings resulted in a sheriff’s sale of the mortgaged property for $6.6MM and a deficiency of $1.8MM.  The guarantor was not a party to those proceedings.  Months later, the lender filed a complaint against the guarantor to collect the deficiency. 

Res judicata/collateral estoppel.  The guarantor disputed the deficiency.  The lender responded by asserting that the guarantor could not contest the elements of, or his liability for, the deficiency because those matters had been determined in the prior foreclosure.  Indeed the doctrine of res judicata “bars the litigation of a claim after final judgment has been rendered in a prior action involving the same claim between the same parties for their privies.”  The guarantor’s retort was that, since he was not a party to the foreclosure proceedings, he was not precluded from challenging the elements of the deficiency judgment.  The Court agreed:  “[the guarantor] did not have a full and fair opportunity to litigate the enforceability of the Note or his Guaranty.”  Weinreb highlights the question of whether to name guarantors as defendants in the initial foreclosure lawsuit.  You don’t have to, but in doing so, you avoid litigating two lawsuits.  (There are reasons why a lender may not want to name a guarantor in the foreclosure case.  For example, the lender could reach a sheriff’s sale more quickly without resistance from a defendant guarantor.)  The main point here is that the Court of Appeals, in the post-foreclosure action, gave the guarantor an opportunity to contest the enforceability of the loan documents and the amount of the deficiency.  Although the opinion leaves room for argument depending upon the facts of a particular case, the foreclosure action in Weinreb did not set the deficiency in stone.

Alleged ambiguity.  Despite winning the res judicata battle, the guarantor in Weinreb ultimately lost the deficiency war.  His two arguments against the enforceability of the guaranty failed.  The first was that summary judgment in favor of the lender was inappropriate because the loan documents were “extrinsically ambiguous.”  The guarantor’s theory was similar to the “confusion defense” articulated in my 1/14/13 post.  After addressing Indiana law related to alleged ambiguities in contracts, the Court concluded that “parties are obligated to know the terms of the agreement they are signing, and cannot avoid their obligations under the agreement due to a failure to read it.”  The guarantor’s alleged failure to read did not equate to an ambiguity, and the Court affirmed the trial court’s summary judgment for the lender. 

Unconscionability.  The guarantor’s second contention was that summary judgment should not have been granted due to factual questions surrounding whether the lender “used superior bargaining power to cause hardship to him.”  This triggered a discussion by the Court of the doctrine of unconscionability.  The rule in Indiana is that “a contract will be deemed unconscionable [and thus unenforceable] when a great disparity in bargaining power exists which leads the weaker party to sign a contract unwillingly or without being aware of its terms.”  This is always  a steep hill to climb in Indiana, and Weinreb was no different.  The evidence was undisputed that the guarantor was not in a position of weakness or unequal bargaining power.  The Court held that the loan documents, including the guaranty, were not unconscionable. 

The Court enforced the deficiency arising out of the prior foreclosure judgment.  For more on the liability of, and defenses surrounding, guarantors, please click on the Guarantors category on the right side of my home page. 

2003 Guaranty Applied To 2007 Promissory Note And Other Post-2003 Liabilities

 

Judge Barker’s opinion in Knauf v. Southern Brands, U.S. Dist. LEXIS 38435 (S.D. Ind. 2013) (.pdf), dealt with defendant guarantors’ motion to dismiss.  As reported here previously, guarantors’ efforts to defeat liability in Indiana is a challenge to say the least.  Knauf is yet another opinion rejecting defenses to a guaranty.

The players.  Knauf did not involve a traditional lender/borrower commercial mortgage loan but rather a manufacturer and a distributor.  The opinion details a multitude of financial transactions between the parties.  For purposes of this post, the case turned on a 2003 guaranty signed by a husband and wife, who were the owners and operators of the distributor indebted to the manufacturer. 

The guaranty.  In 2003, the distributor signed a promissory note for nearly $800,000, and the subject guaranty was to be in effect “[u]ntil all [l]iabilities guaranteed [there] by [were] paid in full.”  In 2006, the 2003 note was paid in full.  In 2007 the distributor signed another promissory note, in the amount of $1.9MM, upon which it later defaulted.  The manufacturer sought to recover on the 2007 note plus an additional $1.6MM for goods the distributor purchased over the course of the relationship.

Defense.  The guarantors filed a motion to dismiss and asserted that the 2003 guaranty “expired on its own terms in July 2006, when the “liabilities guaranteed hereby [were] paid in full.”  In short, the guarantors contended that the guaranty only applied to the corresponding 2003 note. 

Offense.  The manufacturer, in turn, argued that the guarantors misinterpreted the guaranty’s definition of the term “liabilities.”  The provision stated:

[T]he undersigned hereby unconditionally guarantees the full and prompt payment when due, whether by acceleration or otherwise, and at all times thereafter, of all obligations of the DEBTOR to the CREDITOR, howsoever created, arising or evidenced, whether direct or indirect. Absolute or contingent, or now or hereafter existing, or due or to become due (all such obligations being collectively called the “Liabilities”). . . .

The manufacturer reasoned that the language defining “liabilities” was unambiguous and reflected the guarantors’ stipulation to vouch for the distributor as to all obligations owed to the manufacturer, “howsoever created.” 

Finding.  The Court denied the motion to dismiss and held that the parties intended the term “liabilities” to include several amounts, not just the sum due under the 2003 note that had been paid, but rather the 2007 note and the additional sums owed for goods purchased over time.  The result in Knauf was similar to that in the TW General Contracting Services case addressed in my August 6, 2009 post.  In Indiana, the language in the guaranty will control the outcome.  Broad language likely will be applied broadly. 

While it may be advisable for lenders, when renewing promissory notes or obtaining subsequent promissory notes, to have a new guaranty signed, Indiana law does not appear to this in cases in which guaranty-related language is open-ended.  Certainly each case, and each guaranty, is different, but generally speaking decks are stacked against guarantors in Indiana. 

Execution Upon Indiana Real Estate Owned As “Tenancy By The Entireties”

Is real estate that spouses own jointly subject to execution to satisfy a judgment entered against only one of the spouses?  Not in Indiana.

Definition.  Black’s Law Dictionary’s definition of “tenancy by the entireties” is:

A tenancy which is created between a husband and wife and by which together they hold title to the whole with right of survivorship . . ..  It is essentially a “joint tenancy,” modified by the common-law theory that husband and wife are one person, and survivorship is the predominant and distinguishing feature of each.

Indiana’s rules.  As a matter of law, real estate owned by a husband and wife is held under a form of ownership known as “tenancy by the entireties.”  There are only two requirements for a tenancy by the entireties to exist:  (1) that spouses be legally married at the time of the conveyance; and (2) that the deed include both spouse’s names.  No “magic language” is required on the deed.  If, for example, the deed states that the grantor conveys the real estate “to Eddie Doe and Betty Doe, husband and wife,” then under Indiana law the couple owns the real estate as tenants by the entireties.

Exempt.  In Indiana, a creditor of one spouse cannot execute upon real estate owned as tenants by entireties.  See Ind. Code § 34-55-10-2(C)(5); see also Diss v. Agri Bus. Int’l, 670 N.E.2d 97, 99 (Ind. Ct. App. 1996) (“A tenancy by the entirety is immune from seizure in satisfaction of the individual debts of either of the co-tenant spouses.”).  Thus, any real estate owned jointly as spouses is exempt from collection by any creditor that obtains a judgment against one spouse individually. 

Sale proceeds/rents.  As a general rule, proceeds arising from the sale of entireties property also are exempt from collection by the creditors of one spouse.  Thus, where entireties property is sold, the sale proceeds do not lose their exemption protection so long as no action is taken contrary to treatment as entireties property (i.e., the proceeds are not split, divided or otherwise designated to either spouse’s individual creditors) and/or there is a particular statement by the couple that they intend the proceeds to be, and are, held as entireties property.  Whitlock v. Public Service Company of Indiana, Inc., 159 N.E.2d 280 (Ind. 1959).  On the other hand, rents are not immune. 

Co-borrowers/guarantors.  These laws protect an innocent spouse or, in other words, a spouse that was not a defendant in the lawsuit or a party to the underlying transaction.  The entireties exemption explains why, on the front-end of a deal, a lender might insist upon spouses co-signing a note or require guaranties from both spouses, even though only one of the spouses is in the business.  If both spouses are judgment debtors, co-borrowers or co-guarantors, then their real estate held as tenancy by the entireties is not shielded from post-judgment collection. 

Thanks to my colleague Matt Millis for his input into this post.  He took the lead with the legal research this week and, as always, is an effective post-draft editor for me. 

Claim For Contribution Against “Accommodation Party” Fails

In re Simpson, 2012 Bankr. LEXIS 3021 (S.D. Ind. 2012) (.pdf), decided by the United States Bankruptcy Court for the Southern District of Indiana, involved a Chapter 7 Trustee’s adversary proceeding seeking contribution from the debtor’s spouse.  The opinion is thorough and complicated.  My goal here merely is to touch upon the concepts of common law contribution  and accommodation parties, which are similar to guarantors but ultimately treated differently under the law. 

Loan basics.  In Simpson, the debtor, an individual, operated a farm on residential real estate that he and his spouse owned.  To help fund the business, the debtor borrowed money from a lender secured by a mortgage on the real estate.  Interestingly, the wife also signed the subject promissory note, but the opinion doesn’t specifically explain why.  The spouse was not a partner in the debtor’s business and did not directly benefit from the proceeds of the subject loan.  But, to make the loan, the lender needed the mortgage, which the debtor could not have granted without the signature of his spouse.

Contribution.  Within the Chapter 7 bankruptcy case, the Trustee sought a judgment against the debtor’s spouse to recover half the amount of the joint loan.  In cases like these, the Trustee stands in the shoes of the debtor.  The Trustee claimed that the spouse was liable to the bankruptcy estate pursuant to Indiana’s doctrine of contribution, about which I wrote on 2/1/12 and 10/10/08.   

Accommodation party defense.  Following a lengthy discussion, the Court concluded that Indiana law permits an action for contribution as between spouses.  The opinion next focused on the affirmative defense asserted by the spouse.  Specifically, Indiana’s UCC provides that an action for contribution may lie “except as provided in I.C. § 26-1-3.1-419(f) . . ..”  See, I.C. § 26-1-3.1-116(b).  Section 419(f) states that:

[a]n accommodation party who pays the instrument is entitled to reimbursement from the accommodated party and is entitled to enforce the instrument against the accommodated party . . . [but a]n accommodated party that pays the instrument has no right of recourse against, and is not entitled to contribution from, an accommodation party.

The legal question became whether the spouse was an “accommodation party” under I.C. § 26-1-3.1-419(a). 

Accommodation party defined.  Generally, an accommodation party “signs the instrument for the purpose of incurring liability on the instrument without being a direct beneficiary of the value given for the instrument.”  I.C.§ 26-1-3.1-419(a).  The Court addressed various cases regarding who qualifies as an accommodation party.  This included the Keesling case, which was the subject of my 2/23/07 post.  The Court concluded that any benefit to the spouse was “indirect within in the meaning of I.C. § 26-1-3.1-419(a) and Keesling.”  Because the debtor’s spouse was an accommodation party, the Court held that the Trustee’s claim for contribution failed.
 
Simpson tells us that, in Indiana, there isn’t a viable claim for contribution against an accommodation party.    

Does A Deed-In-Lieu Of Foreclosure Automatically Release A Borrower From Personal Liability?

A deed-in-lieu of foreclosure (DIL) is one of many alternatives to foreclosure.  For background, review my post Deeds In Lieu Of Foreclosure: Who, What, When, Where, Why And How.  Today I discuss the Indiana Court of Appeals’ opinion in GMAC Mortgage v. Dyer, 965 N.E.2d 762 (Ind. Ct. App. 2012), which explored whether a DIL in a residential mortgage foreclosure case released the defendant borrower from personal liability. 

Deficiency.  In GMAC Mortgage, the borrower sought to be released from any deficiency.  The term “deficiency” typically refers to the difference between the fair market value of the mortgaged real estate and the debt, assuming a negative equity situation.  Exposure to personal liability arises out of the potential for a “deficiency judgment,” which refers to the money still owed by the borrower following a sheriff’s sale.  The amount is the result of subtracting the price paid at the sheriff’s sale from the judgment amount.  (For more on this topic, please review my August 1, 2008, June 29, 2009 and March 9, 2012 posts.) 

DIL, explained.  GMAC Mortgage includes really good background information on the nature of a DIL, particularly in the context of residential/consumer mortgages.  According to the U.S. Department of Housing and Urban Development (HUD), a DIL “allows a mortgagor in default, who does not qualify for any other HUD Loss Mitigation option, to sign the house back over to the mortgage company.”  A letter issued by HUD in 2000 further provides:

[d]eed-in-lieu of foreclosure (DIL) is a disposition option in which a borrower voluntarily deeds collateral property to HUD in exchange for a release from all obligations under the mortgage.  Though this option results in the borrower losing the property, it is usually preferable to foreclosure because the borrower mitigates the cost and emotional trauma of foreclosure . . ..  Also, a DIL is generally less damaging than foreclosure to a borrower’s ability to obtain credit in the future.  DIL is preferred by HUD because it avoids the time and expense of a legal foreclosure action, and due to the cooperative nature of the transaction, the property is generally in better physical condition at acquisition.

Release of liability in FHA/HUD residential cases.  The borrower in GMAC Mortgage had defaulted on an FHA-insured loan.  The parties tentatively settled the case and entered into a DIL agreement providing language required by HUD that neither the lender nor HUD would pursue a deficiency judgment.  The borrower wanted a stronger resolution stating that he was released from all personal liability.  The issue in GMAC Mortgage was whether the executed DIL agreement precluded personal liability of the borrower under federal law and HUD regulations.  The Court discussed various federal protections afforded to defaulting borrowers with FHA-insured loans, including DILs.  In the final analysis, the Court held that HUD’s regulations are clear:  “A [DIL] releases the borrower from all obligations under the mortgage, and the [DIL agreement] must contain an acknowledgement that the borrower shall not be pursued for deficiency judgments.”  In short, the Court concluded that a DIL releases a borrower from personal liability as a matter of law. 

Commercial cases.  In commercial mortgage foreclosure cases, however, a lender/mortgagee may preserve the right to pursue a deficiency, because the federal rules and regulations outlined in GMAC Mortgage do not apply to business loans or commercial property.  The parties to the DIL agreement can agree to virtually any terms, including whether, or to what extent, personal liability for any deficiency is being released.  The point is that the issue of a full release (versus the right to pursue a deficiency) should be negotiated in advance and then clearly articulated in any settlement documents.  A release is not automatic. 

GMAC Mortgage is a residential, not a commercial, case.  The opinion does not provide that all DILs release a borrower from personal liability, and the precedent does not directly apply to an Indiana commercial mortgage foreclosure case. 

Must Banks Provide Advice To Their Customers During Loan Transactions?

When making a commercial loan, do lenders have a fiduciary duty to their Indiana borrowers or guarantors?  The Indiana Court of Appeals, in Paul v. Home Bank, 953 N.E.2d 497 (Ind. Ct. App. 2011), said no.

The loans.  Paul dealt with two loans to a borrower for the development of a hotel.  The first loan involved a promissory note, assignment of leases, a mortgage and a set of guaranties signed by the individual investors, who were also physicians.  The second loan, executed the same date, was a line of credit and also involved a promissory note, a mortgage and a set of guaranties signed by the same individuals.  The borrower defaulted on both loans, and the bank obtained a summary judgment permitting a sheriff’s sale of the mortgaged property.  Since the sheriff’s sale satisfied only the first (larger) loan, the bank moved for summary judgment against the guarantors to collect the debt owed on the second loan. 

The “confusion defense.”  The guarantors filed their own summary judgment motion making all sorts of arguments, only one of which I will discuss today.  The guarantors asserted they should prevail because “they are not lawyers, and [the bank] failed to advise them as to the meaning of the [guaranties].”  The guarantors thought the guaranties executed for the first loan released the guaranties for the second loan.  The guarantors believed the documents meant one thing and faulted the bank for not advising them that the documents said something else.  I have labeled this the “confusion defense.”

No fiduciary duty.  The Court dismissed the guarantors’ argument and relied upon the following well-settled Indiana law applicable to the relationship between banks and customers:

[A] business or “arm’s length” contractual relationship does not give rise to a fiduciary relationship.  That is, the mere existence of a relationship between parties of bank and customer or depositor does not create a special relationship of trust and confidence.  In the context of mortgagor/mortgagee relationship, mortgages do not transform a traditional debtor-creditor relationship into a fiduciary relationship absent an intent by the parties to do so.  Absent special circumstances, a lender does not owe a fiduciary duty to a borrower. 

The “special circumstances” are “when one party has confidence in the other party and is ‘in a position of inequality, dependence, weakness, or lack of knowledge.’”  The evidence must show that the dominant party improperly influenced the weaker party so as to gain an “unconscionable advantage.” 

Big boys shouldn’t cry.  Applying Indiana law to the facts in Paul, the Court noted that the guarantors were physicians who “embarked upon a sophisticated business venture . . . [and] cannot now complain because they failed to read the [guaranty] or seek the advice of legal counsel before signing [it].”  In Indiana, one is presumed to understand the document he signs and cannot be released from its terms due to his failure to read it.  The Court affirmed the summary judgment in favor of the bank. 

Paul is another illustration of the enforceability of solid loan documents.  In Indiana, a well-written guaranty is tough to beat.  If you click on the “Guarantors” category to the left, you will see several posts that address a number of defenses that were roundly rejected in Indiana cases.  Certainly there are circumstances when a guaranty may not be enforceable or a guarantor may be released, but those cases are rare. 

“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.

Indiana District Court Examines “Material Adverse Change” Default Provision

The most common loan default is for non-payment.  But there are many other events that can trigger a default.  Indeed loan documents, including guaranties, typically contain a multitude of default-related provisions.  One provision that we often see, but rarely apply, looks something like this:

Insecurity.  Lender determines in good faith that a material adverse change has occurred in Guarantor’s financial condition from the conditions set forth in the most recent financial statement before the date of the Guaranty or that the prospect for payment or performance of the Debt is impaired for any reason.

Greenwood Place v. The Huntington National Bank, 2011 U.S. Dist. LEXIS 78736 (S.D. Ind. 2011) (rt click/save target as for .pdf) addresses a similar material adverse change (“MAC”) clause. 

Summary judgment.  In Greenwood Place, Southern District of Indiana Judge Tanya Walton Pratt issued a ruling on a motion for summary judgment filed by a lender against two borrowers based on the theory that there had been a “material adverse change in the financial condition of” the guarantor of the loans.  The opinion did not quote the entire clause, but it was clear that the subject loan agreement provided that “any material adverse change in the financial condition of” the guarantor constituted an event of default.  (Note that an alleged default occurred even though the loan payments were current.) 

The change.  Since the execution of the loan agreement, the guarantor’s cash had been almost completely depleted, his net worth had decreased by 60%, his equity in real estate had diminished by 80%, and he had unpaid judgments against him for several million dollars.  According to the Court, “to be sure, [guarantor] has experienced an adverse change in his financial condition.”  But, “whether this change has been material . . . is a more difficult question.”

The Court’s struggle.  The Court conceded that “at first blush, it would appear that this change has been material as that word is used in common parlance.”  Nevertheless, the Court noted that the loan documents did not define “any material adverse change.”  Evidence from six witnesses suggested different definitions.  Although the lender urged the Court to accept a “know it when you see it” interpretation, the Court was “uncomfortable” with applying such an approach at the summary judgment stage.  “Materiality,” noted the Court, is an “inherently amorphous concept.”  The guarantor still had a sizeable net worth that, based on certain assumptions, could be enough to absorb any liability stemming out of the underlying loans.  “This cushion creates questions as to whether the adverse change in [guarantor’s] financial condition is, in fact, material.” 

Ambiguous.  The Court denied the lender’s motion for summary judgment:

Given the “sliding scale” nature of materiality, coupled with the lack of a definition or objective standard found in the [loan agreement], the Court cannot help but find that the term is ambiguous because reasonable people could come to different conclusions about its meaning.  . . .  [T]herefore, “an examination of relevant extrinsic evidence is appropriate in order to ascertain the parties’ intent.”

Essentially, the Court held that the issue of materiality was a question of fact for trial. 

What we learned.  The Court’s analysis of the relevant financial conditions provides a road map for prosecutors (or defenders) of similar defaults.  The Court’s opinion does not question the fundamental validity or enforceability of MAC provisions.  The opinion does, however, raise the question of whether such a provision can form the basis for a pre-trial disposition of the case:  “when it comes to materiality, it’s all relative.”  The implication is that every case (financial condition) is different, and facts may need to be weighed.  On the other hand, Greenwood Place does not go so far as to proclaim that summary judgment should be denied in every case.  The opinion merely demonstrates how difficult summary judgment might be to achieve. 

Guarantor Strikes Out With Defenses To Guaranty

Defenses to liability under a guaranty are few and far between in Indiana.  General Electric Capital v. Delaware Machinery, 2011 U.S. Dist. LEXIS 53897 (S. D. Ind. 2011) (.pdf) illustrates this. 

Set up.  The General Electric opinion dealt with a lender’s motion for summary judgment against a guarantor.  In 2003, the lender and the borrower entered into a master lease agreement that obligated the borrower to make payments on certain equipment in eighty-three monthly installments.  The lender obtained a guaranty in connection with the master lease agreement.  In 2009, the borrower failed to make lease payments, so the lender accelerated the amounts due and filed suit against the guarantor.  The Court concluded that, under the unambiguous language of the guaranty, the guarantor was liable to the lender for the borrower’s obligations.  (The opinion quotes the operative language of the guaranty.) 

The guarantor asserted three arguments as to why, despite the language in the guaranty, he should not be liable: 

Fraudulent inducement.  The guarantor’s first argument was that the lender fraudulently induced him to enter into the guaranty through representations that the master lease agreement would constitute a lease agreement, and not a purchase or security agreement.  The lender countered that fraudulent inducement based on misrepresentations “of the legal effect of a document” are not recognized in Indiana.  Indiana law generally recognizes fraudulent inducement as a defense to a contract, but one exception to the rule is:

when the representation at issue, though false, relates to the legal effect of the instrument sued on.  Every person is presumed to know the contents of the agreement which he signs, and has, therefore, no right to rely on the statements of the other party as to its legal effect.

Since the alleged characterization of the subject contract was a question as to the contract’s legal effect, the guarantor had no right to rely on the alleged misrepresentations of the lender.  Strike one.

Judicial estoppel.  The guarantor’s second defense was that the lender was judicially estopped from claiming damages for more than the amount claimed in the complaint.  In Indiana, “judicial estoppel prevents a party from pursuing a theory incompatible with its original theory in the same litigation.”  The opinion sets out three factors to be considered by courts, including whether the party’s later position was “clearly inconsistent” with its earlier position.  In its complaint, the lender stated that “at present, the amount due . . . totals not less than $279,074.43.”  In its subsequent motion for summary judgment, the lender sought over $415,000.00.  The operative language in the lender’s complaint was “at present.”  The guarantor could not show that the lender’s current position was “clearly inconsistent” with its position in the complaint.  Strike two. 

Indemnification.  The guarantor’s third contention was that he should not be liable due to the lender’s failure to perfect its security interest.  According to the guarantor, “this amounts to seeking indemnification for [lender’s] own negligence in failing to perfect.”  (Evidently, the equipment was not available as a source of recovery.)  The guarantor argued that, had lender perfected its interest, the lender could have sold the subject equipment for in excess of $500,000.00 and therefore covered all of the lender’s alleged damages.  The Court focused on the language of the guaranty, which provided that guarantor’s obligations were not affected by the borrower’s “failure to . . . perfect and maintain a security interest in, or the time, place and manner of any sale or other disposition” of the equipment.  Thus the express terms of the guaranty entitled the lender to recover damages regardless of its failure to perfect its security interest.  Strike three.

Language in guaranties usually rules the day.  That certainly was the case in General Electric.  The defenses asserted by the guarantor, although creative, ultimately did not defeat the lender’s summary judgment motion.

Attorney Fee Awards in Indiana

Parties that foreclose commercial mortgages, and collect debts based upon promissory notes or guaranties, almost always seek to recover their attorney’s fees.  Today’s post sets out why such a claim can be made and how the fees should be calculated.

American rule – contract needed.  Indiana follows the so-called “American Rule,” which provides that, in the absence of statutory authority or an agreement between the parties to the contrary, a prevailing party has no right to recover attorney’s fees from the opposition.  (Under the “English Rule,” the losing party pays the fees to the winning.)  Loparex v. MPI Release, 964 N.E.2d 806 (Ind. 2011).  Indiana’s foreclosure and commercial collection statutes generally do not authorize the recovery of attorney’s fees.  That’s why virtually every loan document I’ve seen contains an attorney fee clause. 

40% flat fee.  Corvee, Inc. v. Mark French, 934 N.E.2d 844 (Ind. Ct. App. 2011) teaches litigants about the amount of attorney’s fees a trial court may award to the plaintiff in a successful collection action in Indiana.  Corvee did not involve a promissory note but a similar written agreement between the parties related to the collection of reasonable attorney’s fees in a suit to recover a debt.  The provision in Corvee stated that the defendant was responsible “for reasonable interest, collection fees, attorney fees of the greater of a) forty percent (40%) or b) $300 of the outstanding balance, and/or court costs incurred in connection with any attempt to collect amounts I may owe.”  There was no dispute that the contract unambiguously required the defendant to pay the 40% amount.  The question was whether such provision was enforceable.

Liquidated damages.  The Court in Corvee concluded that the attorney fee provision in the contract was in the nature of a liquidated damages clause, which means that the contract provided for the forfeiture of a stated sum of money without proof of damages.  In Indiana, courts will not enforce a liquidated damages provision that operates as a penalty.  Liquidated damages clauses generally are valid only if the nature of the contract is such that damages resulting from a breach “would be uncertain and difficult to ascertain.”  The calculation of attorney’s fees incurred in litigation is not difficult to ascertain.  The Court said:  “it strikes us as unnecessary to transform a standard attorney fee provision in a contract into, effectively, a liquidated damages provision that may or may not have any correlation to actually incurred attorney’s fees.” 

The right way.  In Indiana, even with specific contract language, “an award of attorney’s fees must be reasonable.”  Citing to a case involving promissory notes, the Court stated that provisions “for the payment of attorney’s fees ‘should not extend beyond reimbursing the holder of the note for the necessary attorney’s fees reasonably and actually incurred in vindicating the holder’s collection rights by obtaining judgment on the note.’”  In Corvee, there was no evidence of the amount of attorney’s fees that the plaintiff actually incurred in attempting to collect the debt.  Thus the 40% recovery could have given rise to a windfall at the defendant’s expense.  “Collection actions should permit creditors to recover that to which they are rightfully entitled to make themselves whole, and no more.”  As such, Corvee held the 40% attorney fee provision to be unenforceable.

Assuming the existence of an attorney fee provision, lenders in loan enforcement actions may recover fees that are reasonable and actually incurred.  According to Corvee, flat-fee or percentage-based attorney fee clauses may be difficult to enforce in Indiana. 

(See also:  Unsettled:  Recovery of Attorney's Fees for In-House Counsel.)

Forgery Defense Must Be Raised Immediately

Weinreb v. TR Developers, 943 N.E.2d 856 (Ind. Ct. Ap. 2011) dealt with a guarantor’s claim that he did not sign the guaranty upon which the judgment entered against him was based.  The Court’s opinion involves technicalities surrounding a couple rules of procedure, but there is a broader message for defendants in Indiana foreclosure cases:  denials of document execution should be raised right away.

Case history.  In September, 2008, the lender filed its complaint, including copies of the subject guaranty.  The guarantor filed an answer to the complaint and asserted a general denial to all of the allegations.  The lender subsequently filed a motion for summary judgment that resulted in the entry of judgment in May of 2009.  In June, 2009, after the period for filing an appeal had run, the guarantor filed a Rule 60(B) motion and submitted for the first time evidence suggesting that the guaranty had been forged.  The trial court denied the motion, and the guarantor filed a second Rule 60(B) motion on the same grounds, plus an allegation of negligence on the part of the guarantor’s original attorney.  The trial court denied the second motion as well, and the guarantor appealed.

Operative rule of procedure.  Indiana Trial Rule 9.2(B) provides that, when a complaint is founded on a written instrument (such as a guaranty) and such instrument is filed with the complaint, “execution . . . shall be deemed to be established and the instrument, if otherwise admissible, shall be deemed admitted into evidence in the action without proving its execution unless execution be denied under oath in the [answer] or by an affidavit filed therewith.”  In Weinreb, the Court noted that an attorney’s signature on a general denial does not constitute an oath by which the defendant denies execution of an instrument.  Because the guarantor failed to deny, under oath, that he executed the guaranty, “execution . . . was deemed established by operation of Trial Rule 9.2(B).” 

Summary judgment.  The Court hinted that the defect in the pleadings could have been cured during the summary judgment stage.  Nevertheless, in Weinreb, “the trial court properly presumed execution of [the guaranty] at summary judgment because [the guarantor] failed to introduce in a timely manner any evidence that would support a contrary finding.”  Ultimately:

[the guarantor] failed to respond to [the lender’s] motion for summary judgment within the time limits prescribed by Trial Rule 56(C).  Despite notice and two distinct opportunities to challenge [the lender’s] documentation, [the guarantor] failed to raise his forgery defense at any stage of the proceedings before final judgment was entered against him.

Explanation.  The Weinreb opinion discussed at length the principles and standards applicable to Trial Rule 60(B) motions.  In the final analysis, the Court concluded that “newly discovered” evidence did not exist.  Rather, the guarantor’s failure to use due diligence was the compelling factor.  The Court held:

With this equivocal evidence before it, distilling essentially to a swearing contest that should have been raised long before, the trial court was well within its discretion to reject [the guarantor’s] equitable demands that the trial court set aside the judgment entered against him under Trial Rule 60(B)(8).  [The guarantor’s] second Trial Rule 60(B) motion did not present any grounds that would entitle him to relief from judgment that were unknown or unknowable at the time he filed his first such motion.

Take away.  Borrowers and guarantors, and their counsel, should raise in their initial response to the lender’s complaint the defense of forgery, assuming there is evidence supporting such a defense.  Even if the guaranty was forged in Weinreb, the guarantor (or his lawyer) was too late in asserting the defense.  On the other hand, for lenders and their counsel, the Weinreb is a reminder to attach to the complaint any and all loan documents that form the basis of the action. 

Criminal Bank Fraud As A Collection Tool?

Secured lenders caught up in loan defaults typically pursue the contract-based remedies of damages and foreclosure designed to make lenders whole for their actual losses (unpaid principle balance, interest and attorney fees).  In Klinker v. First Merchants Bank, 964 N.E.2d 190 (Ind. 2012), a lender sought statutory-based treble damages for alleged criminal acts of fraud by a guarantor.  It was an aggressive strategy, but was it worth it?

Default.  Klinker involved a used car dealership that borrowed money from a lender to purchase cars under a floor-plan agreement.  The terms of the loan, which the dealership’s principle guaranteed, required the borrower to pay money to the lender whenever it sold a car.  Also, the borrower could not transfer title without the lender’s consent.  When the lender audited the dealership, it learned that thirty-one cars for which the lender had loaned money were gone.  The borrower had failed to turn over any sale proceeds for the thirty-one cars.   

CVCA.  What was unique about Klinker was the lender’s claims under Ind. Code § 34-24-3-1, known as the Indiana Crime Victims’ Compensation Act (“CVCA”).  The CVCA permits one who suffers a pecuniary (monetary) loss as a result of certain property crimes to bring a civil action against the person who caused such loss.  The victim can recover up to three times its actual damages.  Although a criminal conviction is not required, the plaintiff must prove each element of the underlying crime, including criminal intent. 

Claim 1.  The lender’s CVCA action asserted two fraud claims based on I.C. §§ 35-43-5-4 and 8, which are criminal statutes.  Under the first, the lender could obtain summary judgment only if undisputed facts showed (1) the guarantor (2) concealed, encumbered or transferred property (3) with the specific intent to defraud the lender.  The guarantor transferred financed vehicles without the lender’s knowledge and thus concealed them from his creditor.  This constituted a breach of contract, but did “not lead inescapably to a finding of criminal fraud.”  This is because the lender also must demonstrate undisputed facts showing that the guarantor acted with the requisite “mens rea – the specific intent to defraud.”  There must have been undisputed facts to establish that, when the guarantor made the challenged transfers, “his conscience objective was to cause injury or loss” to the lender by deceit.

Mens rea.  When judgment creditors bring proceedings supplemental to set aside fraudulent conveyances, fraudulent intent may be inferred from the “8 badges of fraud,” about which I have written previously.  In Klinker, the lender designated evidence that established three badges of fraud, but summary judgment was inappropriate due to the absence of the mens rea element:

summary judgment is almost never appropriate where the claim requires a showing that the defendant acted with criminal intent or fraudulent intent.  . . .  This is particularly so for CVCA claims.  The CVCA provides a punitive remedy if the claimant can prove that the defendant violated a penal statute, and, as a punitive measure, it should be strictly construed and applied only where the challenged conduct is clearly proscribed.  Moreover, because CVCA claims combine criminal and civil law, they implicate the state constitutional policy favoring jury intervention in both criminal trials and civil trials.

The Court concluded that “drawing all reasonable inferences in favor of the non-moving party, it is possible that the trier of fact could find a simple breach of contract here instead of criminal fraud, regardless of how strong the badges of fraud may be.”

Claim 2.  As to the second claim, to be entitled to summary judgment the lender must show undisputed facts establishing that (1) the guarantor (2) knowingly (3) executed or attempted to execute (4) a scheme or artifice (5) to obtain the lender’s money or other property (6) by means of false or fraudulent pretenses, representations, or promises, and (7) that the lender is a state or federally chartered or federally insured financial institution.  In Indiana, “a person engages in conduct ‘knowingly’ if, when he engages in the conduct, he is aware of a high probability that he is doing so.”  I.C. § 35-41-2-2(b).  “The fraudulent-conveyance badges of fraud (circumstantial evidence) are not relevant in this context – other circumstantial evidence must be presented.”  In addition to the “knowingly” problem, the lender in Klinkler had a fatal timing issue with this particular claim.  The alleged misrepresentations occurred after the guarantor had obtained the loans.  The fraudulent activity must have been done at the time of execution.

No summary judgment.  The Indiana Supreme Court reversed the trial court’s summary judgment for the lender.  The result reveals at least one drawback of the lender’s aggressive loan enforcement approach - CVCA cases virtually guarantee a trial.  This means that the case will be lengthier and more expensive.  As illustrated by Klinker, although CVCA claims are available to lenders in Indiana, the pursuit of such claims almost certainly will slow down the collection process.

Judgment Deemed Satisfied After Defendant Guarantor Utilizes Strawman To Purchase It

In commercial foreclosure actions, creative parties and counsel often reach unique settlements that satisfy the needs of both the lender and the borrower or guarantor(s). The case of TacCo v. Atlantic Limited Partnership, 937 N.E.2d 1212 (Ind. Ct. App. 2010) shows such creativity in action. TacCo is a lesson in satisfaction of judgments and the strawman defense, but the more interesting facet of the case is the maneuvering between co-guarantors over their shared exposure to a $3.2MM judgment.

Players. I’ll label the key players in TacCo as follows: Lender, Borrower, Strong Guarantor, Strawman and Weak Guarantor. “Strong” and “weak” signify that one of the co-guarantors seemingly had the financial capacity or willingness to pay the debt, while the other did not. Lender initiated a commercial mortgage foreclosure action against Borrower, Strong Guarantor and Weak Guarantor. The suit resulted in a judgment for $3.2MM.

Post-judgment settlement. Before the sheriff’s sale, Lender and Strong Guarantor entered into a settlement agreement that centered on Lender’s sale of the judgment for $1.5MM in cash, a $1.5MM promissory note and a $250,000 letter of credit. On paper, the settlement was conditioned upon Strong Guarantor’s ability to locate a purchaser of the judgment, which purchaser ended up being Strawman. Lender obtained the cash and promissory note, and Strawman obtained an assignment of the judgment. Strawman then submitted a credit bid at the sheriff’s sale for $1.5MM and acquired the subject property.

Purpose. Lender got paid off, but Weak Guarantor was not a part of the deal. Although Weak Guarantor and Strawman submitted conflicting evidence and theories, it appears that the settlement was structured to deliver Strong Guarantor the real estate and to expose Weak Guarantor to judgment enforcement (collection) efforts by Strawman.

Post-settlement motion. After the settlement occurred, Weak Guarantor filed a motion for entry of satisfaction of judgment. See, Ind. Trial Rule 67(B) . Weak Guarantor asserted that the judgment had been paid in full. Strawman contended that the judgment still existed and that, as the assignee of the judgment, it could collect the entire $1.7MM+ deficiency from Weak Guarantor.

Judgment satisfaction rules. The legal issue was whether the intent of the post-judgment settlement transaction was to extinguish the judgment against Strong Guarantor. The Court in TacCo outlined the applicable Indiana legal principles:

1. Payment of a judgment by one of the judgment debtors (defendants) is a satisfaction of the judgment, notwithstanding the fact that an assignment of the judgment is made to such debtor or to someone else.
2. Where a strawman is used by a co-debtor to purchase an assignment of a judgment, the judgment is deemed to have been purchased by one of the joint judgment debtors.
3. The controlling fact in such a case is the payment by one legally bound to pay, and the fact that an assignment is made to him or to someone else is not of controlling importance.
4. If one whose duty is to pay the debt makes the payment, then an assignment will not keep the debt alive.

Judgment satisfied. Without regurgitating all of the detail here, the Court in TacCo followed the money, evaluated the actors’ involvement and concluded that Strawman and Strong Guarantor essentially were the same entity. Here is how the Court of Appeals in TacCo applied the rules to reach its conclusion:

We conclude that the evidence presented to the trial court showed that [Strong Guarantor] made payment to [Lender] to purchase the Consent Judgment and assigned the judgment to [Strawman]. . . . Here, [Strong Guarantor] was a party legally bound to pay the judgment, and the evidence showed that it was the party who made payment to [Lender] for purchase of the judgment. The fact that an assignment of the judgment was made to [Strawman] does not change the fact that such payment resulted in a satisfaction of the judgment. The trial court did not abuse its discretion when it found that [Strong Guarantor] used [Strawman] as its strawman to purchase the Consent Judgment and deemed that the judgment had been satisfied.

Result. The upshot was that the judgment no longer existed, and Weak Guarantor’s exposure to the full $1.7MM+ deficiency disappeared. Strawman thus could not enforce the judgment against Weak Guarantor.

Arguably, Strong Guarantor still might have a contribution claim against Weak Guarantor for a pro rata portion of the deficiency ($850,000+), but the Court did not address that issue. In the end, the settlement structure in TacCo was a creative design for Strong Guarantor that didn’t quite work.

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.)

To Be Enforceable, An Indiana Mortgage Must Adequately Describe The Debt It Purports To Secure

It’s pretty rare to read a case in which a court renders a commercial mortgage invalid.  But that’s what happened in SPCP v. Dolson, 2010 Ind. App. LEXIS 1852 (Ind. Ct. App. 2010) (.pdf).  Secured lenders beware:  if your mortgage contains an inaccurate and materially misleading description of the debt, you will lose your foreclosure remedy.

Purported mortgagor was a surety.  In SPCP, the alleged mortgagor, Holland, owned real estate that she leased to Dolson, a company that operated a pub.  The lease provided that Holland and Dolson could participate in a mortgage loan related to the real estate.  In fact, a lender, SPCP, made a $700,000 loan to Dolson.  The Dolls (officers in Dolson) and Thompson (Mrs. Doll’s father) guaranteed the loan.  Holland co-signed a mortgage with Dolson in favor of SPCP.  Holland did not, however, review or sign the underlying promissory note.   

Mortgages 101.  The SPCP opinion outlined the basic statutory requirements for a valid mortgage in Indiana (Ind. Code § 32-29-1-5).  A mortgage must recite both (1) the date for repayment and (2) one or more of:  (a) the sum for which it is granted; (b) the notes or evidences of debt; or (c) a description of the debt sought to be secured.  Mortgages must also be dated and signed, sealed and acknowledged by the grantor. 

Debt description.  With regard to the accuracy of the debt description, Indiana cases say:

literal accuracy in describing the debt secured by the mortgage is not required, but the description of the debt must be correct, so far as it goes, and full enough to direct attention to the sources of correct information in regard to it, and be such as not to mislead or deceive, as to the nature or amount of it, by the language used.  . . .  A reasonably certain description of the debt is required so as to preclude the parties from substituting debts other than those described for the mere purpose of defrauding creditors.

SPCP refined this summary of the law into a two-part test:  (1) whether the debt description was inaccurate and (2) whether the inaccuracy was sufficiently material to mislead or deceive the grantor/mortgagor as to the nature or amount of the debt. 

The inaccuracy.  The mortgage signed in SPCP secured debt “incurred under the terms of ‘a’ Promissory Note dated December 27, 2001 executed by Dolson, the Dolls and Thompson and maturing December 27, 2021.”  This accurately described the date of execution of the subject note and the maturity date but inaccurately described the identity of the note’s makers.  Thompson did not execute the note.  He signed a guaranty.  The Court held that the mortgage’s description of the debt was inaccurate. 

Materially misleading.  Moreover, the Court, in affirming the trial court’s summary judgment for Holland, concluded that the inaccuracy was sufficiently material so as to mislead Holland.  The Court articulated three reasons for its decision, all of which centered on the role of Thompson:

     1. Release.  After Dolson defaulted on the loan, SPCP settled with Thompson for $550,000 and released him from liability.  Holland, in agreeing to the mortgage, acted only as a surety pledging collateral to secure the loan of Dolson.  If Thompson had been liable on the note as a primary obligor (a maker), and not a guarantor, then any release of Thompson would, under Indiana law, have released Holland and her real estate.  Because Thompson was only a guarantor and thus a co-surety with Holland, the release of Thompson did not have that effect. 

     2. Subrogation.  Thompson’s status as guarantor, instead of co-maker of the note, changed Holland’s recourse against Thompson.  Under Indiana law, sureties have the right to complete reimbursement and subrogation from makers.  As only a co-surety, Thompson, at most, was exposed to Holland for Holland’s pro-rata contribution to the debt.  Thus the loan structure increased Holland’s risk of loss.  (I discussed suretyship law on 5-23-07.)

     3. Detrimental reliance.  Holland testified it was her understanding that her real estate would be subject to foreclosure only if the Dolls and Thompson failed to pay the debt.  Holland therefore relied to her detriment on the mortgage’s inaccurate description of Thompson as a co-maker.  Holland claimed that she would not have signed the mortgage had she known that Thompson was only a guarantor. 

Over the last few years, I have seen a handful of cases like SPCP in which the mortgagor was not the borrower but merely a pledgor of real estate.  In those cases, unlike SPCP, the language in the mortgage clearly connected the mortgage with the note.  The loan documents in SPCP lacked that clarity, and the alleged mortgagor was able to seize on the inaccuracy to save her commercial real estate from foreclosure.

Indiana Only Requires The Guarantor To Sign A Guaranty

Secured lenders pursuing guaranty enforcement actions sometimes face resistance from guarantors despite clear and well-written guaranties.  Guarantors may go to great lengths to avoid a judgment.  The recent Indiana Court of Appeals case of Grabill Cabinet Company, Inc. v. Sullivan, 919 N.E.2d 1162 (Ind. Ct. App. 2010) (.pdf ) appears to be one of those cases, but the ultimate decision favors creditors.

What happened.  Plaintiff Supplier sued defendant Individual, who was once a manager and member of LLC.  In 2006, LLC submitted a credit application to Supplier, and Individual signed a guaranty of the LLC debt owed to Supplier.  Individual signed in her personal capacity.  Individual subsequently assigned her interests in LLC and resigned from the company.  A couple years later, LLC ordered product from Supplier for which LLC failed to pay.  This resulted in a lawsuit in which Supplier named Individual as a defendant based upon her guaranty. 

General guaranty law.  The Court’s opinion has a nice summary that defines a guaranty and a continuing guaranty, as well as an outline of the general rules applicable to the liability of a guarantor.  If you or your counsel need to learn more about the basics of guaranties, click on the .pdf of the decision I’ve provided above.

The defense.  Individual’s primary defense was that Supplier needed to sign the guaranty in order for it to be valid and enforceable.  She also argued that the guaranty should have been automatically terminated upon her disassociation with LLC.  The trial court bought the argument.  The Court of Appeals didn’t. 

The Statue of Frauds.  The Court found no Indiana case law supporting the proposition that, for a guaranty to be valid, it must be signed by the primary debtor and/or the creditor.  The Court focused upon Indiana’s Statute of Frauds, Ind. Code § 32-21-1-1(b), which states in pertinent part:

  A person may not bring any of the following actions unless the
  promise, contract, or agreement on which the action is based, or
  a memorandum or note describing the promise, contract, or
  agreement on which the action is based, is in writing and signed
  by the party against whom the action is brought or by the party’s
  authorized agent:

   (2)  An action charging any person, upon any special promise, to answer for the debt, default, or miscarriage of another.

The holding.  The Court concluded:  “although the Statute of Frauds requires a guaranty to be in writing, only the ‘party against whom the action is brought’ need sign it, and that requirement has been met here.”  The Court also found the language in the guaranty to be consistent with the outcome.  The Court was, indeed, emphatic that, for a guaranty to be valid and enforceable, a guaranty need not be signed by anyone other than the guarantor. 

Of interest.  Supplier initiated its collection action on August 10, 2008.  The date of the Court of Appeals decision reversing the trial court was January 14, 2010, almost one-and-a-half years after the filing of the case.  The case still needed additional trial court proceedings to adjudicate Supplier’s damages.  My point – bear in mind that Indiana collection cases, including mortgage foreclosure actions, are like any other lawsuit, which can be full of unexpected delays and expense.

Impairment Of Collateral Defense Denied

If your financial institution is seeking to collect a business debt from a guarantor that is asserting an “impairment of collateral” defense, the recent decision by the Northern District of Indiana in LEAF Funding v. Brogan, 2009 US Dist. LEXIS 65203 (N.D. Ind. 2009) (Leaf.pdf) should help you understand the defense and help you convince the guarantor that the defense may not apply. 

The situation.  Plaintiff LEAF, equipment lessor (lender), sued defendant Brogan, equipment lessee, for breach of a medical equipment lease.  Dines, also a named defendant, was the guarantor of the lease.  Brogan had defaulted on the lease for a failure to make payments.  LEAF had been unable to repossess the equipment, as allowed under the lease, because Brogan’s landlord had changed the locks to Brogan’s plant.  And a court order arising out of a separate state court lawsuit froze all of Brogan’s assets, which order contributed to LEAF’s inability to repossess the equipment.

The argument.  Dines’ only contention in response to LEAF’s motion for summary judgment was that LEAF impaired the collateral (the equipment) when LEAF “failed to take timely possession of and to promptly liquidate the leased property after Dines made two phone calls to LEAF requesting that LEAF make arrangements to come and retrieve the Equipment.”  Dines sought to be discharged from liability.

The defense, generally.  LEAF identified several Indiana points of law applicable to the defense:

 The guarantor’s liability [could be] discharged if the facts establish that the creditor’s conduct unjustifiably impaired the collateral securing the debt.

 The guarantor has the burden of proving the impairment (damage/loss of value), and impairment to the collateral is a necessary element of the defense.

 When a creditor releases or negligently fails to protect security put in his possession by the principal debtor, the surety is released to the extent of the value of the security so impaired.

Indiana case law focuses on the conduct of the creditor.  The creditor (the plaintiff) must have acted improperly and caused harm to the collateral.  Absent a reduction in value of the collateral attributable to the creditor, the defense will not apply.  The Court also cited to the UCC at Ind. Code § 26-1-3.1-605(g), which says that impairing value of an interest in collateral includes:

 (1)  failure to obtain or maintain perfection or recordation of the interest
 in collateral;
 (2)  release of collateral without substitution of collateral of equal value;
 (3)  failure to perform a duty to preserve the value of collateral owed,
 under IC 26-1-9.1 or other law to a debtor or surety or other person
 secondarily liable; or
 (4)  failure to comply with applicable law in disposing of collateral.

No discharge.  While some Indiana cases suggest that the guarantor’s debt can be fully discharged upon proof of the defense, in actuality Indiana law provides that the guarantor will only be released “to the extent of the value of the security so impaired.”  Indiana favors a “pro tanto [for so much] approach that measures the amount of the impairment at the time of default” as opposed to allowing for a complete discharge of any liability.

Not applicable in LEAF.  After taking inventory of Indiana’s rules and policies applicable to the impairment of collateral defense, the Court in LEAF concluded that the defense should fail and that Dines remained jointly and severally liable to LEAF for the damages resulting from Brogan’s breach.  The inaccessibility of the collateral was not the result of actions taken or caused by LEAF, which was unable to repossess the equipment due to circumstances outside of its control.  Moreover, the lease specifically provided that Brogan had an obligation to deliver the equipment to LEAF upon default.  LEAF had no duty to retrieve the equipment at Brogan’s request.  Finally, none of the UCC § 605(g) elements were present in LEAF. 

Guarantors in lien enforcement cases may try to duck or delay collection efforts by asserting the impairment of collateral defense when, in my view, the defense should only apply in very limited circumstances in which the plaintiff/lender/creditor has actually caused harm to the collateral while the collateral was in its possession or control. 

Indiana Guaranties Enforced In Note/Renewal Context

As previously posted here, there can be obstacles, under Indiana law, to obtaining a quick and inexpensive judgment against a guarantor.  Fortunately for lenders, on April 30, 2009 the Indiana Court of Appeals decided TW General Contracting Services v. First Farmers Bank and Trust, 2009 Ind. App. LEXIS 735 (Ind. Ct. App. 2009) (.pdf), which should help in overcoming some of those obstacles.

The players.  TW General Contracting involved the standard cast of characters in a commercial loan:  a lender, a borrower and a handful of guarantors.  The guarantors argued that their initial personal guaranties should not apply to the subsequent promissory notes. 

The loans and renewals.  Here is a summary of the relevant loan transactions with the borrower:

 05/11/05 Note #1 delivered; guarantors each signed a guaranty

 06/13/06 Note #1 renewed by Note #2

 03/06/07 New Note (#3) delivered

 06/01/07 New Note (#4) delivered; Note #1 renewed by Note #5

 09/21/07 Note #1 renewed by Note #6

The lawsuit against the borrower and the guarantors concerned defaults on three notes – Note #6 (renewal of Note #1), Note #3 (new note) and Note #4 (another new note).  Guaranties were only signed in connection with Note #1, however, back on May 11, 2005.

Material alteration?  In the plaintiff lender’s motion for summary judgment, the defendant guarantors asserted that the execution of the three new notes materially altered the guaranties and, as such, the lender’s claims had no merit.  For more about the “material alteration” defense, please click on my prior posts of 01/10/09 and 03/23/07.  In support of their theory, the guarantors submitted an affidavit from one of the guarantors stating/contending:

 ● The guarantor did not intend to personally guarantee the new notes.
 ● The new notes were unrelated to the 2005 obligations.
 ● The guarantor informed the lender that the new notes were for an independen project and that he would not personally guarantee the 2007 loans.
 ● The guarantor did not intend or contemplate that the 2005 guaranties would be applicable to the subsequent notes.
 ● The loans of 2005 had been satisfied and the accounts closed.
 ● It was the guarantor’s understanding that personally guaranteeing further loans would require the signing of a new guaranty.
 ● The new notes were not within the scope of what was contemplated by the guaranties when they were executed.
 ● The guarantor never consented to guaranteeing the new notes and was never given any consideration for doing so.

In short, the guarantors argued that “material alterations as a result of [Notes #6, #3 and #4] were not within their contemplation when they executed the guaranties.”  The Court of Appeals, in a pro-lender opinion, slammed the door shut on the guarantors.

Language fatal.  In its detailed and thoughtful opinion, the Court sliced and diced the language in various provisions in the guaranties.  The terms showed the guarantors “entered into unmistakable, very expansive guaranties to ‘induce’ the Lender to make loans to [borrower], the S-Corporation in which they are sole shareholders.”  The subsequent notes were signed by at least one of the four guarantors, albeit in their corporate (not individual) capacity.  “As such, the additional obligations to [borrower], and in turn the Guarantors, could not have come as a complete surprise . . ..”  The Court of Appeals was emphatic in its decision: 

  pursuant to the clear, extremely global language of the Guaranties,
  these additional obligations could hardly be characterized as
  material alterations but rather as a logical continuation of the
  mutually beneficial lender-borrower-guarantor arrangement.

Bullet dodged.  The circumstances in TW General Contracting were not unique.  These renewal/new note scenarios, which rely on prior guaranties, are out there.  Fortunately for lenders, the Court of Appeals’ opinion in TW General Contracting establishes strong legal precedent enabling lenders to overcome the “material alteration” defense.  Perhaps not all guaranties will have such definitive language, but the case’s fundamental holding should be of great help to lenders in their motions for summary judgment.

Even though the Court of Appeals affirmed the trial court’s summary judgment in favor of the lender, it is still advisable, when renewing notes or making subsequent notes, to have a new guaranty signed or at least to have a signed document (our firm uses a “Consent and Confirmation of Guaranty”) acknowledging that the prior guaranty remains in force.   

“Material Alteration” Defense Rejected In Indiana Guaranty Enforcement Action

Today we build upon my March 23, 2007 post entitled “Liability Of Guarantors Or Accommodation Parties When The Original Obligation Is Materially Altered.”  That post discussed Keesling v. T.E.K. Partners, 2007 Ind. App. LEXIS 358 (Ind. Ct. App. 2007), where the Indiana Court of Appeals held that the guarantor was released from liability.  Confronted with a different set of facts, on December 10, 2008 Magistrate Judge Nuechterlein of the Northern District of Indiana ruled the opposite way, concluding that the defendant guarantor did not provide sufficient evidence to establish a release.  Conn-Selmer, Inc. v. Bamber, 2008 U.S. Dist. LEXIS 99921 (N.D. Ind. 2008) (ConnSelmer.pdf).  Keesling and Conn-Selmer are good reads for secured lenders who may be struggling with a guarantor’s contention that the underlying loan transaction was materially altered so as to release the guarantor from liability.

The parties.  Selmer Company was the lender.  The defendant/borrower was Woodwind, and the defendant/guarantor was Bamber.  Selmer Company provided credit to Woodwind.  Bamber executed a personal guaranty in favor of Selmer Company to cover repayment of the credit.  The security agreement between Selmer Company and Woodwind stated that the “guaranty shall, without further consent of or notice to the undersigned, pass to, and may be relied upon and enforced by any successor or assignee of [Selmer Company] and any transferee or subsequent holder of any indebtedness, liability or obligation.”  After the execution of the underlying security agreement and guaranty, Selmer Company changed ownership several times.  Plaintiff Conn-Selmer was the party that ultimately sued Bamber.

Guarantor’s contention.  Bamber did not dispute execution of the personal guaranty or the terms and conditions of the guaranty.  Rather, he argued that, since the liabilities under the security agreement had changed over time, he was relieved from liability under the guaranty. 

Basic rule.  Magistrate Judge Nuechterlein noted that, in Indiana, it is a general rule that:

when the principal and obligee cause a material alteration of the underlying obligation without the consent of the guarantor, the guarantor is discharged from further liability.  A material alteration which will effect a discharge of the guarantor must be a change which alters the legal identity of the principal’s contract, substantially increases the risk of loss to the guarantor, or places the guarantor in a different position.

Insufficient evidence of lack of consent.  The Court decided the Conn-Selmer case in the context of a motion for summary judgment filed by plaintiff Conn-Selmer.  In response to Conn-Selmer’s motion, Bamber was compelled to provide evidence of the material alteration and whether it was without his consent.  While the Keeling decision analyzed, and rested upon, the “material alteration” element of the defense, the Conn-Selmer decision centered upon the “lack of consent” element:

Bamber offers documentation of a few communications made between Bamber and the various successors of the Selmer Company memorializing agreed changes to the credit repayment rates and deadlines.  However, three of these documents addressed Dennis Bamber personally, and one was drafted by Dennis Bamber himself.  Further, each appears, in substance, to confirm agreements made between the Selmer Company and Dennis Bamber, on behalf of Woodwind.  As such, Bamber cannot argue that he was not privy to any changes made to the underlying security agreement.  Indeed, these documents attest that Bamber was simultaneously fulfilling both roles as “obligee” on the debt, in his professional role as head of Woodwind, and as “guarantor” under the ongoing security agreement.  Consequently, Bamber cannot, and indeed does not, argue that he did not consent to any asserted changes made to [the] security agreement.  Because lack of consent is a necessary element to relieve Bamber of liability under the personal guaranty, this Court concludes that Bamber has not provided sufficient evidence to establish release from liability under the guaranty.

Bamber was unable to prove that any material alteration of the underlying obligation was without his consent so as to discharge him from personal liability.  One of the lessons for secured lenders who may be pursuing a guaranty enforcement action in Indiana is to review your files for evidence showing that the guarantor consented to any alterations to the note/security agreement.  Armed with any such evidence, you should be able to defeat the material alteration defense as Conn-Selmer was able to.

Guarantor Contribution Claims And The Meaning Of “Joint And Several Liability”

If by chance you want to learn about contribution claims between guarantors, I recommend reading the September 29, 2008 opinion in Balvich v. Spicer, 2008 Ind. App. LEXIS 2117 (Ind. Ct. App. 2008) (Balvich.pdf).  The Court details Indiana’s laws of contribution, including the applicable statute of limitations.  Although contribution does not directly concern secured lenders, the related concept of joint and several liability does. 

Contribution, generally.  A suit for contribution involves the partial reimbursement of one who has discharged a common liability.  “The doctrine of contribution rests on the principle that where parties stand in equal right, equality of burden becomes equity.”  The right of contribution “operates to make sure those who assume a common burden carry it in equal portions.”  As a basic example, if one of three guarantors paid a lender $100,000 to satisfy a deficiency judgment, then that guarantor could sue the other two guarantors to recover their pro rata portion of the $100,000.

Joint and several liability, defined.  As I read through the Balvich case, it occurred to me that it might be useful to explain what “joint and several” liability means.  If you deal with commercial foreclosures, you may be familiar the “joint and several” terminology in the context of a judgment against multiple guarantors.  When a court enters a money judgment against more than one guarantor, one will see language like:

Lender hereby is granted judgment in its favor and against the defendants, Guarantor I, Guarantor II, and Guarantor III, jointly and severally, with regard to the Guaranties, in the amount of . . ..

There were multiple guarantors in Balvich.  The Court of Appeals, relying upon Indiana Trial Rule 54(E), noted generally that a judgment against two or more persons, jointly and severally, permits “enforcement proceedings jointly or separately against different parties or jointly or separately against their property.”  The all-important Black’s Law Dictionary defines “joint and several liability” as:

A liability is said to be joint and several when the creditor may sue one or more of the parties to such liability separately, or all of them together at his option.  A joint and several . . . [promissory] note is one in which the obligors or makers bind themselves both jointly and individually to the obligee or payee, so that all may be sued together for its enforcement, or the creditor may select one or more as the object of his suit . . ..

Significance of joint and several liability to secured lenders.  In a case of joint and several liability among multiple guarantors, lenders can pick and choose which guarantors to go after for the entire amount owed.  For example, if there are three guarantors, but investigation discloses that two of them are judgment proof, one can opt to chase only the solvent guarantor for all of the unpaid debt.  Plaintiff lenders in Indiana would not be required to sue all three, and lenders would not be limited to a recovery of a specific co-guarantor’s pro rata portion. 

Jurisdiction Over Out-Of-State Guarantors

In what state can a commercial lender bring its case against an out-of-state guarantor of an Indiana loan?  Judge David Hamilton of the Southern District of Indiana helps answer this question in Automotive Finance v. Aberdeen Auto Sales, 2007 U.S. Dist. LEXIS 60136 (S.D. Ind. 2007) (AutomotiveOpinion.pdf), in which he denied a motion to dismiss filed by a Mississippi defendant/guarantor in an Indiana commercial collection action. 

The status.  Plaintiff lender (Automotive Finance) filed an Indiana federal court foreclosure case against defendant borrower (Aberdeen), a Mississippi entity, for breach of an auto dealer floor-plan financing contract intended to support Aberdeen’s Indiana operations.  In addition to naming Aberdeen as a defendant, the lender named a Mississippi citizen who had guaranteed the deal.  The guarantor (Mitchell) filed a motion to dismiss for lack of personal jurisdiction, asserting that the lender could only sue her in Mississippi to pursue damages based on the guaranty.

The issue.  One of the questions in the case was whether Mitchell’s guaranty of an Indiana debt was sufficient to justify the exercise of specific jurisdiction over her in Indiana.  Mitchell’s only tie to Indiana was that she signed the guaranty – in Mississippi.  She did not communicate with anyone in Indiana or travel to Indiana in connection with the deal.  She received no compensation from the business borrower for the floor-plan financing.  “If the court has jurisdiction over Mitchell, it must be based on the guaranty for the benefit of [borrower], which Mitchell admits she signed.”  Id. at 4. 

The guaranty.  The language of the guaranty was somewhat unique.  Mitchell explicitly agreed in the guaranty to submit to the personal jurisdiction of Indiana.  The guaranty also provided that it shall be governed by Indiana law.  (It also should be noted that Mitchell was a director and/or officer of the borrower.)

The jurisdiction lesson.  Indiana extends its personal jurisdiction to the full extent of the due process clause of the Fourteenth Amendment.  Under applicable constitutional principles and Indiana case law, Judge Hamilton held that the court could exercise personal jurisdiction over the Mississippi guarantor: 

  Plaintiff and the defendants entered into a substantial and
  long-term commercial financing relationship in which a
  lender in Indiana extended credit to a borrower in Mississippi,
  with guaranties from other Mississippi residents, including
  Mitchell.  As part of the guaranty, Mitchell agreed to jurisdiction
  and venue in Indiana.  Based on the clear terms of the guaranty,
  Mitchell obviously had “fair warning,” . . . that she could be sued
  in Indiana with respect to this transaction.  She could reasonably
  anticipate that she would be “haled into court” in Indiana in
  disputes arising out of the guaranty.  The guaranty itself told her
  that she was agreeing to precisely that possibility.  She also
  agreed that if she filed suit herself relating to the guaranty, she
  would file it in Marion County [Indianapolis], Indiana.

Id. at 5.  Judge Hamilton further reasoned that, because the borrower was subject to jurisdiction in Indiana, Mitchell’s guaranty was presumably “an essential term of [lender’s] agreement to extend $100,000 in credit to a corporation whose creditworthiness was uncertain.”  Id. at 7.  From the perspective of the lender, Judge Hamilton concluded, it made “good sense” to secure the agreement of all parties to the transaction so that any lawsuit arising from it could be heard in one venue with all interested parties, including guarantors.  Without such an agreement, credit would be more difficult and expensive to obtain.  Id. 

The upshot.   Automotive Finance is a favorable decision to creditors with Indiana deals involving out-of-state guarantors.  Depending upon the facts of the particular case, Judge Hamilton’s opinion supports the notion that, even though guarantors may have little-to-no contacts with Indiana, the mere fact that the individual guaranteed a loan for an Indiana project may be sufficient to subject that individual to jurisdiction here. 

Normally, it’s in the best interests of lenders to avoid the need to file suits in multiple states for the same debt.  Secured lenders are thus advised to utilize the language mentioned in the Automotive Finance guaranty – that is, have the guarantor stipulate to personal jurisdiction and venue in Indiana (or wherever the loan collateral is).  Without such an express statement, winning the jurisdictional battle may be more difficult. 

IRISH V. WOODS: Which Surety Was Left Holding the $500,000 Bag?

A secured lender’s primary source of recovery when a project goes bad usually is the loan collateral.  Secondary sources could be the assets of a guarantor, a surety or an accommodation party, labels that often are used interchangeably to describe a person who signed a loan document but who did not directly benefit from the loan.  (See, March 23, 2007 post, Liability of Guarantors or Accommodation Parties when the Original Obligation Is Materially Altered).  The April 24, 2007 decision by the Indiana Court of Appeals in John T. Irish v. F. Lawrence Woods, 2007 Ind. App. LEXIS 786 (IrishOpinion.pdf) addresses some general rules applicable to these secondary sources and also provides a good suretyship vocabulary lesson. 

Backdrop.  Plaintiff Irish and defendant Woods formed LLC.  Lender Old National Bank loaned LLC about $500,000.  Both LLC and Irish were named borrowers on the note, but Irish did not directly benefit from the loan.  Only LLC did.  Woods guaranteed the note and, interestingly, also signed a separate guaranty of Irish’s debt under the note.  LLC defaulted but evidently was judgment proof.  Irish settled with Old National for the total amount due by purchasing the note.  Irish then sued Woods for the debt, claiming Woods was liable as the guarantor of the note.  Irish also asserted a contribution claim against Woods based on the guaranty of Irish’s obligation under the note. 

7 things to know about Indiana suretyship law. 

1. A borrower is a “principal obligor” – here, the LLC.  Id. at 6.

2. When a party places a signature on a note solely for the benefit of another party, and without receiving any direct benefit, he or she is an “accommodation party” – here, Irish.  Id. 

3. An accommodation party is considered a “surety.”  When the term surety refers to a person, it is a person who is liable for the payment of a debt, or performance of a duty, of another person.  Id.  (The words “guaranty” and “guarantor” are synonyms for “suretyship” and “surety.”  Id. at 7, n.4.)   

4. The liability of an accommodation party only is relevant in the event of a default by the accommodated party.  Ind. Code § 26-1-3.1-419(e).  In such event, the accommodation party’s suretyship status allows him to seek reimbursement from the accommodated party.  As a party with recourse against another party, the accommodation party’s suretyship status is equivalent to that of a “secondary obligor.”  Id.

5. A “cosuretyship” occurs when two secondary obligors agree that, as between themselves, each should perform part of its secondary obligation or bear part of the cost of performance.  The test of cosuretyship is a common liability for the same debt or burden.  Id. at 8-9.

6. A “subsuretyship” occurs if two secondary obligors agree that, as between themselves, one (the ‘principal surety’ – here, Irish) rather than the other (the ‘subsurety’ – here, Woods) should perform or bear the cost of performance.  Id. at 9.

7. Whether a particular party is a cosurety with, or a subsurety to, another party affects rights of contribution.  The right of contribution operates to make those who assume a common burden bear it in equal proportions.  In a cosuretyship, one cosurety is entitled to contribution from the other cosureties so that all cosureties bear the burden in equal, or otherwise agreed to, proportions.  With regard to subsuretyships, if the principal surety performs on the obligation, it is not entitled to contribution from a subsurety.  But, if the subsurety performs on the principal obligation, the subsurety is entitled to reimbursement from the principal surety.  Id.

The upshot.  The lender, Old National, was well-served by having Irish co-sign the note.  Even though the direct beneficiary of the loan (the LLC) defaulted, Old National evidently still recovered the debt from Irish, an accommodation party.  There was no need for Old National to pursue the guarantor, Woods.  Because Irish anted up, Woods got off scot-free.

Irish, as principal surety, “purchased” the note for the amount of his liability and then sought to enforce the guaranty of Woods, the subsurety.  But a principal surety cannot “purchase” his own debt and unilaterally create liability for a subsurety, who would not otherwise be liable.  Id. at 13.  The Court also determined that Woods, as guarantor of the note, only was secondarily liable.  Irish, as principal surety, was primarily liable for the cost of performance on the note.  In other words, in what may have been a close call for the Court, the judges ruled that the note’s co-signor (Irish) was on the hook but that the note’s guarantor (Woods) was not.

LIABILITY OF GUARANTORS OR ACCOMMODATION PARTIES WHEN THE ORIGINAL OBLIGATION IS MATERIALLY ALTERED

On February 28, 2007, the Indiana Court of Appeals decided a case about the personal liability of guarantors/accommodation parties in Keesling v. T.E.K. Partners, 2007 Ind. App. LEXIS 358.  If you’re a lender that modifies deals, or enforces loans that have been reworked, Keesling is instructive.

Background.  In Keesling, an Indiana commercial foreclosure case, there were multiple parties to an installment note and mortgage related to the development of a residential neighborhood.  Three entities and four individuals in their personal capacities signed the original note of $300,000.  (There were no guaranties.)  When the note came due, there was approximately $50,000 left to be paid.  Some, but not all, of the original parties entered into a second note that took into consideration the balance remaining of the original note and about another $50,000.  The parties to the second note ultimately defaulted, and the plaintiff assignee, who held the note and mortgage, sued everyone, including the original signatories.  The defendants relevant to this article did not know about or consent to the execution of the second note.  They contended that they merely were accommodation parties on the original note and that, because the second note constituted a material alteration of the original obligation, they should be discharged from further personal liability under either note.  The Court agreed.

Guarantor vs. accommodation party.  The Indiana Court of Appeals labeled the individuals who signed the original note in their personal capacity as “accommodation parties” pursuant to the definition in Indiana’s UCC, Article 3.1:  I.C. 26-1-3.1-419.  An accommodation party, according to the Indiana UCC, is someone who signs an instrument for the purpose of incurring liability on the instrument without being a direct beneficiary of the value given for the instrument.  Keesling at 7.  As a practical matter, particularly for purposes of enforcement, an accommodation party essentially is the same as a guarantor, the primary difference being that a guarantor signs a separate instrument – a guaranty.  (Also, accommodation parties, sometimes called co-makers or co-borrowers, may have available to them common law surety defenses - a topic I’ll tackle another day.)  The Court in Keesling concluded that the subject defendants signed the original note but were not direct beneficiaries of the value given for the instrument.  So, the Court deemed them to be accommodation parties, although the opinion also referred to them as guarantors and applied general guaranty law.   

Material alteration.  The Court noted that, generally, a guaranty is a promise to answer for the debt and default of another.  When parties cause a material alteration of an underlying obligation, without the consent of the guarantor, the guarantor is discharged from further liability.  Indiana defines a material alteration as a “change which alters the legal identity of the principal’s contract, substantially increases the risk of loss to the guarantor, or places the guarantor in a different position.”  Keeling at 6-7.

The Keesling illustration.  The plaintiff basically tried to characterize the second note as a refinance of the original note.  Not so fast, said the Court.  The second note purported to add accounts payable of other parties, and it capitalized interest due on the original note.  “In itself, this capitalization of interest was a material alteration.”  Id. at 10-11.  So, the second note not only added new debt but increased the total principle draws beyond the original amount of the note.  Significantly, the alterations occurred without the knowledge or consent of the parties alleged to be personally liable.  The Court held that the alterations were material and that the defendants were “not chargeable with the second note, a new agreement which did not include their signatures.”  Id. at 13.  The Court also discharged the defendants from any liability as to the original note. 

Morals of the story.  If as a lender you intend to refinance or modify the original deal, each and every party you want to answer for the debt should sign off on the new loan documents.  This is particularly true if you materially alter the original obligation.  The lesson is a simple one and, maybe to most of you reading this, an obvious one – get the guarantors to sign another guaranty or get the accommodation parties to sign the second note.  Lenders should view the matter as an entirely new transaction. 

On the flip side, if you’re a lender who acquired, perhaps through an assignment, a loan that has been modified in some fashion, as was the case in Keesling, you should research and identify all individuals that might be deemed accommodation parties or guarantors.  Because your institution may not have originally documented the transaction, obtain all the loan papers and study the deal’s history.  If there was not a material alteration of the original debt, missing signatures or guaranties may not be fatal.  To maximize your financial recovery, you should consider the possibility of pursuing anyone who signed any of the loan documents prepared throughout the life of the deal.

ALLEGED GUARANTORS NEED NOT PROVE A NEGATIVE

In my January 16 post, The Commercial Lender's 8-Item Care Package for its Foreclosure Attorney, I recommend (as item number one) that all applicable loan documents be provided to outside counsel.  This would include any guaranty that was a part of the loan transaction.  As most of you reading this blog know, it is not uncommon for some business loans to have a personal guaranty, which specifically requires an individual to guarantee the financial obligations undertaken by the business.  In other words, the guarantor becomes secondarily liable for the business debt and, as such, will invariably be named as a defendant in the foreclosure suit.   

Although it may seem obvious, the plaintiff lender has the burden of proving the existence of the guaranty.  Without such evidence, a claim against a guarantor will fail, which is exactly what happened in a February 16, 2007 ruling by United States Magistrate Judge Andrew P. Rodovich for the Northern District of Indiana in Case No. 2:97 cv 276, United Consumers Club, Inc. et. al. v. Mark Bledsoe, et. al., 2007 U.S. Dist. LEXIS 11489.  Although the case involved the breach of a franchise agreement, not a promissory note, the holding applies with equal vigor to lenders:

If [plaintiff] is to maintain a claim based upon the execution of a written instrument, their initial burden of providing evidence of the document's existence cannot be shifted by requiring [defendants/alleged guarantors] to prove its non-existence....  [T]here is no evidence before the court that [defendants/alleged guarantors] signed a personal guaranty.  Accordingly, summary judgment is proper in favor of [defendants] on [plaintiff's] claim for breach of the personal guaranty.

The opinion does not specify whether someone lost the guaranty or whether there never was a guaranty in the first place.  The obvious point is - if as a lender you want to sue on a guaranty, you need to produce the written instrument, preferably to your attorney before suit is even filed.  Simply alleging a guaranty existed won't cut it - alleged guarantors are not required to prove a negative in order to prevail.