When is a Guarantee Not a Guarantee?

Guarantees provide lenders with security and instill motivation in borrowers. Even with iron-clad loan documentation, however, a lender may be faced with a litigious and creative guarantor seeking to undo the very language of the guarantee document. The arguments are typically presented in two forms: discharge or counterclaim.

Lenders are occasionally horrified to learn that they have taken some action on a loan, but failed to get written approval of all the guarantors. This may not be realized until lawyers are involved, dissecting the loan file.

Several important points for a lender to consider should include:

• Are guarantors made a party to the forbearance agreement?
• When additional time for an installment payment is extended, do you notify the guarantors and obtain their consent?
• Do you release (intentionally or accidentally) any collateral (financing statement expired, insurance lapsed, allow a partial release)?

If so, you may jeopardize your ability to enforce the guarantee because of the doctrine of discharge.

The law imposes duties on guarantors to live up to their obligations, but not to take on additional risk. If the lender materially alters the nature of the risk, or deprives the guarantor of the ability to protect himself/herself/itself given the change in the status of collateral, the law discharges the guarantor to the extent of the increased risk. This can be a complete discharge of the obligation to pay.

To avoid this headache, a lender should always include the signature of the guarantors on any forbearance agreement or default notice. Forbearance agreements should contain acknowledgments of defaults and waivers of all claims. Courts remain skeptical of discharge claims, but carefully documenting default and forbearance agreement with guarantor signatures will help you avoid the argument.

Even when you carefully include broad waivers of claims in your guarantees, you should beware of the fraud or 'good faith' counterclaim. The law is clear that an unambiguous guarantee will be enforced, with waivers of claims receiving great respect. Nevertheless, whenever discretion is involved, the courts have reserved fraud or breach of the duty of good faith and fair dealing from a waiver's power. If you have a simple note and guarantee, with no discretion involved and an underlying general business transaction, the courts have resisted such claims.

In one case, a personally guaranteed car dealership loan was enforced despite claims of fraudulent disposition of collateral and breach of the duty of good faith and fair dealing. The guarantees contained broad waivers of all claims and there was no discretion exercised by the lender in disposing of collateral. In another case, however, the trial court allowed claims for fraud and breach of the duty of good faith and fair dealings where the guarantors cited specific examples of the lender's discretionary acts. The courts ignored the express provisions of the waivers contained in the guarantees in both these cases.

These cases and circumstances share a common theme. Guarantors and their lawyers should carefully examine every word of the loan documents and every action taken before, during and after an event of default. Careful scrutiny of the loan documents and procedures are only half the battle. The strategy taken by the lender in defense of any counterclaim or affirmative defense will also affect the outcome.

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