United States: Some Ideas To Protect The Guarantor

Every real estate developer has signed a guaranty. And every real estate developer knows that, once you make the business deal about whether the guaranty is unlimited or limited, and is joint and several or several, there’s not much more to be done. The lender’s got you, and you’ll just have to be tough at the workout table.

You might be able to do a bit better than that when you understand some of the underlying rights of a guarantor vis-à-vis the borrower and other guarantors, especially the rights that you give away as "boilerplate." Many of these opportunities for you to pull something out of the ashes can be negotiated.

The lender wants a guaranty of payment, not of collection. Your typical instruction to your lawyer is to require the lender to go after the collateral first, which is really a guaranty of collection. The negotiation is likely to go nowhere. But your request lays the groundwork for something that you are more likely to get the lender to change, and that has to do with your subrogation rights. If the lender will not agree to go after the property before going after you, try to make sure the lender leaves the property there for you to go after in reimbursement. More on this later.

Next, can you negotiate a specific limit to your guaranty? If so, is it going to be the first (or "top") dollars of the loan, so that when the borrower pays a dollar of principal it releases a dollar of your guaranty? Or will it be the last (or "bottom") dollars of the loan, so that your release does not begin to kick in until the loan principal is first reduced to the amount of your guaranty?

The lender wants your liability to be joint and several so it can go after any of the guarantors for the full amount. You, however, want to be responsible only for a specific part of the loan, and let your partners be responsible for their part. You want "several" liability. You may be able to negotiate this. If you cannot, you console yourself with the thought that you have right of contribution against the other guarantors. That is, if you are the guarantor that the lender catches first, you have the right to be reimbursed by the co-guarantors until the liability is shared pro rata. But here, too, there are waiver traps in the boilerplate. For example, you don’t want the lender to release a co-guarantor and possibly take away your contribution right. And you may be asked to standstill on your contribution rights until the lender is paid in full. Read on.

The lender wants your liability to be primary and independent. While you think you are just backing up the borrower, primary and independent liability makes you a better target than the borrower. Your liability is not through the borrower, so you do not get the benefit of the borrower’s defenses. Usually in the boilerplate, you waive everything that the borrower might be able to throw at the lender, including claims (lender liability), offsets and even the statute of limitations. You might have less liability if you were a direct co-signer on the note! Some of these waivers may be negotiable if your lawyer knows you want him to "lawyer" the document a bit and work his way through the boilerplate.

The lender next wants to take away your own defenses -- the lender wants to have no responsibility to you at all. For example, in the boilerplate you waive notice of default of the borrower. Nonsense! You are liable – you have every right to get the notice officially, and you ought to negotiate for the right to cure the default and reinstate the loan. You also waive defenses based on the lender’s compromising with or releasing the borrower, releasing collateral or releasing a guarantor. Again, nonsense. Try to require the lender to act in a commercially reasonable manner. If the borrower is forgiven, that may take away your claim to reimbursement, your claim to creditor status. If collateral is released, it not only puts a potential source of repayment out of the lender’s reach; it may put that collateral out of your reach. The lender should be responsible to have a business reason for everything it does that adversely affects you, and you ought to have the right to raise that as a defense.

Which brings us to the right of subrogation. Basically, the legal concept is that when the guarantor pays the lender, the debt has not really be repaid. It has been replaced by a debt from the borrower to the guarantor. The same debt. The same terms. Even the same collateral with the same priority! The guarantor becomes the secured creditor. Cherish that position. For example, do not turn your guaranty payments into equity in the borrower (watch out for that in the operating or partnership agreement). Why move from first in line to last in line? And since you will step into the shoes of the lender, you want the lender to leave you something – the debt, the collateral, the sureties.

The typical guaranty will recognize that you have subrogation rights. It may ask you to waive them. Don’t. It may ask you to not exercise them so long as any part of the loan remains outstanding. The lender doesn’t want you to get any of the borrower’s money so long as the borrower continues to owe any money to the lender. But the lender may ask you to stand still for too long a period of time, even after the loan as been repaid. Look at that closely. You do not want to be standing there helpless while your collateral loses value, as the lender waits for a bankruptcy filing that probably won’t happen and a preference issue that probably won’t be raised. Supposedly, the lender is worried that if the borrower takes bankruptcy, payments made within the prior 90 days not for current fair consideration can be set aside as a preference. It is worried it will have to pay some of the money back. But if you paid the debt under the guaranty, there is no preferential payment by the borrower for the bankruptcy to set aside. Even if the lender makes a good case here, the standstill period should be about 90 days. Many lenders try for 12 months, because payments to an insider can be set aside in bankruptcy for 12 months. It’s almost always an unreasonable stretch to believe the lender is an insider to the borrower.

Clever negotiating with a sophisticated lender will not help you break your guaranty. It is a tough, enforceable document. But there is more packed into the usual commercial guaranty than one would understand to be included in the business agreement for you to be responsible for the debt of the borrower. That excess is fair game for hard negotiation.