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Recently, in the case of Emerald Portfolio, LLC v. Outer
Banks/Kinnakeet Associates, LLC, the North Carolina Court of
Appeals issued an opinion that reaffirms the independent nature of
personal guaranty agreements. The court held that a guaranty
agreement is not absolutely tethered to the promissory note it
promises to pay if the borrower does not pay the note. Rather, a
guaranty agreement is a separate obligation enforceable by a
creditor even if the creditor cannot enforce the related promissory
note. The decision is a welcome reminder for creditors −
particularly where the creditor has problems with its promissory
note.
The Backstory
Here are the important facts from Emerald Portfolio: Outer
Banks/Kinnakeet Associates, LLC ("OBKA") executed a
promissory note to First South Bank. As part of the loan
transaction, Ray Hollowell and Donna Hollowell signed commercial
guaranty agreements. Several years later, First South Bank sold the
loan to Emerald Portfolio, LLC. Upon default, Emerald sued OBKA and
the Hollowells under the note and guaranty agreements.
On its claim against OBKA − the borrower and maker of the
note − Emerald ran into trouble because it did not have
possession of the original note. Emerald alleged it was the lawful
owner and payee of the note, that it could not locate the note, and
that First South Bank had endorsed the note to it. OBKA contended
that Emerald could not enforce the lost note. The trial court
rejected this argument and entered summary judgment for Emerald on
the note and Ray Hollowell's guaranty agreement. As to Donna
Hollowell, the court found she was a guarantor and that she was
jointly and severally liable to Emerald under the note unless she
could prove an affirmative defense under the Equal Credit
Opportunity Act.
The Case Heads to the N.C. Court of Appeals
On appeal, the North Carolina Court of Appeals reversed in part,
holding that under N.C. Gen. Stat. § 25–3–309,
Emerald could not enforce the note. The court held that where a
party who would otherwise have a right to enforce a lost note under
N.C. Gen. Stat. § 25–3–309 subsequently assigns
that note, the assignee does not acquire the right to enforce the
note unless the assignee is in actual possession of the note. Since
the note remained missing, Emerald could not enforce it against
OBKA.
The court then turned to Ray Hollowell's guaranty agreement.
Hollowell argued he could not be held liable as a guarantor if the
note itself could not be enforced. The court rejected his argument,
holding that North Carolina law recognizes that the obligation of
the guarantor and that of the maker of a note, while often
coextensive are, nonetheless, separate and distinct. A
guarantor's liability depends on the terms of the contract
− the guaranty agreement − construed by the general
rules of contract construction. Summing up, the court held: "A
guaranty is an obligation in contract, and irrespective of the
status of the note, may be enforced in contract."
The court reiterated that a guaranty of payment is an absolute
and unconditional promise to pay a debt at maturity (or default) if
not paid by the maker. Here, by his guaranty, Hollowell
contractually promised to pay the outstanding debt represented by
the missing note if OBKA failed to do so. The unenforceability of
the obligation by Emerald against OBKA was no defense for Ray
Hollowell as guarantor.
Conclusion
The takeaway for creditors is that even if there is a fatal
defect in a promissory note, they should not concede defeat. If
they have guarantors, creditors have a separate path to enforce
their debt. Although they may have no recourse against the
borrower, they may have an enforceable obligation against their
guarantors.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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