United States: Enforcement Of Guarantees - Beware Of The Traps

The California Uniform Commercial Code, like the Commercial Code throughout most of the United States allows for companies or individuals to act as guarantors of corporate loans. Banks, non-commercial lenders and persons who are selling a business frequently demand that, in addition to pledging property as collateral for a loan, a debtor/buyer, also have a guarantor.

Cerritos Valley Bank v. Sterling is a textbook example of the pitfalls for the unwary in loan guarantee enforcement. The bank in this scenario lent substantial monies and received a promissory note from a corporation. The principal of the corporate entity also executed a guarantee. All of the assets of the corporation were pledged as collateral, and a UCC 1 Financing Statement was recorded with the Secretary of State.

The corporate debtor defaulted and filed a bankruptcy petition. The bank, after the default in payment by the corporate debtor, moved to repossess and sell the guarantor’s personal property pledged as collateral. The bank sent timely notice of sale of the collateral to the corporate debtor, however, they neglected to provide notice of the planned sale of collateral to the guarantor. When the collateral was sold and failed to generate sufficient funds to repay the loan, the bank, as expected, filed an action against the guarantor to collect the principal balance (deficiency) still due and owing.

The failure of the bank to provide notice of the sale of the collateral to the guarantor resulted in the guarantor winning summary judgment in his favor. Thus, the bank (creditor) lost the ability to sue the guarantor for the debt still owing, the corporate debtor was bankrupt, and the collateral had been exhausted.

Two lessons from this recent case are clear. One: Form waivers of notice by a guarantor will not be accepted or enforced in California if the waivers relate to a sale or to other disposition of collateral. Collateral simply cannot be gathered and sold without all of the notice and "due process" requisites under the Uniform Commercial Code being followed. Two: Preparation of valid and up-to-date guarantees and related lending documents are critical for lenders/sellers.

If you are buying or selling the assets of a business, (or if you are requested to execute a guarantee in such a transaction), it is imperative that all of the documentation for the transaction be reviewed by counsel. The bank in the foregoing "real life" example proceeded in accordance with the written terms of the documentation. Unfortunately, the documentation did not comply with well known California statutory law.

Loan guarantees and other forms prepared by escrow companies or by attorneys who do not know or understand the Uniform Commercial Code frequently lead to such problems in debt collection/contract enforcement. Whether you are a buyer, a seller, a lender, or a guarantor, it is imperative that you know that the documents you are executing are enforceable and are in your best interest. The bank, by not having form agreements reviewed for enforceability on a periodic basis, literally lost over $500,000. Be certain your rights are protected.