Over the past number of years, there has been increasing litigation over the enforcement of commercial guarantees by lenders across the country. As more and more primary borrowers either default on their loans or file for protection under federal bankruptcy law, the existence of an enforceable personal guarantee is often the only way a lender can avoid going home empty-handed. Given the importance of these instruments, it is surprising how many lenders fail to properly structure language in the guarantee to fully protect their interests.
A. The basics of a guaranty. A guaranty is a promise to answer for the payment of some debt or the performance of some duty in the case of the failure of another who is liable in the first instance. Before there is a guarantee there must the existence of a primary debt obligation. In the context of a loan transaction, for example, a guarantee serves as a form of collateral to support the underlying primary debt obligation between the debtor and the creditor. However, the guarantee and the underlying loan agreement are to be considered separate obligations and are not compromised by the fact that both agreements are written on the same instrument or executed concurrently.
B. There are many kinds of guarantees and Massachusetts law enforces guarantees strictly. Guarantees can be absolute, conditional, continuing or based on performance or payment. Whatever form a guarantee takes, Massachusetts law strictly enforces guarantees and construes and enforces each guaranty according to its plain language. The reason behind this rule is that public policy favors the enforcement of these instruments so as to provide certainty in business relationships and to ensure the free flow of credit.
C. Waiver of defenses to enforcement. What this means is simply that in many contracts the borrower has waived any defense to enforcement of a guarantee as a condition of receiving a loan. Commercial loan guarantees in Massachusetts often contain provisions whereby the guarantor expressly waives the ability to assert certain rights and defenses to a lender's enforcement efforts. Courts in this state have allowed such waivers to withstand court scrutiny believing that any such waiver was a term negotiated between sophisticated business entities and, as such, that all such waivers, like guarantees, shall be enforced as to their plain language. In many cases, guarantors may attempt to assert defenses and claims belonging to the borrower. In Massachusetts, these attempts have gained little traction with our courts. The rationale behind this thinking is based on the fact that where the guarantor is not part of the underlying transaction the guarantor cannot later take advantage of any claims and defenses that might arise out of that underlying loan transaction.
D. The elements of a well-structured guarantee are as follows:
1. The instrument must clearly recite that consideration for the guarantee in the text of the agreement. Guarantees have to be made in writing as the law does not recognize oral guarantees.
2. Make sure that any guarantee is separated from the rest of the underlying agreement and contains its own signature lines and acknowledgment.
3. If you intend to hold the guarantor responsible for paying reasonable attorney's fees, costs and expenses in the event of collection, then language referring to reasonable attorney's fees, costs and expenses must be explicitly stated in the text of the guarantee.
4. Make sure that the guarantor both signs and prints his name. This will work against any argument that the signature is not that of the guarantor. We see this issue arise all the time.
5. Insist that the owner or principal sign the guarantee.
6. The guarantee must be structured so as to include the phrase absolute and unconditional liability upon the guarantor. What this means is that the guarantor promises to pay or perform his obligations of the debtor upon the occurrence of an event of default. The result is that the guarantor becomes principally liable in the first instance with the debtor. This allows the creditor to proceed against both the debtor and the guarantor without having to be required to satisfy the obligations in the first instance against the debtor before proceeding against the guarantor.
7. Engage in due diligence as it relates to the creditworthiness of the guarantor himself. Often times, companies will spend the requisite time to research the creditworthiness of the principal borrower and completely forget to do the same with respect to the guarantor. Remember, the guarantee is only as good as the person signing it. Have the guarantor submit a separate credit application and put that application through your company's usual credit process. Another reason to "vet" your guarantor is that many guarantors, particularly in the construction business, guarantee multiple obligations at the same time. A guarantor's multiple obligations can often put them in a state of economic peril when it comes to potentially paying on all or some of their obligations. Put another way, just because you have a guarantee does mean that you are guaranteed payment. You must do your due diligence when it comes to the background of any guarantor. You might be surprised at what you might find!
8. Make sure that you have placed language in the guarantee that holds that the guarantor waives the ability to assert certain rights.
9. Once your guarantee is ready to be enforced against a guarantor, make sure that you, as a lender, enforce the guarantee in accordance with the terms of the guarantee or, if applicable, as it pertains to any terms present in the underlying loan agreement.
Commercial guarantees in Massachusetts are strictly enforced according to their contractual provisions and their enforcement is favored as a matter of public policy. Therefore, in order to take advantage of laws favorable to creditors in this state, it is important that you take the time to craft a solid guarantee in order to fully protect your business interests. At the Katz Law Group, we have been representing the interests of creditors for 37 years. Please feel free to call us at 508-480-8202.