And Some Guidelines to Avoid Holding an Empty Bag

by Alexander C. Blackburn
Grajewski & Blackburn

Why It’s Important to Have an Enforceable Guarantee

Although private money lenders typically secure their loans with real estate, and usually have more than enough equity in the security to cover the loan in the event of default, lenders also often obtain guarantees. These guarantees are most likely to be important in the event of a severe economic downturn when real property prices have plunged, and the security is not sufficient to cover a defaulted loan. Thus, when a lender must enforce a guaranty it is likely to be in an environment of great stress when the lender can least afford to discover that they have an unenforceable guaranty. Although errors and omission insurance may cover the shortfall if a guaranty turns out to be unenforceable, that insurance will only kick in once the lender is sued by its investors or is threatened with a suit by its investors. Of course, merely being sued by one’s investors, even if insurance pays the cost of defense and ultimately pays the claim, can have a host of negative consequences. Some of those consequences include a loss of prestige amongst potential investors, skyrocketing insurance premiums, payment of a large deductible, and the opportunity cost of Bagthe time spent defending a lawsuit rather than building one’s business. None of those consequences are ever desirable, but they are especially undesirable in the type of challenging environment in which a lender is likely to need to enforce a guaranty. Therefore, this article provides some guidelines on how to maximize the likelihood of enforceability. More specifically, the article provides some targeted guidance on some key rules for enforceability as well as some cautionary tails from the litigation trenches.

RULE NO.1: Ambiguities In a Guaranty Are Construed Against the Drafter, So Don’t Draft an Ambiguous Guaranty

An ambiguity exists in a contract when at least one of its provisions is capable of more than one reasonable construction. (Supervalu, Inc. v Wexford Underwriting Managers, Inc. (2009) 175 Cal. App. 4th 64, 73).
California Civil Code §1654 provides that “[i]n cases of uncertainty not removed by [the other rules of contract interpretation], the language of a contract should be interpreted most strongly against the party who caused the uncertainty to exist.” Section 1654 canonizes the long-established rule of contract interpretation that “ambiguities are generally construed against the party who caused the uncertainty to exist.” (Powerine Oil Co., Inc. v Superior Court (2005) 37 Cal.4th 377). In other words, ambiguities are construed against the drafter; furthermore, the rule applies with “peculiar force” when dealing with contracts of adhesion. (Sandquist v Lebo Automotive, Inc. (2016) 1 Cal.5th 233, 248). A contract of adhesion is a standardized contract, drafted and imposed on the weaker party by the stronger party without giving the weaker party a chance to negotiate its terms. The weaker party has “only the opportunity to adhere to the contract or reject it.” (Armendariz v Foundation Health Psychcare Servs., Inc. (2000) 24 Cal.4th 83, 113).

Lenders are almost always the drafters of loan guarantees and there is a benefit to that – drafting your own guaranty gives you the opportunity to make it the strongest guaranty it can be. However, being the drafter also comes with risk – the risk that ambiguities in the guaranty will be construed against you. While guarantees are generally not considered contracts of adhesion, a lender who obtains a guaranty from an unsophisticated and desperate guarantor does run the risk that the guaranty will be construed as adhesionary. Thus, there is a chance under those circumstances that any ambiguities in a guaranty will be construed against the lender with “peculiar force.”

Of all the cases that I have litigated, my favorite case to date has been a guaranty case that turned on Civil Code §1654. In that case, the purported guarantor agreed to guarantee “any and all debt however arising.” I represented the guarantor in that case – an elderly woman who had dutifully signed a guaranty of a merchant services account for her ever-unlucky son’s promising new business venture. Yes, you guessed it: against all odds the business venture immediately failed. In the process, one of the son’s customers executed an $84,000 chargeback, he couldn’t pay it, and the merchant services provider demanded that the guarantor (my client) pay the bill. Despite that seemingly all-inclusive language of the guaranty, I immediately identified a key ambiguity in the guaranty and used Civil Code §1654 to successfully argue on summary judgment that my client had not guaranteed the debt in question. My client didn’t pay a dime and the initially haughty opposition found itself in the very humble position of having to pay my client’s attorney’s fees.

The ambiguity I identified for the court related to whether my client had guaranteed all credit card-related debt or only Visa and MasterCard-related debt. The chargeback to the unlucky son’s merchant services account had been on an American Express card. Although the guaranty did say that the guarantor guaranteed “any and all debt however arising” that language came after language stating that the guaranty remained valid for a period of seven months after the last Visa and MasterCard transaction. I argued that the 7-month tail existed to capture any potential chargebacks, and if the guaranty had been intended to apply to American Express, or other cards, the 7-month tail would have been from the date of the last “card transaction.” Instead, the guaranty very specifically stated that the 7-month tail was from the date of the last Visa or MasterCard transaction. I further argued that although the “any and all debt” language existed, it existed after the guaranty had already specified that it only applied to Visa and MasterCard transactions, and that the language was more appropriately read as “any and all Visa and MasterCard debt however arising.” Those arguments were enough for the court to deny the plaintiff’s summary judgment motion and state her belief that the guaranty was ambiguous, for the reasons I illuminated, and that it she would therefor most likely interpret the guaranty against the plaintiff.

Early in the case, my client, who had no taste for litigation, offered to pay half of the demanded amount. Plaintiff’s arrogant counsel completely ignored the offer and shortly before the court’s ruling on her summary judgment motion stated that she had “stood on principal.” After she lost her summary judgment motion she sent a junior associate with hat in hand to try to negotiate a reduction in how much plaintiff would pay my client for her attorney’s fees.

So, the lesson is this: draft the clearest guaranty that you can so that you are not the one holding an empty bag in one hand and your hat in the other as you try to negotiate for a reduction in the amount of attorney’s fees you have to pay the other side. You can probably eliminate a lot of ambiguities by merely translating the legalese in your guaranty to ordinary English and by checking for potential internal inconsistencies. Of course, it is impossible to eliminate every potential argument that your guaranty is ambiguous. All you can do is hire a great attorney who is very familiar with guarantees and who has litigated them extensively (I can recommend a great guy).

RULE NO.2: A Guaranty Must Be in Writing. In Other Words, a Verbal Guaranty Is No Bueno

With limited exceptions, a guaranty must be in writing. Civil Code §2793 states in relevant part that “… a [guaranty] must be in writing, and signed by the [guarantor]….” Of course, most seasoned lenders already know that a guaranty must be in writing to be enforceable. However, because this rule is so critical I thought it important to reinforce the rule.
The limited exceptions are found in Civil Code §2794 and do not apply to the situation in which a private lender obtains a guaranty of a loan.

RULE NO.3: To Be Enforceable, Without the Need for Further Consideration, a Guaranty Must Be Obtained at the Time That a Loan Commitment Is Made

A valid guaranty is a form of a contract, and for a contract to exist the parties must exchange consideration. “Consideration” is something of value that a party to a contract gives to the other party to a contract. Consideration can take many forms, including money, non-money assets, promises to do something and promises to not do something. So, with that having been said, you might conclude that to be valid a guaranty requires the lender to give the guarantor some form of consideration. That conclusion would be correct; however, the consideration that a lender gives to the guarantor does not have to be in addition to what the lender is already giving to the principal borrower. In other words, the lender’s commitment to loan to the borrower can be sufficient consideration for both the lender’s contract with the borrower and the guarantor. (Civil Code §2792). However, to take advantage of that law, the guaranty must be obtained contemporaneously with the making of the loan.

If a guaranty is obtained after the lender commits to the loan, then for the guarantee to be valid the lender will likely be required to give the guarantor additional consideration, which is independent of what the lender gave the borrower. (See Civil Code §2792; Rancho Santa Fe Pharmacy, Inc, v. Seyfert (1990) 219 Cal. App. 3d 875, 878; Rusk v. Johnston (1937) 18 Cal. App. 2d 408, 409). The logic here is simple: where a guaranty is a required condition precedent to the loan, then the consideration the guarantor gets is the lender’s commitment to make the loan; however, if the lender has already made the loan then the lender’s prior commitment to make the loan is of no value to the guarantor and therefore the guarantor has not received any consideration. If the guarantor has not received anything of value, then he has not received “consideration” and therefore there is no valid contract.

This rule relates to an interesting case that I am currently litigating. In this case, I represent the purported guarantor. Plaintiff in this case claims that she made a loan to a limited liability company (which she did not, but which is beside the point for this article) and that my client guaranteed the loan. Plaintiff even has a document that she claims constitutes a guarantee by my client. However, the purported written guaranty was executed years after Plaintiff allegedly made her loan to the LLC. Thus, because of the time lapse between when the loan was allegedly made and when the purported guaranty was signed, the loan commitment does not constitute consideration for the purported guaranty. Additionally, Plaintiff has admitted in deposition that she gave nothing else to my client in exchange for signing the purported guaranty. So, it seems clear that Plaintiff will lose.

Defense counsel also seems to have accepted this reality because he is now desperately trying to bootstrap himself into an argument that Defendant is not a guarantor but is instead a principal borrower. Plaintiff is now claiming that she did not make a loan to the LLC but instead made it directly to the Defendant she formerly characterized as a guarantor. This case is set for trial in August, so I cannot yet tell you how the judge has decided the issue. Nonetheless, the lesson is clear: don’t be the guy desperately trying to bootstrap himself into some viable legal theory with dubious chances of success. Instead, be the guy who obtained a clearly written and fully executed guaranty as a condition precedent to closing the loan.

Endnotes

1 Actually, Plaintiff loaned money to her son, who invested money in the LLC, which he lost, and which Plaintiff is now trying to recoup by suing my client rather than the rightful defendant – her son).

Alexander Blackburn is a veteran litigator and trial attorney with over ten years of real estate litigation experience. Mr. Blackburn is also the Managing Partner of his firm Grajewski & Blackburn, LLP.
Mr. Blackburn’s partner, Wayne Grajewski is an esteemed real estate attorney with over forty years of experience. Mr. Grajewski has many years of experience in the private lending industry and was a good friend and former partner of CMA General Counsel Bruce Newman.