Guarantors Beware: Ignore Boilerplate at Your Peril

Edwards Family P’ship v Dickson, 821 F.3d 614 (5th Cir. 2016)

Prior to bankruptcy the debtor obtained loans from two lenders totaling $16 million that were guaranteed by its CEO. After the debtor defaulted and filed bankruptcy, the lenders sought to recover the outstanding debt from the guarantor. The district court granted summary judgment in favor of the lenders against the guarantor, finding him liable, and the guarantor appealed to the Fifth Circuit.

The loans were evidenced by two identical loan agreements and promissory notes, all of which were signed by the debtor’s founder, president and CEO (Dickson) on behalf of the debtor (Community) and as a personal guarantor. After the debtor filed bankruptcy, the lenders obtained severance of claims in pending litigation to allow the case to proceed against the guarantor notwithstanding the debtor’s bankruptcy. Community and Dickson then filed a complaint in the bankruptcy proceeding contesting the “extent and validity” of Community’s obligations to the lenders.

Dickson’s primary argument was that it was premature to rule on his liability given that there was an outstanding proceeding in the bankruptcy court challenging the underlying obligation. The court agreed that there was some “intuitive force” to his arguments: A guarantee is “a collateral undertaking by one person to answer for the payment of a debt for the performance of some contract or duty in the case of the default of another person who is liable for such payment or performance in the first instance.” Further if the primary obligation is extinguished, generally the guarantor’s obligation is also extinguished. From this Dickson concluded that his guarantor liability was entirely derivative of Community’s, which could be discharged in the bankruptcy.

While “colorable,” the court pointed out that these arguments ignored the language of the guaranties. Under state law a guarantee is to be interpreted under rules generally applicable to contract, and the unambiguous language of the guaranty required the guarantor to pay regardless of the outcome of the bankruptcy dispute or challenges to the underlying obligation of the debtor.

To support its conclusions, the court quoted at length from the guaranties:

  • Dickson “unconditionally and absolutely guarantee[d] [ ] the due and punctual payment and performance when due of the principal of the Note and the interest thereon…”
  • Liability was “primary and direct and not conditional or contingent upon the enforceability of any obligation, the solvency of [Community]…, [or] any obligation or circumstance which might otherwise constitute a legal or equitable discharge or defense of a surety or guaranty…”
  • The lenders were not required to “make any demand” upon or “exhaust [their] remedies against” Community, any collateral, or other guarantor before recovering from Dickson.
  • “The obligations of [Dickson] hereunder shall not in any way be affected by any action taken or not taken by [the Lenders], which action or inaction is hereby consented and agreed to by [Dickson], or by the partial or complete unenforceability or invalidity of… the value, genuineness, validity or enforceability of the Collateral or any of the Guaranteed Obligations.”
  • “[Dickson] hereby waives… all defenses with respect to… any other action taken by Lender in reliance hereon… It being the intention hereof that [Dickson] shall remain liable as a principal until the full amount of Guaranteed Obligations shall have been indefeasibly paid in full in cash and performed and satisfied… In full… and the Loan Agreement terminated, notwithstanding any act, omission or anything else which might otherwise operate as the legal or equitable discharge of [Dickson].”
  • “[Dickson] acknowledges and agrees that his obligations as Guarantor shall not be impaired, modified, changed, released or limited in any manner whatsoever by any impairment, modification, change, release or limitation of the liability of [Community] or any other guarantor of the Guaranteed Obligations or any other Person or his or their respective estates in bankruptcy resulting from the operation of any present or future provision of the bankruptcy laws or other similar statute, or from the decision of any court.”
  • “[Dickson] hereby waives and agrees not to assert against [the Lenders] any rights which a guarantor or surety could exercise.”
  • “[Dickson] agrees that his obligations hereunder are irrevocable, joint and several, and independent of the obligations of [Community] or any other guarantor of the Guaranteed Obligations…”

The court noted that while it might be sensible for a guarantor to include a provision in a guaranty that it is not liable until a lender shows that the borrower is liable on the underlying obligation, Dickson’s guaranties did not contain any such provision. There were no conditions on his liability other than the debtor’s default on the notes.

Consequently, the Fifth Circuit affirmed the district court’s grant of summary judgment with a finding that Dickson was liable for ~$25.8 million plus accruing interest.

The guaranty language quoted by the Fifth Circuit will look very familiar to anyone who has reviewed a typical lender’s guaranty. From the guarantor’s perspective it certainly would be preferable to condition its liability on the borrower’s liability on the underlying obligation. Good luck with that. Rather the lesson to be learned is that while this language may be boilerplate, it has teeth and is likely to be enforced against the guarantor.

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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