A noteholder sought to enforce a guaranty of a $17.5 million loan made to various entities for the purpose of acquiring tenant-in-common interests in a real estate project. The case turned on whether the term “Borrower” meant only the group of entities collectively or also included the entities individually. The District Court found in favor of the guarantor, and the noteholder appealed to the 5th Circuit.
The loan was secured by a deed of trust and a guaranty. Shortly after the lender advised the borrowing entities that they were in default, one of the entities filed bankruptcy and listed its 3.305% tenant-in-common interests in the project as an asset of the bankruptcy estate. The lender foreclosed and purchased the tenant-in-common interests of the rest of the entities. Ultimately it obtained relief from the automatic stay and foreclosed on the bankrupt debtor’s interest, so that it owned 100% of the project. The lender claimed that there was a remaining deficiency of ~$14.6 million.
In suing the guarantor for the deficiency, the lender claimed that liability arose when the debtor’s interest in the project became an asset in its bankruptcy, relying on guaranty provision holding the guarantor fully liable for amounts “which may be due and owing by Borrower… from and after… the Property or any part thereof becoming [sic] an asset in (x) a voluntary bankruptcy or insolvency proceeding of Borrower.”
The guarantor countered that the term “Borrower” as defined in the guaranty referred only to the group of borrowers collectively, and not to a single borrower entity. Since only one entity filed bankruptcy, this provision was not applicable.
The guaranty included the following recital (emphasis added):
WHEREAS, [LLC 1], … [LLC 15], and [LLC 16], each a Delaware limited liability company (as defined in the Security Instrument), the “Borrower“), have obtained a loan (the “Loan“) in the principal amount of Seventeen Million Five Hundred Thousand and No/100 Dollars ($17,500,000.00) from [lender].
The critical point being that the guaranty recital contained an extra parentheses. Undoubtedly there would not have been a case without this typo. If the guaranty had simply stated “(as defined in the Security Instrument, the “Borrower“)” it would have been clear that the definition in the deed of trust controlled for the guaranty.
The deed of trust define the term “Borrower” as follows (emphasis added):
THIS [deed of trust] is made as of June 20, 2007, by [LLC 0], a Delaware limited liability company (“Initial Borrower“) and by [LLC 1], … [LLC 15], [LLC 16], each a Delaware limited liability company (collectively, together with Initial Borrower and each Co-Owner Transferee (as hereinafter defined) acquiring an interest in the Property (as hereinafter defined) in accordance with the terms hereof, individually or collectively as the context may require, “Borrower“)
Further, another section of the deed of trust provided:
Borrower References. Wherever the defined term “Borrower” is used throughout this Deed of Trust, such term shall be read to include each entity comprising Borrower and the representation, covenant, condition, requirement or provision relating thereto shall be applicable to each entity comprising Borrower.
So, if the deed of trust definition applied to the guaranty, the fact that the tenet-in-common interests of a single entity became a bankruptcy asset would have triggered full liability under the guaranty.
However, based on the extra parentheses, the guarantor contended that it was unclear what the phrase “as defined in the Security Instrument” modified, arguing that there were three possibilities – the phrase followed “Delaware limited liability company” and it preceded two different defined terms, namely “Borrower” and “Loan.” And if it did not apply to “Borrower” and that term was defined without reference to the deed of trust, the guarantor argued that using the word “and” (as opposed to, for example, “and/or”) meant that “Borrower” was defined as the entire group of entities collectively.
Although the District Court bought the guarantor’s arguments, the 5th Circuit did not agree.
First, the 5th Circuit noted that the recital was a statement of fact: the parties meant to say that all of the entities obtained a loan, and did not mean to say that one or more of the identified entities obtained a loan. Thus, the use of “and/or” would have been inappropriate in that context.
Second, the court noted the maxim that the words, not punctuation, control in interpreting a contract. In this case it was clear that the intent was to incorporate the deed of trust definition of Borrower.
Finally, a survey of the guaranty revealed a number provisions that would have been meaningless if “Borrower” was limited to the collective group and did not also include reference to individual entities. Among other things, the court did not believe that the collective group would be eligible to file bankruptcy. Thus the guarantor’s narrow definition of Borrower would render the bankruptcy provision meaningless.
Consequently, the 5th Circuit concluded that the “only reasonable, textually supportable interpretation” was that “Borrower” referred to both the collective entities and to each individual entity, as required by the context.
It was interesting to see how the court dealt with the issue of ambiguity: Interpretation of an unambiguous contract is a legal question that can be decided de novo on appeal, while if a contract is ambiguous, the lower court’s findings of fact are reviewed for clear error. In articulating the standard of review, the court noted (emphasis added): “Ambiguity does not arise simply because of a lack of clarity, or because the parties proffer different interpretations of the contract. … Instead, a contract is ambiguous ‘only if it is subject to two or more reasonable interpretations after applying the pertinent canons of construction.'” The court did not view the guarantor’s interpretation as reasonable.
Vicki R Harding, Esq.