Married Individual Guarantor: Collecting from Property Subject to a Spouse’s Interest Can Be “Iffy”

First Community Bank v. Gaughan (In re Miller), 853 F.3d 508 (9th Cir. 2017)

A creditor obtained an Arizona judgment against the debtor arising from the guarantee which it recorded and registered in California. After the debtor filed bankruptcy the bank sought a determination that the judgment was enforceable against California property owned by the debtor and his spouse. Applying California law, the bankruptcy court found in favor of the creditor. On appeal the district court reversed based on Arizona law. The creditor appealed to the Ninth Circuit.

The debtor was president of a corporation that was a general partner of two limited partnerships. All of the entities were organized in California. A California bank loaned ~$5.75 million to the two partnerships pursuant to loan documents governed by California’s local law.

The debtor personally guaranteed the loan pursuant to a guaranty that was governed by California law and which stated that “[a]ny married person who signs this Guaranty hereby expressly agrees that recourse under this Guaranty may be had against both his or her separate property and community property.” The debtor’s spouse did not sign the guaranty.

The debtor and his spouse were domiciled in Arizona. They jointly owned a co-op apartment in California. (Technically they owned shares in the co-op and had a leasehold interest in their unit, which was treated as a real property interest under California law.)

The borrowers defaulted on the loan and the debtor defaulted on the guarantee. The bank sued the debtor and his wife in federal court in Arizona. It moved for summary judgment as to the debtor’s liability and requested a ruling that the spouse received notice and due process to the extent that property subject to enforcement in execution “whether located in the State of Arizona, the State of California or elsewhere, is asserted to belong in whole or in part to her marital community.”

The answer to the complaint alleged that the spouse’s marital community property and separate property was not subject to the bank’s claims, although the only legal argument was that California law required the bank to collect first from collateral securing the loan.

The district court entered judgment against the debtor. It did not reference the community property although the order observed “in dictum and without undertaking a choice-of-law analysis, that ‘any [liability of the marital community] appears to be precluded by [an Arizona statute.]'” The bank registered this judgment in a California federal court. At that time the debtor and his spouse owned the California co-op.

Several years later the debtor filed a Chapter 11 bankruptcy in Arizona that was converted to a chapter 7 liquidation. After the chapter 7 trustee sold the co-op, the bank filed an adversary proceeding seeking a declaration that it had an enforceable judgment lien on the co-op which gave it priority over the proceeds of the sale.

Although both Arizona and California are community property states, in Arizona a statute bars collection of guaranteed debt from the community’s property unless both spouses sign the guaranty. In California the community property was subject to collection even if only one spouse signs the guaranty. In addition, the co-op did not come within the definition of community property under California statutes because the debtor and his spouse were domiciled in Arizona, not California. Rather, under California law they owned the co-op as tenants-in-common. Accordingly, if Arizona law applied, the debtor and his spouse won, but if California law applied, the bank won.

The bankruptcy court held that California law governed because the judgment was registered in California, and under California law the bank could execute against the community property located in California to satisfy the judgment. The district court disagreed, concluding that the registered judgment did not lien the community real property in California. This conclusion was based on the Arizona statute in combination with California choice of law principles, which would yield to Arizona marital law.

In rejecting the district court’s decision, the Ninth Circuit concluded that based on California law the debtor and his spouse owned the co-op as tenants-in-common, with a presumption that they held in equal shares, and the debtor’s interest was subject to enforcement of a judgment lien. Thus, the court viewed the issue as whether California should yield to Arizona’s community property law.

While registering the lien in California gave the bank a judgment lien, perfection of a lien does not mean that it can be enforced against particular property. The court engaged in an analysis of conflict of laws rules that ultimately led to reliance on the Restatement (Second) of Conflict of Laws: (1) does the law vary between jurisdictions, (2) if so is there a true conflict such that each state has a “legitimate and conflicting interest in applying its own law,” and (3) if there is a true conflict, “which state’s interest would be more impaired if its policy were subordinated to the policy of the other state”?

In considering the Arizona signature requirement, the court noted that the lack of signature by one spouse did not mean that the guarantee was per se void, but only voidable, and there were circumstances where a spouse could be estopped from disaffirming the guarantee. In reviewing the facts of this case, the court did not necessarily invoke estoppel, but did argued that the lack of a signature did not necessarily implicate the underlying policy of protecting a spouse who lacks knowledge of the guarantee.

In contrast it concluded that California has a significant interest “in effectuating its policy regarding enforcement of judgments in favor of California creditors against real property located there, whether the property constitutes community property or a tenancy-in-common.” Quoting from a prior opinion: “California, as does every state, has a substantial interest in the economic health of corporations which do business within its borders. It derives substantial sales and income taxes, as well as other revenues, directly and indirectly from a corporation’s activities within the state.” The court also found that California had an interest in “fostering the growth of commercial activities that require ready access to credit – a policy that would be undermined by limiting the ability of California creditors to enforce obligations for activities undertaken in California and made subject to the operation of California law but some of the parties.”

It concluded these interests were particularly relevant given that the parties voluntarily agreed to be governed by California law. Under the Restatement, parties are generally entitled to agree to a choice of law subject to 2 exceptions: (1) the chosen state does not have a sufficient relationship to the parties of the transaction, or (2) the chosen law would be contrary to “a fundamental policy of the state which has a materially greater interest than the chosen state.” Neither exception was applicable here.

After laying the groundwork, the court decided that the contractual choice of law should bind the debtor and permit enforcement against his interest in the co-op as a tenant-in-common. This protected the spouse’s one-half interest while giving the bank the ability to recover the debtor’s share of the co-op sale proceeds.

“In sum, we agree with [the bank] ‘that California [has] a compelling interest in applying its law,’ under the circumstances presented here.”

The analysis of the competing state interests seems a bit odd. It appears to give short shrift to the concept of community property, while elevating some sort of interest in general economic well-being. If a lender is truly interested in collecting on an individual guaranty, it should be wary of its ability to reach property of a married debtor that constitutes community property or that is held as tenants by the entirety.

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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