Nebraska law defines a “guaranty” as a collateral promise or undertaking by one person to answer for payment of some debt or performance of some duty in case of a default by a primary obligor in the performance or payment of its obligations. The guarantor is a surety and the guarantor’s promise or undertaking is separate and independent from the debtors promise. The guarantor is therefore only secondarily liable, subject to the default of the primary obligor.
The fact that the obligation of the guarantor is separate and distinct from that of the primary obligor does not require the lender to first pursue the primary obligor. In many cases the guarantor has assumed a primary obligation. However, before a lender may demand payment or performance from the guarantor, there must have been a default by the primary obligor.
I. TYPES OF GUARANTEES
A. Unconditional Guaranty/Guaranty of Payment
A guaranty agreement should specify clearly which obligations, both in the form of indebtedness and performance, are guaranteed. The guaranty agreement should provide that the lender or obligee has immediate recourse to the guarantor for the entirety of the obligations upon the failure of the debtor or obligor to satisfy such obligation without a need to pursue rights against the primary obligor. This is commonly known as an unconditional guaranty of payment and provides maximum flexibility in pursuing collection of an unpaid loan. This type of guaranty agreement should provide that the satisfaction of the obligation may be required upon default or as it becomes due by acceleration or otherwise. A statement to this effect in the guaranty agreement will serve to deny the guarantor the argument that the guaranty obligation may be satisfied simply by curing a single missed payment or a series of missed payments or failures to satisfy certain obligations as they ordinarily become due, thus preventing recourse in a default and acceleration situation.
B. Conditional Guaranty/Guaranty of Collection
If the lender agrees that it will exhaust its remedies against the debtor or obligor before resorting to the guarantor, the relationship is often referred to as a conditional guaranty. Under this type of guaranty agreement, the guarantor engages that if the obligation is not paid when due he will pay it according to its tenor, but only after the lender has reduced its claim against the primary obligor to judgment and execution has been returned unsatisfied, or after the debtor has become insolvent or it is otherwise apparent that it would be useless to proceed against him.
II. REQUIREMENTS OF GUARANTY AGREEMENTS
A. Must Independent Consideration Exist for a Guaranty Agreement to be Binding?
General principles of contract law provide that without the existence of consideration to support it, a contract will not be valid and enforceable. However, if a guaranty agreement is entered into at the time of the contract to which it relates so as to constitute a part of the consideration for the contract, a finding of adequate consideration will be established to uphold the validity of the guaranty agreement. Nebraska case law provides that it is not necessary for a guarantor to derive any specific benefit from the principal contract or guaranty agreement. There is sufficient consideration to support a guaranty if funds are loaned to the primary obligor in reliance on the guaranty. Consideration for the guaranty agreement exists where the execution and delivery of the guaranty agreement induces a lender or obligee to execute the main contract with the primary obligor.
B. Under What Circumstances May a Guaranty Agreement Executed Subsequent to the Execution of the Principal Contract be Enforceable?
Generally speaking, if a guaranty was not part of the transaction which created the debt, but is independent thereof, then the guarantors promise must be supported by consideration which is separate and distinct from the principal debt. In order for a guaranty agreement executed subsequent to a principal contract to be regarded as being made at the same time so as to be supported by the same consideration, it must generally be shown that (i) the guaranty agreement was executed pursuant to an understanding which was reached before, and that it was an inducement, to the execution of the principal contract (ii) the guaranty agreement was delivered before any obligation or liability was incurred under the principal contract (iii) the guaranty agreement was made pursuant to a contract provision (iv) the principal contract does not become operative until the execution of the guaranty agreement and (v) the guaranty agreement expressly refers to the previous agreement between the obligee and obligor which is executory in its character and embraces prospective dealings between parties. As a result, lenders should carefully document either in the loan commitment or in a separate writing that the loan is made in reliance on the guarantees which are to be executed. The lender should also require, whenever possible, that all guarantees be executed and delivered prior to the loan closing.
C. May a Guarantor Submit as a Defense to Liability Under the Guaranty Agreement His Failure to Read or Understand the Guaranty Agreement?
A guarantor will not generally be permitted to rely on his own failure to read and ascertain the provisions of a guaranty agreement which he has signed as a defense to enforceability of the guaranty agreement. A guarantor cannot avoid liability under the guaranty agreement on the ground that he signed the instrument under mistake due to his own fault as to the facts, especially where the guarantor is put on inquiry and should ascertain facts. It is no excuse that a guaranty agreement is signed by the guarantor without reading it and that the guarantor relies instead on the statements of others. However, a guaranty agreement cannot be enforced by the obligee where the guarantor has been induced to enter into the guaranty agreement by duress, fraudulent misrepresentations or concealment by the obligee.
To constitute duress there must be an application of such pressure or constraint as compels a man to go against his will and takes away his free agency, destroying the power of refusal to comply with the unjust demands of another.
To establish a fraudulent misrepresentation to set aside a guaranty, the party alleging it must prove that a representation was made, that the representation was false; that the representation was known to be false when made, or was made recklessly without knowledge of its truth and as a positive assertion; that it was made with the intention that the guarantor should rely on it; that the guarantor reasonably did so rely; and that the guarantor suffered damage as a result.
D. What is the Nature of a Continuing Guaranty Versus a Restrictive Guaranty?
A continuing guaranty agreement involves two legal concepts: a contract between the guarantor and the obligee or lender as to transactions which have already been consummated between the lender and the debtor and an offer to guaranty as to future transactions between the lender and the primary debtor. A continuing guaranty which is for an indefinite period is revocable by the guarantor provided that such notice is reasonable. The right of revocation exists absent any provision in the guaranty agreement to this effect. The parties can, however, establish in the guaranty agreement reasonable rules as to the exercise of such revocation such as, for example, requiring that such revocation be in writing, etc. A continuing guaranty is one which is not limited to a single transaction but which contemplates a future course of dealing between the obligor and obligee covering a series of transactions, generally for an indefinite period or until revocation. Unless the words in which the guaranty agreement is expressed fairly imply that the liability of the guarantor is to be limited, the guaranty will be regarded as continuing until it is revoked.
Conversely, a restricted guaranty implies the guaranty of payment of performance relating to single or specified transactions. Accordingly, the obligations of the guarantor will not be subject to escalation or modification subsequent to the single transaction at which the finite amount of guaranty liability will be established.
E. Must a Lender Provide a Guarantor With Notice of Default and Demand for Payment?
An absolute guaranty of payment generally does not require demand and notice to the guarantor in case of default in order to invoke the guarantor’s obligation. However, the lender must review the guaranty document, as the terms and conditions of the guaranty will control this issue.
F. May a Guarantors Obligation be Varied by the Unilateral Act of a Lender Without Impacting the Continued Liability of the Guarantor?
If the primary obligor requests a modification of the terms of the principal obligation, the creditor should proceed with caution to avoid an inadvertent release of the guarantor. Nebraska law indicates that any “material departure” from the terms of the principal obligation, if made without the consent of the guarantor, would be sufficient to release the guarantor from liability. Due to the uncertainty of what constitutes a “material departure” from the terms of the principal obligation, the lender should always obtain the written consent of all guarantors before modifying any terms of the principal obligation.
G. May a Guarantor be Released From Liability Under a Guaranty Agreement if the Lender Consents to an Extension of Time for Performance?
A common claim of discharge arises when the time for performance of the principal obligation has been extended without the consent of the guarantor. In the absence of language in the guaranty expressly allowing the lender to extend the time for performance, the extension, renewal, or forbearance on the principal obligation will result in a discharge of the guarantor’s liability. However, when the guaranty expressly authorizes the lender to make extensions of the time for repayment of the principal debt and further waives all defenses by reason of extending the time for repayment, an extension will not discharge the guarantor.
If the primary obligor requests an extension of time for payment or forbearance, the lender should obtain the written consent of the guarantor to such a request.
H. May a Guarantors Liability be Limited or Discharged if the Lender Releases or Impairs Collateral Taken as Security for the Principal Obligation?
The general rule is that where the lender has taken collateral for the principal obligation, the guarantors’ obligation is reduced to the extent the guarantor is harmed if the lender: (a) surrenders or releases the collateral; (b) willfully or negligently harms it; or (c) fails to take reasonable action to preserve its value at a time when the guarantor does not have an opportunity to take such action. However, some cases indicate that the lender’s failure to retain collateral can serve to discharge a guarantor since the guarantor is deprived of a means of preventing loss. Lenders should therefore take appropriate action to protect and preserve collateral at the risk of discharging the guarantor including the insertion of provisions within the guaranty agreement which specifically authorize the lender to release collateral and waive any objection by the guarantor to the banks action in releasing collateral securing the principal obligation.
I. Must a Lender Take Special Precautions in Obtaining a Corporate Guaranty?
Any time that a loan transaction requires that a corporation guaranty the debt, the lender must take appropriate steps to ensure that proper corporate authorization is obtained. It is essential that the lender review the articles of incorporation and bylaws to determine whether the corporation has placed restrictions on the authority of the corporation to guaranty the debts of others. Problems in this area may be reduced by obtaining an opinion of counsel as to corporate authority. In addition, a corporate resolution regarding the guaranty is appropriate. In some instances, shareholder approval may be necessary if enforcement of the guaranty would constitute a disposition of a substantial portion of the corporate assets.
J. What is the Statute of Limitations for Enforcing a Guaranty?
The statute of limitations on a guaranty coincides with the statute of limitations on the principal obligation. Thus, even under a “continuing” guaranty, a cause of action with respect to a particular obligation arises only once, and successive extensions or renewals of the obligation do not toll the statute. Although a partial payment may toll the statute as to the principal obligor, a partial payment without the authority or consent of the guarantor will not toll the statute as to the guarantor. Accordingly, lenders may be forced to initiate actions against guarantors after a default by the primary obligor unless the guarantor has expressly authorized the cure and reinstatement of the debt and guaranty.
III. SALE OF COLLATERAL AFTER DEFAULT
The most dangerous area for a lender with respect to a guaranty has traditionally involved the sale or disposition of collateral which secures the principal obligation. Over the years, the Nebraska Supreme Court continually expanded the lender’s duty under former U.C.C. Section 9-504(3) to give notice of the sale or other disposition of collateral. Failure by a lender to give proper notice of the sale of collateral to a guarantor has generally resulted in a discharge for the guarantor from all further liability on the guaranty. However, in response to the problems resulting from these Supreme Court decisions, legislation was adopted to provide a greater degree of certainty for lenders in meeting the former U.C.C. Section 9-504(3) notice requirements and to minimize the severe consequences which previously attached to a lenders failure to give proper notice of the sale or other disposition of collateral.
A. What Rights are Afforded to Guarantors at Law Relating to the Disposition of Collateral Securing the Obligations?
U.C.C. Section 9-611 requires an authenticated notification of disposition to be sent to a debtor and any secondary obligor (guarantor) regarding a secured party’s disposition of collateral securing the indebtedness after default. The “notice” need not be sent to a secondary obligor (guarantor) if no security for the obligation or indebtedness was taken or contemplated at the time the secondary obligor (guarantor) became accountable in whole or in part for payment or other performance of the obligation.
B. What are the Consequences of Failing to Give Proper Notice of the Disposition of Collateral to a Guarantor?
Traditionally, a lender was barred from seeking a deficiency judgment in cases where the lender failed to give proper notice of the disposition of collateral to a guarantor. This resulted from the interpretation that compliance with the notice provisions of former U.C.C. Section 9-504(3) was a condition precedent to a secured creditor’s right to recover a deficiency judgment against a guarantor. In the event that a secured creditor fails to satisfy the U.C.C. Section 9-611 notice requirements, the consequences of such a failure will no longer prohibit the creditor from recovering a deficiency judgment. Instead, the debtor’s damages, if any, resulting from a secured creditor’s failure to satisfy the U.C.C. Section 9-611 notice requirements would be limited to damages as provided under U.C.C. Section 9-626.
Under U.C.C. Section 9-626, the measure of damages for conducting a “commercially unreasonably disposition” of collateral is determined based upon the “rebuttable presumption” rule. Under this rule, the value of the collateral is deemed to equal the unpaid balance of the debt, unless the creditor proves otherwise. The burden is shifted to the creditor seeking a deficiency to show that it deserves one; and it must come forth with evidence of collateral value independent of the price obtained on foreclosure. By adopting the “rebuttable presumption” rule, the U.C.C. rejects the absolute bar to a deficiency judgment rule under which a creditor’s claim to a deficiency would be eliminated irrespective of any harm caused by creditor misbehavior during repossession and foreclosure.
C. How Can a Lender Satisfy the Notice Requirements of U.C.C. Section 9-611?
U.C.C. Section 9-611 allows a secured party, after default, to sell, lease, license or otherwise dispose of any or all of the collateral which secures the principal obligation. U.C.C. Section 9-611 requires that notice must be sent to any secondary obligor (guarantor) prior to any “sale or other disposition” of collateral and further provides that the sale or disposition of collateral may be made by public or private sale and may be made by way of one or more contracts, as a unit or in parcels, and at any time and place and on any terms.
While the former U.C.C. Section 9-504(3) notice requirements have given rise to a great deal of litigation, revised Article 9 of the Uniform Commercial Code has provided additional certainty regarding the form of notice required and the time within which notice must be sent. U.C.C. Section 9-612 provides that “a notification of disposition sent after default and ten days or more before the earliest time of disposition set forth in the notification is deemed to be sent within a reasonable time before the disposition.” In addition, the provisions of U.C.C. Section 9-613 and U.C.C. Section 9-614 provide a “safe harbor” form of notification that can be used for all types of transactions and, the use of which will be deemed to constitute compliance with the “reasonable authenticated notification” requirement of U.C.C. Section 9-611.
In addition, with respect to providing reasonable notification to guarantors, the provisions of U.C.C. Section 9-613 and U.C.C. Section 9-614 specifically provide that “In no event shall it be necessary for the notification of disposition to refer to any guarantee agreement, to identify or designate the capacity in which a debtor or secondary obligor is being sent such notification, or to identify or designate the capacity in which the debtor or secondary obligor may be liable for any deficiency existing after sale or disposition of collateral.”
D. What Type of Notice is Required if the Lender Intends to Dispose of Repossessed Collateral by Multiple Sales?
In the event that the lender has repossessed collateral and desires to sell it in more than one sale, notice of all subsequent sales must be given as described above. If a lender gives proper notice of an initial sale, but fails to give notice of subsequent sales, the guarantor could be discharged.