Loan Guaranty Enforcement: Bad Boy, Upstream, Affiliated and …media.straffordpub.com/products/loan-guaranty... · 2013. 10. 29. · Loan Guaranty Enforcement: "Bad Boy,“ Upstream,

Loan Guaranty Enforcement: "Bad Boy," Upstream, Affiliated and Other Agreements Best Practices for Lenders and Guarantors In and Outside of Bankruptcy

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TUESDAY, OCTOBER 29, 2013

Presenting a live 90-minute webinar with interactive Q&A

Aric T. Stienessen, Partner, Hinshaw & Culbertson, Minneapolis

Anthony J. Jacob, Partner, Hinshaw & Culbertson, Chicago

William Connelly, Partner, Hinshaw & Culbertson, Chicago

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Loan Guaranty Enforcement: "Bad Boy,“ Upstream, Affiliated

and Other Agreements

Best Practices for Lenders and Guarantors In and Outside of Bankruptcy

October 29, 2013

1:00 PM – 2:30 PM Eastern Standard Time

6 6

Presenters

Aric T. Stienessen, Partner

Hinshaw & Culbertson LLP, Minneapolis

He represents lenders, investment banks and borrowers in commercial

finance transactions. He also represents businesses and real property

developers in sales and purchase transactions involving commercial

real property, and handles transactions involving mergers,

acquisitions, divestitures and corporate organization and governance.

7 7

Presenters

Anthony J. Jacob, Partner

Hinshaw & Culbertson, Chicago

Mr. Jacob is engaged in general corporate practice, including various

aspects of private merger, acquisition, divestiture and employee

benefit matters. In addition, Mr. Jacob’s practice includes secured and

unsecured lending transactions, asset securitization and structured

finance, ESOP loans, initial debt and equity offerings, primary and

secondary debt offerings, corporate reorganizations and restructuring,

joint ventures and syndicated commercial financing transactions. His

clients include domestic and foreign corporations, limited liability

companies and partnerships, and banks and other lending institutions.

8 8

Presenters

William J. Connelly, Partner


Mr. Connelly has practiced for more than two decades in the areas of

creditors’ rights, bankruptcy, corporate and commercial litigation.

Since joining Hinshaw & Culbertson LLP in 1987, he has focused on

creditors’ rights, bankruptcy, and litigation, prosecuting claims on

behalf of, and defending claims against, corporations, banks, credit

unions and other financial institutions.

9 9

Outline

Overview of General Types of Guaranties

General Legal Issues to Enforce and Defend

Guaranties

Bankruptcy Issues

Questions and Answers

10 10

I. Overview of General Types of Guaranties

The Guaranty Agreement A guaranty is an agreement made by a third party, whether a

person, trust or a business entity, to pay and/or perform the

obligations of a debtor for the satisfaction of a debt owed to a

creditor upon the occurrence of an event, typically a default by

the debtor under the original loan agreement.

A guaranty, like any contract, requires mutual assent, adequate

consideration, definiteness and a meeting of the minds. Under

most states’ Statute of Frauds, a guaranty must be in writing,

signed by the guarantor(s) and delivered to the creditor.

11 11

I. Overview of General Types of Guaranties

In the context of a loan transaction, a guaranty serves as a form

of collateral to support the debt obligation between the debtor and

the creditor.

But, the guaranty and the loan agreement evidence separate

obligations, and their independence is not affected by the fact that

both agreements are written on the same paper or instrument or

are contemporaneously executed.

The guaranty cannot exist without a primary debt obligation. Thus,

if the primary debt obligation has been fully satisfied, is void or is

illegal, a guaranty of the debt obligation is also unenforceable.

12 12

II. Enforcement and Defense of Guaranties

Consideration A guaranty is a contract and, as such, it must be supported by

consideration. A guaranty without consideration is merely an

unenforceable gratuitous promise. While some guaranties are founded

on separate consideration than the original credit transaction, the

guarantor need not receive a direct benefit for consideration to exist.

The consideration usually consists of a benefit to the debtor or a

detriment to the creditor.

13 13


Courts have deemed consideration to be sufficient in the following

cases:

Guaranty is made contemporaneously with loan agreement. See, In re Kraft,

LLC, 429 B.R. 637, 659 (Bankr.N.D.Ind. 2010); Jackson v. Luellen Farms, Inc.,

877 N.E.2d 848 (Ind. Ct. App. 2007).

Guaranty is made as part of the loan transaction, even if the two documents are

not executed on the same date. See, Michelin Management Co., Inc. v.

Mayaud, 307 A.D.2d 280, 762 N.Y.S.2d 108 (2d Dep't 2003).

Amendment to the loan agreement, note or other loan document that is

acknowledged and approved by the guarantor. See, First Commerce Bank v.

Palmer, 226 S.W.3d 396 (Tex. 2007); Caves v. Columbus Bank & Trust Co.,

589 S.E.2d 670, 676 (Ga.App. 2003); Brown v. Lawrenceville Properties, LLC,

710 S.E.2d 682, 685 (Ga.App. 2011).

14 14


Resolution and/or settlement of claims against debtor; the creditor's

compromise of a claim against the debtor. See, Cincinnati Ins. Co. v.

American Hardware Mfrs. Ass'n, 898 N.E.2d 216, 230 (Ill.App. 1st Dist.

2008); Tag to Print 3Tower Investors, LLC v. 111 East Chestnut

Consultants, Inc., 864 N.E.2d 927, 937 (Ill.App. 1st Dist. 2007).

Continuance and/or expansion of debtor’s business with creditor or other

vendors or service providers; the creditor's agreement to continue doing

business with the primary debtor. See, Material Partnerships, Inc. v.

Ventura, 102 S.W.3d 252 (Tex. App. 14th Dist. 2003).

Creditor’s agreement to conduct business with guarantor or to provide

guarantor with a benefit outside of the guaranty agreement; a bank's

retention of the guarantor's friend in his position as president of the bank.

See, Performance Elec., Inc. v. CIB Bank, 864 N.E.2d 779, 784 (Ill.App. 1

Dist. 2007).

15 15


Joint and Several Liability Typically, with multiple guarantors of the same debt obligation,

the creditor can proceed against less than all of the co-

guarantors for recovery of the entire guaranteed obligations.

See Wachovia Bank, Nat. Ass'n v. Horizon Wholesale Foods,

LLC, 2009 WL 3526662 (S.D.Ala. 2009); Finagin v. Arkansas

Dev. Fin. Auth., 139 S.W.3d 797, 803 (Ark. 2003); Century

Business Credit Corp. v. Gargiulo Foods, L.L.C., 2003 WL

21998959 (S.D.N.Y.,2003).

16 16


Death of Guarantor Unless expressly provided in the guaranty, a guarantor's death does

not terminate a guaranty. See, In re Steagall's Estate, 444 N.E.2d 838

(4th Dist. 1983); In re Klink's Estate, 35 N.E.2d 684 (1st Dist. 1941).

The death of the guarantor of a continuing guaranty may limit the

guarantor’s liability as it relates to future transactions but does not

affect the credit transaction that was originally guaranteed. However,

the estate of the deceased continues to guaranty a credit transaction

by providing for renewals, as the consideration for the additional

obligation that was extended before the guarantor's death.

17 17


Release of Co- Guarantors The discharge of one co-guarantor's direct liability to the creditor does

not relieve him or her from liability to contribute to the other co-

guarantors. In addition, the fact that a creditor sues only some of the

co-guarantors, or recovers a judgment against fewer than all of them,

does not excuse those not sued or not included in the judgment from

paying their part of the joint debt. Accordingly, as a general rule, one or

more of the co-guarantors against whom the judgment is recovered

may, upon paying the creditor, compel contribution from all other co-

guarantors. A creditor’s release of one guarantor does not necessarily

release the co-guarantors. See Lestorti v. DeLeo et al., 4 A3d 269

(Conn.Sup.Ct. 2010).

18 18


Impracticability/Frustration of Purpose Twin Holdings of Delaware LLC v. CW Capital, LLC, 2010 WL 309022

(N.Y.Sup.,2010); a guarantor claimed that the decline in the real estate

market, a factor outside their control, made it more difficult to lease out

space in their building. The guarantor also alleged that the financial

crisis in the real estate market made it more difficult for the debtor and

guarantor to refinance the loan.

Flathead-Michigan I, LLC v. Penninsula Development, L.L.C., 2011 WL

940048 (E.D.Mich. 2011); a guarantor claimed that the economic

fallout in 2008 frustrated the terms of the guaranteed obligations.

19 19


Misrepresentation

Courts do not look favorable upon a guarantor’s claim of

misrepresentation, especially when the guaranty agreement is

absolute and unconditional. See, 627 Acquisition Company,

LLC v. 627 Greenwich, LLC et al., 85 A.D.3d 645 (N.Y.Sup.Ct.

2011); Alerus Financial, N.A. v. Marcil Group Inc., 2011 WL

4924152 (N.D. Oct. 18, 2011); Outsource Services

Management, LLC v. Ginsgurg, 2010 WL 5088190 (D.Minn

2010).

20 20


Lack of Notice

In certain instances, a creditor must provide the guarantor with

notice of a default or triggering event under the primary debt

obligation before seeking to enforce a guaranty agreement.

However, the language of the guaranty is controlling in

determining whether the creditor is under a duty to notify the

guarantor of a default, and notice need not be given when the

terms of the guaranty expressly dispense with the need for the

notice.

Comerica Bank v. Cohen, 291 Mich.App. 40 (Oct. 21, 2010)

Vision Bank v. 145, LLC et al., 2011 WL 5289070 (S.D.Ala Nov.

4, 2011)

21 21


Types of Guaranties Absolute

An absolute guaranty provides that the guarantor promises to pay

or perform the obligations of the debtor upon the occurrence of a

default event (typically debtor’s default). If a guaranty does not

contain words of limitation or conditions, it is typically construed as

an absolute guaranty.

Conditional

A conditional guaranty requires the happening of some contingent

event (other than the default of the debtor) or the performance of

some act on the part of the creditor before the guarantor will be

liable.

22 22


Payment A payment guaranty obligates the guarantor to pay the debt at maturity

(which may arise due to an event of default). Upon the occurrence of a

debtor's default, the guarantor’s obligation becomes fixed and the

creditor does not need to make a demand on the debtor.

Collection A guaranty of collection is a guarantor’s promise that if the creditor

cannot collect the claim with due diligence, usually after suit (and

exhaustion of remedies) against the debtor, the guarantor will pay the

creditor.

Performance A performance guaranty obligates the guarantor to perform some

obligation on behalf of the debtor for the benefit of the creditor.

23 23


Continuing A guaranty is continuing when it is not limited to a single transaction

but contemplates a future course of dealing which may encompass a

series of transactions, may be for an indefinite period and/or may be

intended to secure payment or performance of an overall debt of the

debtor. As such, a continuing guaranty may include subsequent

indebtedness without new consideration.

Restricted A guaranty is a restricted guaranty when it is limited to a single or

limited number of transactions, to a certain part of the debt obligation

and/or to a certain period of time.

24 24


Downstream A downstream guaranty is a guaranty by a parent corporation for the

obligations of its subsidiary. In this scenario, a lender will look to the parent corporation to back up the debt of a subsidiary corporation due to the parent corporation’s superior assets and financial condition.

Upstream An upstream guaranty is a guaranty by a subsidiary corporation for the

obligations of its parent corporation. Typically, a creditor will require an upstream guaranty when debtor’s, i.e. the parent corporation’s, only assets are the stock of a subsidiary, and the subsidiary owns assets used as collateral to secure the credit obligations.

Cross-stream A cross-stream guaranty is a guaranty among affiliated corporations,

whose stock are both owned by the same parent.

25 25


“Bad Boy” Guaranty Many non-recourse guaranties will include provisions that carve-out

instances where the guarantor may be personally liable upon the

occurrence of certain enumerated bad acts. This type of guaranty is

referred to as a “bad boy” guaranty. The types of bad acts commonly

include matters such as fraud, misappropriation, waste, and other acts

that show some bad act on the part of the guarantor. Since the

guarantor’s personal liability arises only upon the occurrence of a bad

act, the guaranty’s liability is sometimes referred to as a springing

liability.

26 26

III. Guarantor as Eligible Contract Participant

Statutory Basis Section 723(a)(2) of the Dodd-Frank Wall Street Reform and

Consumer Protection Act amended Section 2(e) of the

Commodity Exchange Act

Added:

"(e) Limitation on participation

It shall be unlawful for any person, other than an eligible

contract participant, to enter into a swap unless the swap is

entered into on, or subject to the rules of, a board of trade

designated as a contract market under section 7 of this title."

7 U.S.C.A. § 2(e)

27 27

III. Guarantor as Eligible Contract Participant

ECP defined under Dodd-Frank/CEA – 7 USC Sec.

1(a)(18)

ECP under CFTC Regulations – 17 CFR Sec. 1.3(m)

ECP – similar definitions Eligible Swap Participant – 17 CFR Sec. 35.1(b)(2)

Eligible Participant – 17 CFR Sec. 36.1(c)(2)

Appropriate Person – 17 USC Sec. 6(c)

28 28

IV. Guarantors and Swaps

Swap under Dodd Frank/CEA – 7 USC Sec.

1(a)(47)

Swap under CFTC Regulations – 17 CFR

Section 1.3(xxx)

Swap under Bankruptcy Code Bankruptcy Code defines “swap agreement," but provides that the term "is applicable for

purposes of this title only, and shall not be construed or applied so as to challenge or affect

the characterization, definition, or treatment of any swap agreement under any other

statute, regulation, or rule, including the Gramm-Leach-Bliley Act, the Legal Certainty for

Bank Products Act of 2000, the securities laws (as such term is defined in section 3(a)(47)

of the Securities Exchange Act of 1934) and the Commodity Exchange Act." (11 USC

§101(53B))

29 29

V. "Bad Boy Guaranties and Bankruptcy

Are such springing recourse guarantees void

as against public policy in a Bankruptcy

context?

Can third parties (non-guarantors) take actions

which trigger the guaranty?

Can the guarantor shed their liabilities under

the guaranty by filing Bankruptcy?

Do the unintended consequences of the bad

boy guarantees outweigh the benefits?

30 30

Bankruptcy and Public Policy

Hayhoe v. Cole (In re Cole), 226 B.R. 647, 651 n.6

(9th Cir. B.A.P. 1998)

In re Detrano, 222 B.R. 685, 688 (Bankr. E.D.N.Y.

1998);

In re Minor, 115 B.R. 690, 694–96 (D. Colo. 1990);

In re Ethridge, 80 B.R. 581, 586 (Bankr. M.D. Ga.

1987);

In re Halpern, 50 B.R. 260, 262 (Bankr. N.D. Ga.

1985), aff’d, 810 F.2d 1061 (11th Cir. 1987); and

In re Bisbach, 36 B.R. 350, 352 (Bankr. W.D. Wis.

1984);

31 31

Bankruptcy and Public Policy

In re 203 North LaSalle Street Partnership, the

Court said, “…since bankruptcy is designed to

produce a system of reorganization and

distribution different from what would obtain

under nonbankruptcy law, it would defeat the

purpose of the Code to allow parties to provide

by contract that the provisions of the Code

should not apply." 246 B.R. 325 (Bankr. N.D.

Ill. 2000).

32 32

Can Third Parties Trigger the Guaranty?

Yes!

The efficacy of a bad boy provision as a hindrance to

the commencement of a Bankruptcy has been

destroyed when the person with their hand on the

button may not be harmed if the button is pushed.

A lender or other who succeeds to the guarantor's

position of power can file a Bankruptcy with impunity.

Unless an inter-creditor or some other agreement

addresses the issue.

33 33

Guarantor's Bankruptcy Eliminates Liabilities?

Maybe.

To be treated as any other similar debt.

Can be objected to as any other similar

debt

Fraudulent Conveyance?

Over-reaching?

34 34

Unintended Consequences?

Be Careful What You Ask For.

Too Much of A good Thing Can Hurt.

Practicality Often Trumps Strict

Adherence

35 35

Questions and Answers

Aric T. Stienessen

Hinshaw & Culbertson, Minneapolis

[email protected]

Anthony J. Jacob


[email protected]

William Connelly


[email protected]

Documents

Loan Guaranty Enforcement: Bad Boy, Upstream, Affiliated and …media.straffordpub.com/products/loan-guaranty... · 2013. 10. 29. · Loan Guaranty Enforcement: "Bad Boy,“ Upstream,