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GUARANTIES UNDER CALIFORNIA LAW
INTRODUCTION:
If one person agrees
to pay the existing or potential debts or obligation of another person or
for an entity such as a corporation or limited liability company, then
one is said to be "guarantying" the debt and one becomes
as liable for payment as if one had incurred the obligation directly. The
"guarantor" is the person guarantying the debt while the
party who originally incurred the debt is the "principle"
and the creditor is the "guaranteed party." Under California law, if properly drafted, a
guaranty is a fully enforceable obligation which allows the guaranteed
party to proceed directly against the guarantor, often without having to
even exhaust first any remedies against the principle.
The guaranty is a
powerful and common tool both in business and real estate transactions
and forms the basis for thousands if not tens of thousands of
transactions in California annually. Most creditors and
landlords, confronting a limited liability entity without substantial
assets, will demand a guaranty from the owners of the business so that if
the company becomes insolvent, personal liability may be imposed on the
owners or whoever else guaranteed the debts. Landlords renting to such
entities, banks granting credit lines, manufacturers providing products
to distributors, all such transactions often require guaranties being
provided by the owners of the entities.
If you are a
creditor, such a tool is probably the single most powerful weapon in your
arsenal of collection and, assuming the owners of the entity have assets,
can provide payment even if the entity becomes defunct or files
bankruptcy. If you are the owner of the entity seeking credit, or a
person seeking to have credit provided to another person, the guaranty is
a obligation to be taken seriously. It is not unusual for a father's
guaranty of a son's obligation or a departing shareholder's continuing
guaranty of a company she has left to result in significant liability
being imposed, often years later after the guarantor may have even
forgotten that the guaranty was granted.
It must be recalled
that typically the guaranty applies to the debt regardless of the cause
of the debt or if the principle acted wisely or foolishly. It applies
whether or not the guaranteed party failed to notify the guarantor of its
actions or whether or not the creditor was foolish in continuing to lend
the money.
It is, in short,
almost a blank check written to the creditor on behalf of the principle.
Before undertaking such an obligation or, if you are a creditor relying
on a guaranty, the basics described in this article should be understood
and, of course, good legal advice obtained before creating such a
document.
CALIFORNIA REQUIREMENTS FOR A GUARANTY
1. IN WRITING
Oral guaranties are
almost never enforceable in California though many creditors have
attempted to enforce them claiming that they only extended credit
predicated on various oral assurances from the owners of the debtor.
While the law provides that a guaranty must be written, inventive
creditors have sought to impose liability on the verbal
"guarantors" by claiming constructive fraud, negligent misrepresentation
and piercing the corporate veil
theories. These efforts are seldom successful and both the statute and
common sense indicate that something as serious as a guaranty MUST be in
writing which carefully lays out the principle, guarantor, and guaranteed
party and whether the guaranty relates to all debts and is in effect for
a specific period of time.
The writing must
be executed by the Party to be charged to perform under the guaranty (the
guarantor)
and is usually but need not be executed by the principle and the
guaranteed party. The key is to have the guarantor sign.
The writing should
clearly state all elements of the guaranty and describe in some detail
the process for revoking the guaranty.
The writing should indicate
whether the principle must first have its funds exhausted before the
creditor can seek recovery from the guarantor. (Minus clauses to that
effect in the document, many courts require exhaustion of remedies
against the principle first.)
The usual standard
terms of any contract, ranging from clauses as to how to alter the
contract to a provision providing for arbitration and attorneys fees
being awarded to the prevailing party should be included and the reader
is advised to review the article on
Contracts
as well as on Arbitration
on this website for a full discussion of such terms.
2. CONSIDERATION
The writing should
specify some form of "consideration" being given to the
guarantor for the guaranty. As noted in the article on
Contracts, to be binding
either some form of consideration must be paid to a party, or reasonable
reliance and detriment must be shown for the relying party. One can not
be bound to a contract unless one either gets something for such
obligation or leads the other party to presume that you will perform.
Mutuality of consideration, in which parties to a contract either get
something for agreeing to be bound, or require the other party to give
something up, is an element of most contracts, including guaranties.
Commonly, the
guarantor has an ownership interest in the entity or a family interest
with the principle and that fact should be recited in the guaranty.
Typically, a clause will read, "X agrees to pay all debts of Y, a
company in which X has an ownership interest," or "X wishes
Bank to loan monies to Y and understands that Y has refused to do so
unless X guaranties all obligations of Y to Bank. Bank relies on this
unconditional guaranty of X to pay obligations of Y to Bank in making any
loans to Y hereunder."
3. CONDITIONS OF
GUARANTY
An unconditional
guaranty does not place upon the guaranteed party any obligation to
perform certain functions before relying on the guaranty. For example, a
guaranty may be conditioned on first exhausting all efforts to collect
against the principle; it may be conditioned on the debt being only for a
particular type of transaction; it may be conditioned on the guaranteed
party giving adequate and written notice to the guarantor of the
obligations being incurred.
Most modern
guaranties, however, are unconditional, placing the full burden on the
guarantor without requiring the guaranteed party to do more than make demand
for payment upon the guarantor whenever a debt is not paid.
Typical language in
such a guaranty is:
"Guarantor
unconditionally and irrevocably guarantees all obligations of X owed to
Y, and waives forever any right whatsoever to require Y to first proceed
against X before making demand upon Y for payment in full. The guaranty
shall continue in full force and effect and may only be terminated in a
writing delivered to Y thirty days before termination of the guaranty and
such termination shall not eliminate the guaranty as to sums already
advanced. Y shall not be required to advise Guarantor as to any sums
advanced to X hereunder and it shall be incumbent upon Guarantor to keep
itself fully advised as to the state of the transactions between X and Y.
Guarantor shall promptly and fully pay all obligations of X to Y upon
receipt of written demand for payment from Y."
Normally, a guarantor
obtains all the benefits of the clauses protecting the principle. Thus,
if the principle has a clause in its contract with the guaranteed party
that limits the obligation or which delays when payment is due, the
guarantor may rely on those protections as well: the guarantor, in
effect, steps into the shoes of the debtor, no better, nor worse. It is
thus a very good idea for the guarantor to carefully review all the
documents binding the principle before the guaranty is made.
But the danger
remains that the obligation of the principle to the guaranteed party may
be altered between them without notice or warning to the guarantor and
many guaranties give the guaranteed party the right to do precisely that.
The careless guarantor may therefore find itself guarantying an
obligation far broader and more onerous than first encountered. The
prudent guarantor shall insist in the guaranty that the obligation may
not be altered in its terms without prior advice and consent of the
guarantor.
CREDIT APPLICATIONS AND GUARANTIES
Amidst the small
print and recitals at the end of many bank loan applications as well as
line of credit applications one finds guaranties slipped in which, if not
carefully considered, can have devastating effect on the debtor. Our
office makes it a standard practice when drafting credit applications for
our clients to submit to new customers to have a guaranty provision just
before the signature line for the credit application so that the
potential customer is confronted with the question of whether to guaranty
the debts of the corporation or limited liability company from the moment
the account is opened. It is a fact of business that once the account is
opened it is much more difficult to approach the principles of the
business and then ask them to execute the guaranty.
To our surprise, when
we take action to enforce such guaranties in the credit applications we
find that many of the debtors did not even realize they were executing a
guaranty when signing the credit application! Apparently after filling in
the various blanks with the information the credit manager wanted, they
glossed over the wording above the signature which usually provided words
to the following effect: "The Applicant for the Credit hereby
unconditionally and irrevocably agrees to guaranty any and all
obligations of the Company to XYZ Supplier and understands that such
guaranty is a condition to supplying any credit from XYZ to
Company."
Other companies that
we represent have the credit applicant execute a full and complete
guaranty agreement using a variation of the form below:
PERSONAL GUARANTEE AGREEMENT
The undersigned
GUARANTOR agrees with_____________________ (hereafter termed____________
) as follows:
1. GUARANTOR
desires to have____________grant credit terms as described on the
attached Application to ____________________ (hereafter termed
"FIRM"). __________________ has advised GUARANTOR that no
credit will be allowed to FIRM without GUARANTOR personally guaranteeing,
by this Agreement, all sums owed to ______________ by FIRM.
2. In
consideration of the granting of credit to FIRM by ______________, GUARANTOR
does guarantee prompt payment of any and all past, present and future
charges and payments due to________ by FIRM for goods sold to FIRM by
____________________ ***OPTIONAL INDICATE "YES" OR
"NO": This includes sums due prior to execution of this
Agreement but unpaid at this time.*** ***OPTIONAL INDICATE
"YES" OR "NO": This guarantee also covers all
merchandise back ordered or to be shipped from the factory as of date of
termination of this Agreement.***
3. This Guarantee
is a continuing one until terminated by GUARANTOR in writing by
registered mail to____________ . The termination shall be effective 15
days after receipt of written notice by____________ .
4. Should FIRM
default in the prompt payment of sums due________________ ,
___________________ may immediately proceed against GUARANTOR, and shall
give written notice to the GUARANTOR, together with an accounting of all
sums due as to which FIRM is in default, by regular or certified mail.
_________________ may, from time to time, extend the time for payment or
accept partial payments of or additional security for balances due or to
become due from the FIRM without or prior to, such notice to the
GUARANTOR. GUARANTOR hereby waives the right to require________________ to
first proceed against FIRM prior to enforcing this Guarantee.
***OPTIONAL
INDICATE "YES" OR "NO": 5._______ may refuse to sell
to FIRM, place sales to FIRM on a C.O.D. basis, or limit the amount of
credit granted FIRM at any time and without notice to GUARANTOR or the
FIRM. Guarantor shall remain responsible for the invoice charges for all
materials sold to the FIRM prior to the change of sales terms, or
afterwards, even if merchandise is sold or credit is extended by mistake.
This Guarantee shall apply to any purchases by FIRM, its successors in
interest, and shall also apply to any new corporate entity which owns any
or all of the assets of FIRM.***
#. Any and all notices
to_______________ or to the GUARANTOR or to the FIRM shall be mailed to
it, postage prepaid, at the addresses herein set forth or at such other
addresses as they shall designate by a written notice to the others.
#. Any and all disputes
relating to this Agreement or its breach shall be settled by arbitration ***OPTIONAL
INDICATE "YES" OR "NO":, by a single arbitrator,***
in , California, in accordance with the then-current rules of the
American Arbitration Association ("AAA"), and judgment upon the
award entered by the arbitrator may be entered in any Court having
jurisdiction hereof. Costs of arbitration, including ALL/REASONABLE
attorney's fees incurred in arbitration, **CHOICE INDICATE
"I" OR "II" AT: as presented to the arbitrator
by the prevailing Party, OR as determined by the arbitrator,**
together with ALL/ANY REASONABLE attorney's fees incurred by
prevailing Party in Court enforcement of the arbitration award after it
is rendered by the arbitrator, must be paid to the prevailing Party by
the Party designated by the Arbitrator or Court. Said arbitration shall
be conducted in the English language and the award rendered in United States dollars. Service of the
Petition to Confirm Arbitration and written notice of the time and place
of hearing on the Petition to Confirm the Award of the Arbitrator shall
be made in the manner provided herein for all notice. Such service shall
be complete on personal delivery or the deposit of the Petition and
notice in the United States mail.
Should one party
either dismiss or abandon his/her claim or counterclaim before hearing
thereon, the other Party shall be deemed the "prevailing Party"
pursuant to this Agreement. Should both Parties receive judgment or award
on their respective claims, the Party in whose favor the larger judgment
or award is rendered shall be deemed the "prevailing Party"
pursuant to this Agreement.
***OPTIONAL
INDICATE "YES" OR "NO":
At any time after the initiation of arbitration and not less than twenty
(20) days prior to the arbitration hearing, any Party may serve an offer
in writing upon any other Party to the action to allow an arbitration
award to be made in accordance with the terms and conditions stated in
the written offer. If the offer is accepted, the offer, together with
written acceptance, shall be submitted to the arbitrator and an award
made thereon without further hearing between those Parties. If the offer
is not accepted in writing, prior to five (5) days before the hearing or
within ten (10) days of mailing of offer, whichever first occurs, it
shall be deemed withdrawn and cannot be given in evidence at the hearing.
If the Party to whom said written offer was made fails to obtain a larger
or more beneficial monetary judgment than the offer from the arbitrator
after hearing, the Party to whom the offer was made must pay to the
offering Party the offering Party's costs of arbitration, including, but
not limited to, AAA administrative fees, arbitrator's fees and the costs
of experts necessarily incurred in preparation for the arbitration, as
well as all attorneys fees incurred by the prevailing Party. The
attorney's fees so incurred shall form part of the judgment and shall not
be reduced by the Arbitrator unless the Arbitrator determines that clear
and convincing evidence has been presented that such fees are
unconscionable.***
#. This instrument contains the
entire Agreement between the parties relating to representations made,
the rights herein granted, and the obligations herein assumed. Any
modifications of this instrument shall be of no force or effect unless
reduced to writing signed by all parties.
Agreed and
Accepted:
________________________________________________________
DATE:
________________
For the debtor
executing such a document, it is vital to understand that this will cut
through the protections of limited liability found in corporations,
limited liability companies, limited partnerships, etc. For the creditor
obtaining such a guaranty, it does allow significant additional
protection.but if the guarantor has no assets or files bankruptcy, the
protection will do little good. Only security in the form of deeds of
trust on real property or UCC-1 filings on equipment will provide the
additional protection many creditors require.
GUARANTIES IN OTHER STATES OR
COUNTRIES
It is important to
recall that the above law is California law and depending on where
the guaranty is entered into, the law can significantly alter. It is
entirely legal for a guaranty, like any other contract, to incorporate
the law of a different state.or even different country.and have it
enforceable in California as long as there is some
connection to the other jurisdiction and informed consent of the Parties.
Given the increasingly multi state 9and multi national) nature of so much
business, one should carefully note the state or country whose law is
incorporated into the guaranty before assuming that the various
protections of California will apply.and for creditors, they should be
aware that certain states, such as Texas and Florida, have remarkable
protections for debtors which may mitigate against the usefulness of the
guaranty. As with so much in the modern global economy, careful
consideration must be given to the locus of the transaction, the right
wording to vest jurisdiction and choice of law in California, etc. Given the dangers and
power of the guaranty, good legal advice is required before either
drafting.or executing such an instrument.
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