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California Court Rejects “Sham Guarantee” Defense

Editor’s Note:  Bank Bryan Cave is going into its ninth year as one of the nation’s leading blogs on financial institution regulatory, M&A, securities, and litigation issues.  Here’s a recent post on Bryan Cave’s successful work for the California Bankers Association (“CBA”), headed up by Joseph Poppen of BC’s San Francisco office.

 

Bryan Cave LLP recently served as counsel for amicus curiae California Bankers Association (“CBA”) and helped score a victory in an important California appellate case of great interest to the banking industry, LSREF2 Clover Property 4 LLC v. Festival Retail Fund 1 357 N. Beverly Drive LP (Second District, California Court of Appeal case number B259937) (Link to the opinion is here).

The trial court had ruled that the guarantor of a commercial loan was excused from performance on the grounds that the guaranty was a “sham,” structured by the lender to circumvent California’s anti-deficiency laws.  The guarantor essentially argued that there was no legal separation between it and the borrower because it was the borrower’s “alter ego,” and as support they identified evidence that the two entities failed to observe basic corporate formalities.  According to the guarantor, it should be excused from its obligations because it was essentially the same as the borrower, and thus protected by California’s anti-deficiency laws.

In Bryan Cave’s amicus brief, the CBA raised two principal arguments, both of which were adopted by the court of appeal in its published opinion reversing the trial court’s judgment in favor of the guarantor Festival Fund.

The CBA first argued that there was no evidence to support a “sham guarantee” finding because the undisputed evidence showed that the borrower Festival 357, its general partner FRF1, and the guarantor Festival Fund, were separate legal entities formed prior to any involvement with the lender.  The court of appeal adopted this argument in holding that “in this action, there was no basis to find that the Bank had a role in the formation of Festival Fund or its affiliated entities, and no evidence to support a conclusion that the entities were designed by the lender to conceal the identity of the primary obligor.”  (Op. at pg. 11.)

The CBA also argued that the lower court erred by allowing the guarantor to invoke the alter ego or “unity of interest” doctrine because those doctrines permit an affirmative cause of action by a third party against a corporate creditor, not a defense that can be asserted by a corporation or its alter egos to evade liability to a third party.  Thus, the CBA argued, the lower court’s ruling allowing guarantor Festival Fund and the borrower’s general partner FRF1 to affirmatively disclaim their otherwise separate corporate existences, based on their own failures to observe corporate formalities, was not supported by any evidence of inequity to a third party creditor, as required for either doctrine to apply.  The court of appeal adopted this argument in holding that “[t]o allow a guarantor to avoid its obligations simply because the debtor’s general partner—which is owned entirely by the guarantor—avoided complying with corporate necessities would work an absurdity. Guarantors could choose to avoid liability by instructing their affiliated companies to disregard corporate formalities. If an alter ego (or single business enterprise) defense applied in these situations, it would promote an inequitable result, exactly what the doctrine is designed to avoid.” (Op. at pgs. 15-16.)

By defeating the “sham guarantee” defense in this important case, the CBA and its counsel, Bryan Cave, have helped the banking industry avoid a disastrous result that would have devalued commercial guarantees and likely restricted the availability of commercial lending in the State of California.

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The Guarantor Chronicles – Can a guarantor waive its right to a foreclosure confirmation proceeding?

Editor’s Note #1: This post first appeared last week on Bank Bryan Cave, a top blog on regulatory, M&A, and litigation issues for those in the banking world, located at http://www.bankbryancave.com/. Given the close relationship of this post’s topic to the world of distress, we are cross-posting it here.

Editor’s Note #2: For prior posts of interest to those involved in guarantor litigation, see Ninth Circuit Decides Issue of First Impression, Protects Insider Guarantor from Preference Liability, located at http://bankruptcycave.com/ninth-circuit-decides-issue-of-first-impression-protects-insider-guarantor-from-preference-liability/.

Can a guarantor waive his right to a confirmation proceeding under Georgia law, after a non-judicial foreclosure results in a deficiency still owing? Yes.  Last week, in case closely watched by Georgia commercial real estate lenders, borrowers, and guarantors, the Supreme Court of Georgia issued its opinion in PNC Bank, N.A.  v. Smith, 2016 Ga. LEXIS 169 (Ga. Sup. Court Feb. 22, 2016). The case was before the Georgia Supreme Court on two certified questions from the United States District Court for the Northern District of Georgia.  The two Certified Questions were: (1) Is a lender’s compliance with the requirements contained in O.C.G.A. § 44-14-161 a condition precedent to the lender’s ability to pursue a borrower and/or guarantor for a deficiency after a foreclosure has been conducted?; and (2) If so, can borrowers or guarantors waive the condition precedent requirements of such statute by virtue of waiver clauses in the loan documents?

In answering the first question in the affirmative, the Georgia Supreme Court upheld its reasoning in First Nat. Bank & Trust Co. v. Kunes, 230 Ga. 888, 890-91 (1973).  The Georgia Supreme Court echoed the reasoning in Kunes by stating “that notice to both sureties and guarantors is necessary to satisfy the purpose of the confirmation statute— ‘to limit and abate deficiency judgments in suits and foreclosure proceedings on debts’ and to enable sureties and guarantors ‘an opportunity to contest the approval of the [foreclosure] sales.”

The Court’s analysis of the critical second question focused on the Georgia Court of Appeals’ ruling in HWA Properties, Inc. v. Cmty. & S. Bank, 322 Ga. App. 877 (2013), holding that a lender is entitled to pursue a guarantor for any deficiency remaining on a debt after a foreclosure, regardless of whether the lender has confirmed the foreclosure sale, if the guaranty included language waiving all defenses to collection of the debt.  As set forth in Bryan Cave’s amicus curiae brief filed on behalf of the Georgia Bankers Association,[1] a ruling by the Georgia Supreme Court upholding HWA and its progeny, Cmty. & S. Bank v. DCB Investments, LLC, 328 Ga. App. 605 (2014), will do much to correct the current abuse of Georgia’s foreclosure confirmation statute, O.C.G.A. § 44-14-16, which some commercial borrowers and guarantors have used to draw out foreclosure proceedings and prevent collection of any deficiency.  In support of this argument, Bryan Cave’s amicus brief focused on Georgia’s long standing recognition of the freedom to contract, and more specifically, the ability of a party to waive certain defenses.

Justice Melton, writing for the majority in the PNC Bank case, agreed with the reasoning in HWA and DCB Investments reiterating that “a guarantor retains the contractual ability to waive the condition precedent requirement.”  In fact, the PNC Bank opinion explicitly states “[t]his result creates an appropriate balance between the statutory protections of the confirmation statute and the freedom of a guarantor to enter contracts deemed beneficial.”  Accordingly, the Georgia Supreme Court’s opinion upholds HWA and DCB Investments by affirming that guarantors may waive compliance with the confirmation statute.

In a concurrence, Chief Justice Nahmias expressed concerns with the consequences of the decision and suggested that the legislature may wish to examine the issue. We will continue to watch both legislative and judicial activity on this issue and keep readers apprised of any further developments.

[1] Those of you who regularly visit The Bankruptcy Cave will recall the prior post noting that Bryan Cave, on behalf of the Georgia Bankers Association, filed an amicus curiae brief in support of a common sense approach to this matter, allowing parties to freely negotiate as to what notices are warranted, and the waiver of defenses by parties who chose to guaranty debt. http://bankruptcycave.com/bryan-caves-atlanta-office-files-amicus-brief-for-georgia-bankers-association-regarding-guarantor-deficiency-claims/

 

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Bryan Cave’s Atlanta Office Files Amicus Brief for Georgia Bankers Association Regarding Guarantor / Deficiency Claims

On September 11, 2015, three of Bryan Cave’s financial institution / banking litigators (Curtis Romig, Edwin Cook, and Leah Fiorenza McNeill) filed an amicus curiae brief on behalf of the Georgia Bankers Association in a case currently pending before the Georgia Supreme Court, PNC Bank, N.A v. Smith, Case No. S15Q1445.  The case is of great interest to banks operating in Georgia, as well as other states that reject the “single action” rule and allow pursuit of judgments after foreclosure.  The focus of the Supreme Court will be the Georgia Court of Appeals’ 2013 ruling in HWA Properties, Inc. v. Cmty. & S. Bank, 322 Ga. App. 877 (2013), holding that a lender was entitled to pursue a guarantor for any deficiency remaining on a debt after a foreclosure, regardless of whether the lender had confirmed the foreclosure sale, if the guaranty included language waiving all defenses to collection of the debt.  As set forth in Bryan Cave’s amicus brief, a ruling by the Georgia Supreme Court upholding HWA and its progeny will do much to correct the current abuse of Georgia’s foreclosure confirmation statute, O.C.G.A. § 44-14-16, which commercial borrowers and guarantors have long used to draw out foreclosure proceedings and prevent collection of any deficiency.  A copy of the brief is available here.  Check back in a few months, or reach out to Curtis, Win, or Leah, to hear the results or to consult with them on your commercial guaranty matters.

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