Guaranties Are What They Say They Are

In debt refinancing transactions, it is common practice to obtain guarantor consent to the recasting of the underlying indebtedness, or to obtain new guaranties from the guarantors as a part of the transaction. A recent Indiana Court of Appeals decision makes clear that either step may be unnecessary if the guaranty is properly drafted.

What is a guaranty? A guaranty is a conditional promise to answer for the debt (payment guaranty) or default (performance guaranty) of a borrower. Virtually every state requires that a guaranty agreement be in writing. Because guaranties are not favored in the law, and are strictly construed, the language of the guaranty is of great importance. In construing a guaranty, a court must give effect to the intentions of the parties, which are to be ascertained from the language of the contract in light of the surrounding circumstances. Generally, the nature and extent of a guarantor’s liability depends upon the terms of the contract, and a guarantor cannot be made liable beyond the terms.

The language of the guaranty. In a new decision from the Indiana Court of Appeals, the lender brought an action against the borrower and the guarantors seeking judgment and foreclosure after the borrower defaulted on the underlying notes. Because the notes had recently been recast, and the guarantors had not signed new guaranties, the guarantors contended that the underlying obligations had been materially altered, and that the parties did not contemplate that the guaranties would continue.

The Appellate Court examined the language of the guaranties, and found that the guarantors consented to the recasting of the underlying obligations because the guarantors consented to future renewals, extensions and refinancings of the underlying obligations in the guaranties. The guaranties at issue contained consents and waivers which made clear that obtaining new guaranty agreements from the guarantors was unnecessary. The Court also noted that the guaranties specifically provided that they may not be waived, modified, amended, terminated, released or otherwise changed except by a writing signed by the guarantors and the lender. Having found that the terms of the guaranties were not vague or ambiguous, the Court agreed with the lender that the guaranties were still in effect and enforceable.

The Court of Appeals’ decision makes clear that, if properly drafted, a guaranty survives refinancings, and new guaranty agreements need not be obtained by the lender. Nevertheless, it remains a best practice to obtain written consent through a new guaranty agreement from the guarantor before any underlying debt is renewed, extended or refinanced.

Henry Efroymson is the chair of the Bankruptcy and Creditor/Debtor Disputes Practice Group. Concentrating his practice in loan workout, creditor/debtor disputes and bankruptcy for over 28 years, he helps guide small, medium and large businesses through the complexities of financial distress.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.