The Dos And Don’ts In Drafting And Enforcing Personal Guarantees On Real Estate Loans

Let’s start with the basics – what is a personal guaranty? At its core, a personal guaranty is exactly what it sounds like; an agreement whereby a non-party contractually agrees to be liable for the complete performance of another. In essence, the “guarantor” or “surety” is guaranteeing that the indebted party will fulfill the contract terms and agree to be held personally liable in the event of default. Sounds easy enough, right? Not so fast. Requiring a non-party to assume the debt of another is not to be taken lightly and should never be done without a solid written agreement to ensure the creditor maximum flexibility in its enforcement.

This is crucial in California since a guarantor may be relieved of the obligation if the enforcing party (i.e., the creditor) acts in a way which alters or affects the original obligation under the agreement. California Civil Code §2819 states, “[a] surety is exonerated … if by any act of the creditor, without the consent of the surety the original obligation of the principal is altered in any respect, or the remedies or rights of the creditor against the principal, in respect thereto, in any way impaired or suspended.” Under Civil Code §2845, “[a] surety may require the creditor … to proceed against the principal, or to pursue any other remedy in the creditor’s power which the surety cannot pursue, and which would lighten the surety’s burden; and if the creditor neglects to do so, the surety is exonerated to the extent to which the surety is thereby prejudiced.” In plain English, this means that if the creditor modifies or amends the original indebtedness or seeks recovery from the guarantor first before seeking relief from the indebted party and/or any collateral securing the debt, the guarantor’s obligation may be subject to termination.

But a personal guaranty is like any other contract and is deemed a separate agreement in and of itself apart from any agreement between the creditor and the debtor. Because the personal guaranty is a separate agreement, the parties to it are bound by its terms, and limitations to its enforcement can be predetermined and dispelled up front. In fact, a creditor is entitled to seek payment from the guarantor only as permitted by the personal guaranty. To that end, a good personal guaranty should contain clear provisions waiving entitlement to certain Code sections, including those discussed above. California courts routinely uphold waivers agreed upon by a guarantor in the absence of fraud. Union Bank v. Ross (1976) 54 Cal.App. 3d 290, 294-295 (“[t]he Rosses argue that the law requires a creditor to sell collateral on demand if it is sufficient in value to satisfy the obligation.

Although this is a correct statement of the law [citations omitted] the Rosses waived their rights” in a personal guaranty and “a waiver of the right to proceed against collateral is valid.”). Accordingly, depending on the wording of the personal guaranty, the creditor may be entitled to payment from the personal guarantor without first enforcing its rights against the debtor or even warning the guarantor of a default. If the original obligation is secured by real property, provisions regarding rights to offset and waivers dealing with California’s anti-deficiency and one-action statutes (under Code of Civil Procedure §§580 and 726) are also extremely important.

There are also different types of guarantees which could affect a creditor’s recovery. The two primary types of guarantees are a “guaranty of payment” or a “guaranty of collection.” A guaranty of payment is favored by creditors since the guarantor is essentially telling the creditor that the guarantor will pay the entire debt in the event the borrower does not. Typically, a guaranty of payment includes the waivers discussed above such that the creditor can immediately seek recovery from the guarantor in the event of default. A guaranty of collection, on the other hand, is more favorable to the guarantor.

Under a guaranty of collection, the lender must first pursue recovery from the debtor and is often required to obtain a judgment and partake in efforts to collect on the judgment before seeking recovery from the guarantor. To avoid ambiguity, any lender seeking to obtain a personal guaranty should be sure to include language detailing the agreement as “a guaranty of payment, not collection” and include all applicable waivers and offset provisions.

Guarantees can also be “limited” or “unlimited” and relate to a single loan transaction or be a “continuing guaranty” whereby the guarantor remains liable for an indefinite time for the repayment of debtor’s past, current, and future obligations. While a limited guaranty places certain limits on the extent of the guarantor’s obligations, an unlimited guaranty does not limit a guarantor’s obligation to any particular time period or amount.

Authors: Todd E. Chvat, Esq. and T. Robert Finlay, Esq. of Wright, Finlay & Zak, LLP