CHAPTER 13.06. Guarantor's Defenses

• Jurisdiction: United States

13.06. Guarantor's Defenses

The defenses that may be available to a guarantor can be grouped into three categories: (i) defenses of the primary obligor, (ii) suretyship defenses, and (iii) other defenses.

[1] Defenses of the Primary Obligor

General black-letter law states that a guarantor may raise at least some of the primary obligor's defenses against the obligee by virtue of its status as guarantor, though with some limitations.⁴⁴ However, under Delaware law, whether and to what extent a guarantor by virtue of this status may assert the primary obligor's defenses against the obligee is unclear. Some Delaware decisions cast doubt on the ability of the guarantor to raise the defenses of the primary obligor except under certain specific circumstances.⁴⁵

Other decisions have suggested that a guarantor has a right to those defenses.⁴⁶ Although no published Delaware decision meaningfully addresses this issue with respect to guarantors, the Delaware Superior Court has held that a surety on a bond could avoid liability by raising the principal's defenses because "a surety on a bond is not liable unless the principal is liable."⁴⁷ However, Delaware courts have acknowledged the distinction between sureties and guarantors.⁴⁸

[2] Suretyship Defenses

[a] Change in Identity of the Primary Obligor

The general rule is that a change in the identity of the principal obligor that significantly alters the nature of the guarantor's undertaking and results in increased risk to the guarantor will release the guarantor unless the guarantor consents to the change or the guaranty provides for a change in status.⁴⁹

Delaware law is less clear about the extent to which a change in the identity of the principal obligor will discharge the guarantor's obligation to the obligee. In an unreported opinion in 2010, the Delaware Superior Court found "no relevant Delaware case law" when confronted with the question of whether the incorporation of the primary obligor, formerly an unincorporated sole proprietorship operated by the guarantor, revoked the guarantor's obligations under his personal guaranty.⁵⁰

Parties to a guaranty can obviate this lack of clarity with respect to the default rule by drafting to indicate whether the parties intend for the guaranty to continue after a change in the primary obligor.⁵¹

[b] Change in Identity of the Obligee

A special guaranty (that is, one addressed to a specific obligee or group of obligees) is generally non-assignable and only enforceable by the party to whom it was addressed unless it expressly permits assignment by the obligee.⁵² Delaware courts have left open the possibility that certain factual situations might permit the enforcement of a special guaranty by an assignee of the original obligee.⁵³ For example, the Delaware Supreme Court has identified succession by merger to the original obligee as one such situation.⁵⁴ Again, parties to a guaranty can obviate this lack of clarity with respect to the default rule by drafting to indicate whether the parties intend for the guaranty to continue after a change in the obligee.⁵⁵

[c] Action by the Creditor that Increases the Risk of the Guarantor

Under Delaware law, "[i]t is a firmly established legal principle that an act or omission by a creditor which increases a surety's or guarantor's risk, or injures his rights will discharge the surety's obligation."⁵⁶ For example, in Federal Deposit Insurance Corp. v. Bloom, the primary obligor was developing properties that were already subject to certain mortgages.⁵⁷ The obligee made a loan to the primary obligor for this development. The loan agreement provided for funds to be disbursed by the obligee upon the demand of the primary obligor to pay off those mortgages.⁵⁸ The loan agreement also required the defendants to become sureties for the loan.⁵⁹ The primary obligor was offered an opportunity to discharge the mortgages at a discount, but the obligee wrongfully refused to disburse the funds for that payment.⁶⁰ Consequently, the court held that "the defendants are discharged of their obligations under the Suretyship Agreement . . . because [this breach of the underlying loan agreement] increased the defendants' risk and injured their rights."⁶¹

Similarly, in S & S Builders, Inc. v. Di Mondi, the Delaware Supreme Court stated the rule, in dicta, that "if a creditor, even by mistake, advises a guarantor that the claim, the payment of which has been guarantied by him, has been paid and the guarantor as a result . . . in some . . . manner changes his position to his disadvantage, the guarantor is thereby released from any liability under the guaranty."⁶² This rule was found inapplicable in that case, as the court found that the guarantor's change in position resulted from its own action and not from the action of the creditor.⁶³

[d] Modification of the Underlying Obligation

Delaware follows the general rule that "a guarantor cannot be held liable beyond the strict terms of his contract."⁶⁴ It generally follows from this rule that a guarantor will be released from the guaranty by any material alteration of the guarantied obligation without the guarantor's consent.⁶⁵ For example, this could occur if the obligee extends the primary obligor's time for performance.⁶⁶ However, in the case of a "compensated surety,"⁶⁷ liability will only be discharged for an alteration that was not only material, but also prejudicial."⁶⁸ In either case, a guarantor may consent in advance to modifications of the guarantied obligation without affecting the guaranty.⁶⁹

[e] Release of the Primary Obligor

The general rule is that the release of the primary obligor without the consent of the guarantor releases the guarantor from liability under the guaranty unless: (i) the guarantor agrees to remain liable, or (ii) the obligee reserves the right in the release to proceed against the guarantor.⁷⁰ Although no Delaware case has directly addressed this issue with respect to a guaranty, it seems likely that a Delaware court would follow the rule that, absent the consent of the guarantor, the guarantor is released if the primary obligor is released.⁷¹

Parties to a guaranty can obviate the lack of clarity with respect to the default rule by drafting to indicate whether the parties intend the guaranty to continue if the obligee releases the primary obligor.⁷²

[f] Release or Impairment of Security for the Underlying Obligation

Delaware law provides that a surety's liability is reduced, pro tanto, to the extent the obligee has security from the primary obligor and knows of the surety's obligation if the obligee: (i) surrenders or releases the security, (ii) willfully or negligently harms the security, or (iii) fails to take reasonable action to preserve the value of the security at a time when the surety does not have an opportunity to take such action.⁷³

The Delaware Superior Court, finding no Delaware cases on point, enunciated this rule by citing the Restatement of Security, which generally uses "surety" and "guarantor" interchangeably.⁷⁴ The Restatement of Security's rationale is that the surety is "entitled" to the obligee's rights in the security upon performance of the underlying obligation.⁷⁵ Thus, where the obligee reduces the value of its rights in the security, its right to the obligation of the surety should be similarly reduced.⁷⁶This is consistent with Delaware's view, equally applicable to guarantors, that a surety that satisfies the primary obligor's obligation has equitably purchased the creditor's rights vis-à-vis the primary obligor.⁷⁷

[3] Other Defenses

[a] Failure to Fulfill a Condition Precedent

As discussed above,⁷⁸ a conditional guaranty is one in which the liability of the guarantor is conditioned on the happening of some condition precedent in addition to the default of the primary obligor.⁷⁹ When a condition precedent has not been fulfilled, the guarantor is not liable.⁸⁰ Accordingly, an obligee must strictly comply with the conditions in the guaranty before it may obtain satisfaction from the guarantor.⁸¹

[b] Modification of the Guaranty

A guaranty may be modified by the parties like any other contract. An oral or written modification of a guaranty "must be based on [mutual] assent and consideration," or it will be unenforceable.⁸²

[c] Failure to Pursue the Primary Obligor

Whether the obligee's failure to pursue the primary obligor provides a defense to the guarantor's liability turns on the intent of the parties as expressed in the guaranty.⁸³ As discussed above, in the case of absolute guaranties, including guaranties of payment, there is no requirement that the obligee demonstrate any level of diligence in obtaining satisfaction from the primary...