CHAPTER 13.08. Bankruptcy and Reinstatement of a Guaranty

• Jurisdiction: United States

13.08. Bankruptcy and Reinstatement of a Guaranty

A key bankruptcy consideration is whether a guaranty can still be enforced in the event of the bankruptcy of the primary obligor after repayment of the underlying obligation. Generally, where a primary obligor fully satisfies the underlying obligation, this discharges the guarantor from liability under the contract of guaranty.¹⁰¹ However, if the primary obligor subsequently files for bankruptcy, the obligee may have to repay amounts received by it that constitute preferences or fraudulent conveyances. Bankruptcy discharges the primary obligor of its personal liability for the debt, but it does not discharge the debt itself.¹⁰² Consequently, lenders often include terms in the guaranty providing for reinstatement of the guarantor's liability for the underlying obligation where the obligee is required to repay all or some of the amount received by it in satisfaction of the underlying obligation.

There is no Delaware case that directly addresses whether such a reinstatement clause would be enforced in the case of a guaranty. However, it is likely that such a provision would be enforceable under Delaware law. Delaware courts will only decline to enforce the terms of a valid contract in extreme circumstances, none of which seem to apply in this case.¹⁰³ A contract term providing for the reinstatement of a contract under certain conditions is neither illegal nor in violation of public policy.¹⁰⁴ Consequently, the effect on the guarantor would seem to be no different than agreeing to permit the obligee and primary obligor to extend the life of the underlying obligation, which is permissible under Delaware law.¹⁰⁵

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Notes:

^[101] 38 Am. Jur. 2d Guaranty § 65 at 1011 (2010) ("The guarantor's obligation ends when the debtor's obligation has been paid or otherwise satisfied."); 38A C.J.S Guaranty § 92 at 657 (1996); Cf. S & S Builders, Inc. v. Di Mondi, 126 A.2d 826, 830 (Del. 1956).

^[102] See Chrysler Fin. Corp. v. Fruit of the Loom, Inc., 1993 WL 19659, at *5 (Del. Super. Jan. 12, 1993), aff'd, 628 A.2d 83 (Table) (Del. 1993).

^[103] Libeau v. Fox, 880 A.2d 1049, 1056 (Del. Ch. 2005); State v. Tabasso, 28 A.2d 248, 252 (Del. Gen. Sess. 1942) ("[F]reedom of contract is the rule and restraints on this freedom the exception, and to justify this exception unusual circumstances should exist.").

^[104] See Harris v. N.Y. Life Ins., 33 A.2d 154, 158 (Del. Ch. 1943) (refusing to rescind a "reinstatement contract" made...