Enforcing Commercial Real Estate Loan Guaranties
| Publication year | 2009 |
| Pages | 0012 |
A Look at the Law
Enforcing Commercial Real Estate Loan Guaranties
by Stephen Peterson, Susan Tarnower and Kevin Watters
He who is guarantor for a Stranger will surely suffer for it, But he who hates being a guarantor is secure.[1]
Despite ancient admonitions to the contrary, people have been guarantying debt as long as others have been borrowing money. In better times, guaranties were negotiated, executed and delivered with little expectation that the guarantors would be called upon to answer for the debts. In the current economic climate, guarantors and lenders are taking a closer look at their guaranty agreements. This is particularly true in the area of commercial real estate loans.
The May 4, 2009, issue of Barron's magazine included an article titled "The Other Shoe," in which the author speculated that, while most analysts have been focusing on the residential real estate market, commercial real estate loans will be the next major problem for banks.[2]The author writes, "Since peaking in early 2007, the value of the nation's commercial property has fallen an estimated 30% to 40% [and] many of the underlying properties aren't worth the value of the loans."[3]
Real estate investment trust (REIT) shares, another measure of commercial real estate values, dropped 19 percent from Feb. 7, 2007, to Sept. 19, 2008. They plummeted another 66.2 percent by March 19, 2009.[4] This precipitous drop may be only the opening chapter of the story because a significant share of the debt on this devalued commercial real estate matures in the next two years.
According to the Real Estate Roundtable, about $500 billion in commercial real estate debt matures in 2009, followed by $525 billion in 2010 and $550 billion in 2011.[5] The lack of available refinancing (demonstrated most dramatically by the collapse of the commercial mortgage-backed securities market, as discussed later in this article), combined with this staggering amount of maturing debt, indicates significantly increased commercial real estate loan defaults in the coming months.
The combination of increasing loan defaults from loan maturities and payment defaults, together with declining commercial property values, will prompt many lenders to look to sources other than their collateral for repayment of their debt. The most likely source of repayment is a high net worth guarantor.
The Guaranty Agreement
A guaranty is a contract to pay the debt of another, owed and payable by the principal debtor to the creditor upon default.[6] In short, a guaranty agreement is simply a contract. The same requirements for the formation of a contract under Georgia law apply to guaranties.[7] The same process used to evaluate the enforceability of a contract is also applied regarding the enforcement of a guaranty. There are some distinctions, however, that relate to the enforcement of a guaranty agreement. Although Georgia once recognized a distinction between a contract of surety and one of guaranty, that common law distinction no longer exists. A contract of guaranty will be treated the same as a contract for surety.[8]
Consideration
As with all Georgia contracts, a guaranty agreement must contain sufficient consideration. The guarantor need not receive a direct benefit under the guaranty agreement. Rather, any benefit flowing to a
common principal of a borrower and guarantor will constitute sufficient consideration to render a guaranty enforceable.[9] Even a nominal amount given in addition to mutual promises and considerations constitutes sufficient consideration for a guaranty agreement to be enforceable.[10] As long as the benefit has been provided to the principal, it is unlikely that lack of consideration will present an obstacle to enforcing the guaranty agreement.
Interpretation
Under Georgia law, the scope of a guaranty agreement is strictly construed, and the guarantor's obligation will not be extended by implication or interpretation.[11] This generally means that a court will not expand the realm of a guarantor's liability beyond that explicitly contained within the agreement.[12]When the terms contained within the guaranty agreement are plain and unambiguous, however, the guaranty agreement is interpreted as strongly as possible against the party giving the guaranty.[13]
Transferability
Under Georgia law, the transfer of the guaranteed obligation is generally held to operate as an assignment of the guaranty.[14] This rule applies, however, only if the assignor of the principal obligation (the loan) is also the obligee of the guaranty.[15] As with all contracts, the actual language of the guaranty agreement controls the transferability of the guaranty agreement. In the case of a securitized loan, a guaranty should and typically does include a clause indicating that the guaranty runs to the benefit of the lender's successors and assigns.
Pursuing Remedies Against the Guarantor
In Georgia, guarantors are jointly and separately liable for the guaranteed obligations, unless stated otherwise in the guaranty agreement.[16] It is important to read the guaranty agreement carefully to determine what remedies may be pursued by a lender against any guarantor. For example, some guaranty agreements are conditional and may require that action first be brought against the debtor or may otherwise limit the liability of the guarantor only to the extent that the debtor is unable to pay the amounts owed.[17] In these situations, all conditions contained in the guaranty agreement would first have to be met before a lender may proceed against a guarantor.
Release of Guarantor
When a defaulted loan has more than one guarantor, a lender may wish to settle with fewer than all of the guarantors. When there are multiple guarantors, a lender must be careful not to take any action that will adversely affect the right to enforce the guaranty agreement against the remaining guarantors. Georgia law specifically provides that a release of one guarantor will operate as a release of all other guarantors from their obligations.[18] The parties may, and in the context of commercial real estate generally do, contract out of this requirement.[19] If the guaranty agreement does not contain such language, the lender will need to obtain approval from all other guarantors before settling with any one guarantor, or risk losing the right to pursue remedies against the other guarantors.
Notice
A lender's obligation to provide notice to the guarantor of the borrower's default is defined by the guaranty agreement.[20] If the guaranty agreement is silent, the best practice is for a holder to provide all guarantors with any notice of default sent to the debtor.
Novation and Increased Risk
Under Georgia law, if the lender and borrower agree to change the terms of the obligation, or do anything to increase the guarantor's risk under the guaranty without the consent of the guarantor, the guarantor will be released from its obligations.[21] This requirement may be waived by a guarantor, however, if the guaranty provides that the lender may take the action that is alleged to have increased the guarantor's risk.[22] It is very important that the lender's attorney read the guaranty agreement carefully before agreeing to modify any guaranteed obligations.
Generally, a suit on a guaranty is no different from a suit on any other contract. As with all contracts, it is important to understand the terms of the guaranty agreement, as Georgia law allows for the parties to contract around many of the laws governing guaranty agreements.
Post-Foreclosure Enforcement of Guaranties
In Georgia, a lender's ability to pursue a guarantor following a real estate foreclosure is controlled by statute. Generally, there are two options for the lender to pursue.
First, as discussed in more detail below, judicial real estate foreclosure on collateral involves first filing suit against the borrower or guarantors, obtaining a final judgment and a deed of levy[23] and having a sheriff's sale of the property.[24] If a deficiency exists after the sheriff's sale, the lender may immediately pursue the deficiency. A mortgagee with real estate collateral located in Georgia, however, will usually conduct a nonjudicial foreclosure under the power of sale granted in the deed to secure debt.
Second, in the case of non-judicial foreclosure, a confirmation hearing is required under O.C.G.A. § 44-14-161 in order to pursue the borrower or a guarantor for a deficiency remaining after the foreclosure sale. Filing to request a confirmation hearing must be made in the appropriate superior court within 30 days of the non-judicial foreclosure.
Judicial Foreclosure
Judicial foreclosure is rarely used in Georgia because it is time-consuming and expensive. Judicial foreclosure involves filing suit against the mortgagor and other obligors, including guarantors, for a monetary judgment. Counterclaims against the lender, as...
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