Tag: guaranty

Unconscionability: Substantive and Procedural – Illinois Case Snapshot

The Case: Rosenbach v. NorStates Bank, 2014 IL App (2d) 131162-U

Facts Summary: Plaintiff LLC member who guaranteed commercial real estate loan sues the lender after lender makes (allegedly) unauthorized loan advances, declares a default against the LLC and seizes over $200,000 of the plaintiff’s personal funds that were pledged to induce the loan to the LLC.  Plaintiff’s claims are for breach of contract and a declaratory judgment action seeking ruling that the commercial guaranty is unconscionable under Illinois law.

Procedural History: Lender moves to dismiss on dual bases that (1) plaintiff’s injury is derivative of injury to the LLC borrower; and (2) commercial guaranty is not procedurally or substantively unconscionable.  Trial court grants motion and plaintiff appeals.

Result: Trial court’s dismissal upheld.  Lender wins, plaintiff LLC member/guarantor loses.

Operative Rules:

To defeat a guaranty claim, a guarantor must establish he suffered a direct injury as a result of a lender’s breach; as opposed to injury that is derivative of the injury suffered by the borrower.  So, if a corporate borrower is damaged due to a lender’s breach, the borrowing entity has a right to sue; not a constituent (individual) member of that borrower (e.g. an officer, shareholder, employee, etc.);

Illinois’ declaratory judgment statute allows a court to make binding declarations of rights in cases where the parties’ dispute has crystallized and they have reached an impasse.  The “dec action” plaintiff must show (1) a tangible legal interest in the subject of the suit; (2) a defendant with an opposing interest to plaintiff’s; and (3) an actual controversy between the parties. 735 ILCS 5/2-701(a);

Illinois recognizes (a) procedural unconscionability; and (b) substantive unconscionability.  The former means there is unfairness during the contract formation stage that deprives one of the parties of freedom of choice.  The latter (substantive unconscionability) looks to the terms of a contract and whether they are so one-sided that they oppress or unfairly burden an innocent party and show an imbalance in obligations among the contracting parties.

Procedural unconscionability factors include whether each party had a chance to understand the terms of the contract, whether key terms were hidden amid “a maze of fine print” and any other circumstances surrounding contract formation.

¶¶ 20-28, 31-35

Application:

Plaintiff’s claimed injuries in the breach of guaranty count were purely derivative of the LLC borrower’s.  The extent of plaintiff’s liability to the lender defendant was tied directly to the borrowing entity’s liability to the lender defendant.  There were no facts pled that showed plaintiff would have any different (in nature or amount) liability to defendant than the underlying corporate borrower.

The court held that loss of a guarantor’s investment is a derivative injury, not a direct one.  As a result, plaintiff’s claims were defeated since he failed to plead a direct (as opposed to flow-through) injury as the result of any lender conduct.

The plaintiff’s unconscionability arguments also failed.  The plaintiff only made conclusory allegations that the guaranty was a pre-printed document, drafted by the lender who had a superior bargaining stance compared to the plaintiff.  These blanket allegations weren’t enough though to show a defect during the formation and execution of the guaranty.

The court also held that even if the guaranty was procedurally unconscionable, the plaintiff would still have to show sustantive unconscionability – that the guaranty terms were inordinately one-sided in favor of the lender (and against the plaintiff) that no court could fairly enforce the guaranty.

Here, the court allowed that the guaranty definitely did favor the lender and the lender was probably in a stronger contracting position than the plaintiff.  Still, the terms weren’t so one-sided that the court should abstain from enforcing them.  In rejecting the plaintiff’s substantive unconscionability argument, the court also cited the fact that the guaranty terms weren’t hidden or hard to understand or any unfair surprise.

Afterwords:

Individual guarantor of a corporate borrower must show separate and distinct injury from the corporate borrower to have standing to sue a lender for breach;

A sophisticated borrower will likely need to show both procedural (formation defects) and substantive unconscionability (unfair or one-sided contract terms) to free himself from a contract he willingly signed.

Release and Satisfaction of Judgment and Guaranty Liability – IL Law

ReleaseBrahos v. Chickerneo,  2014 IL App (2d) 130543-U, examines Illinois money damages rules, the extent of a guarantor’s liability and satisfaction-of-judgment requirements against the backdrop of a business dispute involving a failed car dealership.

The plaintiff got a multi-million dollar fraud judgment against multiple defendants that stemmed from a failed car dealership business venture.  In post-judgment proceedings, the dealership was sold and the sale proceeds satisfied plaintiff’s judgment against all defendants except for one.  That remaining defendant then moved to dismiss the citation proceedings and for satisfaction of the remaining judgment balance – about $600K.  The trial court agreed and ordered the judgment satisfied.  The plaintiff appealed.

Held: Reversed.  The $600,000 still owed the plaintiff on the money judgment was not satisfied by the bank releasing the investor guarantors from liability under the various dealership loans.

Rules/Reasoning:

Reversing the trial court and finding that the plaintiff still could purse defendant for the balance of the money judgment, the Court applied several salient guaranty and release/satisfaction-of-judgment rules:

– Generally, the discharge of the principal obligation discharges the guarantor’s obligation;

– Code Section 12-183 (735 ILCS 5/12-183) requires a judgment creditor to sign a release and satisfaction of judgment so that the debtor can record that release with the Court that entered the judgment

– the party seeking the release of a judgment bears the burden of proving that a judgment entered against him was released;

– a release is a contract and is governed by contract law;

– the contracting parties intention is determined by the plain language of the contract;

– it is only where a contract is ambiguous (reasonably susceptible to two opposing meanings) that evidence is allowed in to explain what the contracting parties intended;

– typically, a money judgment can only be satisfied by paying the judgment unless the parties agree otherwise.

(¶¶ 32-35).

The Second District sided with the plaintiff and found that his money judgment shouldn’t have been deemed satisfied by the trial court.  The plaintiff never agreed to release his money judgment against the defendant and there was no evidence that plaintiff agreed to accept a “noncash benefit”- namely, the release from his guarantor liability to the bank.

The Court also pointed to the promissory note that required defendant to pay the judgment’s remaining $600K to the plaintiff.  The bank’s release of the dealership investors from their loan and guaranty liabilities didn’t  affect the defendant’s note liability.

In addition, the dealership lender’s release of the various investors (including plaintiff) from their bank obligations didn’t mention plaintiff’s damage award against the remaining defendant. (¶ 35).

The defendant’s double recovery argument – that the plaintiff got a windfall having his guaranty liability to the bank released while getting paid $600K from the defendant – was also rejected. 

The Court found there was no double recovery because plaintiff was not getting paid twice for the same injury and the bank was not a “joint tortfeasor” with the defendant.  Instead, the bank was a third-party creditor. ¶ 37.

Take-aways: 

–  A release of judgment will be construed as written and not expanded beyond its clear terms;

– A creditor isn’t required to release a money judgment unless that creditor is paid or the parties agree otherwise.  

Illinois Guaranty Law: Increasing Guarantor’ Risk or Changing the Terms = Discharged Guaranty

In Southern Wine and Spirits of Illinois, Inc. v. Steiner, 2014 IL App (1st) 123435, the First District outlined and applied the rules governing the interpretation and enforcement of written guaranty agreements in Illinois.

The plaintiff wine distributor purchased the assets of another distributor that had previously entered into a contract with a liquor store company; a contract personally guaranteed by the individual liquor store owners.

The year after the asset purchase, the plaintiff began supplying wine to the defendants’ liquor store on account.  But neither the plaintiff nor the purchased distributor informed the guarantors of the asset purchase.  Because of this, the guarantors had no idea that the assets of the distributor were sold to the plaintiff.  The defendants also didn’t know that the plaintiff now held the guaranty given by the liquor store owners to purchased distributor.

When the liquor store defaulted on about $20,000 worth of merchandise, the plaintiff sued under the guaranty signed by the liquor store owners.

The defendants moved to dismiss on the basis that the personal guaranty wasn’t assignable to the plaintiff since defendants didn’t know they were guaranteeing the liquor store’s contract obligations to the plaintiff.  The trial court agreed and plaintiff appealed.

Result: Trial court affirmed.

Rules/Reasoning:

In Illinois, a guaranty is simply a contract where a guarantor promises to pay the debts of a “principal” (the main debtor) to a third party creditor.

A guaranty is construed like any other contract and a guarantor is given the benefit of any doubts that may arise from the language of a guaranty.  A guarantor’s liability can’t exceed the scope of what he has agreed to accept and guaranties are strictly construed in favor of the guarantor; especially when the creditor drafted the guaranty.  ¶ 16. 

Guaranty agreements are generally not assignable but a guaranty can be assigned where the essentials of the original contract are not changed and the performance required under the guaranty isn’t materially different from what was originally contemplated. 

Where (1) a guarantor’s risk is increased or (2) performance is materially changed by the assignment of a guaranty or a merger involving the plaintiff-creditor, the guarantor’s obligations can be discharged. ( ¶ 18).

The Court held that because the defendants didn’t know that the guaranty was assigned to the plaintiff and because the amount owed the plaintiff fluctuated from month-to-month (in contrast to the  fixed amount the guarantors owed the original distributor), the defendants’ risk under the guaranty was materially increased by the assignment to plaintiff.

This was deemed a material change in the terms of the agreement that defendants entered into with plaintiff’s predecessor and changed defendants’ risk from known to completely unknown.  (¶¶ 21-22).

The Court also held that the trial court properly struck key parts of the plaintiff’s affidavit filed in response to defendants’ motion to dismiss.

The plaintiff filed the affidavit of its credit manager who testified that she reviewed the payment history involving the purchased distributor and the guarantors’ liquor store business.  The credit manager attached about two years’ worth of invoices and a payment ledger to her affidavit.

But the invoices didn’t  reference the prior wine distributor and only identified the guarantors’ liquor store.  The Court found that because the affidavit attachments failed to link the plaintiff directly to either the guarantor defendants or their liquor business, the plaintiff failed to lay an adequate foundation for the invoices as business records.

Take-aways:

– A guaranty agreement should specify whether or not it’s assignable and enforceable by third parties;

– Where a guaranty is assigned to a third party, the original creditor and assignee should both notify the guarantor and make it clear that the assignee creditor plans to hold the guarantor to the terms of the guaranty;

– Where an assigned or sold guaranty either changes the guarantor’s performance or materially increases his risk, for example by increasing the payment terms or frequency, the guaranty will likely not be enforceable by a third party/assignee.