The simplest and most common form of third party
obligation available to creditors isthe guaranty.
This ancient legal form of “pledge” is defined as a commitment
made by a person to pay the debt or to fulfill some other obligation of
another person, in the event of default.
The language of a guaranty need not be formal to be enforceable and
there is no requirement that guarantees be recorded.
With the complete abolishment of the Deprizio Rule in the
Bankruptcy Reform Act of 2005 there is no reason not to obtain as many
guaranties as is possible. Guarantees are, however, subject to the Statute
of Frauds requirement that “pledges to pay the debts of another” be
reduced to writing and signed by the person making the guaranty, or the
GUARANTIES ARE NOT ENFORCEABLE.
In addition to the requirement that a guaranty must
be in writing, every guaranty must also include elements necessary to make
an enforceable contract. These
Identification of the parties, including the guarantor(s),
the party whose debt is to be guaranteed, and the creditor
A clear commitment by the guarantor to perform, i.e. exactly
what will happen and when
Consideration for the guarantor to make the commitment
THE PROBLEMS WITH GUARANTEES
Since January of this year we have been engaged in
auditing the credit files of one of our clients and have made note of two
specific occurrences. One, the majority of credit applications have not
been updated in quite awhile, in some cases never, and two, the
application includes a boilerplate guaranty of no more than a paragraph or
two and does not include two of the three elements mentioned above.
In reviewing the boilerplate guaranty, we encountered
the following sentence: The guarantor waives protest, presentment and
notice of dishonor. This language leads us to believe that whoever
created the guaranty was either trying to find a way to draft a lock-tight
guaranty that would negate any "suretyship defenses." There are
many of these types of defenses that enable a guarantor to evade its
obligations due to the actions of the creditor that often increases the
guarantor's risk. Or the wording was taken from another guaranty, possibly
a longer one, and minimized to fit the guaranty included on the credit
application, which, we believe, was more likely, the case.
GUARANTY LAW AND THE UCC
Guaranty law is largely court-made and because
guarantees are promises to pay made by parties not otherwise liable to
creditors, courts have a tendency not to strongly enforce them.
That is, if there exists any ambiguity or uncertainty in the
language of the guaranty it will usually be interpreted adversely towards
the creditor. Further, a
number of states have enacted statutes imposing specific limitations on
guarantees, such as requirements that the maximum aggregate amount of
liability on the guaranteed debt is specified and that guaranties are
current with respect to the date signed. These rules vary from state to
state and as a result, there is no generally accepted statues of time or
list of suretyship defenses. So when drafting guarantees attorneys
generally try to cover every base. A good creditors rights attorney knows
that an endorser of a negotiable instrument is a surety — "... if
an instrument is dishonored, an indorser is obliged to pay the amount due
on the instrument ... according to the terms of the instrument at the time
it was indorsed...." (This can be found in Section 3-415 of the
post- 1990 Article 3 of the Uniform Commercial Code)
What's more, the creditors rights attorney knows that
Article 3 of the UCC gives a specific statutory instruction as to how to
negate one particular form of suretyship defense. Of course those
attorneys who elected not to take the Uniform Commercial Code course in
law school usually haven’t a clue and generally are the ones who simply
cut and paste form guaranties to fit whatever the need their clients are
Under Article 3, if the guarantor is obligated on a purchase where payment
is due on 30 day terms, September 1, and the creditor, as holder of the
invoice and guaranty, extends the time for payment to the debtor until
September 15 (thus extending the time for payment of the invoice) or
delays notifying the guarantor that the original purchase terms as stated
on the instrument (invoice) has been dishonored, then the guarantor may
have a defense to his obligation. Article 3 does provide specific words
that can be incorporated into the guaranty that can make this defense
difficult to the guarantor. That phrase is "By the terms of the
instrument, presentment is not necessary to enforce the obligation of
indorser” and “The indorser whose obligation is being enforced
has waived presentment." (Section 3-504 of Article 3.)
The other difficult aspect of guaranty enforcement is
duration. Consider this
situation: Amalgamated, Inc. opens a credit account with creditor X, but
only after Amalgamateds’ president provides creditor X with a personal
guaranty. Nine years later,
Amalgamated defaults on its payment obligation to Creditor X, and creditor
X pursues the guarantor for payment. The
guarantor objects saying that he sold Amalgamated to others, three years
after the account was opened with creditor X and he has had no interest in
the operations of Amalgamated since his departure.
Creditor X argues the guaranty plainly guarantees payment in event
of default by Amalgamated, Inc., and it is also a continuing guaranty and
valid unless revoked in writing. The
guarantor admits he did not revoke the guaranty.
Can creditor X collect from the guarantor?
State courts will generally enforce guarantees as
drafted and signed by the parties unless the effect would be injurious to
public policy. In cases like
our example, courts often attempt to find for the guarantor on the basis
of any available legal theory – except the law of guaranty.
Creditors probably cannot rely on the courts to enforce guarantees
with unlimited duration. Several states have even proposed laws to
automatically require renewal of all guarantees after specified time
periods. It is, therefore,
probably advisable to include expiration terms in commercial guarantees,
and to carefully monitor renewals as needed.
WHAT IS A GUARANTY?
Creditors rights attorneys’ inform us a guaranty isn't a negotiable
instrument but rather a contract and the guaranty can be drafted to do
whatever the parties mutually agree to do. The law of guaranty then is
nothing more than a set of rules that establishes when default occurs and
the obligations of the parties in default, in writing. Thus the extension
of time is only one of the defenses available to the guarantor. Moreover,
under the pre-1990 version of Article 3, "when words of guaranty
are used, presentment, notice of dishonor and protest are not necessary to
charge the user." (§ 3-416(5)).
We mention the pre-1990 version of Article 3 of the UCC because
many of the “form” guaranties in existence and still being used today
have not been changed to reflect the post-1990 Article 3 revisions.
In every obligation by one party to the guaranty there are reciprocal
obligations of the other parties and it is important to be aware that any
party may have defenses based on the conduct of the other two parties. For
example the guarantor could be partially or totally discharged from its
guaranty if the creditor took actions that increased the guarantor’s
risk. For example: say the debtor was past due or made it known to the
creditor that they were not going to be able to pay present obligations on
the due date but the creditor continued to sell to the debtor because they
had a guaranty. This action on the part of the creditor increases the risk
to the guarantor. If the guarantor can show that the creditor was careless
in its performance and placed the guarantor at increased risk the
guarantor could be deemed as not responsible for any of the debt incurred
beyond the past due amount and the Court, if it chose, could rule the
guarantor not responsible for any of the debt.
We have seen some guaranties that include language
that states, “the guarantor’s obligation under this guaranty is
primary and not secondary.” That’s a nice try on the part of the
drafter and such a statement may succeed as a waiver of suretyship rights
but common sense says if it is a primary obligation, then it can’t be a
guaranty and in order for it to be a primary obligation the guarantor
would have had to have benefit of the consideration.
COMMON TYPES OF GUARANTIES
The most common types of guarantees used in
commercial credit transactions are.
As the name suggests, personal guarantees are obtained from
individuals. This very common
guaranty is standard procedure for most creditors in extending credit to
new, small or financially weak businesses.
Typically, personal guarantors are principals in the debtor
business, although persons unrelated to the debtor can guarantee its
debts. Personal guarantors
promise to pay upon default of the debtor, and creditors may look to the
guarantors’ personal assets for payment.
This raises the practical question for creditors,
whether the guaranty provides any real value in event of enforcement;
evaluation of the guarantor’s personal creditworthiness is essential to
answer the question. Further,
a guaranty from a proprietor or general partner adds no value for a
creditor. This may also be true of members of a limited liability company
whose state does not recognize them as corporations.
Corporate guarantees are often seen in the context of establishing
trade accounts for spin-off companies, new or small debtors in which the
corporate guarantor has a vested financial interest, and circumstances
where the guarantor needs an uninterrupted supply of goods from the
creditor to its critical vendor. In
each case, the guarantor acts in self-interest to assist the debtor obtain
credit, and the creditor gains vital protection from loss.
Corporate guarantors should be financially scrutinized as carefully
as any debtor.
Resolutions. Although all employees of a corporation are legally
“agents”, only certain employees are authorized by the Board of
Directors to enter into agreements or bind the corporation through
guarantees or security agreements.
These employees are authorized during meetings of the
Board of Directors and the information is entered in the minutes of the
Board. It is vital when securing any agreement that the signature of the
party signing on behalf of the corporation be binding. The legal method
for this is to have a board resolution completed and signed by the
Corporate Secretary attesting to the fact that the person signing the
Agreement is authorized to bind the corporation by its’ Board of
WHERE DO THESE DOCUMENTS COME FROM?
At some point in time someone mentions at an industry credit meeting or
other function that they are in need of a guaranty or other form. Another
creditor responds saying they have one and will fax it over that
afternoon. The requesting creditor changes the names and dates, and the
guaranty ends up in another company’s forms file and so it goes.
One thing is clear — the creditor, neither one, has no idea what the
provisions mean in those forms. Most likely, they think it means that (1)
the creditor doesn't have to present the guaranty when it demands payment
(it says “waives presentment,”), and (2)
the guarantor will have no right to object to the demand for payment
("waives protest"). Although that is the way the document
reads it does not mean it is legally correct.
How do I know these guaranties are inadequate? Well, there have been
several developments in commercial law since 1980 and it is my business to
know what they are. I also know if more credit professionals were paying
attention and been aware of these changes instead of borrowing forms from
their peers, the results of that learning would have shown up in their
First, UCC Article 3 was substantially revised in 1990. In particular, old
Section 3-606, which described the actions of the holder that would
discharge a guarantor (that is, the "suretyship defenses") was
replaced by new Section 3-605, which among other things, added the
following helpful provision: (i) A [guarantor] is not discharged under
this section if ... the instrument or a separate agreement provides for
waiver of discharge under this section either specifically or by general
language indicating that the parties waive defenses based on suretyship or
impairment of collateral.
So under post-1990 Article 3, you can waive all suretyship defenses by
including the phrase "I waive defenses based on suretyship
or impairment of collateral." But those words usually don't
appear in the majority of the boilerplate guaranties because they were
created prior to 1990 under the old UCC Article 3.
The point is not that non-creditor rights attorneys are often ignorant of
commercial law principles (they are), or that they are too prone to defer
to out-dated forms (they do!). Article 3 suretyship principles are not
central to most lawyers' concerns, and usually credit professionals are
not asking their attorneys to update their forms and if they do the
majority of company attorneys are not up-to-date in creditors rights law.
They just look for a form or ask another attorney if they have a form.
I know this because I get calls and emails daily from
both creditors and their attorneys, people I don’t even know, who have
found my website and inquire if I have such and such form available. My
point is the too often tendency of forms to contain language that once was
correct but is not any more.
IS THERE ANYTHING WE CAN DO?
Lately, as we discover these standard forms of legal boilerplate that
seem to reproduce not only within industries but also cross-pollinate into
others (we suspect this occurs as credit professionals change jobs and
take their forms with them to their new gig) we ask the question,
“What else can we do?” The majority of these boilerplate
documents were once created in legal practice, and very seldom are they
updated. Not surprisingly, lawyers are more interested in solving problems
then creating forms. The result is there exists a majority of standard
legal forms being used that may or may not protect those who are using
What's to be done? There are a few who often publish forms of commercial
law documents, with commentary, but these seldom have the institutional
backing to ensure that they are kept up to date. Even forms publications
offered by various credit associations are usually not updated but instead
are just recycled with a new printing date. The UCC Commission has a
Permanent Editorial Board for the UCC, but not for commercial law forms.
And even if you publish a useful form, it's not clear that a legal journal
or association will want to publish annual updates that make the minor
changes (no income in it).
When the revisions to Article 9 of the UCC were
introduced I wrote a manual updating the procedures, definitions and new
forms to be used under the revised UCC Article 9 (RA-9), and although it
was sent out to several industry (legal and commercial credit) forms
publishers it wasn't clear that anyone wanted to publish it. In fact,
several wrote back suggesting if I had a website I should just post it
And there's another problem: Even if there were a reliable source for
up-to-date forms, it's unclear that they would be used. Law firms tend to
use their own forms, because they want to offer a product that differs
from the product offered by other firms. It’s one of the dirty little
secrets as to why legal expenses are so high, the battle of the forms. And
if they don’t have a particular form in their library they don't want to
tell the client that they acquired the document from a publicly available
source that may or may not be up-to-date.
Credit professionals need to review their forms
annually with qualified legal counsel to make certain the documents they
are using to protect the second most important asset of their organization
are up-to-date and can be relied upon.
I wish you well.
The information provided above is for
educational purposes only and not provided as legal advice. Legal advice
should be obtained from a licensed attorney in good standing with the Bar
Association and preferably Board Certified in either Creditor Rights or