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Commercial Loan Guaranty AgreementsEnforcing and Defending "Bad Boy," Upstream, Affiliated and Other Personal and Corporate Guaranties

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1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

WEDNESDAY, NOVEMBER 9, 2011

Today’s faculty features:

Aric T. Stienessen, Attorney, Hinshaw & Culbertson, Minneapolis

Greg Yates, Partner, Seyfarth Shaw, New York

Anthony J. Jacob, Partner, Hinshaw & Culbertson, Chicago

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C i l LCommercial Loan Guaranty AgreementsGuaranty Agreements

Enforcing and Defending “Bad Boy,” Upstream Affiliated and Other Personal andUpstream, Affiliated and Other Personal and

Corporate Guaranties

November 9 2011November 9, 2011

Aric T. Stienessen Anthony J. Jacob Greg YatesAric T. [email protected]

612-334-2504

Anthony J. [email protected]

312-704-3105

Greg [email protected]

212-218-3336

PresentersPresenters

Aric T Stienessen PartnerAric T. Stienessen, PartnerHinshaw & Culbertson LLP, MinneapolisHe represents lenders, investment banks and borrowers in commercial p ,finance transactions. He also represents businesses and real property developers in sales and purchase transactions involving commercial real property, and handles transactions involving mergers, acquisitions, divestitures and corporate organization and governance.

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Anthony J Jacob PartnerAnthony J. Jacob, PartnerHinshaw & Culbertson, ChicagoMr. Jacob is engaged in general corporate practice, including various g g g p p , gaspects of private merger, acquisition, divestiture and employee benefit matters. In addition, Mr. Jacob’s practice includes secured and unsecured lending transactions, asset securitization and structured finance, ESOP loans, initial debt and equity offerings, primary and secondary debt offerings, corporate reorganizations and restructuring, joint ventures and syndicated commercial financing transactions. His li t i l d d ti d f i ti li it d li bilitclients include domestic and foreign corporations, limited liability

companies and partnerships, and banks and other lending institutions.

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Greg Yates PartnerGreg Yates, PartnerSeyfarth Shaw, New YorkA member of the Bankruptcy, Workouts & Reorganization Department, p y, g p ,he is a trusted advisor to financial institutions as well as to non-institutional lenders and investors. Mr. Yates’ national practice is concentrated in the area of debtor/creditor relations, including workouts, restructurings, and bankruptcy. A key focus of his practice is advising clients on creative solutions to distressed commercial real estate transactions and, if necessary, litigation relating to those t ti I 2011 M Y t l t d b th T dtransactions. In 2011, Mr. Yates was selected by the Turnaround Management Association as a recipient of its Transaction of the Year -Large Turnaround Award.

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OutlineOutlineI Overview of General Types of GuarantiesI. Overview of General Types of Guaranties II. General Legal Issues to Enforce and Defend GuarantiesIII. Bankruptcy Issues IVIV. Questions and Answers

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I Overview of General Types of GuarantiesI. Overview of General Types of Guaranties

Th G t A t The Guaranty Agreement A guaranty is an agreement made by a third party, whether a

person, trust or a business entity, to pay and/or perform the obligations of a debtor for the satisfaction of a debt owed to a creditor upon the occurrence of an event, typically a default by the debtor under the original loan agreement.

A guaranty, like any contract, requires mutual assent, adequate consideration, definiteness and a meeting of the minds. Under most states’ Statute of Frauds, a guaranty must be in writing, i d b th t ( ) d d li d t th ditsigned by the guarantor(s) and delivered to the creditor.

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In the context of a loan transaction a guaranty serves as a form In the context of a loan transaction, a guaranty serves as a form of collateral to support the debt obligation between the debtor and the creditor.

But the guaranty and the loan agreement evidence separate But, the guaranty and the loan agreement evidence separate obligations, and their independence is not affected by the fact that both agreements are written on the same paper or instrument or are contemporaneously executed.are contemporaneously executed.

The guaranty cannot exist without a primary debt obligation. Thus, if the primary debt obligation has been fully satisfied, is void or is illegal, a guaranty of the debt obligation is also unenforceable.illegal, a guaranty of the debt obligation is also unenforceable.

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Consideration Consideration A guaranty is a contract and, as such, it must be supported by

consideration. A guaranty without consideration is merely an unenforceable gratuitous promise While some guaranties are foundedunenforceable gratuitous promise. While some guaranties are founded on separate consideration than the original credit transaction, the guarantor need not receive a direct benefit for consideration to exist. The consideration usually consists of a benefit to the debtor or a detriment to the creditor.

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Courts have deemed consideration to be sufficient in the following Courts have deemed consideration to be sufficient in the following cases: Guaranty is made contemporaneously with loan agreement. See, In re Kraft,

LLC, 429 B.R. 637, 659 (Bankr.N.D.Ind. 2010); Jackson v. Luellen Farms, Inc., ( )877 N.E.2d 848 (Ind. Ct. App. 2007).

Guaranty is made as part of the loan transaction, even if the two documents are not executed on the same date. See, Michelin Management Co., Inc. v. Mayaud, 307 A.D.2d 280, 762 N.Y.S.2d 108 (2d Dep't 2003).Mayaud, 307 A.D.2d 280, 762 N.Y.S.2d 108 (2d Dep t 2003).

Amendment to the loan agreement, note or other loan document that is acknowledged and approved by the guarantor. See, First Commerce Bank v. Palmer, 226 S.W.3d 396 (Tex. 2007); Caves v. Columbus Bank & Trust Co., 589 S E 2d 670 676 (Ga App 2003); Brown v Lawrenceville Properties LLC589 S.E.2d 670, 676 (Ga.App. 2003); Brown v. Lawrenceville Properties, LLC, 710 S.E.2d 682, 685 (Ga.App. 2011).

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Resolution and/or settlement of claims against debtor; the creditor's Resolution and/or settlement of claims against debtor; the creditor s compromise of a claim against the debtor. See, Cincinnati Ins. Co. v. American Hardware Mfrs. Ass'n, 898 N.E.2d 216, 230 (Ill.App. 1st Dist. 2008); Tag to Print 3Tower Investors, LLC v. 111 East Chestnut Consultants, Inc., 864 N.E.2d 927, 937 (Ill.App. 1st Dist. 2007).

Continuance and/or expansion of debtor’s business with creditor or other vendors or service providers; the creditor's agreement to continue doing business with the primary debtor See Material Partnerships Inc vbusiness with the primary debtor. See, Material Partnerships, Inc. v. Ventura, 102 S.W.3d 252 (Tex. App. 14th Dist. 2003).

Creditor’s agreement to conduct business with guarantor or to provide guarantor with a benefit outside of the guaranty agreement; a bank's g g y g ;retention of the guarantor's friend in his position as president of the bank. See, Performance Elec., Inc. v. CIB Bank, 864 N.E.2d 779, 784 (Ill.App. 1 Dist. 2007).

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J i t d S l Li bilit Joint and Several Liability Typically, with multiple guarantors of the same debt obligation,

the creditor can proceed against less than all of the co-guarantors for recovery of the entire guaranteed obligations. See Wachovia Bank, Nat. Ass'n v. Horizon Wholesale Foods, LLC, 2009 WL 3526662 (S.D.Ala. 2009); Finagin v. ArkansaD Fi A th 139 S W 3d 797 803 (A k 2003) C tDev. Fin. Auth., 139 S.W.3d 797, 803 (Ark. 2003); Century Business Credit Corp. v. Gargiulo Foods, L.L.C., 2003 WL 21998959 (S.D.N.Y.,2003).

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Death of Guarantor Death of Guarantor Unless expressly provided in the guaranty, a guarantor's death does

not terminate a guaranty. See, In re Steagall's Estate, 444 N.E.2d 838 (4th Dist 1983); In re Klink's Estate 35 N E 2d 684 (1st Dist 1941)(4th Dist. 1983); In re Klink s Estate, 35 N.E.2d 684 (1st Dist. 1941). The death of the guarantor of a continuing guaranty may limit the guarantor’s liability as it relates to future transactions but does not affect the credit transaction that was originally guaranteed. However, the estate of the deceased continues to guaranty a credit transaction by providing for renewals, as the consideration for the additional obligation that was extended before the guarantor's death.

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Types of Guaranties Types of Guaranties Absolute An absolute guaranty provides that the guarantor promises to pay

or perform the obligations of the debtor upon the occurrence of aor perform the obligations of the debtor upon the occurrence of a default event (typically debtor’s default). If a guaranty does not contain words of limitation or conditions, it is typically construed as an absolute guaranty. g y

Conditional A conditional guaranty requires the happening of some contingent

event (other than the default of the debtor) or the performance of some act on the part of the creditor before the guarantor will be liable.

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Payment Payment A payment guaranty obligates the guarantor to pay the debt at maturity

(which may arise due to an event of default). Upon the occurrence of a debtor's default the guarantor’s obligation becomes fixed and thedebtor s default, the guarantor s obligation becomes fixed and the creditor does not need to make a demand on the debtor.

Collection A g arant of collection is a g arantor’s promise that if the creditor A guaranty of collection is a guarantor’s promise that if the creditor

cannot collect the claim with due diligence, usually after suit (and exhaustion of remedies) against the debtor, the guarantor will pay the creditor.

Performance A performance guaranty obligates the guarantor to perform some

obligation on behalf of the debtor for the benefit of the creditor

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obligation on behalf of the debtor for the benefit of the creditor.


Continuing Continuing A guaranty is continuing when it is not limited to a single transaction

but contemplates a future course of dealing which may encompass a series of transactions may be for an indefinite period and/or may beseries of transactions, may be for an indefinite period and/or may be intended to secure payment or performance of an overall debt of the debtor. As such, a continuing guaranty may include subsequent indebtedness without new consideration.

Restricted A guaranty is a restricted guaranty when it is limited to a single or

limited number of transactions, to a certain part of the debt obligation p gand/or to a certain period of time.

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Downstream Downstream A downstream guaranty is a guaranty by a parent corporation for the

obligations of its subsidiary. In this scenario, a lender will look to the parent corporation to back up the debt of a subsidiary corporation due to the parent corporation’s superior assets and financial condition.

Upstream An upstream guaranty is a guaranty by a subsidiary corporation for the

bli ti f it t ti T i ll dit ill iobligations of its parent corporation. Typically, a creditor will require an upstream guaranty when debtor’s, i.e. the parent corporation’s, only assets are the stock of a subsidiary, and the subsidiary owns assets used as collateral to secure the credit obligations.

Cross-stream A cross-stream guaranty is a guaranty among affiliated corporations,

whose stock are both owned by the same parent.

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“Bad Boy” Guaranty Bad Boy Guaranty Many non-recourse guaranties will include provisions that carve-out

instances where the guarantor may be personally liable upon the occurrence of certain enumerated bad acts This type of guaranty isoccurrence of certain enumerated bad acts. This type of guaranty is referred to as a “bad boy” guaranty. The types of bad acts commonly include matters such as fraud, misappropriation, waste, and other acts that show some bad act on the part of the guarantor. Since the guarantor’s personal liability arises only upon the occurrence of a bad act, the guaranty’s liability is sometimes referred to as a springing liability.

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II Enforcement and Defense of GuarantiesII. Enforcement and Defense of Guaranties

Capacity Capacity Delaware Corporations – General Power “(a) In addition to the powers enumerated in § 122 of this title, every

corporation its officers directors and stockholders shall possesscorporation, its officers, directors and stockholders shall possess and may exercise all the powers and privileges granted by this chapter or by any other law or by its certificate of incorporation, together with any powers incidental thereto, so far as such powers g y p pand privileges are necessary or convenient to the conduct, promotion or attainment of the business or purposes set forth in its certificate of incorporation.(b) E ti h ll b d b th i i d b (b) Every corporation shall be governed by the provisions and be subject to the restrictions and liabilities contained in this chapter.”

8 Del.C. § 121

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Capacity Capacity Delaware Limited Liability Companies – General and Specific Guaranty Power “(b) A limited liability company shall possess and may exercise all the

powers and privileges granted by this chapter or by any other law or by its li it d li bilit t t th ith i id t llimited liability company agreement, together with any powers incidental thereto, including such powers and privileges as are necessary or convenient to the conduct, promotion or attainment of the business, purposes or activities of the limited liability company.

(c) Notwithstanding any provision of this chapter to the contrary without (c) Notwithstanding any provision of this chapter to the contrary, without limiting the general powers enumerated in subsection (b) of this section, a limited liability company shall, subject to such standards and restrictions, if any, as are set forth in its limited liability company agreement, have the power and authority to make contracts of guaranty and suretyship and enter p y g y y pinto interest rate, basis, currency, hedge or other swap agreements or cap, floor, put, call, option, exchange or collar agreements, derivative agreements, or other agreements similar to any of the foregoing.”

6 Del.C. § 18-106

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Capacity Capacity Delaware Corporations – Specific Guaranty Power “Every corporation created under this chapter shall have power to:

a. (13) Make contracts, including contracts of guaranty and suretyship, incur liabilities, b t h t f i t t th ti d t i i itborrow money at such rates of interest as the corporation may determine, issue its notes, bonds and other obligations, and secure any of its obligations by mortgage, pledge or other encumbrance of all or any of its property, franchises and income, and make contracts of guaranty and suretyship which are necessary or convenient to the conduct, promotion or attainment of the business of (a) a corporation all of th t t di t k f hi h i d di tl i di tl b th t tithe outstanding stock of which is owned, directly or indirectly, by the contracting corporation, or (b) a corporation which owns, directly or indirectly, all of the outstanding stock of the contracting corporation, or (c) a corporation all of the outstanding stock of which is owned, directly or indirectly, by a corporation which owns, directly or indirectly, all of the outstanding stock of the contracting corporation which contracts of guaranty and suretyship shall be deemed to becorporation, which contracts of guaranty and suretyship shall be deemed to be necessary or convenient to the conduct, promotion or attainment of the business of the contracting corporation, and make other contracts of guaranty and suretyshipwhich are necessary or convenient to the conduct, promotion or attainment of the business of the contracting corporation;”

8 D l C § 122

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8 Del.C. § 122


Statute of Frauds Statute of Frauds Mistake MisrepresentationMisrepresentation Parol Evidence Interpretation

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Impossibility Impracticability and Frustration of Impossibility, Impracticability, and Frustration of Purpose

Accord and Satisfaction Novation Statute of Limitations Lack of Notice of Adverse Effects

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Material Change in Debt and Impairment of Collateral UCC 3-605 Material Change in Debt and Impairment of Collateral – UCC 3-605 “(a) If a person entitled to enforce an instrument releases the obligation of a principal

obligor in whole or in part, and another party to the instrument is a secondary obligor with respect to the obligation of that principal obligor, the following rules apply: (1) Any obligations of the principal obligor to the secondary obligor with respect to any (1) Any obligations of the principal obligor to the secondary obligor with respect to any

previous payment by the secondary obligor are not affected. Unless the terms of the release preserve the secondary obligor's recourse, the principal obligor is discharged, to the extent of the release, from any other duties to the secondary obligor under this article.

(2) Unless the terms of the release provide that the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor, the secondary obligor is discharged to the same extent as the principal obligor from any unperformed portion of its obligation on the instrument. If the instrument is a check and the obligation of the secondary obligor is based on an indorsement of the check thethe obligation of the secondary obligor is based on an indorsement of the check, the secondary obligor is discharged without regard to the language or circumstances of the discharge or other release.

(3) If the secondary obligor is not discharged under paragraph (2), the secondary obligor is discharged to the extent of the value of the consideration for the release, and

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to the extent that the release would otherwise cause the secondary obligor a loss.


Material Change in Debt and Impairment of Collateral UCC 3-605 Material Change in Debt and Impairment of Collateral – UCC 3-605 (b) If a person entitled to enforce an instrument grants a principal obligor an extension of

the time at which one or more payments are due on the instrument and another party to the instrument is a secondary obligor with respect to the obligation of that principal obligor, the following rules apply:g pp y (1) Any obligations of the principal obligor to the secondary obligor with respect to any

previous payment by the secondary obligor are not affected. Unless the terms of the extension preserve the secondary obligor's recourse, the extension correspondingly extends the time for performance of any other duties owed to the secondary obligor by h i i l bli d hi i lthe principal obligor under this article.

(2) The secondary obligor is discharged to the extent that the extension would otherwise cause the secondary obligor a loss.

(3) To the extent that the secondary obligor is not discharged under paragraph (2), the secondary obligor may perform its obligations to a person entitled to enforce thesecondary obligor may perform its obligations to a person entitled to enforce the instrument as if the time for payment had not been extended or, unless the terms of the extension provide that the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor as if the time for payment had not been extended, treat the time for performance of its obligations as having been

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extended correspondingly.


Material Change in Debt and Impairment of Collateral – UCC 3-Material Change in Debt and Impairment of Collateral – UCC 3-605 (c) If a person entitled to enforce an instrument agrees, with or without

consideration, to a modification of the obligation of a principal obligor other than a complete or partial release or an extension of the due date and another partya complete or partial release or an extension of the due date and another party to the instrument is a secondary obligor with respect to the obligation of that principal obligor, the following rules apply: (1) Any obligations of the principal obligor to the secondary obligor with

respect to any previous payment by the secondary obligor are not affectedrespect to any previous payment by the secondary obligor are not affected. The modification correspondingly modifies any other duties owed to the secondary obligor by the principal obligor under this article.

(2) The secondary obligor is discharged from any unperformed portion of its obligation to the extent that the modification would otherwise cause the gsecondary obligor a loss.

(3) To the extent that the secondary obligor is not discharged under paragraph (2), the secondary obligor may satisfy its obligation on the instrument as if the modification had not occurred, or treat its obligation on th i t t h i b difi d di l

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the instrument as having been modified correspondingly.


Material Change in Debt and Impairment of Collateral – UCC 3-Material Change in Debt and Impairment of Collateral – UCC 3-605 (d) If the obligation of a principal obligor is secured by an interest in collateral,

another party to the instrument is a secondary obligor with respect to that obligation and a person entitled to enforce the instrument impairs the value ofobligation, and a person entitled to enforce the instrument impairs the value of the interest in collateral, the obligation of the secondary obligor is discharged to the extent of the impairment. The value of an interest in collateral is impaired to the extent the value of the interest is reduced to an amount less than the amount of the recourse of the secondary obligor, or the reduction in value of the y g ,interest causes an increase in the amount by which the amount of the recourse exceeds the value of the interest. For purposes of this subsection, impairing the value of an interest in collateral includes failure to obtain or maintain perfection or recordation of the interest in collateral, release of collateral without substitution of collateral of equal value or equivalent reduction of the underlyingsubstitution of collateral of equal value or equivalent reduction of the underlying obligation, failure to perform a duty to preserve the value of collateral owed, under Article 9 or other law, to a debtor or other person secondarily liable, and failure to comply with applicable law in disposing of or otherwise enforcing the interest in collateral.

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Material Change in Debt and Impairment of Collateral UCC 3 Material Change in Debt and Impairment of Collateral – UCC 3-605 (e) A secondary obligor is not discharged under subsections (a)(3), (b), (c), or

(d) unless the person entitled to enforce the instrument knows that the person is ( ) p pa secondary obligor or has notice under Section 3-419(c) that the instrument was signed for accommodation.

(f) A secondary obligor is not discharged under this section if the secondary obligor consents to the event or conduct that is the basis of the discharge, orobligor consents to the event or conduct that is the basis of the discharge, or the instrument or a separate agreement of the party provides for waiver of discharge under this section specifically or by general language indicating that parties waive defenses based on suretyship or impairment of collateral. Unless the circumstances indicate otherwise, consent by the principal obligor to an actthe circumstances indicate otherwise, consent by the principal obligor to an act that would lead to a discharge under this section constitutes consent to that act by the secondary obligor if the secondary obligor controls the principal obligor or deals with the person entitled to enforce the instrument on behalf of the principal obligor.

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principal obligor.


Material Change in Debt and Impairment of Collateral Material Change in Debt and Impairment of Collateral – UCC 3-605 (g) A release or extension preserves a secondary obligor's recourse if

th t f th l t i id th tthe terms of the release or extension provide that: (1) the person entitled to enforce the instrument retains the right to

enforce the instrument against the secondary obligor; and (2) the recourse of the secondary obligor continues as if the release (2) the recourse of the secondary obligor continues as if the release

or extension had not been granted. (h) Except as otherwise provided in subsection (i), a secondary obligor

asserting discharge under this section has the burden of persuasionasserting discharge under this section has the burden of persuasion both with respect to the occurrence of the acts alleged to harm the secondary obligor and loss or prejudice caused by those acts.

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Material Change in Debt and Impairment of Collateral Material Change in Debt and Impairment of Collateral – UCC 3-605 (i) If the secondary obligor demonstrates prejudice caused by an impairment of

its recourse and the circumstances of the case indicate that the amount of lossits recourse, and the circumstances of the case indicate that the amount of loss is not reasonably susceptible of calculation or requires proof of facts that are not ascertainable, it is presumed that the act impairing recourse caused a loss or impairment equal to the liability of the secondary obligor on the instrument. In that event the burden of persuasion as to any lesser amount of the loss is onthat event, the burden of persuasion as to any lesser amount of the loss is on the person entitled to enforce the instrument.”

Unif.Commercial Code § 3-605

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Change in Creditor Change in Creditor Lack of Notice of Foreclosure Sale Failure to Conduct Commercially Reasonable Foreclosure Sale Release of Co-guarantors Negligent Loan Administration Failure to Pursue the Underlying Debtory g Defense on the Underlying Debt Bankruptcy Issues (ex. automatic stay and fraudulent

conveyances)conveyances)

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III Bankruptcy IssuesIII. Bankruptcy Issues

Springing (“Bad Boy”) Guaranties Generally Enforced Springing ( Bad Boy ) Guaranties Generally Enforced By Bankruptcy Court (See In re Extended Stay Inc., 418 B.R. 49 (Bankr. S.D.N.Y. 2009)

ff’d i t b I E t d d St I 435 B R 139 (S D N Y 2010))aff’d in part by In re Extended Stay Inc., 435 B.R. 139 (S.D.N.Y. 2010)) Bankruptcy Courts Will Typically Abstain from Hearing Springing

Guaranty Actions Removed From State Court Guarantors Must Have Waived Any Indemnity or Contribution Guarantors Must Have Waived Any Indemnity or Contribution

Claims Against the Debtor Potential for State Court Guaranty Action to be Stayed Under §105

of Bankruptcy if Guarantor is “Integral” to Debtor Case and Actionof Bankruptcy if Guarantor is Integral to Debtor Case and Action Would Significantly Limit Guarantor’s Participation In Bankruptcy

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P t ti l F d l t C E Potential Fraudulent Conveyance Exposure Most Risk for Upstream and Cross-Stream Guaranties Intercorporate Guaranties Can Be Unwound In Bankruptcy p p y

Under: Bankruptcy Code §548 (Guaranties Made Up to Two Years

Before Filing), org) Under Bankruptcy Code §544 and the Uniform Fraudulent

Transfer Act (UFTA) or the Uniform Fraudulent Conveyances Act (UFCA) (Typically, Guaranties Made From y ( ) ( yp yFour to Six Years Before Filing)

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Inquiry is Typically Constructive Fraud Inquiry is Typically Constructive Fraud Under Bankruptcy Code §544 and the UFTA, the Test is

Whether the Guarantor (Debtor) received “Reasonably E i l t V l ”Equivalent Value”

Under the UFTA, the Test is Whether the Guarantor (Debtor) Received “Fair Consideration”

Drafting Considerations Net Worth Guaranty Savings ClauseSavings Clause

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III Bankruptcy IssuesIII. Bankruptcy Issues Risk of Separate Classification of Deficiency Claims in Bankruptcy Risk of Separate Classification of Deficiency Claims in Bankruptcy

Plan(See In re Loop, 442 B.R. 714 (Bankr. D. Ariz. 2010) Bankruptcy Code §544 Requires that Substantially Similar Claims May Not BeBankruptcy Code §544 Requires that Substantially Similar Claims May Not Be

Put Into Separate Classes to Gerrymander an Affirmative Vote to Confirm a Plan Under Bankruptcy Code §1129(b)

Some Bankruptcy Courts are Now Holding that Guaranteed Deficiency Claims are Different Than Other Unsecured Claims and Are Permitted to Be Separatelyare Different Than Other Unsecured Claims and Are Permitted to Be Separately Classified

Separate Classification May Result in Unsecured Creditors Voting in Favor of a Plan and the Debtor Being Able to Confirm a Cramdown Plan of Reorganization

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