TEXAS TECH LAW REVIEW

TEXAS TECH LAW REVIEWVOLUME XII 1981 NUMBER 4

ENFORCING COMMERCIAL GUARANTIESIN TEXAS: VANISHING LIMITATIONS,

REMAINING QUESTIONS

byTerry W. Conner*

I. INTRODUCTION .................................... 786A. Types of Guaranties ......................... 788

1. Guaranty of Payment ..................... 7892. Guaranty of Collection .................... 7893. Continuing Guaranty ..................... 7914. Guaranties Governed by Article 3 of the

Texas Business and Commerce Code ....... 791B. Fundamental Contract Considerations ......... 793

II. PROBLEMS OF CONSIDERATION AND BENEFIT .......... 796A. Contract Consideration ....................... 796B. The Role of "Benefit" in Corporate Guaranties 797

1. Articles 1302-2.06 and 2.04 ................ 7972. Guaranties as Fraudulent Conveyances Under

Section 548(a) of the Bankruptcy Code ..... 8033. Fraudulent Conveyances Under Section

544(b) of the Bankruptcy Code and Section24.03 of the Texas Business and CommerceCode .................................. 809

4. Avoiding "Consideration" Problems:Suggestions for the Creditor ............... 810

III. LIMITATIONS ON INDEBTEDNESS GUARANTEED ......... 811A. General Contract Limitations ................. 811

* Attorney, Dallas, Texas. B.A., J.D., University of Texas.

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1. "Measures" of Liability ................... 8112. Scope of Continuing Guaranties ............ 8123. Effect of Renewals, Extensions, and

Modifications Under Non-ContinuingG uaranties ............................... 814

B. Effect of Unenforceability of the PrincipalO bligation ................................... 8171. Necessity for Principal Obligation .......... 8182. Defenses Available to Principal Obligor ..... 8193. "Personal" Defenses Not Assertable ........ 8204. Traditional Cases Involving Illegal Principal

O bligations .............................. 8205. Recent Decisions Involving Illegal or Invalid

Principal Obligations ..................... 8226. Conclusions and Suggestions ............... 824

IV. CREDITOR'S ACTIONS REGARDING OTHER OBLIGORS ANDCOLLATERAL ..................................... 827A. Actions and Omissions Regarding Principal

Obligor or Co-Guarantors ..................... 8271. General Rules ............................ 8272. Application of General Rules Under Texas

L aw ..................................... 829B. Potential for Discharge Through Actions and

Omissions Regarding Collateral ............... 8291. Release or Subordination of Collateral ...... 8302. Failure to Preserve or Properly Dispose of

C ollateral ................................ 8313. Failure to Perfect a Security Interest or Lien 8334. Fraud or Misrepresentations Regarding

Collateral ..................... .......... 8345. Section 3.606. Discharge of the Guarantor

Due to Impairment of Recovery of Collateral 8356. Effect of W aivers ......................... 8377. Notice Under Article 9.504 ................ 840

V . CONCLUSIONS ..................................... 842APPE&NDIX ........................................ 844

I. INTRODUCTION

Guaranties are among the most fundamental and common-place devices for securing the payment and performance of obliga-

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tions, and may be created through the simplest of expressionsunembellished by the lawyer's art.1 Despite their essential simplic-ity and constant usage, however, guaranties continue to spawn dis-agreements over their scope and limitations.' This article will ana-lyze significant developments and questions in three areas thatcontribute regularly to the mass of guaranty litigation: problems ofconsideration and benefit, limitations on the types and extent ofindebtedness guaranteed, and difficulties resulting from the credi-tor's dealing with collateral for the principal obligation. Withinthese general areas, the article devotes particular attention to theavoidance of guaranties as fraudulent conveyances, the effects ofthe creditor's inability to enforce the principal obligation againstthe principal obligor, and potential discharge of the guarantor re-sulting from a creditor's release or mishandling of the collateral

1. Courts have attempted to determine the true intentions of the parties to an ambig-uous agreement in order to determine whether or not a "guaranty" was established. Forexample, a Texas court has held that the agreement to "see that [the principal obligor] willremit from time to time until your account is settled . . . I think she will be able-I willattend to it-to make you a remittance this month" was a guaranty. See Armstrong Cator &Co. v. Snider, 39 S.W. 379, 380 (Tex. Civ. App. 1897, no writ). In addition, an agreement to"see that [the principal obligation] is fixed" was held to constitute a guaranty. See Mc-Cauley v. Cross, 111 S.W. 790, 791 (Tex. Civ. App. 1908, no writ).

On the other hand, the use of the verb "guarantee" does not always create true guar-anty liability. See Texas Tractor Co. v. Texas Power & Light Co., 412 S.W.2d 935 (Tex. Civ.App.-Waco 1967, no writ). Other contracts, although not constituting guaranties per se,have essentially the same intended effects as guaranties in commercial transactions. Forexample, a creditor occasionally will accept, for a variety of reasons, the promise of oneparty to purchase the indebtedness of the principal obligor (rather than a guaranty of thepayment of such indebtedness), purchase the property of the principal obligor, or otherwisesupport the principal obligor. See, e.g., Commercial Credit Equip. Corp. v. Hatton, 429 F.Supp. 997 (N.D. Tex. 1977). A strong corporate parent may also agree with a creditor that itwill cause its subsidiary, as the principal obligor, always to have sufficient working capitalavailable to pay its obligations as they become due, to purchase a certain quantity of thesubsidiary's products (rain or shine), or to lease unconditionally certain property of the sub-sidiary (with lease payments assigned to the lender), thereby assuring the subsidiary andcreditor a constant source of cash flow. Interesting discussions arise between parties desiringto give such "comfort" letters and their accountants, who may view these arrangements asdisguised guaranties required to be treated as such in financial statements. If such an agree-ment is intended to constitute a guaranty, then the guaranty and suretyship principles dis-cussed in this article may apply to its enforceability. See, e.g., id.

2. As a result of unyielding judicial attention, many important issues concerning theenforceability of guaranties in Texas have been answered in recent years, and deserve littlefurther attention. See notes 48-53 infra, and accompanying text.

3. For purposes of this article, in addition to references to the "guarantor," the obligeeor beneficiary of the guaranty will be referred to as the "creditor" and the party primarilyliable on the principal obligation will be referred to as the "principal obligor."


securing the principal obligation. Also, because proper drafting ofguaranties will short-stop many potential problems of enforceabil-ity, drafting suggestions are included. 4 Although the following dis-cussion pertains to most types of guaranties, special problems andequitable considerations attending the enforceability of "non-busi-ness" guaranties are not analyzed.

The enforceability of a guaranty largely depends upon the na-ture and language of the guaranty itself, within the context of thefundamental law of contracts. Therefore, the basic types of guaran-ties used in commercial transactions and the application of funda-mental contract law to guaranties will be discussed initially.

A. Types of Guaranties

Guaranties have been defined by Texas courts simply aspromises of one party to answer for the debts or obligations of an-other party.5 A guarantor's liability approaches that of a surety. Asurety, however, is considered to be a primary obligor and a partyto the principal obligation, while the guarantor's "secondary" lia-bility, which he agreed to under a separate undertaking, arises onlyafter the principal obligor has failed to perform the principal obli-gation. These distinctions are primarily technical, and many rulesgoverning the enforceability and release of guaranties follow thegeneral rules of suretyship.8

4. The issues and answers framed below derive primarily from Texas judicial authori-ties and, to the extent possible, cases of recent decision.

5. See, e.g., Texas Tractor Co. v. Texas Power & Light Co., 412 S.W.2d 935 (Tex. Civ.App.-Waco 1967, no writ).

6. See Metze v. Entman, 584 S.W.2d 512 (Tex. Civ. App.-Houston (14th Dist.] 1979,no writ) (construing guaranty of payment governed by TEx. Bus. & CoM. CoDz ANN. § 3.416(Tex. UCC) (Vernon 1968)); cf. Empire Steel Corp. v. Omni Steel Corp., 378 S.W.2d 905(Tex. Civ. App.-Fort Worth 1964, writ ref'd n.r.e,) (no distinction between guarantor andsurety when question is effect of judgment against principal obligor). Under TEx. Bus. &COM. CODE ANN. § 1.201(40) (Tex. UCC) (Vernon 1968), a guarantor is a type of surety.

7. See 38 C.J.S. Guaranty § 6 (1943).8. In certain circumstances, the obligations of an absolute guarantor of payment, as

described below, also approximate those of a co-maker of an instrument. See notes 10-13infra, and accompanying text, See also Universal Metals & Mach., Inc. v. Bohart, 539S.W.2d 874 (Tex. 1976); Tix. Bus. & COM. CODE ANN. § 3.416(a) (Tex. UCC) (Vernon 1968).Even when the guaranty of payment is created separately from the promissory note guaran-teed, and therefore may not be subject to the provisions of § 3.416, an absolute guaranty ofpayment will create liability similar to that of a co-maker. See El Paso Bank & Trust Co. v.First State Bank, 202 S.W. 522 (Tex. Civ. App.-El Paso 1918, no writ). A discussion of thedistinctions among guarantors, sureties, co-makers, and accommodation makers under arti-cle 3 of the Texas Business and Commerce Code is found at Clark, Suretyship in the Uni-

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Although the nature and extent of guarantor liability dependson the terms of the particular guaranty, a description of four basiccategories of guaranties provides a basis for later analysis.

1. Guaranty of Payment

The guaranty of payment, also known as an "absolute" guar-anty, obligates the guarantor to pay the principal obligation uponthe default of the principal obligor. 10 Creation of a guaranty ofpayment, which permits the creditor to pursue the guarantorwithout first pursuing the principal obligor, results from such sim-ple language as "I unconditionally guarantee the payment whendue of John's indebtedness to you." As expressed in UniversalMetals & Machinery, Inc. v. Bohart,1" a guaranty of payment canimpose liability equivalent to that of a co-maker and a "primaryobligor." Also referred to as an "unconditional" guaranty,"' theguaranty of payment (although still ostensibly a "secondary" obli-gation) has increasingly been recognized as an undertaking that isenforceable in accordance with its own terms and creates liabilityalmost independent of that of the principal obligor.15 Guaranties ofpayment, the most common guaranties in commercial transactions,constitute the primary subject matter for the issues discussedbelow.

2. Guaranty of Collection

Generally, the guarantor of collection promises that it will paythat portion of the principal obligation which remains unpaid afterthe creditor has used reasonable diligence to compel the principalobligor to pay the obligation, or after circumstances render useless

form Commercial Code, 46 TEXAS L. REV. 453, 456 (1968).9. See, e.g., Wolfe v. Schuster, 591 S.W.2d 926 (Tex. Civ. App.-Dallas 1979, no writ);

Estes v. Continental Bank & Trust Co., 421 S.W.2d 158 (Tex. Civ. App.-Dallas 1967, nowrit); McGhee v. Wynnewood State Bank, 297 S.W.2d 876 (Tex. Civ. App.-Dallas 1957,writ ref'd n.r.e.).

10. See Universal Metals & Mach., Inc. v. Bohart, 539 S.W.2d 874 (Tex. 1976).11. 539 S.W.2d 874, 877-78 (Tex. 1976).12. See, e.g., McGhee v. Wynnewood State Bank, 297 S.W.2d 876, 883 (Tex. Civ.

App.-Dallas 1957, writ ref'd n.r.e.).13. See Wolfe v. Schuster, 591 S.W.2d 926 (Tex. Civ. App.-Dallas 1979, no writ)

(construing Tax. Bus. & COM. CODE ANN. § 3.416 (Tex. UCC) (Vernon 1968)); Ferguson v.McCarrell, 582 S.W.2d 539 (Tex. Civ. App.-Austin), writ ref'd n.r.e. per curiam, 588S.W.2d 895 (Tex. 1979); 38 C.J.S. Guaranty §§ 7, 61 (1943).

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further pursuit of the principal obligor."' Besides having to facethe obstacles of delay and proof of loss and diligence, the creditoraccepting a guaranty of collection suffers procedural disadvantages.Under the Texas laws governing the necessity for joining the prin-cipal obligor as a party in an action against the guarantor,' andthe circumstances under which judgment against the guarantoralone is proper," the distinction between guaranties of paymentand guaranties of collection is essential. While the Texas courtsnow generally hold that a guarantor of payment may be sued with-out joinder of the principal obligor, 7 in the absence of a specific

14. See 27 Tzx. Jun. 2d Guaranty § 6 (1961).15. TEx. Rav. CIV. STAT. ANN. arts. 1986, 1987 (Vernon 1964) provide the requirements

for joining principal obligors in suits against parties secondarily liable. Article 1987 providescertain specific exceptions to the general rule that the secondarily liable party cannot besued initially without joinder of the principal. See also Tax. R. Civ. P. 31, which statesgenerally that a surety may not be sued unless the principal obligor is joined with him, withcertain exceptions.

16. TEx. REV. CIV. STAT. ANN. art. 2088 (Vernon 1964) describes the circumstancesunder which the principal may be dismissed from an action against the principal and aparty secondarily liable. See also Tax. R. Civ. P. 163. The general operation of the joinderstatutes and rules is discussed at Cohen, Jurisdictional and Procedural Aspects of SecuringJudgments Against Parties Secondarily Liable-A Proposal for Reform, 9 ST. MARY's L.J.245 (1977).

17. See, e.g., Ferguson v. McCarrell, 588 S.W.2d 895 (Tex. 1979) (per curiam); Univer-sal Metals & Mach., Inc. v. Bohart, 539 S.W.2d 874 (Tex. 1976); Wolfe v. Schuster, 591S.W.2d 926 (Tex. Civ. App.-Dallas 1979, no writ). These cases rely, at least in part, on theprovisions of TEx. Bus. & CoM. CODE ANN. § 3.416 (Tex. UCC) (Vernon 1968), which statesthat a guarantor of payment is liable to pay the guaranteed instrument "without resort bythe holder to any other party." Id. However, since a guaranty of payment, whether given onthe promissory note guaranteed or on a separate document, constitutes an obligation whichis recognized as being enforceable against the guarantor without the requirement that thecreditor pursue the principal obligor, the reasoning should apply to all guaranties of pay-ment. When § 3.416 is not specifically applicable, the courts of civil appeals have disagreedover the application of the joinder statutes. Compare Cook v. Citizens Nat'l Bank, 538S.W.2d 460 (Tex. Civ. App.-Beaumont 1976, no writ) (requiring joinder, and relying onWood v. Canfield Paper Co., 117 Tex. 399, 5 S.W.2d 748 (1928)) with Yandell v. TarrantState Bank, 538 S.W.2d 684 (Tex. Civ. App.-Fort Worth 1976, no writ) (upholding provi-sion in guaranty waiving obligation that principal obligor be joined). See also Cohen, supranote 16; Figari, Texas Civil Procedure, Annual Survey of Texas Law, 31 Sw. L.J. 373, 380(1977). Although deciding the issue on the basis of § 3.616, the Texas Supreme Court inFerguson v. McCarrell, 588 S.W.2d 895 (Tex. 1979) (per curiam), disapproved the holding inCook v. Citizens Nat'l Bank, 538 S.W.2d 460 (Tex. Civ. App.-Beaumont 1976, no writ). See588 S.W.2d at 895. In 1977, the Texas Supreme Court held that a guaranty of payment,although made in an agreement separate from the note guaranteed, essentially waived anyrequirement that the creditor proceed against the principal obligor. See Hopkins v. FirstNat'l Bank, 551 S.W.2d 343 (Tex. 1977). The court relied in part on its decision a yearearlier in Bohart, despite the fact that Bohart was controlled by § 3.416(a). Id. at 345.


exception, the Texas statutes will continue to require joinder in asuit brought against the guarantor of collection."'

3. Continuing Guaranty

The designation of a guaranty as "continuing" does not importthe nature of the liability, or the degree of insulation of the guar-antor from the creditor, but rather signifies the types of indebted-ness that the guaranty covers. A continuing guaranty does not per-tain to a single credit transaction but contemplates a future courseof dealings between the creditor and the principal obligor. The na-ture of the obligation requires the guarantor to answer for all debtsof the principal obligor created in those future dealings, withoutthe need for additional guaranties or description of particular in-debtedness. 19 The parties may contractually limit the guarantor'sliability under a "continuing" guaranty to a maximum amount,and continuing guaranties generally are subject to revocation .'Nevertheless, the "continuing" nature of the guaranty generallyblunts the potential effects of the creditor's renewal, extension,and alteration of the principal indebtedness, as discussed furtherbelow.'

4. Guaranties Governed by Article 3 of the Texas Business andCommerce Code

Section 3.416 of the Texas Business and Commerce Code (theCode)" governs negotiable instruments and describes the liabilityof a party which indorses a negotiable instrument s as a guarantor.Depending upon the language used, the indorsement may create aguaranty of payment or a guaranty of collection," and failure to

18. See Wolfe v. Schuster, 591 S.W.2d 926 (Tex. Civ. App.-Dallas 1979, no writ).19. See, e.g., Dicker v. Lomas & Nettleton Financial Corp., 576 S.W.2d 672 (Tex. Civ.

App.-Texarkana 1978, writ ref'd n.r.e.); Blount v. Westinghouse Credit Corp., 432 S.W.2d549 (Tex. Civ. App.-Dallas 1968, no writ); McGhee v. Wynnewood State Bank, 297 S.W.2d876 (Tex. Civ. App.-Dallas 1956, writ ref'd n.r.e.).

20. See, e.g., Casey v. Gibson Prod. Co., 216 S.W.2d 266 (Tex. Civ. App.-Dallas 1948,writ dism'd).

21. See notes 137-55 infra, and accompanying text.22. Tax. Bus. & COM. CODE ANN. § 3.416 (Tex. UCC) (Vernon 1968).23. Section 3.416 refers to the guaranty of an "instrument," which is defined in § 3.102

to mean a "negotiable instrument." Id. § 3.102.24. Section 3.416 distinguishes between the words "payment guaranteed" or its

equivalent, and "collection guaranteed" or its equivalent. Id. § 3.416.

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specify the type of guaranty implies a guaranty of payment." ForCode purposes, a guarantor is a type of surety,2 and the liability ofa guarantor of payment equals that of a co-maker.27 Under section3.416 of the Code, a guarantor may be charged with liability with-out presentment or notice of dishonor of the instrument.28

Clearly, a guaranty does not itself constitute a negotiable in-strument.2 9 Nevertheless, the question whether sections 3.416 and3.60680 (describing events that may discharge a surety's liability)apply to all guaranties has stirred debate. 1 One commentator hassuggested that article 3 should govern all guaranties,3 ' includingthose given in separate agreements, but courts reviewing "sepa-rate" guaranties have not often looked to article 3 for guidance.The applicability of article 3 to "separate" guaranties has been ad-dressed only infrequently, but several courts have held that article3 does not apply to all guaranties." Although the Texas SupremeCourt has mentioned article 3 at least once in deciding issues in-volving guaranties not given on a negotiable instrument," it ap-pears that article 3 provides only analogous authority for guaran-ties not given on such an instrument. Clearly, even if a separateguaranty of a negotiable instrument is or should be governed byarticle 3, a separate guaranty of some other instrument, debt, orobligation would definitely fall without section 3.416's coverage.3

Therefore, when the distinction is relevant, this article will refer toguaranties governed by article 3 as "Code guaranties."' 6

25. Id. § 3.416(c).26. See Clark, supra note 8, at 456.27. TEX. Bus. & COM. CODE ANN. § 3.416, Comment (Tex. UCC) (Vernon 1968).28. Id. § 3.416(e).29. See Cortez v. National Bank of Commerce, 578 S.W.2d 476 (Tex. Civ. App.-

Corpus Christi 1979, writ ref'd n.r.e.).30. TEx. Bus. & COM. CODE ANN. § 3.606 (Tex. UCC) (Vernon 1968).31. Compare Clark, supra note 8, at 459-61 with Note, The Waiver of Defenses by

Guarantors in Guaranty Contracts and the Nonwaiver Provisions of the Uniform Commer-cial Code, 5 VT. L. REv. 73, 94 (1980).

32. See Clark, supra note 8, at 459, 461.33. See, e.g., Union Planters Nat'l Bank v. Markowitz, 468 F. Supp. 529 (W.D. Tenn.

1979); First Nat'l Bank v. Alford, 65 Mich. App. 634, 635, 237 N.W.2d 592, 593 (1976); Eikelv. Bristow Corp., 529 S.W.2d 795, 799-800 (Tex. Civ. App.-Houston [Ist Dist.] 1975, nowrit). But cf. Commercial Credit Equip. Corp. v. Hatton, 429 F. Supp. 997 (N.D. Tex. 1977)(court, applying Texas law, questions applicability of § 3.606 to "separate" guaranty).

34. See Hopkins v. First Nat'l Bank, 551 S.W.2d 343 (Tex. 1977).35. Accord, 9 ST. MARY'S L.J. 634, 642 (1978).36. This article primarily concerns the enforceability of "separate" guaranties, which

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B. Fundamental Contract Considerations

Despite the prevalence of "guaranty lore" which occasionallyenchants those reviewing guaranty issues,7 a guaranty is simply acontract created and defined by the expressions of the mutual in-tentions of the guarantor and the creditor. As such, creation of avalid guaranty depends on satisfaction of such basic contract re-quirements as "offer and acceptance" and consideration for thegiving of the guaranty. Although the creditor rarely has direct obli-gations to the guarantor, a creditor who fails to perform any suchobligations may subject itself to standard contract defenses basedon breach of contract. 8 In addition, under the statute of frauds, asembodied in section 26.01 of the Code, 9 a guaranty (being a prom-ise to pay the debt of another) is normally enforceable only if ex-pressed in writing. These common contract elements, however,rarely create problems in the context of formal commercial guaran-ties. Similarly, although courts have traditionally held that noticeof acceptance of the guaranty is required,' ° the exceptions to thisrule41 have all but swallowed the rule. Furthermore, while a guar-

are more common in formal lending transactions, but will compare the treatment of Codeguaranties and discuss the extent to which the Code serves as analogous or complementaryauthority in deciding guaranty questions generally. See notes 261-73 infra, and accompany-ing text. In most cases, a properly drafted "separate" guaranty and a properly drafted Codeguaranty will impose essentially the same liability and encounter similar limitations. Seenotes 217-21 infra, and accompanying text.

37. For example, courts continuously refer to the rule of "strict construction" of guar-anties and the associated rule that the guarantor is a "favorite" of the law. See, e.g., Mc-Knight v. Virginia Mirror Co., 463 S.W.2d 428 (Tex. 1971). Although these rules may havesome application when the guaranties considered are ambiguous, they occasionally obscurethe more basic point that a guaranty, as a contract, must be construed realistically in orderto determine the parties' true intentions.

38. See, e.g., Arlington Bank & Trust v. Nowell Motors, Inc., 511 S.W.2d 415 (Tex.Civ. App.-Fort Worth 1974, no writ) (considering effects of creditor's failure to complywith agreement to keep insurance on collateral).

39. TEx. Bus. & COM. CODE ANN. § 26.01 (Vernon Supp. 1980-1981). Section 26.01states that to be enforceable "a promise by one person to answer for the debt, default, ormiscarriage of another person must be in writing and signed by the person who is chargedwith the promise (or his lawful agent)." Id. The effect of the statute of frauds on guarantieshas been considered by the Supreme Court of Texas at least twice in the last twenty years.Under the "main purpose" doctrine of Haas Drilling Co. v. First Nat'l Bank, 456 S.W.2d 886(Tex. 1970), and Gulf Liquid Fertilizer Co. v. Titus, 354 S.W.2d 378 (163 Tex. 260, 1962), ifthe "leading object" or "main purpose" of a person giving an oral guaranty is to serve someinterest or purpose of his own, then the oral guaranty is not within the statute of frauds,provided that the guarantor essentially is assuming primary responsibility.

40. See 38 C.J.S. Guaranty §§ 10-14 (1943).41. Notice of acceptance is unnecessary when: (1) the guaranty is "absolute" in nature,

794 TEXAS TECH LAW REVIEW [Vol. 12:785

anty may be affirmatively attacked on the basis of mistake of fact"or irregularity in the execution process," these arguments seldomprevail. A guarantor's defenses based on fraud in the inducementof the guaranty produce interesting cases,' but the success of

(2) the guarantor has received consideration from the creditor, (3) the nature of the guar-anty eliminates the need for acceptance, (4) the guaranty is "completed," and not in theform of an offer or proposal, or (5) the guaranty contains a statement that notice of accept-ance is unnecessary. See, e.g., Cobb v. Texas Dist., Inc., 524 S.W.2d 342 (Tex. Civ.App.-Dallas 1975, no writ); Eastman Oil Well Survey Co. v. Hamil, 416 S.W.2d 597 (Tex.Civ. App.-Houston 1967, writ ref'd n.r.e.); Hunsley Paint Mfg. Co. v. Gray, 165 S.W.2d 486(Tex. Civ. App.-Amarillo 1942, writ dism'd). See also Annot., 6 A.L.R.3d 355 (1966); 38C.J.S. Guaranty § 11 (1943).

42. As in other contracts, a guaranty entered into as a result of a mutual mistake offact between the guarantor and the creditor, relating to the subject matter of the contractinvolved, could relieve the guarantor from liability. In Durham v. Uvalde Rock Asphalt Co.,599 S.W.2d 866 (Tex. Civ. App.-San Antonio 1980, no writ), the guarantor asserted thatneither the guarantor nor the creditor knew of a financing statement which had been filedagainst the principal obligor and that, had the parties known of the financing statement, theprincipal obligation would not have been entered into. The court stated that there was noevidence that the "mistake" regarding the previous financing statement would have causedthe creditor not to have entered into the guaranty agreement, even if the creditor might nothave entered into the principal contract.

43. It is generally true that the alteration of a guaranty by the creditor, even if notfraudulent, would discharge the guarantor to the extent of the damages resulting from thealteration. See 38 C.J.S. Guaranty § 74 (1943). On the other hand, the erasure and rein-statement of the name of one of several co-guarantors on a particular guaranty was held notto release the remaining co-guarantors. See Tobin Canning Co. v. Fraser, 81 Tex. 407, 17S.W. 25 (1891). Similarly, the failure to include an execution date in the guaranty, the non-fraudulent completion of blanks after the execution of the guaranty, and the presence ofother immaterial blanks in a guaranty, do not render the guaranty invalid. See, e.g., Ameri-can Petrofina Co. v. Bryan, 519 S.W.2d 484 (Tex. Civ. App.-El Paso 1975, no writ); East-man Oil Well Survey Co. v. Hamil, 416 S.W.2d 597 (Tex. Civ. App.-Houston 1967, writref'd n.r.e.). But see Austin v. St. John, 6 S.W.2d 224 (Tex. Civ. App.-Eastland 1928, nowrit) (regarding the effect of altering a date on a guaranty, when the alteration was impor-tant in determining whether the statute of limitations barred enforcement of the guaranty).As with respect to other contracts, a dispute may also arise as to whether a person executesa guaranty in his individual capacity or on behalf of a corporation of which he is an officeror director when, for example, the term "President" is placed beside the signature of the"Guarantor." Although the addition of a title beside the name of the guarantor is confusing,at least one Texas court has held that the addition did not (in light of other language clearlyindicating personal liability) change the fact that the guaranty is a personal guaranty. SeeAmerican Petrofina Co. v. Bryan, 519 S.W.2d 484 (Tex. Civ. App.-El Paso 1975, no writ).

44. In Oilwell Div., United States Steel Corp. v. Fryer, 493 S.W.2d 487 (Tex. 1973), theguaranty stated that "this guaranty shall be revolving and continuous to the extent of$ . . . and in the event that the amount of the liability is not limited in the spaceprovided, then this guaranty shall be unlimited." Id. at 489. This is a common provision instandard form guaranties, and the blank often is not completed, evidencing the parties' in-tention that the guaranty be unlimited in amount. The guarantor in Fryer testified, how-ever, that he told a representative of the creditor that he did not wish for his personal


these defenses often depends on such a special relationship as thatexisting when a bank applies for and induces a Small Business Ad-ministration guaranty of the bank's loan. "5 Usually, the guarantoris intimately familiar with the principal obligor and the risks of theguaranty and cannot honestly cry "fraud."

Failure or lack of consideration regularly surfaces as a defenseto guaranty liability."e Because of the frequency of the complaintand the relationship of "contract consideration" to other effects ofconsideration and benefit (or the absence thereof), the article willreview contract consideration as a prelude to the less pedestrianproblems of consideration and benefit.

guaranty to exceed $100,000 and was informed by the representative that the guaranty heexecuted was "temporary" and that the representative essentially agreed that the guarantywas not intended to secure indebtedness in excess of $100,000. The court stated that toestablish fraud there must be a finding of a false representation, for which no evidence wasestablished. The court distinguished cases dealing with an intention to deceive and thosecases that deal with a false representation made for the purpose of inducing another to takesome action. Id. at 490-91. Although the procedural elements of the case prevented thecourt from deciding the effects of fraud on the guaranty, the case does stand for the proposi-tion that, if properly proved, fraudulent inducements will serve as the basis for dischargingthe guarantor's liability. See also Chemical Bank v. Layne, 423 F. Supp. 869 (S.D.N.Y.1976); Southwestern Sur. Ins. Co. v. Hico Oil Mill, 203 S.W. 137 (Tex. Civ. App.-FortWorth 1918, no writ) (misrepresentation of fact, even if honestly made, discharges guaran-tor). See also notes 256-57 infra, and accompanying text.

45. The court in First Nat'l Bank v. SBA, 429 F.2d 280 (5th Cir. 1970), applying fed-eral common law, considered the relationship between a bank, which had requested that theSmall Business Administration guarantee a loan made by the bank under the SBA's loanguaranty program, and the SBA. The president of the bank advised the representative ofthe SBA that the bank's dealing with the borrower convinced the bank of the borrower'sability to repay the loan and that all other matters, including financing reports, were inorder. On that basis, the SBA authorized disbursement of loan proceeds for specified pur-poses, including reduction of the borrower's indebtedness to the bank, working capital pur-poses, and the purchase of equipment. After the borrower failed, it was shown that a portionof the proceeds which should have gone for other purposes in fact was returned to the bankto refinance a previously uncollectible account. It was also proven that the figures on theborrower's financial statements were false. The SBA claimed that the bank was negligent inadvising the SBA that the borrower was a good credit risk, that the distribution of the loanproceeds was not made in accordance with their contract, and that the bank had mademisrepresentations on its application for the loan guaranty. The court applied federal law inresolving the issues. Without deciding whether the bank was involved in actual fraud orconstructive fraud, the court concluded that the special relationship between a bank and theSBA, in connection with inducement of the SBA to issue a guaranty which benefits thebank, required that the bank exercise due care in providing information and advice to theSBA. Id. at 289.

46. See cases cited at notes 48-53 infra.


II. PROBLEMS OF CONSIDERATION AND BENEFIT

A. Contract Consideration

As discussed below, in certain contexts it is significant that theguarantor itself has received consideration for the giving of theguaranty, or that the value passing to the guarantor balances theobligation incurred by the guarantor. Nevertheless, recent Texascases have enervated the guarantor's defense of "no contractconsideration.

' 47

The consideration sufficient to support a guaranty need notflow directly to the guarantor; that the primary obligor has re-ceived benefit or the creditor has suffered detriment will supportthe guaranty.4 8 Therefore, a guaranty given to induce the creditorto extend credit is supported by adequate consideration. Generally,when the guarantor executes the guaranty after the advancing offunds or credit to the principal obligor, independent considerationto the guarantor must be established.49 Recent cases favoring thecreditor, however, have expanded the circumstances in which aguaranty given after the creditor has advanced funds to the princi-pal obligor, and not supported by independent consideration, willbe held to be valid.50 Furthermore, in one of the more interestingconsideration decisions, a Texas court reviewing a continuing guar-anty has held that a creditor's "implied promise" to advance addi-tional funds constituted sufficient consideration. 1

At least one Texas court has ruled that if the guarantor is ashareholder of the principal obligor, the guarantor may still receivebenefit, whether or not it receives a portion of the loans made to

47. Although one cannot logically conclude that whenever a guarantor consciouslygives a guaranty, consideration must exist, several Texas authorities suggest that result. Seenotes 48-53 infra.

48. See, e.g., Shaw v. McShane, 50 S.W.2d 278 (Tex. Comm'n App. 1932, judgmtadopted); Hargis v. Radio Corp. of America, Elec. Components, 539 S.W.2d 230 (Tex. Civ.App.-Austin 1976, no writ); Diamond Paint Co. v. Embrey, 525 S.W.2d 529 (Tex. Civ.App.-Houston [14th Dist.] 1969, writ ref'd n.r.e.).

49. See, e.g., Diamond Paint Co. v. Embrey, 525 S.W.2d 529 (Tex. Civ. App.-Houston[14th Dist.] 1969, writ ref'd n.r.e.); Waller v. Missouri City State Bank, 482 S.W.2d 40 (Tex.Civ. App.-Tyler 1972, writ ref'd n.r.e.).

50. See, e.g., Mayfield v. Hicks, 575 S.W.2d 571 (Tex. Civ. App.-Dallas 1978, writref'd n.r.e.); Maykus v. Texas Bank & Trust Co., 550 S.W.2d 396 (Tex. Civ. App.-Dallas1977, no writ).

51. See Waller v. Missouri City State Bank, 482 S.W.2d 40 (Tex. Civ. App.-Tyler1972, writ ref'd n.r.e.).

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the principal obligor.2 Presumably, a guarantor who is an em-ployee or officer of the principal obligor, and therefore whose for-tunes coincide with those of the principal obligor, would benefitfrom loans made to the principal obligor. Except when the princi-pal obligor controls (or is under common control with) the guaran-tor, common sense suggests that any party willing to give a guar-anty expects to receive at least indirect benefit from the guarantyor the loans creating the principal obligation.

Texas courts have further strengthened the creditors' positionby holding that the execution of a written guaranty "imports" con-sideration, and therefore the guarantor must shoulder the burdenof proving that the written guaranty was not supported byconsideration."

Based on the foregoing, it appears that the "no consideration"argument will prevail only when (i) the guarantor receives no di-rect benefit from the guaranty or the creditor's extension of creditguaranteed thereby; (ii) the guarantor will not indirectly benefit(e.g., as a result of the guarantor's ownership or other interest inthe principal obligor) from the extension of credit guaranteed; (iii)the guaranty is not given to induce the lender to lend funds, shipgoods, forbear from enforcing the principal obligation, or suffersome other "detriment"; (iv) the guaranty is delivered at a timewhen the lender has no further commitment or contemplation tolend funds; (v) the guaranty is not delivered "contemporaneously"with the creation of the principal obligation; and (vi) the creditordid not extend credit in reliance on the guaranty to be deliveredlater.

B. The Role of "Benefit" in Corporate Guaranties

1. Articles 1302-2.06 and 2.04

In addition to the "no contractual consideration" aspect ofrules on consideration and benefit, the role of benefit is crucial inthe context of corporate guaranties. Under the common law of theState of Texas, a corporation's guaranty of another's obligations

52. See Universal Metals & Mach., Inc. v. Bohart, 539 S.W.2d 874 (Tex. 1976). Cf.Hamil v. Whitlow Steel Co., 596 S.W.2d 293 (Tex. Civ. App.-Houston (14th Dist.] 1980, nowrit) (regarding consideration for co-making indebtedness).

53. See, e.g., Maykus v. Texas Bank & Trust Co., 550 S.W.2d 396 (Tex. Civ.App.-Dallas 1977, no writ); Hargis v. Radio Corp. of America, Elec. Components, 539S.W.2d 230 (Tex. Civ. App.-Austin 1976, no writ).

19811 797


would be unenforceable against the corporation unless the guar-anty directly and substantially benefitted the corporate guaran-tor." Under article 1302-2.06 of the Texas Miscellaneous Corpora-tion Act, a corporation generally may not create any indebtednessunless it receives consideration "reasonably worth at least the sumat which it is taken."55 In the absence of fraud, however, the valueof consideration received may be conclusively established by theboard of directors or the shareholders of the corporation." Moreimportantly, section (B) of article 1302-2.06 5 further states that acorporation may guarantee another's debts if the guaranty "rea-sonably" may be expected to benefit, directly or indirectly, theguarantor corporation. Because the creation of an obligation rarelybenefits the obligor, presumably the benefit requirement is satis-fied provided the loan or extension of credit guaranteed (ratherthan the guaranty itself) benefits the guarantor. Under section (B),the board of directors' determination of benefit binds the guaran-tor corporation and no such guaranty is invalid unless the personseeking enforcement "participated" in a fraud on the guarantorcorporation (resulting in the making of the guaranty) or had noticeof the fraud before accepting the guaranty." Section (B) permits ashareholder to bring suit to enjoin the making of a guaranty thatwould not reasonably be expected to benefit the corporation, butnot to enjoin the performance of a guaranty already made."

The protections afforded to a creditor by section (B) are sup-plemented by section (C).0 The latter section provides that a cor-poration may guarantee the indebtedness of its wholly owned sub-sidiary, the corporation which wholly owns the guarantor, or anaffiliate under common, total ownership with the guarantor.61 Thestatutory authority for a parent to guarantee the indebtedness ofits subsidiaries follows general "benefit" concepts, because a guar-

54. See North Side Ry. v. Worthington, 88 Tex. 562, 30 S.W. 1055 (1895). See gener-ally Slover, Enforceability of Guaranties Made by Texas Corporations, 10 Sw. L.J. 134(1956); Witt, Corporate Guaranties-The Quest for Legislative Clarification, 36 TEX. B.J.907 (1973); Comment, The Guaranty: A Dilemma for Corporate Managers, 23 Sw. L.J. 872(1969).

55. TEx. REv. CIv. STAT. ANN. art. 1302-2.06(A) (Vernon 1980).56. Id.57. Id. art. 1302-2.06(B).58. Id.59. Id.60. Id. art. 1302-2.06(C).61. Id.

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anty given to induce the lending of funds or extension of credit toa subsidiary normally benefits the parent. Unless a subsidiaryguaranteeing its parent's debt receives a portion of the loans guar-anteed, however, the subsidiary will not directly benefit from theguaranty. Of course, since section (C) applies only when no minor-ity ownership interests are involved, the statutory authorization of"upstream" guaranties creates problems only for the subsidiary-guarantor's creditors.

With the possible exception of the "fraud" provision, article1302-2.06 describes the circumstances under which a corporation isempowered and authorized to give a guaranty and does not ad-dress the validity of guaranties. Article 2.04 of the Texas BusinessCorporation Act,"' on the other hand, provides that a corporate actshall not be invalidated simply because such act was beyond thescope of the corporate purposes expressed in the corporation's arti-cles of incorporation, the corporation's "capacity," or the authorityof the corporation's officers" (i.e., because the act was "ultravires") except in certain limited circumstances." Although ques-tions were raised prior to the enactment of article 1302-2.06(B),because of the availability (under the exceptions in article 2.04) ofultra vires arguments to shareholders seeking to enjoin a corpora-tion from performing the ultra vires act, section (B) should elimi-nate most of the problems for creditors accepting guaranties en-compassed by the provisions of section (B)."

62. TEx. Bus. CORP. AcT ANN. art. 2.04 (Vernon 1980).63. Id. Interestingly, article 2.04 never directly mentions actions beyond the corpora-

tion's statutory powers and authority. The fact that the corporation's articles of incorpora-tion expressly state that one of the corporation's purposes is to give guaranties will notavoid the authorization issues. See 19 R. HAMILTON, BusinEss ORGANIZATIONS § 360 (TexasPractice 1973).

64. Article 2.04 permits the ultra vires nature of a corporate act to be asserted in in-junctive proceedings by shareholders against the corporation, in an injunctive action by thestate attorney general, or by the corporation in a suit against its officers or directors. Tax.Bus. CORP. AT ANN. art. 2.04 (Vernon 1980). Section 2.04's limitations on the ultra viresdefense have been upheld in several cases involving guaranties. See Diamond Paint Co. v.Embry, 525 S.W.2d 529 (Tex. Civ. App.-Houston [14th Dist.] 1975, writ ref'd n.r.e.);Cooper Petroleum Co. v. La Gloria Oil & Gas Corp., 423 S.W.2d 645 (Tex. Civ.App.-Houston [14th Dist.] 1967), rev'd on other grounds, 436 S.W.2d 889 (Tex. 1969); Em-pire Steel Corp. v. Omni Steel Corp., 378 S.W.2d 905 (Tex. Civ. App.-Fort Worth 1964,writ ref'd n.r.e.).

65. Tax. REv. CIv. STAT. ANN. art. 1302-2.06(B) (Vernon 1980). For a discussion of theremedial effect of article 1302-2.06(B) on the availability of ultra vires arguments to share-holders, see Witt, supra note 54, at 912-13.

7991981]


Despite the liberalization of enforcing corporate guarantiesunder Texas' corporation statutes, several questions remain forcreditors accepting corporate guaranties. First, article 1302-2.06(B)states that a guaranty made in accordance with section (B) shallnot be "invalid or unenforceable." 61 Therefore, the corporationwishing to avoid liability on its guaranty might argue by implica-tion that a corporate guaranty not so made would be invalid orunenforceable. This argument ignores, however, the fact that sec-tion (B) grants authority for the making of guaranties. Even if aguaranty is not authorized under article 1302-2.06 and, therefore,is ultra vires, article 2.04 should still apply.6 7 In addition, a corpo-rate guaranty not made in accordance with section (B), but in com-pliance with section (A)6 or section (C), obviously would not beinvalid. Finally, the statutory reference to a guaranty's being "in-valid or unenforceable" 9 apparently pertains only to the effect onenforceability of the types of fraud described in section (B).

A second question concerns references in section (B) to the"direct or indirect" benefit to the guarantor corporation. Read lit-erally, any benefit, however small, would support a corporate guar-anty. Although mere contract consideration alone would not neces-sarily support the corporate guaranty (if, for example, the guarantywas given to induce the creditor to lend funds to the principal obli-gor without benefitting the guarantor corporation), the statutedoes not require a certain level or proportion of benefit. Becausesection (B) expands the authorization of section (A), it appearsthat the benefit to the corporation need not be "reasonably worth"the obligation incurred by the guarantor corporation. Also, itwould seem clear that the failure of the guarantor's board of direc-tors to make a determination that the guaranty benefits the corpo-ration would not be detrimental if in fact the guaranty benefits theguarantor.

The scope of the "participation in fraud" or "notice of fraud"exceptions to article 1302-2.06(B) 0 have not been explored.Problems could arise if: (i) a creditor extending credit to corpora-tion A requests that corporation B guarantee the credit; (ii) all

66. TEx. REv. Civ. STAT. ANN. art. 1302-2.06(B) (Vernon 1980).67. TEx. Bus. CORP. ACT ANN. art. 2.04 (Vernon 1980).68. Tax. REv. CIV. STAT. ANN. art. 1302-2.06(A) (Vernon 1980).69. Id. art. 1302-2.06(B).70. See id.

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parties believe that the extension of credit to corporation A willnot benefit corporation B; and, (iii) the directors of corporation Bnevertheless go through the motions of determining that the guar-anty may reasonably be expected to benefit corporation B. Argua-bly, corporation B or its shareholders may assert that the creditorhas participated in (or at least has notice of) "fraud" on corpora-tion B. The hypothetical described above, however, does not depict"actual fraud" 71 and, in the absence of special circumstances,should not render the guaranty invalid. Otherwise, a creditor desir-ing to accept a corporate guaranty would revert to a position ofhaving to determine whether the corporation offering to give theguaranty in fact would benefit from the giving of the guaranty.

Article 1302-2.06 states that it applies both to "domestic" cor-porations (i.e., those incorporated under Texas law) and "foreign"corporations "doing business in this state. 7 2 Obviously, the au-thorization granted by article 1302-2.06 could contradict the au-thorization granted by the corporation laws of a state in which a"foreign" corporation (doing business in Texas) is incorporated, orin which a Texas corporation is doing business as a foreign corpo-ration. Consequently, questions arise over whether the Texas cor-poration statutes override guaranty provisions purporting tochoose the law which will govern the guaranty, or, in the absenceof an express choice of law, conflict of laws rules generally. Takento an illogical extreme, article 1302-2.06 would purport to governthe authority for a multi-national corporation, incorporated in Del-aware and doing business in Texas, to give to a New York lender aguaranty which states that New York law governs. Pragmatically,however, it would appear that a corporation incorporated in Texasshould be bound by article 1302-2.06, regardless of the law chosenin the guaranty, but that the corporate authority for guarantiesgiven by "foreign" corporations should be governed by the laws ofthe state where the foreign corporation is incorporated. 8

71. Generally, the basic elements for establishing "actual fraud" include misrepresen-tation of a material fact, for the purpose of inducing action, which action is induced, result-ing in injury to the party to whom the representation is made. See 25 Tax. JUR. 2d Fraudand Deceit § 13 (1961).

72. Tax. REV. Civ. STAT. ANN. art. 1302-2.06 (Vernon 1980).73. Generally, a corporation doing business outside of the state of its domicile remains

subject to the corporation laws of the state of its domicile. See 20 C.J.S. Corporations§ 1802 (1940). Nevertheless, the exercise of a corporation's powers in another state may belimited by the laws of that state. See id. § 1807; H. GOODRICH & E. SCOLES, CONFLICT OF

1981]


Finally, certain types of corporations and associations, such asbanks, are not empowered to give guaranties. Because section 24 ofthe National Bank Act74 does not expressly authorize a nationalbank to guarantee the debts of others, it has been held that such aguaranty is ultra vires. 5 Similarly, it would appear that a bankorganized under the laws of the State of Texas does not have thestatutory authority to execute and perform guaranty agreements.78Rarely do banks today expressly guarantee the obligations ofothers. Nonetheless, the effect of the ultra vires nature of a bankguaranty in modern commercial transactions assumes particularimportance for the often-used "stand-by letters of credit,"7" whichclosely resemble guaranties. The recent case of Republic NationalBank v. Northwest National Bank 8 describes the circumstancesunder which a stand-by letter of credit issued by a bank will con-stitute an ultra vires "guaranty." Even if a court determines that abank has given a "guaranty," case law7' and the analogous author-

LAWS § 108, at 209 (1964).74. 12 U.S.C. § 24(7) (1976). Section 24 enumerates permissible powers of national

banks, which generally may not be expanded by implication. See, e.g., Colorado Nat'l Bankv. Bedford, 310 U.S. 41 (1940).

75. See, e.g., Farmers' & Miners' Bank v. Bluefield Nat'l Bank, 11 F.2d 83 (4th Cir.),cert. denied, 271 U.S. 669 (1926); Republic Nat'l Bank v. Northwest Nat'l Bank, 578 S.W.2d109 (Tex. 1978); Groos v. Brewster, 55 S.W. 590 (Tex. Civ. App.-1900, writ ref'd). See also2 PATON'S DIGEST OF LEGAL OPINIONS, Guaranty and Suretyship § 1A:1 (1942) [hereinaftercited as PATON'S].

76. See TEx. REv. Civ. STAT. ANN. art. 342-301 (Vernon 1973) (enumerating powers ofstate banks). See also First State Bank v. Sanford, 255 S.W. 644 (Tex. Civ. App.-Dallas1923, no writ). It has been stated that both national banks and state banks may give aguaranty (or at least will be prevented from asserting the defense that the guaranty is ultravires) if the bank has received benefits therefrom, the guaranty is incidental to the bank'sregistration on security, or the bank has an "interest" in the obligation guaranteed. SeeRepublic Nat'l Bank v. Northwest Nat'l Bank, 566 S.W.2d 358 (Tex. Civ. App.-FortWorth), rev'd on other grounds, 578 S.W.2d 109 (Tex. 1978); Taylor v. Hemphill, 238 S.W.986 (Tex. Civ. App.-Austin 1922, writ dism'd); First Nat'l Bank v. Greenville Oil & CottonCo., 60 S.W. 828 (Tex. Civ. App. 1901, no writ); Groos v. Brewster, 55 S.W. 590 (Tex. Civ.App. 1900, writ ref'd). See also Note, 33 Sw. L.J. 1301, 1308 n.45 (1980).

77. For a discussion of the distinction between "standby" letters of credit and tradi-tional, commercial letters of credit, see Note, supra note 76, at 1308-09.

78. 578 S.W.2d 109 (Tex. 1978). See also Pedersen, Standby Letters of Credit, 16BULL. OF SEC. OF TEXAS BAR ON CORP., BANK. & Bus. L. 21 (Mar. 1979).

79. See, e.g., Farmers State Bank v. First State Bank, 260 S.W. 664 (Tex. Civ.App.-El Paso 1924, writ ref'd); Spadra-Clarksville Coal Co. v. Security Nat'l Bank, 206S.W. 200 (Tex. Civ. App.-Dallas 1918, no writ); El Paso Bank & Trust Co. v. First StateBank, 202 S.W. 522 (Tex. Civ. App.-El Paso 1918, no writ).

Other cases, however, indicate that (in the absence of special circumstances) a bankguaranty is unenforceable. See, e.g., First State Bank v. Sanford, 255 S.W. 644 (Tex. Civ.


ity of section 2.04 of the Texas Business Corporation Act s° suggeststhat a bank may not validly assert the ultra vires nature of itsguaranty as a defense against enforceability.

2. Guaranties as Fraudulent Conveyances Under Section 548(a)of the Bankruptcy Code

Section 548 of the Bankruptcy Reform Act,8' which substan-tially recodified section 67(d) of the Bankruptcy Act of 1898, s"states that a transfer by a debtor (or an obligation incurred by thedebtor) within one year before the bankruptcy case is filed may beavoided under section 548(a) if it (1) was made with the actualintent to hinder, delay or defraud the creditor or was made for lessthan a reasonably equivalent value, 88 and (2) the debtor either was"insolvent" or became "insolvent" as a result of the transaction,will be left with an unreasonably small amount of capital for itsbusiness purposes, or intended to incur debts beyond its ability topay." Undoubtedly, a guaranty constitutes either a "transfer" bythe debtor or an "obligation" of the debtor under section 548.85

Section 548 therefore presents potential problems to a creditor ac-cepting a guaranty from a guarantor not receiving direct, apparentbenefit for the guaranty. Although the issue arises regardless ofwhether the guarantor is an individual, partnership, or corpora-tion, the potential problems are most clearly defined when a sub-sidiary corporation guarantees either the indebtedness of its parentcorporation (an "upstream" guaranty) or another subsidiary of itsparent (a "cross-stream" guaranty). Assume, for example, that theparent corporation borrows $100,000,000 from a group of creditorsto be used for the borrower's general corporate purposes and to

App.-Dallas 1923, no writ); Groos v. Brewster, 55 S.W. 590 (Tex. Civ. App. 1900, writref'd). See also Republic Nat'l Bank v. Northwest Nat'l Bank, 566 S.W.2d 358 (Tex. Civ.App.-Fort Worth), rev'd on other grounds, 578 S.W.2d 109 (Tex. 1978); 2 PATON'S, supranote 75, § 1A:1.

80. Tax. Bus. CoRp. AcT ANN. art. 2.04 (Vernon 1980). The Texas Business Corpora-tion Act also states that, except to the extent that the state banking laws address a matterspecifically, the Texas business corporation statutes shall be deemed applicable to banks. Id.art. 9.14. The Texas state banking laws do not provide for the effect of an ultra vires act bya state bank.

81. 11 U.S.C. § 548 (Supp. II 1978).82. 11 U.S.C. § 107(d) (repealed 1978).83. 11 U.S.C. § 548(a) (Supp. 11 1978).84. Id.85. The term "obligation" is not defined.

1981] 803


make occasional advances to its subsidiaries. The lenders requirethat all subsidiaries guarantee the parent's debt before the lenderswill make the loan. The subject corporate guarantor (a Texas cor-poration), as one of the subsidiaries giving guaranties, has assets of$30,000,000 and a net worth of $5,000,000. Because of the provi-sions of article 1302-2.06(C) of the Texas Miscellaneous Corpora-tion Act,"8 Texas corporate law does not hinder enforcement of theguaranty and (because the guaranty is given to induce the lendersto make the loan to the parent) the guaranty is supported by con-tract consideration. 7

Nevertheless, if the guarantor becomes a debtor under theBankruptcy Code, the trustee in bankruptcy will argue that theguarantor did not receive, for purposes of section 548, "reasonablyequivalent value" for its $100,000,000 guaranty "obligation." Fur-thermore, the trustee will argue that, even though the guarantorwas "solvent" at the time the guaranty was given, the giving of theguaranty rendered the guarantor "insolvent." Arguably, the rele-vant Bankruptcy Code definitions are broad enough to support thetrustee's position without close examination. Section 548(d)(2) de-fines the term "value"88 but the Bankruptcy Code does not definethe qualifier "reasonably equivalent." Section 101(26) simply pro-vides that a person becomes "insolvent" when its "debts"8 9 aregreater than the person's "property at a fair valuation." 90

The creditors must prevail on only one of two arguments: ei-ther that the guarantor received reasonably equivalent value orthat the guarantor was not rendered insolvent by the giving of theguaranty. Under the hypothetical described above, in the absenceof special circumstances, the creditors' success would hinge on thevalidity of the propositions that (i) the amount of the "obligation"(for purposes of the "reasonably equivalent value" test) and"debt" (for purposes of the insolvency test) is less than the full$100,000,000 because the guaranty is a contingent obligation thatthe guarantor would probably never be required to perform, and

86. TEx. REV. CIV. STAT. ANN. art. 1302-2.06(C) (Vernon 1980).87. See note 48 supra, and accompanying text.88. The term "value" means "property, or satisfaction or securing of a present or ante-

cedent debt of the debtor, but does not include an unperformed promise to furnish supportto the debtor or to a relative of the debtor." 11 U.S.C. § 548(d)(2) (Supp. II 1978).

89. "Debt" is defined generally in the Bankruptcy Code to mean "liability on a claim."Id. § 101(11).

90. Id. § 101(26).

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(ii) the guarantor in fact received "value" (for purposes of the"reasonably equivalent value" test) or "property" (for purposes ofthe insolvency test) in the form of the rights of subrogation"against the principal obligor and contribution " from co-guaran-tors. The analogy between the "reasonably equivalent value" de-termination and the "insolvency" determination is not perfect and,depending on the particular facts, either the "reasonablyequivalent value" question or the "insolvency" question may be ir-relevant or obviously answered. Nevertheless, given that the"value" definition refers to "property," and given the similarity be-tween the terms "obligation" and "liability" (the essence of "debt"for purposes of the insolvency definition), the two issues may beanalyzed together.'3

Commentators discussing both the old and new fraudulentconveyance provisions agree that the "contingent" nature of theobligation does not, by itself, remove the guaranty from the "debt"column. Commentators disagree, however, over whether the bank-ruptcy statutes authorize judicial "discounting" of the contingentobligation or the inclusion as assets or "property" of the rights of

91. Texas courts have held that when a surety pays indebtedness of the principal, thesurety may bring an action on assumpsit or on the implied obligation to be reimbursed bythe principal or on the "very debt itself." See, e.g., Highland Cable Television, Inc. v. Wong,547 S.W.2d 324 (Tex. Civ. App.-Austin 1977, writ ref'd n.r.e.); Seale v. Hudgens, 538S.W.2d 459 (Tex. Civ. App.-San Antonio 1976, writ dism'd); Fulton v. Edge, 435 S.W.2d263 (Tex. Civ. App.-Waco 1968, writ ref'd n.r.e.). See also TEx. Bus. & COM. CODE ANN.

§ 34.04 (Vernon 1968) (regarding surety's subrogation to creditor's judgment against princi-pal obligor). When the guarantor or surety then pursues the principal, the guarantor is sub-rogated to the position of the principal obligor and "stands in the shoes" of the creditor as

to collateral security and rights of priority. For purposes of this article, the rights of theguarantor to pursue the principal after paying on the guaranty, however derived, are re-ferred to as "subrogation rights." As noted below, however, important distinctions may existbetween the rights of subrogation, which are no greater than the rights of the creditoragainst the principal obligor, and the implied right of reimbursement, which is based on thedetriment suffered by the guarantor. See notes 181, 206 infra, and accompanying text. As acorollary to the statement that the guarantor stands in the shoes of the creditor, in a subro-gation action the principal obligor may assert defenses against the guarantor to the sameextent that defenses could have been asserted against the creditor. See Note, supra note 76,at 1306-08. See also Clark, supra note 8, at 454 (regarding "subrogation" under the Code).

92. The general rule of contribution is that a guarantor who has paid more than hisproportionate share of the principal obligation guaranteed may obtain contribution from co-guarantors in order to equalize their respective liabilities. See Miller v. Miles, 400 S.W.2d 4(Tex. Civ. App.-Tyler 1966, writ ref'd n.r.e.). See generally 38 C.J.S. Guaranty § 115(1943). See also TEx. Bus. & COM. CODE ANN. § 34.04(b)(2) (Vernon 1968).

93. Most of the relevant authorities, as discussed later, pertain to the "insolvency"definition.


subrogation and contribution." One commentator has concludedthat the old bankruptcy statute simply would not permit the dis-counting of contingent liabilities, and any attempt to include sub-rogation rights as an asset must fail because subrogation rights arerelevant only after the principal obligor has defaulted and there-fore offer little benefit to the guarantor seeking recovery. 96 Thecommentator advises that, although the result is not "particularlypleasing," a creditor considering accepting an "upstream" or"cross-stream" guaranty should include the entire amount of theguaranty on the liability side of the balance sheet and not includeany rights of subrogation on the asset side." One noted bank-ruptcy authority disagrees with this approach, and would eitherdiscount the amount of the liability or include subrogation rightson the asset side of the guarantor's balance sheet.9

Despite the difficulties of crafting reasonable discounts or as-sessing the present "value" of subrogation rights, several sources ofauthority support this approach. First, the recent case of KnoxKreations, Inc. v. Nicely,'" although interpreting Tennessee law,exemplifies the practical application of the theory of discountingthe amount of the obligation on the basis of the likelihood of per-

94. See Normandin, Intercorporate Guaranties and Fraudulent Conveyances, in PER-SONAL PROPERTY SEcUTrrY INRmSTS UNDER THE REVISED UCC 361, 380 (1977) (definition of"debt" includes contingent liabilities and thus guaranties must be included as liabilities, butthe "present salable value" test would almost certainly require elimination of rights of sub-rogation and contribution as assets); Rosenberg, Intercorporate Guaranties and the Law ofFraudulent Conveyances: Lender Beware, 125 U. PA. L. Rav. 235, 256 (1976) (guarantyshould be included as a liability, but it is not realistic to offset rights of contribution andsubrogation as contingent assets); 2 COLIIER ON BANauiPTcY 101.26[5] (15th ed. 1980)[hereinafter cited as COLLIE] (guaranty should be included in total indebtedness but appro-priate allowances could be made under asset column for possible rights of subrogation andcontribution). Similarly, it is clear that a guaranty, although only a "contingent" liability,was a "provable debt" within the meaning of § 63 of the Bankruptcy Act of 1898, 11 U.S.C.§ 103(a)(8) (repealed 1978). See, e.g., Guaranty Bank v. Lone Star Life Ins. Co., 568 S.W.2d431 (Tex. Civ. App.-Dallas 1978, writ ref'd n.r.e.).

95. See Rosenberg, supra note 94, at 256. The author cites authority for the proposi-tion that an asset will not be included on the asset side of the balance sheet, for purposes ofthe insolvency determination, unless it has a present salable value. See id. at 254 n.50. Theauthor was construing, however, § 67d(1) of the Bankruptcy Act of 1898, 11 U.S.C. § 107(d)(repealed 1978), which stated that a person is insolvent when the person's debts exceed the"present fair salable value" of his property. The "present fair salable value" term is alsofound in the UNIFORM FRAuDuLzNT CONVEYANcE AcT § 2(1), 7A UNIFORM LAWS ANN. 176(West 1978).

96. Rosenberg, supra note 94, at 257.97. See 2 COLLIER, supra note 94, 1 101.26[5].98. 474 F. Supp. 567 (E.D. Tenn. 1979).

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formance. Certainly, if the $100,000,000 obligation described abovewas secured by a $100,000,000 certificate of deposit, it would beludicrous to hold that the guarantor was rendered insolvent by thegiving of the guaranty or that the full face amount of the guarantybe considered in the "reasonably equivalent value" test."9 Second,although there are those who believe to the contrary,0 0 the rightsof contribution from co-guarantors might indeed be valuable, and,in many cases, the fact that a creditor has pursued the guarantordoes not necessarily indicate that the creditor is penniless or thatall collateral has been liquidated or dissipated. Third, as notedabove, there is judicial authority for the proposition that subroga-tion rights constitute "assets" for purposes of the bankruptcylaws. 10' Fourth, the Bankruptcy Code requires that contingent ob-ligations be estimated for purposes of having such claims allowedand proved under section 502(c).10 2 For example, if the guarantorcorporation files a bankruptcy petition before the principal obliga-tion was in default, the bankruptcy court would estimate the al-lowable value of the creditor's claim against the guarantor. 103 Fi-nally, to include all of the contingent or speculative obligations as"debt," and none of the corresponding contingent or speculativeassets as "property," is neither internally consistent nor requiredby statutory language or purpose.104

99. See Updike v. Oakland Motor Car Co., 53 F.2d 369 (2d Cir. 1931). In addition, thedefinition of "insolvency" in the Uniform Fraudulent Conveyance Act refers to a person's"probable liability" on his debts, thereby supporting a concept of discounting liabilitiesunder that Act. See UNIFORM FRAUDULENT CONVEYANcE AcT § 2(1), 7A UNIFORM LAWS ANN.

176 (West 1978).100. See Rosenberg, supra note 94, at 256.101. See In re Ollag Constr. Equip. Corp., 578 F.2d 904 (2d Cir. 1978) (court specifi-

cally mentioned the value of collateral security for the principal obligations, which wouldbenefit the guarantor even if the principal obligor were insolvent); Wingert v. PresidentDirectors & Co. of Hagerstown Bank, 41 F.2d 660 (4th Cir. 1930) (rights of contributionshould not be estimated at face value but cannot be ignored; full face amount of endorsedpaper should not be included as liability unless value given to right of contribution).

102. 11 U.S.C. § 502(c) (Supp. II 1978).103. A bankruptcy court equipped to make this determination may also make a simi-

lar determination for purposes of the fraudulent conveyance provisions.104. Most of the arguments supporting a "flexible" interpretation of the "insolvency"

definition also pertain to the "reasonably equivalent value" determination. This conclusionfollows from the fact that the key terms in the insolvency definition, "debt" (which in turnis based on the term "liability") and "property," correspond to the § 548's references to"obligation" and "value" (which in turn is based on or includes "property"). The analogymade between the interpretation of the "insolvency" definition and the "reasonablyequivalent value" determination becomes especially important if the guarantor is obviously

1981] 807


Assuming that courts follow a "flexible" approach, creditorsnonetheless must exercise care in avoiding the fraudulent convey-ance trap. First, to the extent that a creditor must establish the"value" of the subrogation rights and contribution rights of theguarantor, it should consider the case of United States v. Im-mordino.10 In Immordino, the court considered the effect of a pro-vision in a guaranty which stated that the creditor could releaseco-guarantors from liability without discharging the subject guar-antor. The court held that this provision constituted an impliedwaiver by the subject guarantor of its rights of contribution, andtherefore that the guarantor could not recover from co-guaran-tors.106 This implied waiver argument could devalue the contribu-tion rights of the guarantor for purposes of section 548. In addi-tion, the "waiver" argument could be expanded to subrogationrights against the principal obligor when the guaranty includes aprovision stating that the guarantor is not discharged from liabilityif the creditor releases the principal obligor.107 Even if the creditornever takes such permitted actions, it could be argued that itsright to do so weakens the guarantor's subrogation rights and im-pairs their value as of the date the guarantor might be required toperform the guaranty (and therefore restricts the court's ability to"discount" the contingent obligation).

3. Fraudulent Conveyances Under Section 544(b) of theBankruptcy Code and Section 24.03 of the Texas Business and

insolvent before the guaranty is given and the creditor must rely on satisfying the "reason-ably equivalent value" test.

It should also be noted that, although the value of subrogation rights may dominatemany considerations, other "indirect" benefits to the guarantor may count in both the "rea-sonably equivalent value" and "insolvency" determinations. While "contract" considerationalone may not protect the guarantor's creditors (when, for example, it is based merely ondetriment suffered by the creditor of value flowing to the principal obligor) a member of thecorporate group often will indirectly benefit from the strengthening of the parent or anothermember of the group. See Normandin, supra note 94, at 266-72; 4 CoLLsM, supra note 94,

67.33 (14th ed. 1978).105. 534 F.2d 1378 (10th Cir. 1976).106. Such provisions are commonly included in guaranty agreements, and are in fact

helpful for the purposes discussed in § IV.A.2. infra. See notes 223-25 infra, and accom-panying text.

107. See 83 C.J.S. Subrogation § 51 (1953). Similarly, § IV.B. below discusses the ben-efits to the creditor of having the guaranty expressly provide that the creditor may releasecollateral without discharging the guarantor. See notes 226-302 infra, and accompanyingtext.

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Commerce Code

Under section 544(b) of the Bankruptcy Code,108 the trusteefor the debtor's estate may also void transfers that would be fraud-ulent under applicable state laws. Although Texas has not adoptedthe Uniform Fraudulent Conveyance Act,109 section 24.03 of theCode 10 states that a transfer by a debtor is void with respect tocreditors of the debtor if the transfer is not made "for full consid-eration" unless, after giving effect to the transfer, the debtor has,in the State of Texas, nonexempt property sufficient to pay all ofits existing debts.' If Texas courts assign to the phrase "full con-sideration" found in section 24.03 of the Code a meaning similar tothat of "reasonably equivalent value," 11' then section 24.03 (and,derivatively, section 544(b)) creates problems similar to those aris-ing under section 548 of the Bankruptcy Code. The problems areexacerbated by the fact that the statute of limitations for violationof section 24.03 is four years18 (compared to the one year reach ofsection 548)14 and that a determination under section 24.03 argua-bly depends only on the value of property of the debtor located inthe State of Texas. Obviously, a corporation doing business inmany states and giving a guaranty governed by the laws of theState of Texas could have total assets which would exceed its in-debtedness and provide a basis for collection of the Texas guarantybut would not have assets located in Texas sufficient to satisfy allof its debts. Presumably, a court would not read section 24.03 soliterally as to dictate an unreasonable result.

108. 11 U.S.C. § 544(b) (Supp. II 1978).109. UNIFORM FRAUDULENT CONVEYANCz AcT, 7A UNIFORM LAWS ANN. 161-366 (West

1978).110. TEx. Bus. & COM. CODE ANN. § 24.03 (Vernon 1968).111. Although the term "debts" is not statutorily defined, at least one Texas case has

broadly defined the term. See Kelley v. Stubblefield, 26 S.W.2d 281 (Tex. Civ. App.-Texarkana 1930, no writ) (court ruled that every debt or claim that can be enforced in thecourts can be taken into consideration in determining insolvency).

112. See notes 81-94 supra, and accompanying text.113. Suits that are filed to set aside fraudulent conveyances are governed by the four

year statute of limitation as provided for in TEx. Rzv. Civ. STAT. ANN. art. 5529 (Vernon1958). See Hoerster v. Wilke, 138 Tex. 263, 158 S.W.2d 288 (1942) (court ruled that thestatute of limitation in article 5529 governed suits filed to set aside fraudulent conveyancesas provided for in TEx. Rsv. CIv. STAT. ANN. art. 3997 (repealed 1967), which was the prede-cessor to § 24.03).

114. 11 U.S.C. § 548(a) (Supp. II 1978).

19811


4. Avoiding "Consideration" Problems: Suggestionsfor the Creditor

A creditor accepting an "upstream" or "cross-stream" guar-anty should recite in the guaranty and otherwise document: (a) thecreditworthiness of the principal obligor and, therefore, the im-probability that the guarantor will be required to perform theguaranty; (b) the value of other security for the principal obliga-tion, to support the improbability that the guarantor will be re-quired to perform and the value of the subrogation rights whichthe guarantor would enjoy in the event that it is required to per-form; and (c) the value and benefits which the guarantor will re-ceive from the loan arrangement. 15 In addition, as suggestedabove, 1 the guaranty should include a provision that, notwith-standing any authority given to the creditor to release other guar-antors or the principal obligor, such authorization does not im-pliedly waive the guarantor's rights to seek reimbursement,subrogation, or contribution after the principal obligation has beenrepaid in full. Furthermore, if the creditor determines that a sub-sidiary with a net worth of $5,000,000 could not possibly perform a$100,000,000 guaranty obligation, then the guaranty could containa reasonable limit on the guarantor's total liability. Also, the credi-tor should require the guarantor to give representations and war-ranties as to its financial condition at the time of the guaranty inorder to establish that the guarantor is "solvent" at the time. Forpurposes of the Texas corporation statutes, the creditor should re-quire certified resolutions of the board of directors of the guaran-tor authorizing the guaranty and declaring that the guaranty willbenefit the guarantor. Although (unlike many other state stat-

115. Guaranties often recite the benefit that the guarantor will receive from the guar-anty and that the guaranty is given to induce the creditor to advance certain funds to theprincipal obligor. Although not establishing consideration, the recitals are considered benefi-cial. In one case, a guarantor advanced the interesting argument that a recital in a continu-ing guaranty, stating that the guaranty was given to induce the lender to extend certaincredit to the principal obligor, evidenced the parties' actual intention that the guarantywould cover only the indebtedness particularly mentioned in the recital. See Reece v. FirstState Bank, 555 S.W.2d 929 (Tex. Civ. App.-Fort Worth 1977), affd, 566 S.W.2d 296 (Tex.1978). The argument failed. A creditor desiring to establish the improbability that the guar-antor will be required to perform should remember, however, that establishing such improb-ability may adversely affect the allowance of the creditor's claim, in a bankruptcy proceed-ing of the guarantor occurring prior to default by the principal obligor, under 11 U.S.C.§ 502(c) (Supp. II 1978).

116. See notes 105-07 supra, and accompanying text.

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utes)1 ' " the Texas statute places no premium on shareholder ap-proval, obtaining shareholder approval of questionable guarantiescould benefit the creditor if a shareholder later attempts to enjoinperformance of the guaranty under the "fraud" exceptions ofarticle 1302-2.06.118

III. LIMITATIONS ON INDEBTEDNESS GUARANTEED

A. General Contract Limitations

1. "Measures" of Liability

Texas courts have adopted several rules that purport to definethe extent of a guarantor's liability. For example, courts havestated that, because the guarantor's liability is "secondary" and"contingent," the guarantor has no liability unless a principal obli-gation has been created,119 the liability of the guarantor generallyis measured by that of the principal obligor, 2 ° and the degree, ex-tent, and nature of the guarantor's obligation includes or dependsupon the terms of the promissory note or underlying obligation.""

The "derivative" nature of a guarantor's liability is exempli-fied by Texas cases that have discussed the question whether at-torneys' fees incurred by the creditor in collecting the principal ob-ligation are covered by the guaranty."' Even if attorneys' fees arenot expressly mentioned in the guaranty, a guaranty which covers"all indebtedness" of the principal obligor to the creditor or allindebtedness under a particular promissory note (which in turn in-

117. See generally Kreidman, The Corporate Guaranty, 13 VAND. L. REv. 229 (1959);Note, The Corporate Guaranty Revisited: Upstream, Downstream, and Beyond-A Statu-tory Approach, 32 RUTGERS L. REv. 312 (1979).

118. TEx. REv. Civ. STAT. ANN. art. 1302-2.06 (Vernon 1980).119. See, e.g., Moore v. Grain Dealers Mut. Ins. Co., 450 S.W.2d 954 (Tex. Civ.

App.-Houston [1st Dist.] 1970, no writ); Girard Fire & Marine Ins. Co. v. Koenigsberg, 65S.W.2d 783 (Tex. Civ. App.-Dallas 1933, no writ).

120. See, e.g., Houston Furniture Distribs., Inc. v. Bank of Woodlake, 562 S.W.2d 880(Tex. Civ. App.-Houston [1st Dist.] 1978, no writ); Gubitosi v. Buddy Schoellkopf Prod.,Inc., 545 S.W.2d 528 (Tex. Civ. App.-Tyler 1976, no writ).

121. See, e.g., Hopkins v. First Nat'l Bank, 551 S.W.2d 343 (Tex. 1977); CommerceSav. Ass'n v. GGE Management Co., 539 S.W.2d 71 (Tex. Civ. App.-Houston [1st Dist.]),modified, 543 S.W.2d 862 (Tex. 1976); Young v. J.F. Zimmerman & Sons, Inc., 434 S.W.2d926 (Tex. Civ. App.-Waco 1968, writ dism'd).

122. See, e.g., Gubitosi v. Buddy Schoellkopf Prod., Inc., 545 S.W.2d 528 (Tex. Civ.App.-Tyler 1976, no writ); Warrior Constructors, Inc. v. Small Bus. Inv. Co., 536 S.W.2d382 (Tex. Civ. App.-Houston [14th Dist.] 1976, no writ).

1981] 811


cludes a provision for attorneys' fees) will impose on the guarantorliability for attorneys' fees incurred by the creditor in collectingthe principal obligation.

The above rules measuring guaranty coverage and the "secon-dary" or "derivative" nature of a guaranty weld the guarantor'sliability to the principal obligation. However, Texas courts recog-nize that a guarantor may, by provision in the guaranty, expresslyassume a greater or lesser liability than that of the principal obli-gor. " ' This latter rule simply underlines the basic proposition thatthe guaranty constitutes an independent contract, and, within cer-tain limits described below,2 4 the guarantor will become liable forthe indebtedness described and defined in the guaranty.

2. Scope of Continuing Guaranties

A properly drafted continuing guaranty extends to all presentand future indebtedness of the principal obligor to the creditor,whether contemplated or contracted for at the time of the guar-anty. '2 Careful draftsmanship also eliminates most questions re-garding the intentions of the parties as to which obligations of theprincipal obligor are guaranteed. With certain exceptions, however,a continuing guaranty does not extend to indebtedness whicharises after the guarantor expressly revokes a guaranty " or afterthe guarantor's death, 127 unless the indebtedness arises pursuant toa binding commitment of the creditor entered into prior to suchoccurrence. In this regard, a continuing guaranty may be charac-terized partially as an "offer" to guarantee future indebtedness.The continuing guaranty may, however, expressly negate revocabil-ity and Texas courts have upheld the irrevocability of such aguaranty.1

2 8

Although the concept of a continuing guaranty is well estab-lished, questions occasionally arise over the continuing guaranty's

123. See, e.g., Gubitosi v. Buddy Schoellkopf Prod., Inc., 545 S.W.2d 528 (Tex. Civ.App.-Tyler 1976, no writ).

124. See notes 126-36 infra, and accompanying text.125. See notes 177-81, 282-303 infra, and accompanying text.126. See, e.g., Casey v. Gibson Prod. Co., 216 S.W.2d 266 (Tex. Civ. App.-Dallas

1948, writ dism'd); 38 C.J.S. Guaranty §§ 36-37 (1943). See also Annot., 55 A.L.R.3d 344(1974).

127. See note 126 supra.128. See, e.g., Straus-Frank Co. v. Hughes, 130 Tex. 50, 156 S.W.2d 519 (1941).

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scope. In Dicker v. Lomas & Nettleton Financial Corp.,1 29 theguarantor argued that it had revoked its liability as to future in-debtedness under the continuing guaranty. The guarantor furtherasserted that after such revocation, the original indebtedness hadbeen renewed and extended and the interest rate on the originalindebtedness had been increased, thereby releasing him from anyliability under the guaranty.180 The court stated that, even if theguarantor had properly revoked its continuing liability, the guar-anty covered "renewals" of indebtedness created prior to revoca-tion and that the post-revocation change in the rate of interestunder the renewal note would not discharge the guarantor. 81 Thisresult is questionable because authorizing "renewals" is not thesame as authorizing "modifications" of the principal debt. 8 2 In therecent case of Holland v. First National Bank,1 83 the court con-cluded that a guaranty covering "any and all indebtedness" of theprincipal obligor meant that the guaranty covered not only in-creases of, and additions to, the original indebtedness but also re-newals and extensions of the original indebtedness.'

Courts have also considered whether a continuing guaranty ex-tends to indebtedness created after the principal obligor reorgan-izes, dissolves, or reincorporates. One Texas court viewed the ques-tion primarily as one of the parties' true intentions and held that acontinuing guaranty covered the debts incurred after the principalobligor was rechartered. 8

5 Another Texas court, however, has indi-cated that a continuing guaranty of a partnership's debts does notextend to debt created after the partnership dissolves throughwithdrawal or addition of members."3 6

129. 576 S.W.2d 672 (Tex. Civ. App.-Texarkana 1978, writ ref'd n.r.e.).130. Id. at 674. See notes 137-55 infra, and accompanying text.131. Id. at 676.132. After a continuing guaranty is revoked, the effect of alterations of the principal

obligations created prior to the revocation must be ascertained under the "alteration" prin-ciples described in § III.A.3. below. See notes 137-55 infra, and accompanying text.

133. 597 S.W.2d 406 (Tex. Civ. App.-Dallas 1980, no writ).134. Id. at 408. The dissenting judge's disagreement with this conclusion stemmed pri-

marily from a different approach to the issue, but underlines the difficulties of preciselydefining the indebtedness guaranteed, even in continuing guaranties. Id. at 413 (Akin, J.,dissenting).

135. See Cooper Grocery Co. v. Eppler, 204 S.W. 338 (Tex. Civ. App.-Austin 1918, nowrit).

136. See Hunt Oil Co. v. Killion, 299 S.W.2d 316 (Tex. Civ. App.-Texarkana 1957,writ ref'd n.r.e.). But cf. U.S. Fidelity & Guar. Co. v. Burton Lumber Co., 221 S.W. 699

1981] 813


When a guaranty is not a "continuing" one, the creditor mayconfront the more difficult problems discussed in the next sectionconcerning the effects of alterations of the principal obligation.

3. Effect of Renewals, Extensions, and Modifications UnderNon-Continuing Guaranties

As recognized by the Supreme Court of the State of Texas, aguarantor is entitled to have its guaranty agreement strictly con-strued, and its liability will not be extended "one jot or tittle" byconstruction or implication beyond the precise terms of the guar-anty contract. 187 It is likewise true that a guaranty agreement willnot be construed to render the guaranty meaningless or to disre-gard the clear expression of the intention of the parties to theguaranty agreement.'" The general rule of strict construction car-ries particular weight, however, when the guaranty is not "continu-ing" or "all-inclusive" but rather refers to a particular indebted-ness or promissory note, and when the terms of that indebtednessor promissory note are later altered or modified. Although oldercases stated that any alteration of the principal contract woulddischarge the guarantor, the general Texas rule now is that modifi-cation of the principal obligation discharges the guarantor if themodification is "material" or "substantial" and the guarantor doesnot authorize the modification.18 ' The rule applies not only tochanges in the basic terms of the principal obligation but also tosimple contractual extensions of the time of payment therefor.Similarly, with respect to Code guaranties, a holder of a negotiableinstrument who agrees to suspend the right to enforce the instru-ment against the principal obligor, without the guarantor's con-sent, will discharge the guarantor on that instrument.14 0

(Tex. Civ. App.-Amarillo 1920, no writ) (regarding effect of change in structure of principalobligor when surety bond statutorily required). See generally Annot., 69 A.L.R.3d 567(1976).

137. See, e.g., McKnight v. Virginia Mirror Co., Inc., 463 S.W.2d 428 (Tex. 1971);Commerce Say. Ass'n v. GGE Management Co., 539 S.W.2d 71 (Tex. Civ. App.-Houston[1st Dist.]), modified, 543 S.W.2d 862 (Tex. 1976).

138. See Southwest Say. Ass'n v. Dunagan, 392 S.W.2d 761 (Tex. Civ. App.-Dallas1965, writ ref'd n.r.e.).

139. See McKnight v. Virginia Mirror Co., Inc., 463 S.W.2d 428 (Tex. 1971); Straus-Frank Co. v. Hughes, 138 Tex 50, 156 S.W.2d 519 (1941). For a statement of the old rule,see Jarecki Mfg. Co. v. Hinds, 295 S.W. 274 (Tex. Civ. App.-Eastland 1927, writ dism'd).

140. TLx. Bus. & COM. CODE ANN. § 3.606 (Tex. UCC) (Vernon 1968). See also Note,

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Two primary theories offer support for the concept that alter-ation of the principal obligation discharges the guarantor. First,the guarantor's contract for a non-continuing guaranty extendsonly to the particular indebtedness described, and the alteration ofthat indebtedness destroys the subject matter of the guaranty."" Asecond rationale is that a contractual change in the principal obli-gation may prejudice the guarantor, who has lost its right to paythe original debt at the time and in the manner originally contem-plated and to obtain reimbursement from the principal obligorthrough subrogation to the creditor's original position.142

Texas authorities have supplemented the basic "alteration"rule in the following ways. First, the courts hold (and section 3.606suggests) 43 that a guarantor's consent to renewal, extension, ormodification of the principal obligation (which defuses the guaran-tor's discharge argument) may be given either in the guarantyagreement itself or separately, at or prior to the time of the altera-tion, and no consideration need be established for the giving ofsuch consent. 44 Second, an agreement of extension between thecreditor and a party other than the principal obligor does not dis-charge a guarantor of the principal obligation.145 Furthermore,mere forbearance from pursuing the principal obligor does not con-stitute a "renewal and extension" or "modification" which woulddischarge the guarantor;' 46 in the absence of a binding extension,the guarantor still has the opportunity to pay the principal debt atthe originally stated maturity and pursue its subrogation rightsagainst the principal obligor. On the basis of a similar theory, the

30 ARK. L. REv. 544 (1977).141. See, e.g., C & G Coin Meter Supply Corp. v. First Nat'l Bank, 413 S.W.2d 151

(Tex. Civ. App.-Eastland 1967, writ ref'd n.r.e.).142. See Tomlin v. Ceres Corp., 507 F.2d 642 (5th Cir. 1975).143. See TEx. Bus. & COM. CODE ANN. § 3.606 (Tex. UCC) (Vernon 1968). It should be

noted that § 3.606(a)(1) does not expressly refer to "modification" of the principal obliga-tion but rather refers to discharge of the principal obligor and suspension of the right ofenforcement.

144. See, e.g., Commerce Sav. Ass'n v. GGE Management Co., 539 S.W.2d 71 (Tex.Civ. App.-Houston [1st Dist.]), modified, 543 S.W.2d 862 (Tex. 1976); C & G Coin Meter.Supply Corp. v. First Nat'l Bank, 412 S.W.2d 151 (Tex. Civ. App.-Eastland 1967, writ ref'dn.r.e.). See also 38 C.J.S. Guaranty § 76 (1943).

145. See, e.g., Tomlin v. Ceres Corp., 507 F.2d 642 (5th Cir. 1975).146. The discharge rule operates only if the creditor has entered into a binding agree-

ment to extend the time for payment. See Tobin Canning Co. v. Fraser, 81 Tex. 407, 411-12,17 S.W. 25, 27 (1891).

1981] 815


creditor's agreement to renew and extend the principal obligationor to "suspend enforcement" against the principal obligor will notdischarge the guarantor when the creditor "reserves rights" againstthe guarantor.1 4

7 Theoretically, this procedure constitutes a "cove-nant" of the creditor not to sue the principal obligor for a statedperiod of time but does not prevent the guarantor from performingthe principal obligation and pursuing the principal obligor on theoriginal contract.1 48

Although the Texas Supreme Court has stated that only a"material" obligation will discharge the guarantor,149 no recentTexas court has generally defined the term "material," or the re-lated term "substantial." It is suggested that discharge should notoccur unless the alteration (i) so alters the basic understanding be-tween the guarantor and creditor that, had the guarantor knownthat the alteration would occur, the guarantor would not have exe-cuted the guaranty, or (ii) if the intention of the parties is not evi-dent, the modification substantially increases the guarantor's riskof loss. This approach combines the two theories for discharge de-scribed previously,150 by focusing both on the intentions of the par-ties and (in the absence of clear intentions) on the substantive ef-fect of the alteration.151

Another question is whether the unauthorized alteration of adocument other than the document creating or representing theprincipal obligation itself, will result in discharge. Although a doc-ument which does not affect the guarantor obviously should not berelevant, modification of certain documents other than the promis-sory note itself may be significant. For example, the promissorynote evidencing the principal obligation may be governed by a loanagreement that contains substantial affirmative and negative cove-nants of the principal obligor and describes "events of default"

147. See generally L. SIMPSON, HANDBOOK ON THE LAW OF SURETYSHIP § 73, at 362-63(1950). See also Tax. Bus. & COM. CODE ANN. § 3.606(b) (Tex. UCC) (Vernon 1968).

148. See L. SIMPSON, supra note 147, § 73, at 261-63.149. McKnight v. Virginia Mirror Co., 463 S.W.2d 428, 430 (Tex. 1971). The Fifth

Circuit believes that the alteration must be sufficiently material to create a "new contract."See Tomlin v. Ceres Corp., 507 F.2d 642 (5th Cir. 1975).

150. See notes 141-42 supra, and accompanying text.151. The requisite determinations are not easily made, but the suggested approach

offers direction in the making of a "materiality" determination and finds support in secon-dary authorities. See, e.g., Meyer & Paluch, The Surety's Liability as Affected by ContractAlterations and Unauthorized Payments-How Much is Too Much?, 15 THE FORUM 982,983-84 (1980).

816 [Vol. 12:785


upon which the creditor may accelerate the maturity of the princi-pal obligation. If the creditor and principal obligor amend the loanagreement to delete covenant protections and dilute the events ofdefault so that the principal obligor's financial condition mightsubstantially deteriorate before default is declared, the effectwould approximate that of extending the maturity of the note it-self. Thus, the alteration of the "collateral" document could be sig-nificant. Conversely, if the events of default or covenant restric-tions are "tightened," the likelihood of the principal's failure toperform will be increased. Again, the effect of an alteration in a"collateral" document should be resolved by a test that considersboth the intention of the parties and the effect of the alteration. Ifa guarantor has authorized or consented to alterations of a promis-sory note or the terms of the principal obligation, the authorizationor consent should also be held to cover changes in relateddocuments.

Finally, although certain earlier cases reached a contrary re-sult,"' the Texas Supreme Court has decided that an alteration ofthe principal obligation which actually benefits a surety will notdischarge the surety.158 Presumably this holding also applies toguarantors. The ruling does not agree with the first theory under-lying discharge on the basis of principal contract alteration (i.e.,that any change in the principal obligation destroys the subjectmatter of the guarantor's contract), but is reasonable and enjoyssupport from other jurisdictions.' Although such contrivancesshould not be necessary, it has been suggested that a guarantor"impliedly" consents to beneficial changes.1 55

B. Effect of Unenforceability of the Principal Obligation

The foregoing limitations on the enforceability of a guaranty,with respect to particular indebtedness, reify the rule that a guar-antor is liable for only those obligations expressly stated in theguaranty agreement. A properly drafted guaranty will resolve these

152. See, e.g., Jarecki Mfg. Co. v. Hinds, 295 S.W. 274 (Tex. Civ. App.-Eastland1927, writ dism'd).

153. See United Concrete Pipe Corp. v. Spin-Line Co., 430 S.W.2d 360 (Tex. 1968).154. See L. SIMPSON, supra note 147, § 72, at 342. Courts have reaffirmed the general

rule but distinguished the cases involving benefit to the guarantor by calling the change awaiver by the creditor of part of the performance due him, the original contract being un-affected. Id. at 343.

155. See id.

1981]


questions before they arise. More piquant issues may develop whena guarantor guarantees payment of certain indebtedness which, forone reason or another, the creditor cannot enforce against the prin-cipal obligor. Fundamentally, as a "secondary" obligation, theguaranty depends to some extent on the status of the principal in-debtedness. Just as naturally, however, a guaranty contemplatesrecovery from a guarantor even though the creditor cannot recoverthe principal obligation from the principal obligor. Although theprimary risk sought to be neutralized is the principal obligor'sfinancial inability to pay, most creditors expect that the guarantymay protect against other contingencies as well.

1. Necessity for Principal Obligation

The first rule pertaining to problems of the unenforceability ofthe principal obligation is a simple truism: if no principal obliga-tion arises, there is no liability on the part of the guarantor.1' Forexample, in Fisher v. Alexander,157 the court held that the creditorcould not enforce a guaranty against the guarantor of specific con-tract obligations because the creditor had failed to satisfy condi-tions precedent to the principal obligor's obligation to perform.'"Similarly, in Reece v. First State Bank,'59 the Texas SupremeCourt noted that the validity of the guaranty generally depends onthe creation of principal indebtedness of the principal obligor. Asexplained more fully below, this rule does not insulate the guaran-tor from liability simply because the principal obligor has escapedliability. In its essential form, the rule merely requires, as a condi-tion to the guarantor's liability, that the creditor has extendedsome benefit to the party whose obligations have been guaranteed,or that indebtedness of the principal obligor otherwise is created.So stated, the rule avoids entanglement with the more difficultrules described in the following section, and rarely poses problemsfor the commercial lender.

156. See, e.g., Moore v. Grain Dealers Mut. Ins. Co., 450 S.W.2d 954 (Tex. Civ.App.-Houston [1st Dist.) 1970, no writ).

157. 137 S.W. 715 (Tex. Civ. App.-Dallas 1911, no writ).

158. Id. at 716.

159. 566 S.W.2d 296 (Tex. 1978).

[Vol. 12:785818


2. Defenses Available to Principal Obligor

It has also been stated that a guarantor may assert defensesthat the principal obligor might have asserted.1" Similarly, Texascourts have held that "that which discharges the principal from hisobligation also exonerates the surety."16 For example, the court inMayfield v. Hicks,1 " after determining that the creditor's recoveryof a default judgment from the principal obligor did not collater-ally estop the guarantor from asserting defenses which were availa-ble to the principal obligor, held that the guarantor was not liableto pay "liquidated damages" (under the principal contract) whichwere in fact a "penalty. ' '1 S8

Other cases confound the general rule. In Jarecki Mfg. Co. v.Hinds,"" the court stated that the guarantor (which had guaran-teed the liability of a buyer of goods to the seller of the goods)could not assert as a defense the fact that the goods shipped fromthe seller to the buyer were in breach of seller's warranty. Thecourt simply stated that the guarantor was not a party to the origi-nal contract.1 "5 More recently, in Shepherd v. Eric SchusterCorp.,16" a manufacturer shipped picture frames to an art gallery,relying on a guaranty of payment from a third party. The goodsshipped did not conform to the contract, and the court recognizedthat the principal obligor might therefore have rescinded the con-tract. The principal obligor, however, did not rescind the contractand effectively accepted the goods.167 Therefore, the court heldthat the creditor could recover from the guarantor the entire salesprice despite the defects in the goods. 1" In El Paso Bank & TrustCo. v. First State Bank,1 9 the guarantor bank absolutely guaran-

160. Mayfield v. Hicks, 575 S.W.2d 571 (Tex. Civ. App.-Dallas 1978, writ ref'd n.r.e.).161. Metze v. Entman, 584 S.W.2d 512, 514 (Tex. Civ. App.-Houston [14th Dist.]

1979, no writ).162. 575 S.W.2d 571 (Tex. Civ. App.-Dallas 1978, writ ref'd n.r.e.).163. Id. at 574-76.164. 295 S.W. 274 (Tex. Civ. App.-Eastland 1927, writ dism'd).165. Id. at 278. An early Texas Supreme Court case, Aultman & Taylor Co. v. Hefner,

67 Tex. 54, 2 S.W. 861 (1886), reached a contrary conclusion. The court stated that, whenthe guarantors had guaranteed the payment of notes at maturity and, because of a breach ofwarranty, the principal obligor was entitled to an offset under the notes, the notes wereessentially paid and the guaranty was deemed to be satisfied.

166. 424 S.W.2d 693 (Tex. Civ. App.-Houston [14th Dist.] 1968, writ ref'd n.r.e.).167. Id. at 696.168. Id.169. 202 S.W. 522 (Tex. Civ. App.-El Paso 1918, no writ).

1981]


teed payment of three hundred dollars to the creditor bank in or-der to induce the creditor to advance three hundred dollars to aseller of melons.170 The seller of the melons later defaulted on itsobligation to deliver the goods on a timely basis and the guarantorbank argued that, since no liability of the purchaser had arisen, thebank was not liable to pay on the guaranty.1

7 The court held thatthe guarantor bank, having agreed to unconditionally guaranteepayment of a specific sum, was liable.17

2 This case differs frommost "breach of warranty" and "contract defense" cases, however,because the guarantor unconditionally guaranteed payment of aspecific sum to a bank that was not a party to the underlying con-tract. Therefore, the seller's performance of its contract with thepurchaser was irrelevant.1 73

3. "Personal" Defenses Not Assertable

A third rule, exemplified by the "statute of limitations" cases,states that the guarantor may not assert defenses "personal" to theprincipal obligor.17 4 In addition to the rule that a guarantor's lia-bility is not destroyed simply because the statute of limitationsbars action against the principal obligor, e courts generally holdthat a contract which is unenforceable against the principal obligorbecause of the principal's minority or lack of personal capacitydoes not bar recovery from the guarantor.17 6

4. Traditional Rules Involving Illegal Principal Obligations

Courts in Texas and other jurisdictions often state that aguarantor is not obligated to pay a principal obligation that is"illegal.' 77 One commentator has observed that "illegality" cases

170. Id.171. Id. at 523.172. Id. at 524.173. In other jurisdictions, the validity of a guarantor's assertions of the principal obli-

gor's rights of offset or counterclaim against the creditor has depended on such factors aswhether the offset or counterclaim was "liquidated," whether the offset or counterclaimarose in the same transaction as the obligation guaranteed, and whether the principalobligor was solvent. See L. SIMPSON, supra note 147, § 58.

174. See 2 PATON'S, supra note 75, § 11 (Supp. 1968).175. See, e.g., Beddall v. Reader's Wholesale Distrib., Inc., 408 S.W.2d 237 (Tex. Civ.

App.-Houston 1966, no writ).176. See 2 PATON'S, supra note 75, § 11 (Supp. 1968).177. See 38 C.J.S. Guaranty §§ 16, 43 (1943); 57 TEx. JUR. 2d Guaranty § 46 (1961).

820 [Vol. 12:785


generally are not predicated merely on the unenforceability of theprincipal obligation but rather on the public policy basis that theillegality taints and permeates the entire transaction. 78 Three oldTexas cases exemplify the distinction between a principal obliga-tion that is merely unenforceable against, or voidable by, the prin-cipal obligor and a principal obligation that is void as a result ofillegality. In National City Bank v. Taylor,171 the guarantor guar-anteed the prompt payment of notes which would be discountedby the principal obligor bank to the creditor bank. The transfer ofthe notes discounted in favor of the creditor was ultra vires be-cause the board of directors of the transferor bank had not author-ized the transfer. The court held that the guaranty was valid andthat the principal obligor's legal liability for the indebtedness wasnot a prerequisite to the guarantor's liability. The court stated thatthe obligation "did not belong to a class reprobated by public pol-icy, or in violation of positive law, or against morality" and thatonly when a note is "void for illegality" must the guaranty alsofall.180 Significantly, the court also noted that the guarantor's rightof reimbursement from the principal obligor was not destroyed be-cause the principal obligation itself was merely unenforceable andnot extinguished.181 In Fuqua v. Pabst Brewing Co.' 8 and Howardv. Smith 8 the Texas Supreme Court considered two separatecases in which the principal obligation was illegal and void, and ineach case held that the guaranty could not be enforced. In Fuqua,the principal obligation resulted from the sale of beer pursuant toan agreement in restraint of trade, violating antitrust statutes. InHoward, the principal contract for paving and improving streetswas illegal because it was entered into without provision for a sink-ing fund.

178. See L. SIMPSON, supra note 147, § 58, at 284.

179. 293 S.W. 613 (Tex. Civ. App.-Texarkana 1927, no writ).

180. Id. at 618.

181. Id. As discussed further below, this conclusion means that the existence of theguaranty subjects the principal obligor to greater liability than if no guaranty had existed,and raises difficult policy questions. See notes 206, 280-85 infra, and accompanying text.

182. 90 Tex. 298, 38 S.W. 29 (1897).

183. 91 Tex. 8, 38 S.W. 15 (1896).

1981]


5. Recent Decisions Involving Illegal or Invalid PrincipalObligations

The rules discussed above have been augmented substantiallyby three recent decisions of the Texas Supreme Court. The first,Universal Metals & Machinery, Inc. v. Bohart, " interpreted an"absolute," "unconditional" guaranty of payment that was givenon the promissory note guaranteed and stated that the guarantorwas liable as a "primary obligor." 1s The note guaranteed wasforged and never executed by the principal obligor. Observing thatthe guarantor's liability was essentially that of co-maker, a conclu-sion supported by the comments to Code section 3.416,16 the courtheld that the guarantor was liable to pay the forged note.18 7 Thecourt's reliance on section 3.416 and the fact that the principal ob-ligor and guarantor both received the benefit of the underlyingtransaction arguably limit the scope of the holding, but the deci-sion nevertheless fulminates the theory that a guarantor's liabilityis always secondary and derivative in nature.""

In Reece v. First State Bank,18" the supreme court considereda "separate" guaranty of a forged note. Because the guarantor didnot essentially "co-make" the particular forged note, but ratherguaranteed the "indebtedness" of the purported maker of the note,the court properly observed that the guarantor could not be liableunless "indebtedness" of the principal obligor actually existed. TheReece court found that the obligation represented by the forgednote had essentially been ratified by the principal obligor and thatthe proceeds of the creditor's advance benefitted the principal obli-gor; these two events, therefore, created "indebtedness" of theprincipal obligor for which the guarantor was liable.19"

The most recent of the cases is Houston Sash & Door Co. v.Heaner.19' In Bohart, the court had concluded that an individualguarantor of a corporate debt cannot assert a claim or defense of

184. 539 S.W.2d 874 (Tex. 1976).185. Id. at 875-76.186. TEx. Bus. & COM. CODE ANN. § 3.416, Comment (TeL UCC) (Vernon 1968).187. 539 S.W.2d at 877.188. The court did cite approvingly the El Paso Bank & Trust Co. case discussed

above. See note 169 supra.189. 566 S.W.2d 296 (Tex. 1978).190. Id. at 298.191. 577 S.W.2d 217 (Tex. 1979).

[Vol. 12:785822


usury when the corporate rate is not exceeded. However, Bohartdid not consider whether the creditor could enforce a guarantywhen the principal indebtedness guaranteed was itself usuriousagainst the principal obligor. In Houston Sash, Heaner had exe-cuted a written guaranty of payment, covering all of Bedford's ob-ligations to Houston Sash.19

2 The interest on the underlying debtof Bedford violated the Texas usury laws. The supreme court firstdetermined that Texas usury laws do not render the underlyingobligation "void" and that "it is only when the underlying obliga-tion is void for illegality that a guaranty must fall with it.'"3 Thecourt also believed that the legislature designed usury statutes toprotect the principal obligor and therefore that the right to assertthe forfeiture penalties of the statutes was "personal" to the prin-cipal debtor. Despite the concept of secondary liability normallyassociated with guaranties, the court stated that the guaranty "isnot dependent on the vitality and force of the underlying ac-count."' 9 This holding echoes both the earlier Texas case of Na-tional City Bank v. Taylor'"9 and non-Texas cases concerning theeffect of lending limits violations on the validity of a guaranty ofexcessive loans. 96

Taken together, the three supreme court decisions limit thescope of a guarantor's argument that the invalidity of the principalobligation invalidates the guaranty. On the other hand, the non-Texas case of Stonehill v. Security National Bank'9 illustratesthat, even in normal commercial lending transactions, the underly-ing obligation can be declared "void" for illegality. In Stonehil,the principal obligation was created in violation of section 7 of theSecurities Exchange Act of 1934'"1 and the related margin regula-tions promulgated in Regulation U of the Federal ReserveBoard.' 99 The court noted that section 29(b) of the Securities Ex-change Act of 193400 declared void all contracts made in violation

192. Id. at 218.193. Id. at 222.194. Id.195. See note 179 supra.196. See generally Annot., 92 A.L.R. 341 (1934).197. 68 F.R.D. 24 (S.D.N.Y. 1975). See also National Bank of N. America v. Quest, 425

F. Supp. 186 (E.D.N.Y. 1977).198. 15 U.S.C. § 78g (1976).199. 12 C.F.R. § 221.1 (1980).200. 15 U.S.C. § 78cc(b) (1976). The court did not discuss the effects of § 29(c) of the

8231981]


of the Act.2 0 1 Despite strong language in the guaranty, the courtheld that the creditor could not enforce the guaranty obligationagainst the guarantor.02 The result is questionable, in view of thepublic policy20° of Regulation X of the Federal Reserve Board,""which prohibits borrowers from accepting credit that violates themargin regulations. 05 Nevertheless, the decision suggests that stat-utory violations may affect even the status of an absolute guarantyof payment.

6. Conclusions and Suggestions

The holding in Houston Sash teaches that a guarantor cannotrely heavily on the general rules that a guarantor may assert de-fenses available to the principal obligor or that those occurrencesthat exonerate the principal obligor likewise will exonerate theguarantor. Generally then, if a creditor has a liquidated claimagainst a principal obligor as a result of advancing funds to theprincipal obligor, the creditor can recover the amount of suchclaim from the unconditional guarantor of payment notwithstand-ing the fact that the creditor cannot enforce the claim against theprincipal obligor, unless the claim against the principal obligor is"void" as a result of "illegality." Houston Sash answered the mosttroublesome question for commercial lenders, that of whether thecreditor can collect from a guarantor the full amount of an obliga-tion usurious as to the principal obligor. The case also illustratesvividly that even the existence of strong public policies barring en-forcement of the principal obligation normally will not shatter theguarantor's liability. Significantly, the court did not considerwhether the guarantor could recover from the principal obligor,

Securities Exchange Act. See id. § 78cc(c).201. 68 F.R.D. at 30.202. Id. at 34-35.203. The rule against enforcing a guaranty of a "void and illegal" principal obligation

springs from public policy rather than the intentions of the parties; therefore, the languageof the guaranty will not override the rule.

204. 12 C.F.R. § 224.1 (1980). The effect of Regulation X, promulgated by the FederalReserve Board under the authority of § 7(f) of the Securities Exchange Act of 1934, 15U.S.C. § 78g(f) (1976), has been discussed at Comment, Civil Liability for Margin Viola-tions-The Effect of Section 7(f) and Regulation X, 43 FORDHAm L. Rav. 93 (1974). Seealso Pearlstein v. Scudder & German, 527 F.2d 1141, 1145 n.3 (2d Cir. 1975).

205. Apart from violations of the margin regulations, it is unlikely that many commer-cial loans made for noncriminal, nonfraudulent purposes will be declared "void forillegality."

[Vol. 12:785


through an implied right of reimbursement, the sums paid by theguarantor. If the guarantor can seek reimbursement from the prin-cipal obligor in such cases, many public policies would essentiallybe circumvented through the use of a guaranty °0 6 Even if the guar-antor is not entitled to seek reimbursement, permitting the credi-tor to collect from the guarantor may frustrate the public policiesthat rendered the principal obligation unenforceable."°

As stated above, if a guarantor guarantees the payment of cer-tain "indebtedness" of a principal obligor, the guarantor's obliga-tions obviously do not arise until "indebtedness" has arisen. Onthe other hand, El Paso Bank & Trust Co.2 08 and Bohart209 sup-port the interesting postulate that an unconditional guarantor ofpayment of a particular promissory note, or a guarantor who hasunconditionally "guaranteed" payment of a specific sum of money,may be liable regardless of whether the advance made by the cred-itor actually created an indebtedness in the party expected to be-come the principal obligor. These two decisions define the specialcircumstances in which the "guarantor's" liability is essentially anabsolute primary obligation to pay a certain amount, rather than a"secondary" obligation dependent upon the creation of actual in-debtedness in the purported principal obligor. These cases do,however, depend upon the creditor's advancing funds which it isentitled to collect from some party.

The decisions in Houston Sash and Bohart should not erasethe wisdom of the general rule that a guarantor may assert de-fenses available to the principal obligor, at least when the creditorhas not actually advanced funds and no established, liquidatedclaim has been created.210 The rule should obtain when, for exam-ple, the guarantor guarantees the payment of all indebtedness ofthe principal obligor to the creditor arising under an agreement

206. See note 181 supra, and accompanying text.207. But see National City Bank v. Taylor, 293 S.W. 613 (Tex. Civ. App.-Texarkana

1927, no writ), in which the court stated that the guarantor's right of reimbursement re-mained intact, permitting it to pursue the principal obligor despite the unenforceability ofthe principal obligation by the creditor.

208. El Paso Bank & Trust Co. v. First State Bank, 202 S.W. 522 (Tex. Civ. App.-ElPaso 1918, no writ).

209. Universal Metals & Mach., Inc. v. Bohart, 539 S.W.2d 874 (Tex. 1976).210. Obviously, application of the narrower "defense available" rule simply echoes the

more basic rule, founded in logical contract interpretation, that a guarantor of "indebted-ness" will not be liable except to the extent that "indebtedness" is created. See Fisher v.Alexander, 137 S.W. 715 (Tex. Civ. App.-Dallas 1911, no writ).

1981] 825


governing the sale of goods, the creditor delivers nonconforminggoods to the principal obligor, and a bona fide dispute erupts re-garding the amount of the indebtedness owed. It is uncertain, how-ever, whether the "defense" rule espoused in Mayfield v. Hicks""withstands the broad force of the Houston Sash rationale. Ofcourse, as indicated in Shepherd v. Eric Schuster Corp.,212 theprincipal obligor may choose to accept nonconforming goods orwaive a condition precedent to its obligation to make payments tothe creditor, thereby fixing both the principal obligor's and theguarantor's liability.

Texas decisions have not answered the difficult questions thatarise when (1) the creditor delivers conforming goods, thereby obli-gating the principal obligor to make payments to the creditor but,before the payments are made, the goods malfunction, thereby cre-ating a contractual or statutory warranty or (2) the principal obli-gor is excused from performance of a contractual obligation be-cause of legal impossibility. Similarly, controversy may followwhen a guarantor guarantees the payment of "all indebtedness" ofthe principal obligor to the creditor, the creditor advances money(on a demand basis) to the principal obligor and, in a separatetransaction, the principal obligor advances money (on a demandbasis) to the creditor. Despite some confusion in Texas decisions,and the complicated rules developed in other jurisdictions regard-ing the effect of offsets and breach of warranty defenses,'" a courtfacing these problems must simply analyze the parties' intentionsregarding the effect of counterclaims, offsets, and the availabilityof the principal obligor's defenses. In general, unless the principalobligation is void because of illegality, the intention of the partieswill govern all of the issues discussed above. Therefore, the lan-guage of the guaranty assumes particular importance. For example,a court could narrowly construe the phrase "I guarantee paymentof all indebtedness now or hereafter payable by John to you" asexcluding obligations not actually enforceable against John or per-mitting offset for monies owed to John. Language intended to havethe same effect (e.g., "I guarantee payment of all monies advanced,or credit extended, by you to John") might fare better. The court

211. 575 S.W.2d 571 (Tex. Civ. App.-Dallas 1978, writ ref'd n.r.e.).212. 424 S.W.2d 693 (Tex. Civ. App.-Houston [14th Dist.] 1968, writ ref'd n.r.e.).213. See L. SIMPSON, supra note 147, § 70, at 317-26.

826 [Vol. 12:785


in Houston Sash, however, stated that it was reviewing a guarantyof all sums "owed" by Bedford to Houston Sash and did not dwellon particular guaranty language in reaching its decision."" Simi-larly, a guarantor who has guaranteed payment of the principal ob-ligor's promissory note to the creditor would have difficulty argu-ing that its obligation was reduced by the principal obligor's rightto payment from the creditor under a separate transaction.

IV. CREDITOR'S ACTIONS REGARDING OTHER OBLIGORS AND

COLLATERAL

As discussed above, material alteration of the principal con-tract may, in the absence of consent by the guarantor, release theguarantor." 5 A guarantor's liability may also be affected by otheractions that either injure the guarantor's subrogation rights or in-crease the likelihood that the guarantor will be required to performits guaranty obligations. These types of actions include the releaseby the creditor of the principal obligor or other co-guarantors andthe release, subordination, or other impairment of collateral secur-ity for the principal obligation. In addition to intentional actionsby the creditor, the rights of the guarantor may also be adverselyaffected by the failure of the creditor to pursue diligently the prin-cipal obligor," 6 the failure to maintain or preserve collateral, andthe failure to properly perfect liens and security interests.

A. Actions and Omissions Regarding Principal Obligor

or Co-Guarantors

1. General Rules

When a guarantor executes a guaranty, his primary concern iswhether the principal obligor will fail to perform. The guarantormay take comfort in knowing that other substantial guarantors aregiving their guaranties and, therefore, that he may have valuablerights of contribution and indemnity from the co-guarantors. In

214. Houston Sash & Door Co. v. Heaner, 577 S.W.2d 217, 218 (Tex. 1979).215. See note 139 supra, and accompanying text.216. See First Nat'l Bank v. Hargrove, 503 S.W.2d 856 (Tex. Civ. App.-Texarkana

1973, no writ); TEx. Bus. & CoM. CODE ANN. § 34.02 (Vernon 1968). A creditor's obligationto pursue the principal obligor, after demand by the guarantor, may be waived by the guar-antor. See, e.g., City Nat'l Bank v. Pope, 260 S.W. 903 (Tex. Civ. App.-San Antonio 1924,no writ). This obligation is inconsistent with the concept of a guaranty of payment.

8271981]


addition, the guarantor may expect that the creditor will act toprotect its own position with respect to collection of the principaldebt and thus indirectly shelter the guarantor. The expectations ofthe guarantor may be restricted, however, by the type of guarantyand particular language in the guaranty that authorizes the credi-tor to take actions with respect to the principal obligor and otherguarantors.

Section 3.606 of the Code recognizes that a holder of an in-strument discharges any party to the instrument if, without suchparty's consent, the holder releases or agrees not to sue anotherobligor or discharges the other obligor. " ' Comment 2 to section3.606 recognizes that the guarantor may give its consent in advanceand that such consent is "commonly incorporated in the instru-ment" and requires no consideration."' 8 Similarly, in construingguaranties not governed by article 3, Texas courts have stated thatrelease of the principal obligor or a co-guarantor (where the co-guarantors are liable jointly), without the consent of the guarantor,releases the guarantor." ' When there are two or more guarantors,and the guaranty or guaranties expressly state that the co-guaran-tors are jointly and severally liable, it appears that no further au-thorization for release of a co-guarantor is required.2 20 Under botharticle 3 and common law, a creditor that releases the principalobligor but "reserves rights" against the guarantor does not releasethe guarantor, on the theory that the guarantor may still pursue itssubrogation rights against the principal obligor.22

1 These rules aresimilar to those regarding modification or extension of the princi-pal obligation,22 but derive solely from the principle of protectingthe guarantor from unintended destruction of subrogation rightsrather than destruction of the subject matter of the guaranty.

217. Tax. Bus. & COM. CODE ANN. § 3.606(a) (Tex. UCC) (Vernon 1968). Failure ordelay in making demand and presentment does not discharge the obligor. Id.

218. Id., Comment 2.219. See, e.g., Eastman Oil Well Survey Co. v. Hamil, 416 S.W.2d 597 (Tex. Civ.

App.-Houston 1967, writ ref'd n.r.e.). On the other hand, a co-maker's liability is joint andseveral, and release of one co-maker of an obligation does not release the other co-maker.See Hooper v. Ryan, 581 S.W.2d 237 (Tex. Civ. App.-Waco 1979, no writ).

220. See United States Gypsum Co. v. Sampson, 496 S.W.2d 687 (Tex. Civ. App.-Amarillo 1973, no writ).

221. See TEx. Bus. & Com. CODE ANN. § 3.606 (Tex. UCC) (Vernon 1968); L. SIMPSON,supra note 147, § 64, at 302-04; 38 C.J.S. Guaranty § 83 (1943).


[Vol. 12:785828


2. Application of General Rules Under Texas Law

No Texas case has clearly considered whether a guarantor'sconsent to the creditor's release of other obligors, under a guarantynot governed by article 3, is effective to permit the release withoutdestroying the guaranty.223 On the basis of the analogous authorityof article 3, the "release of collateral" cases described below andthe fact that, in the absence of some overriding policy, a guarantyshould be enforced in accordance with its terms, Texas courtsshould uphold a consent to release, whether contained in a Codeguaranty or given separately.

Questions may, of course, arise over the sufficiency and mean-ing of the consent. Despite the "rule of strict construction" appli-cable to guaranties, courts increasingly are interpreting guarantiesin light of the spirit of the instrument. In United States v. Im-mordino,2"2 the guaranty simply provided that the creditor couldrelease all or any part of the "collateral" and did not expressly re-fer to co-guarantors. Nevertheless, the court held that release ofother guarantors did not release the complaining guarantor. Argua-bly, the court should liberally construe authorization or consent ina guaranty of payment, whose essence is that the creditor need notpursue the principal obligor before pursuing the guarantor. On theother hand, because section 3.606 apparently requires an affirma-tive "consent," and does not distinguish between guaranties ofpayment and guaranties of collection in this context, even an abso-lute, unconditional guaranty of payment would, by itself, probablynot constitute an effective "consent" to release other obligors." 6

B. Potential for Discharge Through Actions and OmissionsRegarding Collateral

A creditor may take actions or fail to take actions with respectto collateral for the principal obligation. These actions may varyeither the creditor's understanding with the guarantor or impairthe guarantor's subrogation rights.22 6 There are four separate prob-lem areas regarding dealings with collateral: (1) the creditor's im-

223. See TEx. Bus. & CoM. CODE ANN. § 3.606 (Tex. UCC) (Vernon 1968).224. 534 F.2d 1378 (10th Cir. 1976) (construing Colorado law).225. Accord, Clark, supra note 8, at 462. But see Walter E. Heller & Co. v. Cox, 343 F.

Supp. 519 (S.D.N.Y. 1972).226. See generally L. SIMPSON, supra note 147, §§ 74-75.

1981] 829


pairment of collateral through release or subordination; (2) thecreditor's failure to maintain or care for collateral, or to dispose ofcollateral in a commercially reasonable manner; (3) the creditor'sfailure to document and perfect properly the intended security in-terest or lien in collateral; and (4) the creditor's failure to discloseto the guarantor the true value of the collateral.

1. Release or Subordination of Collateral

In Webb v. Finger Contract Supply Co.,2 27 the Texas SupremeCourt reviewed a contract that permitted "modification" of collat-eral and agreed with the general rule that "the prejudice to thesurety by impairment of his subrogation rights. . . discharges thesurety to the extent of the value of the security surrendered."'The court confirmed that the rule applied to guarantors. M Be-cause the guaranty had merely permitted "modification" of thecollateral, the creditor's subordination of the security dischargedthe guarantor. Although the court narrowly construed the author-ity granted in the guaranty, its opinion implicitly recognizes thatproper authorization of actions regarding collateral would beupheld.

In other Texas cases, such express authorizations have beenupheld. In Estes v. Continental Bank & Trust Co.,"'0 the courtreviewed a guaranty that referred to the guarantor's liability as"primary" and in which the guarantor agreed that the creditorcould allow substitution or withdrawal of collateral or release othersecurity. The court believed the provision to be unambiguous and,because the guaranty was not a guaranty of "collection" but anunconditional guaranty of payment, held that the failure to notifythe guarantor before releasing or allowing withdrawal of collateraldid not discharge the guarantor.2 1 Similarly, the same court inSchubiger v. First Newport Realty Investors 2' discerned from thelanguage of the guaranty, which simply stated that the guarantorwould not be released by "any subordination. . . of any other se-

227. 447 S.W.2d 906 (Tex. 1969).228. Id. at 907 (citing 10 WELLISTON ON CoNRACTs § 1232 (3d ed. 1967)).229. 447 S.W.2d at 908.230. 421 S.W.2d 158 (Tex. Civ. App.-Dallas 1967, no writ).231. Id. at 162.232. 601 S.W.2d 218 (Tex. Civ. App.-Dallas 1980, writ ref'd n.r.e.).

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curity,"' 88 that the parties broadly intended the creditor to be ableto deal with indebtedness and collateral security therefore withoutreleasing the guarantor. This determination was made by the courteven though the guaranty did not expressly authorize the particu-lar action (subordination of a deed of trust lien on the primarysecurity).2 Although Schubiger merely exemplifies a court's at-tempt to determine the parties' true intent, without hypertechnicalinterpretation, it departs from the Webb court's more cautiousapproach.

2. Failure to Preserve or Properly Dispose of Collateral

A variation on the release of collateral question is whether thecreditor's failure to preserve or properly dispose of collateral willrelease the guarantor. In First National Bank v. Brown,"' thecourt of civil appeals stated that a creditor's "active" negligence ormisconduct in failing to preserve a lien and the collateral subjectthereto, if resulting in waste or loss of security, would discharge asurety upon the promissory note. The court determined, however,that impairment or loss of security resulting from "inaction or pas-sive negligence" was not sufficient to discharge the surety.2" Thecourt held that the mere failure to foreclose on a chattel mortgagein a prompt manner would not release the surety.2 7 In First Na-tional Bank v. Helwig,2"8 a case involving a surety's liability, thecourt discussed the distinction between passive negligence and ac-tive negligence, but discarded the active-passive distinction andstated that "the better rule is simply that a creditor in possessionof property securing a debt owes a duty of ordinary care to secureand preserve that property."' 8 9 If the creditor breaches that duty,and the breach causes destruction or damage to the security, thesurety is entitled to be discharged to the extent of the loss. With-out deciding whether Code section 3.606 governed the issue, thecourt stated that section 3.606(a)(2) incorporates the "standardsuretyship defense" based on a creditor's unjustifiable impairment

233. Id. at 221 (emphasis in original).234. Id.235. 172 S.W.2d 151 (Tex. Civ. App.-Fort Worth 1943, writ ref'd n.r.e.).236. Id. at 155.237. Id.238. 464 S.W.2d 953 (Tex. Civ. App.-Austin 1971, no writ).239. Id. at 955.

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of security.24 Although the court's statement of the rule seemedappropriate, and draws analogous authority from section 9.207 ofthe Code,241 the Helwig decision creates a nasty dilemma for thecreditor. The creditor in Helwig had the opportunity to forecloseon collateral, but had refrained from doing so in hopes that theprincipal obligor would resolve its difficulties and eventually repayits indebtedness.2 4 The creditor was not in actual possession of thecollateral (although the court stated that the creditor's "control"essentially constituted possession). The destruction of the collat-eral which gave rise to the surety's defense did not result from anyparticular action of the creditor but from a fire that destroyed aportion of the collateral after the time when the creditor mighthave foreclosed. 43 Under Helwig, a creditor must not refrain fromforeclosing immediately after default if it has any semblance ofcontrol (or, perhaps, right to control) over the collateral. In Heiwig,the surety apparently had not agreed or consented to release, loss,or impairment of collateral security; therefore, the case does notanswer whether the creditor's duty may be dispelled by proper au-thorizing language.

The Fifth Circuit case of Frederick v. United States2 4" recog-nized that a guarantor has a beneficial interest in collateral held bya creditor for the principal debt, and therefore imposed on thecreditor a duty of good faith in preserving, applying, and disposingof the collateral security. The court stated that if the UnitedStates, as creditor, had "mishandled the security .. . it violatednot only a duty imposed by law but also a duty imposed by theguaranty agreement itself. ' 24 5 Even though the guarantor could nothave compelled the creditor to pursue the collateral first, the im-proper disposal of the collateral impaired the guarantor's subro-gation rights and released the guarantor to the extent of theimpairment.

240. Id. See TEx. Bus. & COM. CODE ANN. § 3.606(a)(2) (Tex. UCC) (Vernon 1968).241. See TEx. Bus. & COM. CODE ANN. § 9.207 (Tex. UCC) (Vernon Supp. 1980-1981)

which states that a "secured party must use reasonable care in the custody and preservationof collateral in his possession."

242. 464 S.W.2d at 154.243. Id.244. 386 F.2d 481 (5th Cir. 1967).245. Id. at 487. The guaranty agreement empowered the SBA to deal with the collat-

eral and to purchase the security but stated that these powers "[are] to be exercised only tothe extent permitted by law." Id. at 486.

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3. Failure to Perfect a Security Interest or Lien

Several cases have discussed the effects of a failure of thecreditor to properly perfect a security interest or lien in collateral.In the early Texas case of Nunn v. Smith, "" the court stated the"generally accepted rule that, where the creditor takes a mortgageto secure the payment of a debt, he owes the surety the duty ofhaving it recorded, and if he does not do so, and the security islost, the surety will be released pro tanto.' ' ,

7 The court also notedthat a surety who expressly or impliedly consents to the risk ofsecurity is not released by resulting loss.U" Despite the "passive"nature of the creditor's fault, the rule recognizes that (after theprincipal obligor has executed necessary collateral documents) thecreditor normally is the only party with the power and capabilityto accomplish perfection through recordation or filing.

In a Fifth Circuit case construing Alabama law,"' the courtfirst considered whether the guaranty agreement imposed on thecreditor an obligation to protect the guarantor's right of subroga-tion generally or to perfect security interests in collateral specifi-cally.25 0 The guaranty did not contain such a provision, and in factstated that the guarantors would not be released by "any deterio-ration, waste or loss . ..of any collateral . . . unless . . . causedby the wilful act or wilful failure to act of Bank."251 The guarantyfurther provided that the guarantor would not be released "by rea-son of the fact that a valid lien in any of the collateral may not beconveyed to, or created in favor of, Bank.''2 " Although the dissentdid not believe that the language voided the responsibility of thecreditors to record the security interest, the majority held thatthese duties, if any, had been waived. This case, which demon-strates the importance of the proper language in the guarantyagreement, is echoed by the United States district court case ofUnited States v. Flasher Co.'55 In Flasher, the guarantor argued

246. 194 S.W. 406 (Tex. Civ. App.-Amarillo 1917, no writ).247. Id. at 407. The court indicated that this result was reached only after some diffi-

culty, given previous case law authority distinguishing between "passive" inaction and affir-mative misdeeds. Id.

248. Id. at 408.249. United States v. Proctor, 504 F.2d 954 (5th Cir. 1974).250. Id. at 956.251. Id. at 957 (emphasis in original).252. Id. at 958 (Godbold, J., dissenting).253. 460 F. Supp. 231 (S.D. Tex. 1977).

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that it was released from its guaranty liability because the creditorhad improperly dealt with collateral given as security for the pay-ment of the note, without his consent. This argument was based onthe creditor's failure to file a timely financing statement, whichfailure permitted the Internal Revenue Service to obtain priorityon the collateral. The court reviewed the terms of the guaranty,which stated that the creditor could release all or any part of thecollateral. Although the guaranty did not expressly refer to failureto perfect a security interest or lien, the court found the waiverprovision sufficiently broad to bind the guarantor notwithstandingthe unintentional impairment of collateral security.

Courts reviewing Code guaranties have disagreed over whethera creditor's failure to perfect a lien constitutes "unjustifiable im-pairment"2 5' and whether guaranty language authorizing the credi-tor to "release" collateral effectively waives defenses based on fail-ure to perfect.255

4. Fraud or Misrepresentations Regarding Collateral

Although several Texas cases discuss the effects of fraud in thecreation of a guaranty,2 56 no Texas cases discuss fraud directly re-lating to the value or status of collateral. One case from anotherjurisdiction, however, raises an interesting problem pertaining tothe creditor's handling of collateral. In Chemical Bank v. Layne,'5 7

the guaranties provided that the bank could exchange, surrender,or release any collateral security for the loan or any other obligoron the loan and that the guarantor would remain bound on theguaranty notwithstanding such action. "58 The guarantor did notargue that a release or impairment of collateral security had de-stroyed the guaranty, but rather that the bank failed to disclose tothe guarantor (among other things) certain restrictions on the col-lateral security (corporate stock) which impaired the value of the

254. Compare Hurt v. Citizens Trust Co., 128 Ga. App. 224, 196 S.E.2d 349 (1973)with First New Haven Nat'l Bank v. Tirkot, 25 U.C.C. Rep. 795 (Conn. Super. Ct. 1978).See also First Citizens Bank & Trust Co. v. Larson, 22 N.C. App. 371, 206 S.E.2d 775(1974).

255. Compare Executive Bank v. Tighe, 60 Misc. 2d 70, 411 N.Y.S.2d 939 (Sup. Ct.1978) with Etelson v. Suburban Trust Co., 263 Md. 376, 283 A.2d 408 (1971).

256. See notes 44-45 supra.257. 423 F. Supp. 869 (S.D.N.Y. 1976).258. Id. at 877-78 n.31.

834 [Vol. 12:785


collateral security." " Applying New York law, the court held that,although the guarantor has duties of inquiry and awareness, thebank's failure to disclose the restricted nature of the securities(which substantially reduced their value as collateral), constitutedfraud that released the guarantor.26

0

5. Section 3.606. Discharge of the Guarantor Due toImpairment of Recovery of Collateral

Code section 3.606(a)(2) states that the holder of an instru-ment discharges any party to the instrument to the extent that,without such party's consent, the holder "unjustifiably impairs anycollateral for the instrument."'"I As suggested earlier, section 3.606probably does not govern non-Code guaranties. 26

2 In fact, becausea large body of common law has established rules such as thosediscussed earlier, and because section 3.606's rules are less thanexplicit, courts construing Code guaranties likely will seek gui-dance from non-Code cases.26

Presumably, the types of actions and omissions describedabove would constitute "impairment" of the collateral for purposesof section 3.606. 2

6 In harmony with non-Code law, courts haveviewed "impairment" of collateral as injury to, or deterioration of,the collateral.2 Despite the view of one federal court (construingTexas law) that section 3.606 pertains only to impairment occur-ring while the collateral is in the possession of the creditor, section3.606 should cover a broad category of acts of "impairment," espe-cially if such acts bereave the guarantor of the benefit of the collat-

259. Id. at 870.260. Id. at 882. The court emphasized that the information was not readily available

to the guarantor, that the guarantor, had he known the true value of the collateral, wouldnot have executed the guaranty, and that the guarantor had made specific inquiries aboutthe underlying collateral. Id. at 878-79.

261. Tax. Bus. & COM. CODE ANN. § 3.606(a)(2) (Tex. UCC) (Vernon 1968). Code§ 1.103 imports common law rules into many Code determinations. See id. § 1.103..To theextent that the Code introduces new standards, however, pre-Code law will not necessarilyapply. See Note, 8 IND. L. Rav. 522 (1973).

262. See notes 29-35 supra, and accompanying text.263. See, e.g., Commercial Credit Equip. Corp. v. Hatton, 429 F. Supp. 997 (N.D. Tex.

1977) (court considered non-Code cases in deciding issue which, for purposes of argument,court assumed to be governed by Code § 3.606).

264. See Clark, supra note 8, at 457; Annot., 95 A.L.R.3d 962 (1979). See generallyNote, supra note 261.

265. See, e.g., Hurt v. Citizens Trust Co., 128 Ga. App. 224, 196 S.E.2d 349 (1973).

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TEXAS TECH LAW REVIEW [Vol. 12:785

eral and increase the guarantor's risk.2 6 If a deterioration merelyresults from the creditor's failure to foreclose, the better rule, al-though not recognized by the Texas court in Helwig,267 is that thecreditor's inaction does not discharge the guarantor because theguarantor could have paid the principal obligation and pursued thecollateral by right of subrogation.2 8 On the other hand, the credi-tor's failure to perfect a security interest on which the guarantorrelied, in the absence of appropriate waiver language, should con-stitute "impairment" for purposes of section 3.606.269

Courts generally have ignored (or left undefined) the qualifica-tion that the impairment be "unjustifiable." Even if courts con-cluded that "unjustifiable" should be translated into a more com-mon adjective such as "unreasonable, ' 27 0 this translation wouldnot offer helpful guidance to creditors. Although there is no policyreason that the "unjustifiable impairment" defense of section 3.606should differ substantially from the rules of the common law, sec-tion 3.606's use of the adverb "unjustifiably" suggests at least thatgood faith actions by the creditor, designed to promote the prin-cipal obligor's stability or repayment, would not discharge theguarantor.2 71

266. See note 265 supra. The court stated that references in Comment 5 to § 3.606(stating that § 9.207 "should be consulted") indicated that the types of "unjustifiable im-pairment" contemplated by § 3.606 arose only when the collateral was in the possession ofthe creditor. Commercial Credit Equip. Corp. v. Hatton, 429 F. Supp. 997, 1000 (N.D. Tex.1977). Therefore, the court held that the mere delay in foreclosure on collateral not in thehands of the mortgagee, even if such action were negligent and resulted in loss of security,did not release the sureties. Id. at 1000-01 (citing Dillard v. Chandler, 157 S.W. 303, 304(Tex. Civ. App.-Fort Worth 1913, no writ)). The court essentially distinguished negligent"non-feasance" from affirmative action that disadvantaged the sureties and rendered themunable to protect themselves by repaying the principal obligation and pursuing their subro-gation rights.

267. See notes 238-43 supra, and accompanying text.268. See Commercial Credit Equip. Corp. v. Hatton, 429 F. Supp. 997, 1001 (N.D.

Tex. 1977). Although the court in Hatton views § 3.606 too narrowly in holding that itapplies only if the creditor is in possession, there is additional authority for the positionthat § 3.606 pertains to actions which make the collateral unavailable to the surety andincrease the surety's risk. See Beneficial Fin. Co. v. Marshall, 551 P.2d 315, 320 (Okla. Ct.App. 1976).

269. See note 254 supra.270. See, e.g., Beneficial Fin. Co. v. Marshall, 551 P.2d 315, 320 (Okla. Ct. App. 1976)

(court refers to "unreasonable" acts which render collateral unavailable to surety and in-crease surety's risk).

271. As at common law, unjustifiable impairment under § 3.606 releases the guarantoronly to the extent of impairment. See Tax. Bus. & COM. CODE ANN. § 3.606(a)(2) (Tex.UCC) (Vernon 1968).


Although section 3.606 clearly recognizes the viability of aguarantor's waiver of the defense of even unjustifiable impair-ment, questions will continue to arise (as in non-article 3 cases)over the required specificity of the waiver.27 Because section 3.606specifically states that unjustifiable impairment can be waived orconsented to by the guarantor, and because the drafters of article 3of the Code presumably had knowledge of the workings of article 9of the Code, it may be concluded that the questions discussed be-low217 8 regarding the effect of Code sections 9.207 and 9.504 on theenforceability of waivers do not arise with respect to Codeguaranties.

6. Effect of Waivers

A guarantor apparently may be discharged either by the credi-tor's failure to perfect a mortgage, fraudulent failure to disclosethe value of the collateral security, failure to preserve collateral se-curity within its control or possession, failure to dispose of collat-eral properly, or release or subordination of collateral security tothe detriment of the creditor. Except in the case of fraud, the re-lease will be only to the extent of the loss suffered by the guaran-tor as a result of the action or inaction of the creditor. As sug-gested in several of the cases discussed above, certain of theproblematical actions or inactions may be authorized or consentedto by the guarantor, and the courts will attempt to determine thetrue intention of the parties with respect to the particular actioninvolved.

The scope of a waiver or consent is purely a matter of contractinterpretation. For example, a recurring question is whether aguarantor's express authorization that a creditor "release' 7 4 col-lateral constitutes sufficient authorization or waiver for such otheracts of impairment as failure to perfect liens in the collateral or todispose of the collateral in a reasonable fashion.7 5 Despite the nat-ural tendency of courts to favor the guarantor, it is suggested thata guarantor that has authorized "release" of collateral has also im-plicitly waived all defenses based on collateral impairment because

272. See note 255 supra.273. See notes 277-91 infra, and accompanying text.274. A similar question exists in regard to the guarantor's waiver of any defense aris-

ing from the release.275. See note 255 supra.

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the guarantor has clearly evidenced its general lack of reliance oncollateral security. On the other hand, it appears proper to con-clude that a guarantor giving an absolute, unconditional guarantyof payment does not implicitly waive all defenses based on collat-eral impairment. The fact that the guarantor may be sued undersuch a guaranty without the creditor having first pursued the col-lateral does not suggest that the guarantor was disinterested inpreserving its subrogation rights against collateral after being re-quired to pay the principal obligation. In any event, most potentialproblems regarding the creditor's treatment of collateral are re-moved by including language in the guaranty stating that the guar-antor consents to and waives any rights it might otherwise have asa result of any release, exchange, or subordination of any collateralin connection with the guaranteed debt, or failure of the creditorto exercise reasonable care in the handling or treatment of thecollateral.

There are, however, several potential limitations on the effec-tiveness of this language. First, as suggested above, no languagewill effectively negate the potential effects of a fraud claim by theguarantor. Second, a creditor's actions generally may be subject toa "good faith" limitation,'17 although the "good faith" duty shouldnot mean that a guarantor will be released by negligent actions ofthe creditor or actions which simply injure the guarantor. Finally,although article 9 of the Code imposes no duties or restrictions onthe creditor (vis-a-vis the "debtor") regarding release of personalproperty collateral or failure to perfect collateral (because these ac-tions do not injure the principal debtor), article 9 does impose onthe creditor a duty to preserve collateral in the creditor's posses-sion and to dispose of collateral in a commercially reasonable man-ner.2 7 The creditor's duties of reasonableness and care under sec-tions 9.207 and 9.504 are nonwaiveable 78

276. Code § 1.203 states that "[e]very contract or duty with this title imposes an obli-gation of good faith in its performance or enforcement." TVx. Bus. & COM. CODE ANN.§ 1.203 (Tex. UCC) (Vernon 1968). Contrary to many guaranty issues, most questions aris-ing from a creditor's actions regarding personal property collateral are directly governed bythe Code. See also United States v. Willis, 593 F.2d 247 (6th Cir. 1979).

277. See Tax. Bus. & Co,. CODE ANN. §§ 9.207, 9.504 (Tex. UCC) (Vernon Supp.1980-1981).

278. Code § 1.102(c) prohibits waiver of the obligations of good faith, diligence, rea-sonableness, and care, but permits the parties to establish reasonable standards for the per-formance of these obligations. Tax. Bus. & COM. CODE ANN. § 1.102(c) (Tex. UCC) (Vernon

[Vol. 12:785


As discussed in greater detail below, a guarantor may be con-sidered a "debtor" for certain purposes of article 9. However, sec-tion 9.207 and section 9.504 (insofar as it pertains to the duty ofcommercially reasonable sale, as opposed to the duty to give noticeof foreclosure) do not expressly refer to the duties of the creditorwith respect to the "debtor." Rather, these sections apparently im-pose general duties regarding care and disposition of collateral. Ar-guably, the public policy expressed in these statutory provisionsrequires that the creditor should not be able to recover from theguarantor that which it could not recover from the principal obli-gor. Although the issues have not been widely litigated, several de-cisions in other jurisdictions have held that section 9.207 or section9.504 create nonwaiveable duties that, if breached by the creditor,provide the guarantor with a defense against liability.' 7' At leastone court based its decision, in part, on the need for avoiding theproblem of permitting the creditor to recover from the guarantorsums that could not be recovered from the principal obligor andthen permitting the guarantor to seek reimbursement from theprincipal obligor for amounts paid by the guarantor.2 80 Two courts,however, have concluded that the Code duties simply do not bene-fit guarantors or, at least, can be waived by the guarantor. 81

Several reasons support the conclusion that (assuming argu-endo that sections 9.207 and 9.504 impose general duties on thecreditor, and not duties only to principal obligor and owner of thecollateral) a guarantor may waive the creditor's performance of the

1968). Code § 9.501(c) prohibits waiver of certain obligations of the secured party, andrights of the "debtor" under § 9.504. TEx. Bus. & CoM. CODE ANN. § 9.501(c) (Vernon Supp.1980-1981).

279. See, e.g., United States v. Willis, 593 F.2d 247 (6th Cir. 1979); Mack FinancialCorp. v. Scott, 100 Idaho 889, 606 P.2d 993 (1980). See also FDIC v. Frank L. Marino Corp.,28 U.C.C. Rep. 556 (N.Y. Sup. Ct. 1980).

280. See Mack Financial Corp. v. Scott, 100 Idaho 889, 606 P.2d 993 (1980). Becausereimbursement is an equitable right, a court could also solve this problem by negating theguarantor's right of reimbursement. This reasoning could also apply to other situations inwhich the court desires to enforce the guaranty provisions waiving the guarantor's defenseswithout impairing the position of the principal obligor.

281. See Union Planters Nat'l Bank v. Markowitz, 468 F. Supp. 529 (W.D. Tenn.1979). The court believed that the secured party's liability for "loss" caused by its failure tocomply with § 9.207 ran only to the party who provided the collateral. The court also heldthat the guarantor could not rely on § 3.606 because the guarantor had not signed the in-strument representing the principal obligation. See also First Nat'l Park Bank v. Johnson,553 F.2d 599 (9th Cir. 1977) (guarantor's waiver of creditor's duties of commercially reason-able disposition is effective, absent willful or grossly negligent waste or misconduct).

19811 839


duties of reasonable care and disposition of collateral. First, as il-lustrated in Houston Sash,'s ' the policies that protect a principalobligor should not be transformed into protection for the guaran-tor, especially when the guaranty expresses the parties' intentionsthat the guarantor will be liable notwithstanding irregularities.Second, as noted above, section 3.606 of the Code permits waiverof even "unjustifiable" impairment of collateral security, thus sup-porting the proposition that the drafters did not sanctify sections9.207 and 9.504 insofar as sureties and guarantors are concerned. 2

Third, the expectations of a guarantor and the expectations of theprincipal obligor differ greatly. As discussed previously, the guar-antor may agree that it will be absolutely liable notwithstandingthe occurrence of a number of events which might adversely affectthe guarantor.' 8 Certainly, if a creditor can be authorized to re-lease collateral, the guarantor's position is not worsened by a dis-posal of the collateral for less than fair value at a sale which is notcommercially reasonable. In addition, the general enforceability ofa waiver or consent, as an expression of the parties' intentions, ismade more palatable when tempered by the "good faith" limita-tions described above.285 It is submitted that, in the absence offraud or bad faith by the creditor, and especially in nonconsumerguaranties, the guarantor's clear waiver of the creditor's mishan-dling of collateral should be upheld.

7. Notice Under Article 9.504

It is undisputed that a creditor need not give notice of defaultor acceleration to a guarantor who is unconditionally liable under aguaranty of payment, or if the guaranty expressly dispenses withnotice requirements.'86 Nevertheless, it is uncertain whether aguarantor is a "debtor" within the meaning of Code section9.105(a)(4), 51 to whom notices of foreclosure must be given under

282. See notes 191-94 supra, and accompanying text.283. Because the comments to § 3.606 actually refer, for purposes of example, to viola-

tions of the duties under § 9.207, this conclusion appears unassailable. See Tax. Bus. &COM. CODE ANN. § 3.606, Comment 5 (Tex. UCC) (Vernon 1968).

284. See notes 274-78 supra, and accompanying text.285. See note 276 supra, and accompanying text.286. See, e.g., Knick v. Greene, 545 S.W.2d 269 (Tex. Civ. App.-Waco 1976, writ ref'd

n.r.e.).287. TEx. Bus. & COM. CODE ANN. § 9.105(a)(4) (Tex. UCC) (Vernon Supp. 1980-

1981).

[Vol. 12:785840


section 9.504. Section 9.504 requires that the creditor give reasona-ble notice to the "debtor" prior to foreclosure on collateral (subjectto limited exceptions)'" and section 9.501(c) provides that section9.504's notice requirements cannot be waived prior to default.""Decisions in some jurisdictions provide that failure to give noticeas required by section 9.504 erases any right that the creditormight have to collect from the debtor the deficiency remaining af-ter foreclosure.290 Although not fully developed, Texas law appearsto be that a creditor's failure to give reasonable notice of the fore-closure sale does not destroy the right to a deficiency but creates arebuttable presumption that the value of the collateral equals theamount of the indebtedness. The presumption forces the creditorseeking to recover a deficiency to shoulder the burden of provingthat the fair market value of the collateral was less than theamount of the debt."91

Given the apparent nonwaiveability of the notice provision insection 9.504, and the potentially adverse effects of failure to givenotice, the prudent creditor will give notice of the foreclosure saleto each debtor, the owner of the collateral,"' and all guarantors ofthe debt. If the creditor neglects to give notice to the guarantor,however, the creditor will of course argue that the guarantor is nota "debtor" within the meaning of section 9.105(a)(4), for purposesof the notice requirements of section 9.504."3 Arguably, the guar-antor does not "owe" anything until the principal obligor defaults,but this would not prevent categorization of the guarantor as adebtor for purposes of the notice requirements."' American juris-dictions are split on the question. While several cases hold that theguarantor should not be treated as a debtor," 5 a growing number

288. Id. § 9.504(c).289. Id. § 9.501(c).290. See, e.g., Maryland Natl Bank v. Wathen, 288 Md. 119, 414 A.2d 1261 (1980).291. See United States v. Whitehouse Plastics, 501 F.2d 692 (5th Cir. 1974), cert.

denied, 421 U.S. 912 (1975); Ward v. First State Bank, 605 S.W.2d 404 (Tex. Civ.App.-Amarillo 1980, writ ref'd n.r.e.).

292. See Tim. Bus. & CoM. CODE ANN. § 9.112 (Tex. UCC) (Vernon Supp. 1980-1981).293. Id. § 9.105(a)(4). Section 9-105(a)(4)'s definition of "debtor," which includes a

person who owes payment or performance of the obligations secured, apparently is broadenough to include a guarantor.

294. One commentator concludes that the drafters of the Code did not consider thequestion. See Note, supra note 31, at 91.

295. See, e.g., First Nat'l Park Bank v. Johnson, 553 F.2d 599 (9th Cir. 1977); Brinsonv. Commercial Bank, 138 Ga. App. 177, 225 S.E.2d 701 (1976).

1981]


of courts apparently believe that the policies behind section 9.504apply equally to guarantors.""

Several arguments support the conclusion that a guarantorconstitutes a "debtor" for purposes of section 9.504. First, althoughdisturbing uncertainties would be injected into the guarantor-cred-itor relationship if the guarantor's liability was conditioned uponthe creditor's compliance with the broad and somewhat vague du-ties under sections 9.207 and 9.504, a creditor may easily complywith section 9.504, simply by giving notice to the guarantor. Sec-ond, a "common usage" interpretation of the language of the stat-ute indicates that a guarantor certainly is a person who "owes pay-ments or other performance. 29 7 Furthermore, even though theguarantor is not the primary obligor, the decisions in Bohart2"and related cases, and the authority of section 3.416,299 indicatethat the liability of a guarantor of payment equals that of a pri-mary obligor and a co-maker. A co-maker is of course entitled tonotice under section 9.504, even if the party signs as an accommo-dation co-maker.800

Assuming that a guarantor is a "debtor" for purposes of sec-tion 9.504, creditors may wish to include in guaranties (as they doin collateral security agreements) provisions designated to estab-lish the manner in which "commercially reasonable" notice may begiven.30 1

V. CONCLUSIONS

Many traditional rules affecting the enforceability of guaran-ties apparently were devised by courts in order to deal equitablywith circumstances not expressly addressed in uncomplicated guar-

296. See, e.g., United States v. Cawley, 464 F. Supp. 189 (E.D. Wash. 1979); Barnett v.Barnett Bank, N.A., 345 So. 2d 804 (Fla. Dist. Ct. App. 1977); Chase Manhattan Bank, N.A.v. Natarelli, 23 U.C.C. Rep. 539 (N.Y. Sup. Ct. 1977); FMA Financial Corp. v. Pro-Printers,590 P.2d 803 (Utah 1979).

297. See Tsx. Bus. & CoM. CODE ANN. § 9.105(a)(4) (Tex. UCC) (Vernon Supp. 1980-1981).

298. See notes 185-88 supra, and accompanying text.299. TEx. Bus. & COM. CODE ANN. § 3.416 (Tex. UCC) (Vernon 1968).300. See First State Bank v. Northrop, 519 S.W.2d 161 (Tex. Civ. App.-Waco 1975,

no writ).301. Code § 9.501(c) permits the parties to establish, by contract, standards for com-

mercial reasonableness. TEx. Bus. & COM. CODE ANN. § 9.501(c) (Tex. UCC) (Vernon Supp.1980-1981).

[Vol. 12:785842


anty agreements. For example, a creditor whose guaranty formfailed to describe the effects of the creditor's release of collateralfor the principal debt might encounter the maxim that a guarantorenjoys a favored status under the law or that the creditor's impair-ment of a guarantor's subrogation rights may release the guaran-tor. Despite the longevity of these traditional standards, a creditorin Texas today may comfortably rely on a guaranty. that describesclearly the nature of a guarantor's liability, the types of indebted-ness guaranteed, the effect of the unenforceability of the principalobligation, and the authority for the creditor to deal with the prin-cipal obligation and related collateral security. In an effort to leavelittle to the courts' imagination, creditors and their attorneys havedesigned guaranty provisions (such as the sample provisions illus-trated in the appendix to this article) to handle (almost) every con-ceivable contingency and reflect decisions rendered in particularguaranty cases. As the law of guaranties evolves, however, andTexas courts preserve the spirit of more general guaranty provi-sions, creditors will be able to streamline guaranty agreements.Eventually, a document stating simply that the guarantor uncondi-tionally guarantees payment of all of the principal obligor's indebt-edness to the creditor, regardless of any acts, omissions, or circum-stances, may replace more detailed forms currently in vogue. Forthe present, however, guaranties such as that outlined in the ap-pendix continue to be a necessary part of a creditor's documentaryrepertoire.

1981] 843


APPENDIX

GUARANTY AGREEMENT 02

THIS GUARANTY AGREEMENT is entered into as of this day of, 1981 by and between ("Guarantor"),

and ("Bank").

WITNESSETH:

WHEREAS, pursuant to that certain Loan Agreement (herein referred to,together with all amendments and modifications thereof, as the "Loan Agree-ment") dated , by and between Bankand ("Borrower"), Borrower may from time to timebe indebted to Bank; and

WHEREAS, Bank is not willing to make loans under the Loan Agreement orotherwise extend credit to Borrower unless Guarantor unconditionally guaranteespayment of all present and future indebtedness and obligations of Borrower toBank; and

WHEREAS, Guarantor will directly benefit from Bank's making loans toBorrower;

NOW, THEREFORE, as an inducement to Bank to enter into the LoanAgreement 0 s and to make loans to Borrower thereunder, and to extend suchadditional credit as Bank may from time to time agree to extend, and for othergood and valuable consideration, the receipt and sufficiency of which are herebyacknowledged, the parties do hereby agree as follows:

1. Nature and Scope of Guaranty.1.01. Guaranty of Obligation. Guarantor hereby irrevocablys and uncondi-

tionally guarantees to Bank its successors and assigns (i) the due fulfillment andperformance of all obligations now or hereafter owed by Borrower to Bank, in-

302. This guaranty agreement is not intended to serve as a "model" guaranty or toinclude all possible provisions. It is intended to illustrate the types of contractual provisionswhich may counteract the problems described in the article. As suggested in the conclusionto the article, the most refined product of the lawyer's "art" is not the ability to include allmarginally relevant provisions but rather to simplify and generally streamline the guarantyagreement. Nevertheless, vestigial judicial reliance on the "strict construction" and "mostfavored status" rules forces a certain amount of specificity under current Texas law.

The guaranty agreement in this appendix does not include representations, warranties,covenants, subordination provisions and "miscellaneous" provisions which either depend onthe particular nature of the agreement or are not relevant to the discussion contained in thearticle.

The guaranty agreement describes an unconditional, continuing guaranty of paymentdelivered in connection with a formal loan agreement, and therefore would require substan-tial modification in order to be applicable to other types of guaranty arrangements.

The footnotes to the appendix consist of cross-references to those portions of the articlewhich discuss the need for, or problems associated with, the footnoted provisions.

303. See notes 48, 115 supra, and accompanying text.304. See notes 126, 128 supra, and accompanying text.


cluding without limitation those under the Loan Agreement, and (ii) the due andpunctual payment of the Guaranteed Debt (hereinafter defined). Guarantorhereby irrevocably and unconditionally covenants and agrees that it is liable forthe Guaranteed Debt as primary obligor.

1.02. Definition of Guaranteed Debt. As used herein, the term "GuaranteedDebt" means:

(a) All principal, interest, attorneys' fees, commitment fees, liabilitiesfor costs and expenses and other indebtedness, obligations and liabilities ofBorrower to Bank at any time created or arising under the Loan Agreement,or any amendment thereto or substitution therefor, including but not lim-ited to all indebtedness, obligations, and liabilities arising under the Note(as defined in the Loan Agreement), and under any renewals and extensionsof the Note (collectively, the "Guaranteed Notes");

(b) All liabilities of Borrower for future advances, extensions of credit,sales on account or other value at any time given or made by Bank to Bor-rower, whether or not the advances, credit or value are given pursuant tocommitment;

(c) Any and all other indebtedness, liabilities, obligations and duties ofevery kind and character of Borrower to Bank, whether now or hereafterexisting, or arising, regardless of whether such present or future indebted-ness, liabilities, obligations or duties be direct or indirect, primary or secon-dary, joint, several, or joint and several, fixed or contingent, and regardlessof whether such present or future debts, liabilities, obligations or dutiesmay, prior to their acquisition by Bank, be or have been payable to, or be orhave been in favor of, some other person or have been acquired by Bank inany transaction with a person other than Borrower; together with any andall renewals and extensions of such debts, liabilities, obligations and duties,or any part thereof;

(d) All costs, expenses and fees, including but not limited to court costsand attorneys' fees, arising in connection with the collection of any or allamounts, indebtedness, obligations and liabilities of Borrower to Bank de-scribed in items (a) through (d) of this Section 1.02.

The Guaranteed Notes, indebtedness, liabilities, obligations and otherGuaranteed Debt guaranteed hereby, and the liabilities and obligations ofGuarantor to Bank hereunder, shall not be reduced, discharged or releasedbecause or by reason of any existing or future offset, claim or defense ofBorrower, or any other party, against Bank or against payment of the Guar-anteed Debt, whether such offset, claim or defense arises in connection withthe Guaranteed Debt (or the transactions creating the Guaranteed Debt) orotherwise. 08 Without limiting the foregoing or the Guarantor's liabilityhereunder, to the extent that Bank advances funds or extends credit to Bor-rower, and does not receive payments or benefits thereon in the amountsand at the times, required or provided by applicable agreements or laws,Guarantor is absolutely liable to make such payments to (and confer such



benefits on) Bank, on a timely basis.30oIf Borrower is a partnership or joint venture, the term "Borrower" as used

herein shall include any new partnership or joint venture technically formed as aresult of the dissolution of Borrower, or the admission of new partners or ventur-ers to, or withdrawal of partners or venturers from, Borrower.30

1.03. Payment by Guarantor. If all or any Guaranteed Debt shall not bepunctually paid when due, whether at maturity or earlier by acceleration or other-wise, Guarantor shall, immediately upon demand by Bank, and without present-ment, protest, notice of protest, notice of non-payment, or any other notice what-soever, pay in lawful money of the United States of America, the amount due onthe Guaranteed Debt to Bank at Bank's principal banking office in fTexas. Such demand(s) may be made at any time coincident with or after thetime for payment of all or part of the Guaranteed Debt, and may be made fromtime to time with respect to the same or different items of Guaranteed Debt. Suchdemand shall be deemed made, given and received in accordance with Section__ hereof.

1.04. No Duty to Pursue Others. It shall not be necessary for Bank (andGuarantor hereby waives any rights which it may have to require Bank), in orderto enforce such payment by Guarantor, first to institute suit or exhaust its reme-dies against Borrower or others liable on the Guaranteed Debt or any other per-son, to enforce its rights against any security which shall ever have been given tosecure the Guaranteed Debt, to enforce its rights against any other guarantors ofthe Guaranteed Debt, to join Borrower or any others liable on the GuaranteedDebt in any action seeking to enforce this Guaranty Agreement, to exhaust anyremedies available to it, in its possession or under its control or resort to anyother means of obtaining payment of the Guaranteed Debt.0 " Bank shall not berequired to mitigate damages or take any other action to reduce, collect or enforcethe Guaranteed Debt.

1.05. Waiver of Notices, etc. Guarantor agrees to the provisions of the Guar-anteed Notes and the Loan Agreement, and hereby waives notice of any loans oradvances made by Bank to Borrower, notice of acceptance of this GuarantyAgreement, notice of any amendment or extension of the Guaranteed Notes orthe Loan Agreement or of any other instrument or document pertaining to all orany part of the Guaranteed Debt, notice of the execution and delivery by Bor-rower and Bank of any other loan or credit agreement or of Borrower's executionand delivery of any promissory notes or other documents in connection therewith,notice of the occurrence of any breach by Borrower or Event of Default (as de-fined in the Loan Agreement and collateral documents thereto), notice of Bank'stransfer or disposition of the Guaranteed Debt, or any part thereof, notice of saleor foreclosure8 (or posting or advertising for sale or foreclosure) of any collateralfor the Guaranteed Debt, protest, notice of protest, proof of non-payment or de-fault by Borrower, notice of any other action at any time taken or omitted by

306. See notes 208-09 supra, and accompanying text.307. See note 136 supra, and accompanying text.308. See notes 14-18, 216 supra, and accompanying text.309. See notes 286-301 supra, and accompanying text.


Bank, and, generally, all demands and notices of every kind in connection withthis Guaranty Agreement, the Loan Agreement, any documents or agreements ev-idencing, securing or relating to any of the Guaranteed Debt, and the obligationshereby guaranteed. The parties intend that Guarantor shall not be considered a"Debtor" as defined in Section 9.105 of the Texas Business & Commerce Code.

1.07. Nature of Guaranty. This is an irrevocable, absolute, continuing guar-anty of payment and not a guaranty of collection.81 This guaranty may not berevoked by Guarantor and shall continue to be effective with respect to Guaran-teed Debt arising or created after any attempted revocation by Guarantor andafter (if Guarantor is a natural person) Guarantor's death (in which event thisGuaranty shall be binding upon Guarantor's estate and Guarantor's legal repre-sentatives and heirs). 1 The fact that at any time or from time to time the Guar-anteed Debt may be increased, reduced or paid in full shall not release, discharge,or reduce the obligation of Guarantor with respect to indebtedness or obligationsof Borrower to Bank thereafter incurred (or other Guaranteed Debt thereafterarising) under the Guaranteed Notes or otherwise. This Guaranty shall continueto be effective or reinstated, as the case may be, if at any time any payment toBank of all or part of the Guaranteed Debt is rescinded or must otherwise berestored or refunded by Bank pursuant to any insolvency, bankruptcy, reorganiza-tion, receivership or other debtor relief proceeding involving Borrower. In theevent that Bank must rescind or restore any payment received by Bank in satis-faction of the Guaranteed Debt, as set forth herein, any prior release or dischargefrom the terms of this Guaranty given to Guarantor by Bank shall be withouteffect, and this Guaranty shall remain in full force and effect. It is the intention ofBorrower and Guarantor that Guarantor's obligations hereunder shall not be dis-charged except by Guarantor's performance of such obligations and then only tothe extent of such performance. This Guaranty may be enforced by Bank and anysubsequent holder of the Guaranteed Debt and shall not be discharged by theassignment or negotiation of all or part of the Guaranteed Debt.

2. Events and Circumstances Not Reducing or Discharging Guarantor'sObligations. Guarantor hereby consents and agrees to each of the following, andagrees that Guarantor's obligations under this Guaranty shall not be released, di-minished, impaired, reduced or adversely affected by any of the following, andwaives any rights (including without limitation rights to notice) which Guarantormight otherwise have as a result of or in connection with any of the following:

2.01. Modifications, etc. Any renewal, extension, modification, alteration orrearrangement of all or any part of the Guaranteed Debt, or of the GuaranteedNote, or any loan agreement, security agreement, collateral document or otherdocument, instrument, contract or understanding between Borrower and Bank,or any other parties, pertaining to the Guaranteed Debt;"1'

2.02. Adjustment, etc. Any adjustment, indulgence, forbearance or compro-mise that might be granted or given by Bank to Borrower or Guarantor;

2.03. Condition of Borrower or Guarantor. The insolvency, bankruptcy, ar-

310. See notes 10-21 supra, and accompanying text.311. See note 304 supra.312. See notes 137-155 supra, and accompanying text.


rangement, adjustment, composition, liquidation, disability, dissolution or lack ofpower of Borrower or any other party at any time liable for the payment of all orpart of the Guaranteed Debt; or any dissolution of Borrower or Guarantor, or anysale, lease or transfer of any or all of the assets of Borrower or Guarantor, or anychanges in the shareholders, partners or members of Borrower or Guarantor; orany reorganization of Borrower or Guarantor;

2.04. Invalidity of Guaranteed Debt. The invalidity, illegality or unenforce-ability of all or any part of the Guaranteed Debt, or any document or agreementexecuted in connection with the Guaranteed Debt, for any reason whatsoever,including without limitation the fact that the Guaranteed Debt, or any partthereof, exceeds the amount permitted by law, the act of creating the GuaranteedDebt or any part thereof is ultra vires, the officers or representatives executingthe Guaranteed Notes or other documents or otherwise creating the GuaranteedDebt acted in excess of their authority, the Guaranteed Debt violates applicableusury laws, the Borrower has valid defenses, claims or offsets (whether at law, inequity or by agreement) which render the Guaranteed Debt wholly or partiallyuncollectible from Borrower, the creation, performance or repayment of theGuaranteed Debt (or the execution, delivery and performance of any documentor instrument representing part of the Guaranteed Debt or executed in connec-tion with the Guaranteed Debt, or given to secure the repayment of the Guaran-teed Debt) is illegal, uncollectible, legally impossible or unenforceable, or theGuaranteed Notes, Loan Agreement or other documents or instruments pertain-ing to the Guaranteed Debt have been forged or otherwise are irregular or notgenuine or authentic.310

2.05. Release of Obligors. Any full or partial release of the liability of Bor-rower on the Guaranteed Debt or any part thereof, or of any co-guarantors, orany other person or entity now or hereafter liable, whether directly or indirectly,jointly, severally, or jointly and severally, to pay, perform, guarantee or assurethe payment of the Guaranteed Debt or any part thereof, it being recognized,acknowledged and agreed by Guarantor that Guarantor may be required to payGuaranteed Debt in full without assistance or support of any other party, andGuarantor has not been induced to enter into this Guaranty on the basis of acontemplation, belief, understanding or agreement that other parties will be lia-ble to perform the Guaranteed Debt, or Bank will look to other parties to per-form the Guaranteed Debt; 1' notwithstanding the foregoing, Guarantor does nothereby waive or release (expressly or impliedly) any rights of subrogation, reim-bursement or contribution which it may have, after payment in full of the Guar-anteed Debt, against others liable on the Guaranteed Debt;8 18 Guarantor's rightsof subrogation and reimbursement are, however, subordinate to the rights andclaims of Bank as provided in [Subordination Provision];

2.06. Other Security. The taking or accepting of any other security, collateralor guaranty, or other assurance of payment, for all or any of the GuaranteedDebt;

313. See notes 156-214 supra, and accompanying text.314. See notes 217-225 supra, and accompanying text.315. See notes 105-107 supra, and accompanying text.


2.07. Release of Collateral, etc. Any release, surrender, exchange, subordina-tion, deterioration, waste, loss or impairment (including without limitation negli-gent, willful, unreasonable or unjustifiable impairment) of any collateral, prop-erty or security, at any time existing in connection with, or assuring or securingpayment of, all or any part of the Guaranteed Debt;3 21

2.08. Care and Diligence. The failure of Bank or any other party to exercisediligence or reasonable care in the preservation, protection, enforcement, sale orother handling or treatment of all or any part of such collateral, property orsecurity;

31 7

2.09. Status of Liens. The fact that any collateral, security, security interestor lien contemplated or intended to be given, created or granted as security forthe repayment of the Guaranteed Debt shall not be properly perfected or created,or shall prove to be unenforceable or subordinate to any other security interest orlien,818 it being recognized and agreed by Guarantor that Guarantor is not enter-ing into this Guaranty in reliance on, or in contemplation of the benefits of, thevalidity, enforceability, collectability or value of any of the collateral for theGuaranteed Debt; t'1 notwithstanding the foregoing, Guarantor does not herebywaive or release (expressly or impliedly) any right to be subrogated to the rightsof Bank in any collateral or security for the Guaranteed Debt, after payment infull of the Guaranteed Debt;3 0 Guarantor's rights of subrogation are, however,subordinate to the rights, claims, liens and security interests of Bank as providedin [Subordination Provision].

2.10. Preference. Any payment by Borrower to Bank is held to constitute apreference under bankruptcy laws, or for any reason Bank is required to refundsuch payment or pay such amount to Borrower or someone else; or

2.11. Other Actions Taken or Omitted. Any other action taken or omitted tobe taken with respect to the Loan Agreement, the Guaranteed Debt, or the secur-ity and collateral therefor, whether or not such action or omission prejudicesGuarantor or increases the likelihood that Guarantor will be required to pay theGuaranteed Debt pursuant to the terms hereof; it is the unambiguous and une-quivocal intention of Guarantor that Guarantor shall be obligated to pay theGuaranteed Debt when due, notwithstanding any occurrence, circumstance,event, action, or omission whatsoever, whether contemplated or uncontemplated,and whether or not otherwise or particularly described herein, except for the fulland final payment and satisfaction of the Guaranteed Debt.

4. Subordination by Guarantor.* [Include Appropriate Provision].5. Representations and Warranties. To induce Bank to enter into the Loan

Agreement and extend credit to Borrower, the Guarantor represents and warrantsto Bank that:

5.01. Benefit. Guarantor has received, or will receive, direct or indirectbenefit from the making of this Guaranty and the Guaranteed Debt;

316. See notes 227-234 supra, and accompanying text.317. See notes 235-245 supra, and accompanying text.318. See notes 246-255 supra, and accompanying text.319. See notes 256-260 supra, and accompanying text.320. See note 107 supra.


5.02. Familiarity and Reliance. Guarantor is familiar with, and has in-dependently reviewed books and records regarding, the financial conditionof the Borrower and is familiar with the value of any and all collateral in-tended to be created as security for the payment of the Guaranteed Debt;however, Guarantor is not relying on such financial condition or the collat-eral as an inducement to enter into this Guaranty;

5.03. No Representation by Bank. Neither Bank nor any other partyhas made any representation, warranty or statement to the Guarantor inorder to induce the Guarantor to execute this Guaranty;

5.04. Guarantor's Financial Condition. As of the date hereof, and aftergiving effect to this Guaranty and the contingent obligation evidencedhereby, Guarantor is, and will be, solvent, and has and will have assetswhich, fairly valued, exceed its obligations, liabilities and debts, and hasand will have property and assets in the state of Texas sufficient to satisfyand repay its obligations and liabilities.8 1

[The following applies if Guarantor is a corporation]:

5.05. Directors' Determination of Benefit. The Board of Directors ofGuarantor, acting pursuant to a duly called and constituted meeting, afterproper notice, or pursuant to a valid unanimous consent, has determinedthat this Guaranty directly or indirectly benefits the Guarantor and is inthe best interests of Guarantor;"'

6. Miscellaneous. [Include Appropriate Provisions].

EXECUTED as of the day and year first above written.

GUARANTOR:

By:

BANK:

By:

Notarial Acknowledgement

321. See notes 81-118 supra, and accompanying text.322. See notes 55-59 supra, and accompanying text.

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