Lease Guarantees

In 2003, L + C Unlimited Corp. received the assignment of the tenant’s interest in a lease that permitted the Golden Isle Restaurant to operate in a strip mall. Xiao-Yan Cao, President of L + C, personally guaranteed the performance of L + C.

In 2006 the tenant’s leasehold estate was again assigned, this time to Hong Lin. At the same time, the Lease term was extended five years to September 30, 2013. Both Cao and Lin signed new, personal Guarantees.

From 2008 to 2010 L + C and Lin failed to timely make rent payments, and owed ~ $24,000. However, L + C, Lin and the Landlord PC Riverview, agreed to a repayment schedule to permit L + C and Lin to catch up by making five additional payments. Which Lin did.

In 2013, L + C and Lin defaulted again and failed to pay the last monthly installment of rent. PC Riverview sued both Lin and Cao for the rental deficiency. Cao defended, arguing that the 2010 repayment schedule materially modified the Lease and discharged Cao’s Guaranty, since Cao did not agree to the repayment schedule, was not notified about its existence, and did not execute the repayment agreement.

The district court agreed and ruled in Cao’s favor. PC Riverview appealed.

The court of appeals reversed, reasoning that merely extending the period within which a tenant may pay rent did not materially modify the Lease and consequently, all guarantors remain liable. Cao appealed to the Supreme Court.

The Supremes first turned to Cao’s Guaranty Agreement, which provided that Cao “. . . guarantees performance of all covenants, conditions and obligations and duties required of Tenant under said Lease.” And here’s what the Guaranty Agreement did not provide Cao: right to a notice before the Lease was amended or a prohibition against such amendments without Cao’s consent.

We can guess where the Supremes are headed when they state that before the 2010 Modification was made, Cao was responsible for the payment of rent, interest and late fees. And after the 2010 Modification was signed, Cao was responsible for – wait for it – rent, interest and late fees.

The Supreme Court affirmed the Judgment of the court of appeals. Xiao-Yan Cao is obligated to pay PC Riverview. See PC Riverview LLC v. Xiao-Yan Cao; Case No. 20160781; Utah Supreme Court; August 23, 2017: http://caselaw.findlaw.com/ut-supreme-court/1871913.html.

Lessons learned:

1.      Are you on the Guarantor-side of this issue? Then be sure the Guaranty Agreement does not obligate the Guarantor for future amendments and modifications to the Lease. Also provide that the Guarantor receives notice of all claims of the Landlord against the Tenant, and prohibit the Lease from being amended or extended without Guarantor’s prior written consent.

2.      Are you on the Landlord-side of this issue? Then be sure the Guaranty obligates the Guarantor for all amendments, without any requirement of notification or approval, and that the Guaranty continues until all obligations of the Tenant to the Landlord have been discharged as reported by Landlord.

3.      On both sides of this? Be sure that the Guaranty Agreement is clear and unequivocal, and 12 people sitting in a jury box with average 11^th grade educations can readily understand what you are trying to accomplish in both the Lease and Guaranty.

                                                                                    Stuart A. Lautin, Esq.*

                Reprinted with permission by North Texas Association of REALTORS®, Inc.

               * Board Certified, Commercial (1989) and Residential (1988) Real Estate Law,

                 Texas Board of Legal Specialization

                 Licensed in the States of Texas and New York

 

Whoops Moments

Case One

In 2007 the Charles R. Tips Family Trust and the Hazel W. Tips Family Trust signed a Note to Patriot Bank. The Note was secured by Harris County real estate pursuant to a Deed of Trust and Security Agreement. Charles Watkins, Trustee of both Trusts, also guaranteed the debt.

The Note, Deed of Trust and Guaranty Agreement all described the principal amount of the loan as:

ONE MILLION SEVEN THOUSAND AND NO/100 ($1,700,000.00) DOLLARS.

This language appears five times in the three documents, in exactly the same format each time.

The Trusts made Note payments of approx $600,000. The bank sold the note to PB Commercial, LLC, who sold the property at foreclosure auction for $874,125.

PB, as plaintiff in the lawsuit against the Trusts and Watkins, filed a Motion for Summary Judgment. Assuming an initial principal balance of $1.7 million, PB calculated a deficiency balance of $815,214.

The Trusts and Watkins responded by claiming that the original principal amount was $1,007,000, and that words prevail over numbers when there is a conflict. According to the Trusts and Watkins, after application of the past payments and foreclosure proceeds, the note was fully satisfied and PB collected a surplus of $189,111, which amount should be returned to the Trusts.

The trial court granted PB’s Motion and awarded PB damages of $815,214 plus interest, court costs and attorney’s fees. The Trusts and Watkins appealed.

After concluding that the loan documents were *not* ambiguous, the Court found that the written words control over the numerals – a difference of $693,000.  The Court made this conclusion even after reviewing PB’s evidence that the borrowers had received the full $1.7 million from Patriot Bank, not $1,007,000.

Conclusion: The amount due was determined by the written words, not the numerals. The trial court’s Judgment is reversed and replaced with a new Judgment that the principal amount of the loan was $1,007,000. See Charles R. Tips Family Trust v. PB Commercial, LLC; No. 01-13-00449-CV; Texas Court of Appeals, 1^st District; March 25, 2015.

Case Two

On December 15, 2008, David Duckworth borrowed $1.1 million for the State Bank of Toulon. The Note was dated and signed December 15, but the Security Agreement was dated two days earlier – December 13, 2008.

The Security Agreement properly reflected the debt to be secured, but the identification had a critical mistake. The Security Agreement said that it secured a Note dated December 13, 2008. But there was no note of that date.

Duckworth filed a Chapter 7 bankruptcy petition in 2010. The bankruptcy court held that the mistaken date in the security agreement did not defeat the bank’s security interest. The trustee appealed, claiming that the mistaken date in the Security Agreement defeated the bank’s collateral interest.

The bank contended that the Security Agreement is enforceable, and extrinsic testimony will show clearly that the parties intended the Security Agreement to reflect the proper date of the Note. And that the Security Agreement could easily be changed by the Court – we call this ‘reformed’ – to reflect the proper date.

This Federal Court then concluded, and I’ll spare you the meat-grinder details, that the mistaken identity of the debt to be secured cannot be corrected against the bankruptcy trustee. The judgments of the district court were reversed. The Trustee wins; the Bank loses. See In Re: David L. Duckworth; State Bank of Toulon v. Charles E. Covey, Trustee; No. 1:13-cv-01258-JBM and 1:13-cv-01087-JES; US Court of Appeals, 7^th Circuit; November 21, 2014.

Lessons learned:

1.  In the past, I followed the ancient tradition of using both words and numerals in the docs I prepared. I quit that practice. Now I just use numerals - $1,245,882. No more words. Too many opportunities for a mistake by using words. And inevitably when there is a mistake, it’s in the words – not the numerals.

2.  Proofread your Leases, Contracts, correspondence, emails, texts, listings, buyer or tenant rep agreements, brokerage contracts, commission agreements, everything. Read it all closely. Then wait at least one hour before you read it again.

3.  Practice Point: On the really important stuff, enlist the help of a buddy to proofread too. 

Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.

When a Guaranty Agreement Is Not

In early 1997 Border Patrol of Wisconsin, Inc. purchased nine Taco Bell franchises from Pepsico. In connection with financing the purchase, Scot Wederquist signed a Guaranty Agreement in favor of PFS, a division of Pepsico. At the time, Wederquist owned a 25% interest in Border Patrol and served as its Treasurer, and PFS supplied goods and services to Taco Bell franchisees.

PFS sold its assets including USA and Canadian operations to Ameriserve a few months later. And in January 2000, Ameriserve went bust and filed a Chapter 11 bankruptcy petition in Delaware. The Bankruptcy Court approved the sale of substantially all assets of Ameriserve to McLane Foodservice, Inc. in late 2000.

In June 2010 McLane contracted with Table Rock Restaurants to sell it food supplies and services. Wederquist owned 40% of Table Rock and also served as its Treasurer. Table Rock closed its doors in November 2010, owing McLane approximately $450,000.

In December 2010 McLane sued Table Rock and Wederquist to recover the delinquency. The trial court entered Judgment for McLane against Table Rock, but not against Wederquist, holding that he was not personally liable under the Guaranty Agreement he had signed 13 years before in the Border Patrol – Pepsico deal.

Probably sensing that a Judgment against Table Rock had limited collection value, McLane appealed.

It may have been a hint to the outcome of the case when the first substantive paragraph began with “A guarantor under Texas law is a so-called favorite of the law and as such, a guaranty agreement is construed strictly in [his] favor. . . Thus, where uncertainty exists as to the meaning of a contract of guaranty, its terms should be given a construction which is most favorable to the guarantor.”

The Federal District Court closely examined the language of the Guaranty Agreement. Section 1 of the Guaranty stated that Wederquist unconditionally guaranteed the punctual payment when due of the all indebtedness owing “. . . to Creditor” now or hereafter existing.” The preamble of the Guaranty Agreement defined “Creditor” as PFS and all affiliates of PFS.

McLane was of course not an affiliate of PFS but rather a purchaser of its assets. As such, McLane cited a provision in the Guaranty Agreement stating the Guaranty “. . . shall inure to the benefit of and be enforceable by Creditor and its successors, transferees and assigns.”

McLane argued that since it was a purchaser of PFS’s assets, McLane was also its successor, transferee and assign. And as such, McLane was entitled to the benefits of the Guaranty Agreement.

The Federal Court did not need to decide if McLane was a successor, transferee or assign. It wasn’t relevant to the decision. The definition of “Creditor” in the Guaranty Agreement applied only to PFS. Not McLane. If PFS and Wederquist had intended it to apply to others, then PFS and Wederquist could have easily expanded the definition, instead of limiting it to only PFS.

The US District Court Judgment is affirmed. Wederquist wins; McLane loses. The Guaranty Agreement is not binding.

See McLane Foodservice v. Table Rock Restaurants; No. 12-50980; U.S. Court of Appeals – 5^th Circuit, November 15, 2013.

Lessons learned:

1.      Sometimes Guaranty Agreements are, well, you know – Guaranty Agreements. But not always. Commercial Guaranty Agreements in the context of purchase and sale agreements, financing and leasing need to be carefully reviewed.

2.      Practice Tip: In my world there are all kinds and variations of Guaranty Agreements. Some are limited by time; others by amount. Others are “backup” only – recourse must be pursued against the primary debtor first, without success. Still others expire mid-term automatically if the debtor has not defaulted, while in other iterations the Guarantor might be bound to the original debt but to no further credit or time extensions. Many are joint and several such that a creditor has 100% recourse to all Guarantors, but others are only several and limited to each Guarantor’s pro-rata allocated amount.

3.      Don’t assume any Guaranty Agreement is lawful and binding. You might be unpleasantly surprised.

 Reprinted with the permission of North Texas Commercial Association of REALTORS®, Inc.