But, The Lease Guaranty Had All Of The Right Words – What Happened?

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“I guarantee the full performance of the Lease by the Tenant. This Guarantee is absolute and without any conditions. … This guarantee will not be affected by any change in the Lease whatsoever, including, but not limited to any extension of time or renewals.” “The Guarantor further agrees that this guaranty shall remain and continue in full force and effect as to any renewal, change or extension of the Lease.”

Those were two ways in which two different landlord’s forms of guaranty were intended to give the landlord comfort that a guarantor would not weasel out of the guarantee based upon amendments, extensions, etc. to the guaranteed lease. They didn’t work.

What went wrong? Basically, including such language in a guarantee helps make the guarantee bullet-resistant, not bullet-proof.

Before we give any context to the situations where neither of those “won’t be affected” provisions worked, Ruminations will outline some underlying principles. To begin with, a guarantor won’t be held liable for anything remotely outside of the guarantee’s express terms. Courts believe that guarantors don’t intend to give open-ended guaranties. Even as to their express terms, guaranties are very strictly interpreted, far more than with most any other kind of agreement. Further, a guarantor’s obligation can’t be increased without the guarantor’s clear consent. Lastly, courts look at the sophistication of the guarantor regardless of anything the guaranty might say to negate that enforcement criterion.

Almost everyone who prepares a guaranty knows that if the potential obligation or risk of non-collection from the one who is primarily liable is increased after a guarantee is signed, the guarantor may not be liable for the increased obligation and even may not be liable for the underlying obligation. That bears repeating. If the underlying, guaranteed agreement is modified, and doing that increases the risk (even, if not the total monetary exposure of the guarantor), many courts will release the guarantor entirely. Sometimes, a court will try to figure out how much of the claim arises out of the original, clearly guaranteed agreement, and how much arises out of a subsequent modification to that agreement. And, sometimes a court won’t bother. Here’s an explanatory example.

Suppose a lease for a 1,000 square foot space called for rent of $10,000 a year and that lease was guaranteed. Now, suppose that the lease is amended to add another 500 square feet of space for an additional $5,000 a year. Even if the guaranty had a “generic-type” – “this guaranty will cover lease amendments as well” provision, don’t be shocked if a court won’t bind the guarantor to the additional $5,000 a year rent. More importantly, don’t be surprised if a court won’t enforce the guarantee altogether on the theory that the lease amendment increased the risk that the tenant wouldn’t be able to pay the rent and the guarantor didn’t “bargain” for that risk.

So, if there’s any lesson to be learned from what Ruminations thus far has written, it is that a guarantee will be “put into play” if the document describing the guaranteed obligation is later modified. We’ve described one reason that happens, and it is because the “law” doesn’t think that a guarantor “signs on” to unknown liabilities. In fact, while one often sees a guarantee described as being “unlimited,” “unlimited” is seen as going to the “amount” at risk, not the “reasons” for the risk. That gives rise to support an underlying belief on the part of courts that the guarantor should “know” exactly what is being guaranteed. Whereas the guarantor had the opportunity to read and understand the underlying agreement before first signing a guaranty, without actually having notice about each subsequent change, the guarantor would be signing onto an “unknown.” Courts don’t believe guarantors intend to find themselves in that situation. Yes, like any other agreement, courts are concerned about “intent.”

This would be a good point to tell readers that, today, Ruminations is limiting its remarks to free-standing guarantee agreements, i.e., those with self-contained terms. We don’t have the energy to address “guaranties” that merely add “I guarantee the foregoing obligations” to the end of a lease or other agreement and then add a signature line. That’s a whole other ball of wax, and not for today’s blog posting. That approach may save trees and otherwise be environmentally sound, but at some cost to an E&O carrier.

Guaranties almost always contain a provision wherein the guarantor waives notice as to changes made to the underlying, guaranteed agreement. The party seeking the guarantee insists that because the guarantor, as is almost always the case, is related to or actually control of the party incurring the actual obligation, the guarantor doesn’t need separate notice of any agreed-upon changes to the guaranteed agreement. There is some common sense to that position, though guaranties are intended to survive even if the underlying agreement is assigned to an unrelated party. The problem is that courts apply some notion of “procedural due process” when analyzing whether a guarantor should be liable when the originally guaranteed agreement is changed.

Typically, a guarantor has the right to revoke its guarantee and that would serve to cut off liability for all but those obligations that had already accrued at the time of the revocation. This doesn’t feel like a commercially sound legal outcome, but there is a large body of law, much of it coming out of loan guarantees, that permits such revocation. Wise landlords (and others who rely on guaranties) should probably address that in the guarantee and should probably make any such revocation a default event with respect to the underlying obligation. The two concepts could be tied together in a guarantee, but we have no recollection of ever seeing that happen.

If one accepts Ruminations’ theory that courts have a good sense the guarantor should be able to revoke the guarantee, then is easy to understand why, despite waivers in the guaranty itself, courts believe that guarantors should have notice of changes to the underlying agreement. Basically, “How will a guarantor know if the guarantor should revoke the guarantee if the guarantor doesn’t know of the modification?”

To give readers an idea about how the courts think when it comes to whether a guarantor’s waiver of the right to receive notices of subsequent modifications is effective, even where the waiver is contained within the guaranty itself, pay attention to the following.

In a 2003 New York Court of Appeals decision, that state’s highest court ruled that a guarantor “did not give his consent to the March 26 modification agreement merely because the guarantee waived his right to notice of a modification.” Yes, the guarantee clearly included a waiver, on the part of guarantor, as to the right to receive a notice when a modification of the underlying, guaranteed agreement was made. The court, however, saved the day for the creditor by looking at the guaranteed agreement itself. In this case, the guaranteed agreement was a promissory note that expressly recited that the note could be “renewed from time to time and for any term or terms by agreement between the holder and the Maker without notice, and that after such extension or extensions, renewal or renewals, the liability of all parties shall remain as if no extension or renewal had been made.” [Emphasis ours]. If you’d like to see the court’s decision (it’s short), HERE. Basically, what the court said was that the guarantor’s liability for the subsequently modified note arose not out of the words within the guarantee, but because the guarantor agreed to stand behind a document that, by its own terms, said that the obligation being guaranteed was subject to modification and that the guaranteed obligation included whatever additional burden a modification might bring. That may be a drafting lesson. Even if one or more readers adamantly refuse to accept that courts will frequently ignore the very common provision in a guarantee that the guarantor agrees to remain liable even if the underlying agreement is modified, a belt and suspenders approach might be to draft the underlying agreement (lease, mortgage, etc.) to bring about the same result.

Today’s blog posting began by quoting two very common formulations found in guaranties. Each was intended to extend the guarantor’s liability to the provisions of a guaranteed lease that had subsequently been modified. In both court’s decisions where the “even if modified” text did not work out well for the landlord, the two courts expressed the same basic reasoning. Neither lease before the court contained a renewal or extension option. Instead, the lease term of each was “extended,” but not as a matter of “right.” In one case, the underlying lease was extended while it was still in effect. In the other case, the underlying lease had expired, but an extension agreement purportedly retroactively extended it. In each case, the reasoning that allowed the guarantor to get off the hook was that neither modification was actually an extension. Instead, each purported modification was found to be a new lease. Our review of other case law teaches Ruminations that courts look (stretch?) for factual support as a rationale to override guaranties that purport to remain effective even though the underlying obligations have been modified.

So, what’s a poor landlord or other creditor to do? It’s simple. If you want the guarantor to remain on the hook, get the guarantor to reaffirm the guarantee in connection with the modification. Most often, the guarantor is still related to the contracting party, such as a tenant. That makes it easy. If the guarantor wants the benefit of the modification, the guarantor needs to reaffirm the original guarantee or sign a new one. Where the guarantor is no longer affiliated with the contracting (obligated) party, then to maintain the protection of the guarantee it is even more important to get a reaffirmation or a substitute guarantee or not make the modification at all if the guarantee is a condicio sine qua non.

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