How To Lose Your Lease Guaranty

As a business matter, a lease guaranty is almost always intended to be enforceable “come heck or high water,” no “ifs, ands or buts.” In a particular situation, that might not turn out to be the case, but that’s what people expect. But saying “no ifs, ands or buts,” doesn’t mean that any particular guaranty covers all circumstances for all of time. They are defined by their scope and can be limited by amount or time. We’ve written about limitations before and we’ll try not to cover that ground today. If any reader is interested, those earlier blog postings can be seen by clicking: HERE and HERE.

Today, we’re going to raise some kinds of things that could let a guarantor off the hook, in which case it wouldn’t matter how “tight” the guaranty was written. Regardless of whether space permitted, we couldn’t list every set of circumstances that could cause that result, even if we were good enough to know them all. So, we’ll just lay out some principles. Hopefully they will sensitize readers such that they will be able to look at any situation and know whether there is a possibility that the guaranty will turn out to be nothing more than a used piece of paper.

Anyone who has looked at guaranties knows that they set out more than the basic deal which is: “I’ll be as liable as the tenant would be.” We’ve all seen the language that adds the concepts of: (a) and even if the tenant can avoid paying, such as by proving its insanity at the time of signing the lease or by filing for bankruptcy when the road ahead gets too hard to follow, I, the guarantor will still be there for you, landlord; and (b) landlord, go make whatever later deals you want with the tenant, I’ll still have my checkbook at the ready.” Well, in response to the words of George Orwell’s Winston Smith, “I understand the how; I do not understand the why,” Ruminations will try to explain the “why.”

Most readers have heard of something called a “surety.” A typical definition is: “a person who takes responsibility for another’s performance of an undertaking.” That sounds so much like the definition of a guaranty, that some dictionaries say that a surety is someone who guaranties another’s debt or performance. Invariably, thesauruses list each word as a synonym for the other.

But, a surety and a guarantor are not the same. Though the distinctions have clearly been lost in general parlance, the law (as least to those who are purists in the law, and that includes more than a handful of judges) sees a difference between the two. Here are some of those differences.

A surety has primary and joint liability with the borrower (or tenant). A guarantor’s liability is secondary.

A guarantor answers after the landlord has first made a reasonable effort to get the tenant to pay or perform, and then needs a notice for the landlord before being required to pay or perform. A surety doesn’t get that cushion.

In litigation, a surety can be joined as a co-responsible party, but a guarantor’s liability is founded on a separate contract – the guaranty.

A guaranty can be revoked until it is accepted, but a surety can’t revoke its offer to act as such unless the surety has reserved that right.

As we read those differences, we can’t possibly not be thinking about some of the “extra” text in every guaranty. Immediately, we realize that lots of the words beyond “I’ll be responsible” are there to erase the differences between a surety agreement and a guaranty.

For that reason, let’s all keep in mind that a guaranty is a contract. Though signed only by the guarantor, its acceptance is implied by the landlord entering into the guarantied lease. That’s not to say that we’ll stop including a “waiver of acceptance” into our guaranties and that we shouldn’t have our leases recite that delivery of the guaranty is a condition precedent to the effectiveness of the lease, but the law doesn’t appear to demand such steps. [As an aside, we think guaranties should say that the “Guarantor waives acceptance by the landlord of this Guaranty,” and not just that the “Guarantor waive acceptance.” That’s because in the world of these “collateral agreements,” the words, “waives acceptance” have some technical applications, such as to bills of exchange, and judges can use those related concepts to bring about unintended results. Also, a “condition precedent” means that whatever is the “condition precedent” has to have happened before the lease is really in effect.]

Unlike a surety, a guarantor is bound by a separate contract. And, like any other contract, its words matter. All of the rules of construction and interpretation apply to a guaranty. Ruminations has too many blog postings to list when it comes to interpreting agreements. Readers can search for them using our search box.

Like some, but not all, contracts, a guaranty must be in writing.

Today, because our focus is on the “why,” not the “how,” Ruminations will only set the scene for next week’s blog posting and that posting will address some of the “how.”

In the guarantied lease situation, we have a three-party scenario, one that involves the landlord, the tenant, and the guarantor. The tenant owes an obligation to the landlord. In the “credit” world, that makes the tenant an “obligor.” The landlord is entitled to receive something from the tenant. That would make it an “obligee.” The guarantor’s position is a little more complicated, because it is both an obligor and an obligee. As between it and the landlord, it is an obligor, a secondary one who stands behind the tenant. But, it is also an obligee. The tenant owes it an obligation.

In the law, there is an equitable principle called “the right to contribution.” Basically, even without an agreement between or among parties, when a group of them share a liability and one pays more than its “share,” the other(s) have an obligation to “true up.” That’s called the duty of contribution. So, when a guarantor steps up for the tenant, the tenant takes on the obligation to reimburse the guarantor. It becomes an “obligor” to the guarantor, its “obligee.”

Those concepts or definitions are important to understand. So, we’ll state them differently.

• The landlord is the obligee, the one to whom the obligation is owed.
• The tenant is the primary obligor, the one who owes the obligation to the landlord.
• The guarantor is the secondary obligor (though the terms of the guaranty can make it a primary guarantor). It is the backup for the landlord.
• The tenant has an obligation to the guarantor, called the duty of contribution.

[As a further aside, keeping that list in mind, notwithstanding what some term sheets or even letters of intent say, the tenant can’t be its own guarantor because it can’t be liable to itself.]

Now, we know that some readers are chomping at the bit wanting to know the “how,” but we’re not succumbing to that pressure (until next week). We have another principle to get out on the table because it underlies many of the words we find in modern guaranties.

A critical concept that comes out of our highlighted, bulleted list is that the tenant has two obligations – one to the landlord and one to the guarantor. As a result, not only is the landlord relying on the tenant’s ability to fulfill its financial and other obligations, but the guarantor, likewise, is relying on the ability of the tenant to reimburse it if the guaranty is “called.”

As a result of the guarantor’s reliance on the tenant’s ability to make reimbursement, the guarantor doesn’t want the landlord to do anything that increases the risk of not getting that reimbursement either by increasing the risks within the lease or by impairing the credit of the tenant to the guarantor. Basically, the guarantor doesn’t want the landlord to act in a way, by unilateral action or by agreement with the tenant, that makes it less likely that guarantor will get its money back from the tenant.

There are a lot of things that a landlord could do on its own or by amending the lease, but we’re not going to list them. Absent negating words in the guaranty, most of the things a landlord might do, if they actually or even theoretically raise the risk that a tenant couldn’t reimburse its guarantor, could limit the guaranty or even eliminate it altogether. The kinds of things the landlord could do and things that give rise to what, in the surety world, would be called “surety defenses.” Surety defenses are all based on the obligor (landlord) increasing the risk that reimbursement of the surety (guarantor) won’t happen.

To close out today’s posting, we’ll tell readers about the kind of outcomes that a successful “surety defense” might bring about. Different jurisdictions take different approaches. Though courts are moving toward the least damaging (to a landlord) of these, some states still abide by the harshest (to the landlord) of these. The historic approach is that anything that changes the underlying obligation will invalidate the guaranty. With this approach, it wouldn’t matter if the change would benefit guarantor. Courts following this approach don’t need to weigh the facts.

Some courts were uncomfortable with that “no thinking at all” approach when it comes to invalidating the guaranty if the changes made would benefit the guarantor. So, under their approach, the guarantor will not be released if what the landlord did would benefit the guarantor.

A further gloss distinguishes between paid sureties and voluntary sureties: a voluntary surety will be released upon any change to the underlying obligation, but a paid surety will only be released if the change materially increases the risk that the tenant wouldn’t reimburse the paid surety. There is yet a further gloss on this approach, one that is inexplicable to Ruminations. It says that if the landlord completely releases the tenant from liability, that isn’t a “material increase” in the guarantor’s risk and the guaranty won’t be invalidated.

More commonly, and increasingly the modern legal approach, is that the guarantor will only be released to the extent that the action taken by the landlord or the change made to the tenant’s obligation increases what would be the surety’s obligation to the landlord. Basically, the guarantor will only be released to the extent of the increased harm.

There is one more principle when it comes to surety agreements and to guaranties as well.  All of these defenses can be waived. That sets us up for next week’s blog posting. Stay tuned.