PRACTICAL CONSIDERATIONS WHEN NEGOTIATING GUARANTY

PUBLISHED: 04/30/13

I. Background.

Guaranties are agreements in which a person or entity, commonly known as a “surety” or “guarantor,” promises to answer for the debt, default, or miscarriage of another person or entity, commonly known as the “principal,” for the benefit of the person or entity to whom the obligation is owed, commonly known as the “creditor.”

There are two primary types of guaranty agreements: (1) a limited guaranty, in which the guarantor guarantees the principal’s fixed obligations over a fixed period of time; and (2) a continuing guaranty, in which the guarantor guarantees future liability of the principal under successive transactions, which either continues the guarantor’s liability or from time to time renews it after it has been satisfied.

II. Statutory Limitations on Continuing Guaranties.

Continuing guaranty agreements are common in lease transactions, in which the guarantor guarantees both the present and future lease obligations of the tenant, including the payment of rent and CAM charges, for the benefit of the landlord. Although continuing guaranties are prospective in nature and generally provide security to the creditor with respect to future transactions, there are two fundamental statutory protections granted to guarantors that must be carefully considered when negotiating a guaranty agreement: (i) California Civil Code Section 2815 governing revocation of the guaranty by guarantor and (ii) California Civil Code Section 2819 governing release of the guarantor from liability due to changes in the principal obligation or creditor’s remedies against the principal.

Under Civil Code Section 2815, “A continuing guaranty may be revoked at any time by the guarantor, in respect to future transactions…” For example, a guarantor of a lease may revoke its guaranty with respect to any future lease amendments or extensions of the original lease term after the guaranty is first given, unless this right is contractually waived by the guarantor.

Under Civil Code Section 2819, a guarantor will be released from liability if (i) the original obligation of the principal “is altered in any respect” without the guarantor’s consent or (ii) the rights and remedies of the creditor against the principal “are in any way impaired or suspended.” For example, if the rent payable by a tenant is amended without the lease guarantor’s consent, the guarantor will be released from liability with respect to payment of the new rent, unless the guarantor has contractually waived the provisions of Civil Code Section 2819.

III. Practical Considerations.

In light of the foregoing, below are some practical considerations for creditors and guarantors to consider:

A. If you are the creditor:

· Negotiate for a non-revocable continuing guaranty, rather than a limited guaranty, and expressly title the document “continuing guaranty.”

· Expressly allow the creditor and the principal to alter, modify, amend, extend and renew the principal obligations and the creditor’s rights and remedies with respect to the principal without any notice to, or consent of, the guarantor, and make the guaranty expressly applicable to any such future alterations, modifications, amendments, extensions or renewals of the principal obligation. Similarly, include an express consent by guarantor to any future alterations, modifications, amendments, extensions and renewals of the principal obligations or creditor’s rights and remedies with respect to the principal.

· Include an express waiver by guarantor of its right to revoke the guaranty under California Civil Code Section 2815 and its right to exoneration under California Civil Code Section 2819. Express contractual waivers of these statutory rights are generally enforceable, at least in commercial transactions, provided that they are made sufficiently clear in the guaranty agreement.

· Include a provision that the guaranty agreement may only be terminated by a writing signed by the creditor and principal that expressly terminates guarantor’s obligations under the guaranty.

· If you are ever in doubt about whether the guarantor’s obligations will continue, require the guarantor to sign a consent to the modification and a reaffirmation of the original guaranty or a new guaranty. Examples when the guarantor’s consent might be required include entering into a new or substituted contract with the principal; materially altering or increasing the principal’s obligations in a way that was not contemplated by, or foreseeable from, the initial agreement; imposing fundamentally different risks on guarantor than the original agreement; and month-to-month or holdover tenancies that arise upon expiration of a written lease.

B. If you are the guarantor:

· Negotiate for a limited guaranty with a definite, automatic termination date.

· Expressly limit the guaranty to the principal’s obligations under the current written contract, but not to any alterations, modifications, amendments, extensions or renewals of the original contract.

· Require that any material alterations, modifications, amendments, extensions or renewals of the principal obligation or material changes to the creditor’s rights and remedies with respect to the principal require guarantor’s prior written consent.

· Negotiate for a fixed cap on guarantor’s monetary liability.

· Expressly reserve guarantor’s statutory right to revoke the guaranty under California Civil Code Section 2815 and guarantor’s statutory right to exoneration under California Civil Code Section 2819.