Guaranties
In both consumer and commercial transactions, creditors may request or require a guaranty of payment from a third party or parties in addition to collateral that secures the obligation of the principal obligor. By signing a guaranty, the guarantor becomes obligated to pay the debt, or some small agreed portion of the debt, in the event the principal obligor fails to pay the debt. In addition, the creditor may request or require that the guarantor secure the guaranty with collateral. As with most terms of a loan, the bargaining power of the parties, largely determined by the market for similar loans, will determine whether or not a guaranty is forthcoming and whether or not the guaranty is secured.
Consider the following illustration. A creditor may insist that a principal shareholder of a corporation guarantee the secured debt of the corporation and also that the guarantor secure the guaranty with a deed of trust on the guarantor's principal residence or some other valuable asset. Absent such a guaranty, the principal shareholder generally will be insulated from liability by the principal of limited liability applicable to shareholders of a corporation. Professor Ronald Mann's study of a sample of distressed commercial loans held by a finance company, a bank, and an insurance company sheds some light on the prevalence of the use of guaranties. In his sample of twenty-three distressed commercial loans held by the finance company, mostly secured by inventory or accounts, each of the debtors was a corporation at the time of distress. In each case, the finance company had a guaranty from at least one of the principals of the corporation and in many cases the finance company had a guaranty from each individual stockholder. For the purpose of avoiding marital property defenses to liability on a guaranty, the finance company also held guaranties from spouses of each principal or shareholder that signed a guaranty. R.Mann, Strategy and Force in the Liquidation of Secured Debt, 96 Mich. L. Rev. 159, 173 (1997). In his sample of twenty-eight distressed commercial loans held by the bank, some secured by real and some secured by personal property, the bank held guaranties from all of the shareholders of the thirteen distressed debtors that were corporations. Id. at 186. In his sample of twenty-one distressed commercial loans held by the insurance company, most of which were non-recourse loans made to limited or general partnerships and trusts and most of which were secured by real property, the insurance company held no guaranties. Id. at 200-01.
In these materials we focus on the extent to which real property law affords guarantors the kinds of protections afforded principal obligors (such as the security first and anti-deficiency rules). We do not explore the nature of protections afforded by Article 9 to guarantors of debts secured by personal property. Under Article 9, a guarantor would be included among those identified in the statute as a "secondary obligor." See U.C.C. 9-102(a)(71). For an example of protections afforded a secondary obligor by Article 9, see U.C.C. 9-626(a)(3) (limitation on amount of deficiency).
As our materials reveal, the real property security rules that protect principal obligors afford considerably less protection to guarantors. Accordingly, upon default, the person or entity alleged to be a guarantor may seek to argue that he or she is really a principal obligor, thus invoking protections afforded to principal obligors (such as anti-deficiency legislation). For example, if a general partner of a partnership guarantees a partnership debt, the guarantee will be disregarded because the general partner, under the principles of partnership law, is principally liable for partnership debt.