Personal Guarantees - When a Few Extra Words Really Matter!

Transactional attorneys are especially known for bickering over words or even punctuation when negotiating agreements — “Commercially reasonable efforts” versus “reasonable best efforts” or adding the phrase “not to be unreasonably withheld” after a provision requiring written consent of another party. Often times, there is case law in support of why one provision is more advantageous over another for the client, and other times, attorneys insist on certain language simply because they learned it from their mentors or past practice. Just recently, however, there was a court decision that all lenders, borrowers, and their counsel should definitely take note of in the context of personal guarantees — where a few additional words can make a world of a difference.

The issue before the court, which appears to be one of first impression, not only in California but across the entire country, was the following:

If a personal guaranty specifically excludes a particular asset as source of recovery for the lender, are the proceeds from the sale of that asset still excluded when the lender seeks to enforce the guaranty?

In this California case, in connection with a $3.1 million loan for a real estate development project, the defendant signed a personal guaranty which specifically excluded his personal residence and its contents from the assets that can be collected against under the guaranty. The defendant sold his personal residence in 2011 and the cash proceeds were deposited in accounts segregated from other assets. In March 2012, the plaintiff (junior lender), filed suit to recover the loan balance after the senior lender foreclosed on the development project and defendant refused to honor his guaranty. Plaintiff applied for a prejudgment order of attachment.

Plaintiff made several different arguments as to why the attachment should not apply to “proceeds from the sale” of his personal residence, including a reference to California UCC § 9215(a)(2), which provides that a perfected security interest “attaches to any identifiable proceeds of collateral” covered by the security agreement. But the court held that there is no equivalent statute for sureties, which makes it a matter for the parties’ contractual negotiation. The court went on to state that implied terms “are justified only when they are not inconsistent with some express term of the contract and, in absence of such implied terms, the contract could not be effectively performed.”

The court found that the argument that the term “proceeds” should be an implied term was contrary to the unequivocal language of the personal guaranty that, to be exempt from the guaranty, assets must be “expressly excluded.” The guaranty was fully capable of being effectively performed without the insertion of the term “proceeds.” Defendant could have inserted language extending the exclusion to any proceeds from the sale of his personal residence and he failed to do so. For this reason, the court concluded that the proceeds from the sale of the house were not exempt from being attached to satisfy the personal guaranty.

Lesson of the day – if you are negotiating or looking to enforce a personal guaranty with specific assets excluded, review the language carefully, as the exact wording of what’s excluded really matters. As a borrower, you would want to make sure not only “the proceeds from the sale” of an excluded asset are also excluded from the personal guaranty, but may want to go further and add “any assets purchased from the sale of such proceeds” are excluded as well. As a lender, you may want to approach this differently and restrict the category of excluded assets.