A guaranty often serves as a critical supporting obligation for a loan and a lender must be certain to preserve the rights of the lender arising under that guaranty. If the borrower and the lender enter into a modification of the underlying guaranteed obligation, no matter how routine that modification may seem, the modification could result in the discharge of the surety and the value of that supporting obligation would be lost.

A lender may avoid losing the value of the guaranty by securing the consent of the surety to any modification of the underlying guaranteed obligation and having the surety reaffirm its guaranty of the underlying guaranteed obligation, as so amended. There are occasions, however, when a lender may fail to secure a surety’s contemporaneous consent to the modification of an underlying loan. This article discusses how a surety’s consent (or lack thereof) to a modification of the underlying obligation will be treated under California, Illinois, Massachusetts, and New York law.

As an initial matter, most guaranties granted in a commercial real estate context include an advance waiver of the right to notice of, and consent to, any future modification of the underlying guaranteed obligation. Such advance waivers generally are enforceable in Illinois, Massachusetts, and New York (collectively, the “Common Law States”), although a lender only should rely on an advance waiver that clearly evidences the Guarantor’s intent to waive its suretyship defenses. For example, language to the effect that a guaranty is “absolute” or “unconditional” would not be sufficient to waive a guarantor’s suretyship defenses, but a statement that the guarantor “waives all suretyship defenses” likely would be effective. This also is true in California, where California Civil Code § 2856 provides that the surety may provide an advance waiver of any of certain enumerated defenses (including the modification of the underlying obligation) so long as there is a “contractual provision that expresses an intent to waive” its rights thereunder. The waiver need not refer to any statutory provisions or contain any specific language, although in practice, many guaranties refer to both §2856, as the authority for the waiver, and to the provisions of the California Civil Code that are being waived. In addition, §2856 provides examples of language that may be used to waive defenses arising by reason of an election of remedies by the lender and because the loan is secured by real property.

When the lender fails to obtain the surety’s advance or contemporaneous consent to a modification of the underlying obligation, the lender must rely on state laws related to suretyship defenses which, in this case, are generally not favorable to the lender. The Common Law States separate sureties into two primary classifications: compensated sureties and gratuitous sureties. This distinction is significant because courts in the Common Law States apply different standards when determining whether a surety is released from its obligation because the borrower and lender have modified the underlying obligation. A compensated surety is one who acts as a surety for pecuniary profit or receives consideration in exchange for its promise, such as a construction bonding company. Meanwhile, a gratuitous surety is one who does not receive consideration for its promise to act as a surety on behalf of the borrower. In the context of a commercial real estate transaction, a guarantor is almost always considered to be a gratuitous surety because an “indirect benefit”, such as that which accrues to a sole shareholder, does not constitute consideration making the shareholder/guarantor a “compensated” surety.

Generally, a gratuitous surety is discharged if there is any change made in the underlying obligation without its consent although, provided that under the laws of many states, including Illinois, a change must be “material” to effect a discharge. The courts’ rationale is that a gratuitous surety has agreed to act as a surety as an accommodation to the borrower and, therefore, its obligation should not be modified in any way without its consent. In any event, if a lender does not obtain the advance or concurrent consent to any modification of the underlying obligations, then a lender always may argue that those changes are not material (or in fact benefit the guarantor) or that the guarantor implicitly consented to those changes, but these arguments are primarily factual in nature and are therefore subject to judicial discretion.

In California, a surety is defined by statute as “one who promises to answer for the debt, default, or miscarriage of another, or hypothecates property as security therefor.” Unlike the Common Law States, California’s statute does not recognize a distinction between a compensated and uncompensated surety. California Civil Code § 2819 states that “a surety is exonerated, except so far as he or she may be indemnified by the principal, if by any act of the creditor, without the consent of the surety, the original obligation of the principal is altered in any respect, or the remedies or rights of the creditor against the principal, in respect thereto, [are] in any way impaired or suspended.”

In practice, the California courts have not always applied § 2819 literally. In Texaco Refining v. Aetna Casualty & Surety, 895 F.2d 637, 639 (1990), the court stated “if there has been a change in the contract in any material respect, the inquiry there ends.” (emphasis added). The materiality of the change depends upon whether or not the change works any alteration in the meaning or legal effect of the contract. For example, transforming an immediate obligation to pay into an obligation that is enforceable only according to a schedule of deferred payment is a material change and any contract for an extension for a definite period between the creditor and the borrower, without the assent of the surety, is deemed to be a material change to the agreement.

Overall, if a lender and a borrower negotiate any modification to their loan, the best practice for a lender is to obtain the guarantor’s consent and a reaffirmation of its guaranty. As discussed above, a consent given in advance generally is enforceable, but this practice is preferable because it eliminates the possibility that the guarantor can argue that an intervening event has somehow negated such consent. It is worth noting, however, that if the existing guaranty includes a waiver of defenses (or otherwise provides that such consent and reaffirmation is not necessary), then the lender should require the guarantor to acknowledge that the guarantor’s consent and reaffirmation is not required by the terms of the guaranty and that it is granting its consent and reaffirming its guaranty solely to avoid any future disputes. Otherwise, a guarantor could refuse to grant its consent and then later argue that the lender, by its actions, established that the guarantor’s consent to any modification of the underlying obligation was necessary and that the failure to obtain its consent results in the discharge of the guaranty. Ultimately, obtaining at least some form of consent is critical, because absent any such consent, the lender clearly runs the risk of losing the value of the guaranty.

The preceding is an abridged version of this article. Please contact the authors directly for a copy of the complete article, including extensive statutory and case citations.