The Court of Appeals for the Seventh Circuit recently reinforced a fundamental principle for secured lending: A deficiency claim differs from a guaranty claim in important ways. And in this case, the difference was $17 million. In Inland Mortgage Capital Corp. v. Chivas Retail Partners, LLC, __F.3d__, 2014 WL 310355 (7th Cir. Jan. 29, 2014), the court affirmed a judgment against guarantors for the unpaid balance of a secured loan, even though a state court had extinguished any deficiency claim against the borrower.
In the Inland Mortgage case, the lender loaned $60 million for the development of a Georgia shopping center that was to be anchored by a national retailer. In addition to the standard security for such a loan, namely a mortgage on the property, the lender also received a guaranty from the principals. This guaranty stated that if the lender foreclosed on the property and the collateral was “worth more than the sale price,” the lender would still be able to collect from the guarantors. This was so, even if the foreclosure cut off any rights that the guarantors had to collect from the borrower. Id.at *1.
The anchor tenant never materialized and the borrower defaulted 14 months later. The lender foreclosed on the property and “bid-in” its lien at a public auction to take back the property for $7 million. The lender then sought to confirm the sale in Georgia state court. To do so, the lender had to rely on a statute that would permit confirmation of the sale only if the court was satisfied that the sale had brought its “true market value” — what the Seventh Circuit referred to as “a bit of Southern populism left over from the 1930s depression” and a “legislative fossil.” Id. at *2. After a hearing, the Georgia court ruled that the property was worth more than the $7 million that the lender paid for it (without stating how much more) and refused to confirm the sale.
The lender then sued the guarantors in federal court in Chicago and obtained a judgment for the unpaid balance in the amount of $17 million. On appeal, the guarantors argued that the judgment against them was a deficiency claim that the Georgia court had already extinguished. The Seventh Circuit disagreed and pointed out that a deficiency claim may be sought only against the borrower, and in this suit, the borrower was not a party. As such, there was nothing preventing a separate suit against the guarantors. Id. In addition, the guarantors argued that the $17 million judgment was a “windfall.” The Seventh Circuit rejected this argument as well, since not only was there no evidence of what the property was actually worth, the guaranty agreement itself “couldn’t be clearer” that the guarantors agreed to pay any unpaid balance, even if the collateral was worth more than the lender paid for it. Id.
The court concluded that if the guaranties could be erased simply because a lender buys collateral at foreclosure for less than its fair market value, then lenders would have the incentive to bypass the borrower and sue the guarantor first. The court observed that, “Guaranties would no longer back up creditors; instead they would give debtors a free pass.” And that would create a “topsy-turvy world.” Id. at *3.
While the Inland Mortgage decision did not address all the defenses that a guarantor may have, it does reinforce some basic principles for lenders:
- A guaranty stands on its own; a deficiency claim doesn’t undermine it.
- A guaranty’s language may enhance its enforceability after a deficiency claim arises.
- A lender may pursue recovery against the borrower before the guarantor.