A recent Illinois Supreme Court case illustrates that old common law terms, although obscured by misuse and disuse, may still have critical definitions which could have important implications, particularly for creditors relying on personal guaranties. (JPMorgan Chase Bank, N.A. v. Earth Foods, Inc. Illinois Supreme Court, No. 107682, October 21, 2010)
In 2001, JPMorgan Chase Bank extended a line of credit to Earth Foods, Inc. All three co-owners personally guaranteed the loan. On April 3, 2003, one of the co-owners and personal guarantors, Leonard DeFranco, sent the Bank a letter. The letter warned that Earth Foods was depleting the inventory which served as collateral and demanded the Bank take action. Earth Foods stopped making payments to the Bank in February 2004 and, on April 23, 2004, more than one year after Mr. DeFranco's warning, the Bank sent a notice of default and demand for payment.
Of course, the Bank also sought to enforce the personal guaranties. But Mr. DeFranco fought back. He claimed an affirmative defense under the Illinois Sureties Act (740 ILCS 155/1 (West 2000)). Under the Sureties Act, a surety is given the right to require a creditor to take action when the principal (here, Earth Foods) "is likely to become insolvent." If the creditor fails to do so within a reasonable time, the surety can be discharged. Mr. DeFranco argued that he was discharged by the protections in the Sureties Act.
The circuit/trial court disagreed with Mr. DeFranco. It concluded that Mr. DeFranco was a guarantor and not a surety. Therefore, the Sureties Act was inapplicable. The circuit court granted summary judgment to the Bank. The lower appellate court took a different approach. It concluded that "surety" under the Sureties Act included both a guarantor and a surety. It remanded the case back to the circuit court. However, in the meantime, the Illinois Supreme Court granted the Bank's petition to appeal.
In its opinion, the Illinois Supreme Court spent considerable time discussing the historic distinction between sureties and guarantors, although it acknowledged that current usage has blurred the distinction. But the Court found that, in spite of current usage, it was required to recognize the distinction. In doing so, the Court went way back in time.
The Court noted that the Sureties Act is descended from a statute passed in 1819, with different language but the same effect. The Sureties Act language has been modified and updated, most recently in 1985, but the policy and purpose never changed.
Citing treatises and cases from the 19th century and early 20th century, the Court noted the historic distinction between a guarantor and a surety. As one example, the Court quoted Corpus Juris: "A surety is an insurer of the debt or obligation, while a guarantor is an insurer of the ability or solvency of the principal." (28 C.J. Sections 4 and 5 at 890-891 (1922)). Similarly, the Court cited a 1934 Illinois case: "The true distinction seems to be that a surety is in the first instance answerable for the debt for which he makes himself responsible, while a guarantor is only liable where default is made by the party whose undertaking is guaranteed." (Vermont Marble Co. v. Bayne, 356 Ill. 127 (1934)).
According to the Court (citing a suretyship treatise), at common law, the surety had no right to require the creditor to take action against the principal. So the surety was not discharged, even if the creditor neglected or failed to take action. As a result, many states, including Illinois, passed statutes like the Sureties Act to give the surety protections unavailable at common law.
So, is Mr. DeFranco a surety and able to use the Sureties Act to avoid his "personal guaranty?" Or is Mr. DeFranco a guarantor with primary liability? For a business lawyer, this is where the Court's opinion becomes problematic.
The Court remanded the case for further proceedings to give Mr. DeFranco an opportunity to develop his argument as to whether he was a surety or a guarantor. The Court even suggested parol evidence may be necessary for this purpose. "Thus, the more general meaning of the word "guarantee" often used in business contexts may require courts to consider evidence outside the language used in the document to determine whether the parties intended to create a guaranty or surety."
The Court indicated that the written agreement signed by Mr. DeFranco referred to a "guarantee." But, in other respects, the Court's opinion left out some facts and background that would have been helpful to business lawyers. In a commercial context, guaranties (in the generic sense) generally are self-contained documents with an integration clause. The Court does not indicate whether the guaranty at issue in this case contained an integration clause.
Moreover, most standard form guaranties contain waivers by the guarantor of the type of conduct or nonaction allegedly committed by the Bank. The Court's opinion is silent on this also. In most guaranties, the guarantor's obligation is unconditional, primary and direct, and not dependent on the principal's insolvency or inability to pay, but there is no indication if this provision was in the guaranty agreement at issue.
As we have seen with the recent allegations of improper mortgage documentation by banks, it is not inconceivable that the Bank's form of guarantee was not well drafted or failed to contain some standard commercial terms. But this cannot be assumed.
So an attorney representing a creditor must now be concerned about the potential application of the Sureties Act, regardless of the term used in the document and perhaps even regardless of explicit waivers in the document. As the case illustrates, common law terms can still have viability with real effects in commercial transactions.