Personal Guaranties in Construction Loan Defaults

I. Introduction

The subject of this article is the enforcement of personal guaranties in Tennessee. The guaranties involved relate to an equipment loan and a separate construction financing loan. Caterpillar Financial Services Corporation (Cat Financial) sued three individual guarantors for breach of contract arising out of personal guaranty agreements executed by each individual in favor of Cat Financial. The defendant guarantors raised certain, not atypical, affirmative defenses and counterclaims, the examination, and rejection, of which are discussed below.

II. Factual Background[1]

On Aug. 7, 2006, Cat Financial and Chub Cay Club Associates Ltd. entered into a loan agreement (equipment loan agreement), whereby Cat Financial loaned Chub Cay Club Associates in excess of $6.2 million to finance the purchase of equipment for use in connection with a resort development in the Bahamas, known as Chub Cay Club.

On Sept. 28, 2007, Cat Financial and Chub Cay Club Associates entered into a second loan, evidenced by a Construction Financing Agreement (construction loan), whereby Cat Financial agreed to loan Chub Cay Club Associates up to a maximum aggregate sum of $10.8 million, payable in construction draws, to finance construction at the resort.

Simultaneous with the execution of the Construction Financing Agreement, defendants Kaye Pearson (now deceased), Walt McCrory, and Bob Moss each executed a personal guaranty in favor of Cat Financial. The guaranties were identical and provided, in pertinent part:

SECTION 1. Guaranty of Obligor’s Indebtedness. Guarantor hereby absolutely, irrevocably, and unconditionally agrees to, and by these presents does hereby: (a) guarantee the prompt and punctual satisfaction of all present and future indebtedness and obligations of Obligor to Cat Financial which Obligor now owes to Cat Financial or which Obligor shall at any time or from time to time hereafter owe Cat Financial when the same shall become due in connection with or arising out of that certain Construction Finance Agreement dated AUG. 31, 2007 (the “CFA”), and whether representing, principal, interest and/or late charges or other charges of an original balance, an accelerated balance, a balance reduced by a part payment or a deficiency after sale of collateral or otherwise; and (b) undertake and guarantee to pay on demand and indemnify Cat Financial against all liabilities, losses, costs, attorneys’ fees and expenses which may be suffered by Cat Financial by reason of Obligor’s default or default of the Guarantor (with all of Obligor’s indebtedness and/or obligations as stated above [including all costs, fees and expenses] being hereinafter individually and collectively referred to under this Guaranty as Obligor’s “Indebtedness,” which indebtedness shall be conclusively presumed to have been created in reliance upon this Guaranty). THIS GUARANTY SHALL BE CONTINUING, ABSOLUTE AND UNCONDITIONAL. (emphasis in original)

Chub Cay Club Associates failed to make timely payment due under the Equipment Loan Agreement. That failure may have constituted an Event of Default under Section 6.1(A) of the Equipment Loan Agreement.[2] It did constitute a default under the Construction Loan. Section 8.01(a) of the Construction Financing Agreement defines an Event of Default as when the “Borrower shall fail to make payment of any amounts due under any Note at the time and in the manner specified.”

Although in their guaranties defendants expressly waived “presentment, protest, and demand,” Cat Financial by letters dated Feb. 8, 2008, advised each guarantor of Chub Cay Club Associates’ default and demanded payment in full of all amounts then due and owing, including engineering fees recoverable under the Construction Financing Agreement.

Defendants did not make payment under their guaranties.

III. The Legal Context

The parties did not dispute that the subject guaranties are governed by Tennessee law.[3]

Under Tennessee law, the interpretation of these guaranties, like any contract, is an issue of law, not fact. As the Tennessee Supreme Court explained in Planters Gin Co. v. Federal Compress & Warehouse Co.:[4]

In “resolving disputes concerning contract interpretation, our task is to ascertain the intention of the parties based upon the usual, natural, and ordinary meaning of the contractual language.” *

This determination of the intention of the parties is generally treated as a question of law because the words of the contract are definite and undisputed, and in deciding the legal effect of the words, there is no genuine factual issue left for a jury to decide.*[5]
(emphasis added)
(*Citation omitted)

Further, under Tennessee law, defendants’ personal guaranties are “special contracts.”[6] As Tennessee courts have explained, “a guarantor in a commercial transaction shall be held to the full extent of his engagements and … the words of a guaranty are to be taken as strongly against the guarantor as the sense will permit.” [7]

The guaranties regarding the Construction Finance Agreement are unambiguous.[8] By their express terms, defendants’ personal guaranties cover “present and future indebtedness.” Thus, there is no question regarding what was covered. Accordingly, following Tennessee law regarding the construction of guaranties of commercial loans, both the appellate and trial courts found defendants’ guaranties covered “all present” indebtedness, which included all amounts due under the Equipment Loan.

IV. The Defenses

The defendants raised six “standard” guarantor defenses: (1) plaintiffs were obligated to seek satisfaction by means other than the personal guaranties; (2) the guaranties were extinguished; (3) Chub Cay Associates was an indispensable party; (4) Cat Financial designated other remedies in the event of non-performance; (5) plaintiffs’ claims were barred by failure of consideration or fraud; (6) Cat Financial was not entitled to equitable relief.[9] The trial court for the reasons that follow disallowed the applicability of each defense.

A. The court rejected the defense that “[t]he intention of plaintiff and defendants was for the plaintiff to secure loans that it made to Chub Cay Club Associates by means other than personal guaranties of the defendants.” The court concluded intent of the parties is to be determined from the terms of the guaranties, which are to be given their plain and ordinary meaning, and taken against the defendants, as guarantors, as “strongly as the sense will permit.”[10] The guaranties expressly stated that Cat Financial may collect against guarantors without “first attempting to collect Obligor’s indebtedness from Obligor or from any other Obligor … or attempting to exercise any rights Cat Financial may have against any collateral.”[11] Accordingly, this defense failed as a matter of law.

B. Defendants next alleged as a defense the guaranties were extinguished after March 31, 2008 (the conversion date in the Construction Financing Agreement). Although Section 4.01 of the Construction Financing Agreement provides that “upon the Conversion Date, the [Personal Guaranties] shall also be cancelled and have no further effect,” the court found that Cat Financial demanded payment under the guaranties on Feb. 8, 2008, before the Conversion Date. This defense also failed as a matter of law.

C. The court likewise rejected the defense that Chub Cay Club Associates was an indispensable party in this matter. The defense was negated by Section 8 of guaranties which states that Cat Financial may commence an action against guarantors without the necessity of first “attempting to collect Obligor’s indebtedness from Obligor [Chub Cay Club Associates]” or “including Obligor or any Other Obligor as an additional party defendant in such a collection action against Guarantor.”

D. The defense that Cat Financial had designated and elected specific remedies in the event of non-performance by Chub Cay Club Associates (namely, the retainage created pursuant to the Construction Financing Agreement, a first lien on real estate, and the acceleration of that loan) was held deficient as a matter of law. Section 8 of the guaranties provides, in relevant part, that “Cat Financial may commence such a civil action against Guarantor without the necessity of first …. (iv) pursuing any other remedy in Cat Financial’s power.”

E. In their next defense, the guarantors alleged that “[b]y virtue of its contrived delays in completing documentation of the Construction Financing Agreement and bad faith delays in disbursing construction loan proceeds, Cat Financial’s claims are barred for failure of consideration or fraud in the inducement.” This defense, however, was waived as a matter of law by Section 7 of the Guaranties, which provides that defendants have waived “any defense which is premised on an alleged lack of consideration” and any claim of “fraud.” Moreover, as discussed below, the court found there were no issues of material fact with respect to disbursements of proceeds of the Construction Loan.

F. Finally, the guarantors asserted that Cat Financial was not entitled to equitable relief pursuant to the doctrine of unclean hands. Cat Financial, however, did not bring equitable claims, and moreover, unclean hands is not a defense for actions at law. “The ‘unclean hands’ doctrine provides that he who comes into equity must come with clean hands”[12] (emphasis in original). Because Cat Financial was only alleging legal claims, this defense was denied as a matter of law.

V. The Counterclaims

The defendants asserted a two-count counterclaim against Cat Financial, claiming (1) breach of the duty of good faith and fair dealing, and (2) deceptive and unfair trade practices under Tennessee law. Neither claim was sufficient to withstand summary final judgment relating to the Construction Financing Agreement. As an initial matter, pursuant to Section 7(m) of the Guaranties, guarantors expressly waived “all setoffs and counterclaims against Cat Financial.” Beyond the issue of waiver, the claims did not create a genuine issue of material fact or law.

In count I, guarantors claimed Cat Financial breached its duty of good faith and fair dealing “implied by the Loan Commitment, the Construction Financing Agreement, and applicable law.” The guarantors, however, lacked standing to sue. The guarantors were not parties to the commitment or the Construction Financing Agreement and, therefore, cannot sue for breach of implied duty of good faith and fair dealing. Thus, no breach claim may be asserted by these defendants based upon the loan documents.

The standing issue aside, guarantors cannot vary the terms of the Construction Financing Agreement by asserting an implied duty of good faith and fair dealing. As the Tennessee Court of Appeals explained in Goot v. Metropolitan Government of Nashville and Davidson County,[13] “[t]he implied obligation of good faith and fair dealing does not, however, create new contractual rights or obligations, nor can it be used to circumvent or alter the specific terms of the parties’ agreement.” At the summary judgment hearing in this matter, guarantors argued Cat Financial had a duty to provide construction funding unless there was reason not to do so. This contention is belied by the express terms of the Construction Financing Agreement. Article III of that agreement provides conditions precedent that Chub Cay Club Associates were required to satisfy before Cat Financial was obligated to fund any construction advances. Defendants did not establish by record evidence that Chub Cay Club Associates had satisfied the conditions precedent to trigger Cat Financial’s obligation to fund.

Guarantors’ claim for deceptive and unfair trade practices under Tenn. Statutes § 47-18-104 also failed. As explained in Commerce Federal Savings Bank v. Parten,[14] there is “nothing in the Act [§ 47-18-104] which proscribes the inaction of the lender, on the one hand, or requires it to explain the legal ramifications of commercial documents, on the other.” There was no record evidence that Cat Financial acted in any manner inconsistent with its obligations under the Construction Financing Agreement.

VI. Conclusion

The personal guaranties discussed in this article were unambiguous, comprehensive, and indeed not atypical. Moreover, neither the affirmative defenses nor the counterclaims created genuine issues of material fact, thus, permitting resolution as matters of law.

The courts’ rulings should have positive implications for litigants in construction loan financing agreements and be a warning to guarantors in such circumstances. The execution of a well-drafted guaranty brings with it real and likely, insurmountable risks in the context of a loan default.

Notes

  1. In Caterpillar Financial Services Corporation v. Kaye Pearson, Walt McCrory, and Bob Moss, Case No. 08-16700(07), the Circuit Court of the 17th Judicial Circuit, Broward County, Fla., considered the treatment of personal guaranties under applicable Tennessee law. The ruling in that case and in the appeal that followed provide the basis for this article.
  2. In Kaye Pearson and Bob Moss v. Caterpillar Financial Services Corp., Case No. 4D09-3655 (May 18, 2011), the 4th DCA found that it was unclear whether the Personal Guaranties applied to the Equipment Loan Agreement, but allowed regarding the Construction Loan Agreement guaranties.
  3. Tennessee law and Florida law are virtually identical regarding the obligations of guarantors. See e.g., West Flagler Associates v. Department of Revenue, 633 So. 2d 555 (Fla. 3d DCA 1994).
  4. Planters Gin Co. v. Federal Compress & Warehouse Co., 78 S.W.3d 885, 890-91 (Tenn. 2002).
  5. Id. at 890-91
  6. Id.
  7. Farmers-Peoples Bank v. Clemner, 519 S.W.2d 801, 804-05 (Tenn. 1975). See also Suntrust Bank East Tennessee N.A. v. Dorrough, 59 S.W.3d 153, 156 (Tenn. Ct. App. 2001); Squibb v. Smith, 948 S.W.2d 752, 755 (Tenn. Ct. App. 1997).
  8. In Pearson and Moss v. Caterpillar Financial, supra, the 4th DCA upheld the trial court’s determination that the Personal Guarantee clearly applied to the Construction Finance Agreeement.
  9. Defendants’ “First Defense” was their answer to Cat Financial’s complaint. Admissions and denials of the allegations of a complaint do not constitute a valid affirmative defense. See Rule 1.110(d), Fla. R. Civ. P.
  10. Farmers – Peoples Bank v. Clemner, supra.
  11. Section 8.
  12. Emmit v. Emmit, 174 S.W. 3d 248 (Tenn. Ct. App. 2005) (emphasis in the original). See also In re Estate of Boote, 2007 WL 4562896 (Tenn. Ct. App. 2007) (“the doctrine of unclean hands is a fundamental tenet of the courts of equity”).
  13. Goot v. Metropolitan Government of Nashville and Davidson County, 2005 WL 3031638 (Tenn. Ct. App. 2005).
  14. Commerce Federal Savings Bank v. Parten, 1989 WL 22726 (Tenn. Ct. App. 1989).

Judge Robert A. Rosenberg ROBERT A. ROSENBERG is circuit judge for the 17th Judicial Circuit of Florida in Fort Lauderdale. He received his law degree from the University of Wisconsin Law School in 1967. He is a former assistant U.S. attorney and chief of the Civil Division (Eastern District of Michigan and Southern District of Florida). He has been a guest lecturer, instructor, and/or panel member for The Florida Bar, American Bar Association, United States Department of Justice and the Federal Law Enforcement Training Center. He was visiting professor of comparative constitutional law at Ramkhamhaeng University, Bangkok, Thailand, in 2008.