Draft Carefully to Avoid the Inadvertent Discharge of Your Borrower’s Surety
With foreclsure moratoria behind us, inflation and interest rates on the rise, and the Country seemingly headed toward another recession, post-COVID debt collection activity is ramping up. Accordingly, lenders and creditors must remain vigilant to avoid inadvertent missteps that may compromise their ability to collect on their debts. This includes not only from principal debtors, but from guarantors and other sureties of those debts, as well.
One potential trap for the unwary creditor is found in O.C.G.A. § 10-7-22, which provides as follows:
Any act of the creditor, either before or after judgment against the principal, which injures the surety or increases his risk or exposes him to greater liability shall discharge him; a mere failure by the creditor to sue as soon as the law allows or neglect to prosecute with vigor his legal remedies, unless for a consideration, shall not release the surety.
Under this statute, a surety of a debt (e.g., a personal guarantor of a mortgage loan, lease, etc.) has a potential get-out-of-jail-free card where the creditor commits “any act” that “injures the surety or increases his risk or exposes him to greater liability.” At first blush, this language appears extremely broad and likely to provide an infinite well of debt discharging fact patterns for the astute guarantor. However, existing case law indicates that this escape hatch is one that may not so easily be opened. Moreover, the cases make clear that with careful drafting, a lender may avoid the harsh effects of the statute in advance by including simple but broad waiver language in the guaranty.
The most recent example comes from the United States District Court for the Northern District of Georgia. In Mgmt. Advisory Servs., Inc. v. Brennan, 4:21-CV-47-TWT, 2022 WL 2967612 (N.D. Ga. July 26, 2022), the Defendant, Brennan, had personally guaranteed a loan on behalf of his corporation. Brennan had also been married to the daughter of the plaintiff’s owner and managing partner, Sovey. Unsurprisingly, matters took a turn for the worse when the corporate borrower defaulted on the loan and Brennan’s marriage to Sovey’s daughter failed. Ultimately, the lender sued the corporation on the promissory note and sued Brennan on his guaranty. Both defendants counter claimed for breach of fiduciary duty based on various events during “Brennan’s long familial and business relationship with Sovey, including prior loans requested from Sovey and funded by the Plaintiff.” Id. at *4. Brennan also argued that the same breaches of fiduciary duty by Plaintiff increased his risk as guarantor under O.C.G.A. § 10-7-22, and that he should therefore be discharged from liability. The Court had little difficulty in rejecting this argument. It began its analysis under the following general rule:
[a] creditor in possession of a valid and signed promissory note has a prima facie right to repayment, unless the debtor can establish a valid defense. A debtor cannot defeat this prima facie right of repayment by denying the debt for general reasons; it must assert a valid affirmative defense, such as estoppel or illegality.
Id. at *2 (emphasis added).
First, the Court noted that “breach of fiduciary duty is a standalone claim in Georgia rather than an affirmative defense.” Id. at *3. Therefore, such a claim could not relieve either defendant from their obligations to pay under an otherwise valid promissory note.
While this conclusion, alone, would have been fatal to Brennan’s defense, the Court also looked to the terms of the guaranty itself. That instrument provided that Brennan “unconditionally guaranteed all the obligations of the Borrower” under the promissory note. The Court applied the common meaning to the term “unconditional” to conclude that “Brennan guaranteed [the corporation’s] obligations without conditions.” Id. Then, in ultimately holding that O.C.G.A. § 10-7-22 did not apply, the Court reasoned as follows:
Here, Brennan is essentially asking the Court to consider extrinsic evidence of his familial and business relationship with Sovey—the Plaintiff’s owner and managing partner—to find a condition in that guaranty that Brennan would guarantee Engineered Attachments’ obligation on the Promissory Note so long as Sovey did not increase his risk under the guaranty. But the law does not allow the Court to do so.
Implicit in the Court’s holding is that a surety may waive the protections of the statute in advance. That is, in finding that the “increased risk” provision of the statute would operate as a condition that conflicted with the “unconditional” guarantee, the Court confirmed that the potential escape clause in O.C.G.A. § 10-7-22 can be eliminated entirely at the drafting stage. The Court’s simple but powerful conclusion, which was based on the single word “unconditional,” is consistent with other case law providing the more general rule that “a party may consent in advance to the conduct of future transactions and will not be heard to ‘claim his own discharge’ upon the occurrence of that conduct.” See Fielbon Developmment Co., LLC v. Colony Bank of Houston County, 290 Ga. App. 847, 854 (2008) (quoting Panasonic Indus. Co. V. Hall, 197 Ga. App 860 (1990), where the broad terms of guarantee operated as a consent for the secured lender to file its financing statements in the wrong county, thereby allowing another creditor to obtain a superior claim to the collateral and increasing the guarantor’s risk.)
Ultimately, these cases provide a roadmap for lenders to ensure that the promises of their borrowers’ guarantors remain meaningful, and their just debts remain collectible. Although the statutory language is broad and potentially foreboding when determining when, whether, and how to pursue collection of a debt from a primary debtor, careful drafting of the guaranty at origination can ensure that the lender is not left without a remedy if its initial efforts to collect are unsuccessful.