By Dennis H. Doss
A personal guaranty is a powerful tool in the hands of a sharp hard money lender. Frequently borrowers seek to minimize their risk by putting their properties into entities. They can bankrupt the entities to forestall foreclosure without taking personal hits. Once the private money lender has foreclosed, they can walk away unscathed.
Savvy hard money lenders are aware of this strategy so they require personal guarantees. Not only does a guaranty open up the possibility of recourse after a foreclosure sale, but the hard money lender has the ability to go after the individual’s assets notwithstanding the bankruptcy of the entity borrower. The fastest way to get a defaulting borrower to the bargaining table is to sue the guarantor while foreclosure against his or her real estate is pending and then seek a pre-judgment writ of attachment that ties up all of his or her personal assets such as bank accounts. The writ can even be recorded to tie up title to every piece of property the guarantor owns. Ouch! Now that is a real attention getter!
But all too often we see mistakes in the way private money guaranties are written and utilized, negating all the good they can do.
Mistake Number 1: Omitting statutory waiver language from California Civil Code Section 2856.
Section 2856 provides the exact wording (“magic words”) for an effective waiver of a multitude of the guarantor’s rights that would otherwise defeat the guaranty, including their rights of subrogation, reimbursement, indemnification, contribution, election of remedies, and rights under Sections 580a, 580b, 580d, or 726 of the Code of Civil Procedure. All a smart hard money lender has to do is simply include the statutory language in his or her form of guaranty:
“The guarantor waives all rights and defenses that the guarantor may have because the debtor’s debt is secured by real property. This means, among other things:
(1) The creditor may collect from the guarantor without first foreclosing on any real or personal property collateral pledged by the debtor.
(2) If the creditor forecloses on any real property collateral pledged by the debtor:
(A) The amount of the debt may be reduced only by the price for which that collateral is sold at the foreclosure sale, even if the collateral is worth more than the sale price.
(B) The creditor may collect from the guarantor even if the creditor, by foreclosing on the real property collateral, has destroyed any right the guarantor may have to collect from the debtor.
This is an unconditional and irrevocable waiver of any rights and defenses the guarantor may have because the debtor’s debt is secured by real property. These rights and defenses include, but are not limited to, any rights or defenses based upon Section 580a, 580b, 580d, or 726 of the Code of Civil Procedure.”
So check your guaranty form and make sure it has exactly the above language. The Legislature gave you this gift or certainty—don’t ignore it and take your chances that your waiver language will pass the grade in court.
Mistake Number 2: Full credit bid of a loan with a guaranty.
A full credit bid at a foreclosure sale precludes the hard money lender from seeking a deficiency against a guarantor. When you make a full credit bid, the law considers that you have been paid in full. You don’t have a deficiency; you are presumed to have been paid in full. You have also inadvertently let your guarantor off the hook. Never credit bid more than required to get a property back in foreclosure. The only exception to this rule is when there is an IRS lien on the property. The IRS has 120 days to redeem the property (rare) from you for the amount of your bid. So in that case, credit bid what you would be willing to accept for the property, but not more or less.
Mistake Number 3: Modifying the debt without guarantor consent.
If you change the underlying debt in any way through an extension, new advances, forbearance or other change, and you don’t get the guarantor’s written consent and confirmation that the new debt is still guaranteed, you might be giving the guarantor an excuse to void the guaranty. Yes, I know your guaranty form says you can do these things, but if you harm the guarantor in any way without consent, expect a judge to protect the guarantor.
Mistake Number 4: Requiring the borrower to put title into a sham entity.
California courts have refused to enforce personal guarantees where the lender took an active role is requiring the borrower to put their property into a new entity so the lender could get a personal guaranty from the entity’s owners. This attempt to bypass many of California’s anti-deficiency rules is the essence of the “sham guaranty defense.” If the lender structured the transaction this way, it better be prepared to fight an uphill battle to enforce any resulting guaranty.
This article is intended as educational material not legal advice. Consult a knowledgeable lawyer before implementing any of the ideas in this publication.