Risk is inherent in any loan. If a borrower defaults on its repayment obligations, the creditor is left searching for alternative avenues of recovery. The creditor can fortify its security position by having multiple entities promise repayment, either as borrower and co-borrower(s) or as borrower and guarantor(s). There are important differences between the co-borrower and guarantor status. This article examines those differences, as well as important considerations when deciding whether to have an additional party act as either a co-borrower or guarantor.
I. Differences Between a Co-Borrower and a Guarantor
Key differences between a co-borrower and a guarantor arise in (A) repayment obligations, (B) operative statutes of limitations, and (C) available defenses to a deficiency action.
A. Repayment Obligations
The fundamental difference between a co-borrower and a guarantor is that each has different and independent repayment obligations. The co-borrower has a primary obligation to repay the debt under the promissory note and is not a party to the guaranty. Vice versa, the guarantor is not a party to the promissory note, and therefore its contractual obligations differ from that of the co-borrower.(1)
A co-borrower is primarily liable to repay the debt. This means the co-borrower is obligated to make principal and interest payments as provided in the promissory note, and, upon a default, the creditor may seek repayment of the debt from the co-borrower regardless of whether the default was caused by the borrower or any of its fellow co-borrower(s).
A guarantor signs a guaranty document that provides security for repayment of the debt owed by the borrower(s) under the promissory note.(2) A guarantor is only secondarily liable to repay the borrower’s debt since the guaranty is a separate and independent contract.(3) Thus, in order to collect repayment from a guarantor, the creditor must first prove a default by the borrower. Although the creditor must show the borrower has defaulted, it does not necessarily follow that the creditor must also exhaust all remedies against the borrower before enforcing repayment under the guaranty.(4) Typically the guaranty will allow the creditor the option to seek repayment from the guarantor before, or at the same time that, it seeks repayment from the borrower.
B. Statute of Limitations
The operative statute of limitations for a deficiency judgment is another important difference. In Nebraska, the trustee under a deed of trust may foreclose on real property securing the promissory note either through formal court processes, a “judicial foreclosure,” or exercising its power of sale granted in the deed of trust, otherwise known as “non-judicial foreclosure.” When the proceeds from a sale following a judicial or non-judicial foreclosure fails to cover the full amount of the outstanding indebtedness, the creditor may, under certain circumstances, bring an action to recover the amount of the deficiency from the borrower and/or the guarantor (commonly known as a “deficiency judgment” or “deficiency action”).(5) The Nebraska Trust Deeds Act (the “Act”)(6) requires a creditor to file a claim against the borrower for a deficiency judgment within three months after a non-judicial foreclosure, whereas, under Nebraska’s general statute of limitations for written contracts, the creditor has five years following a non-judicial foreclosure to file such a claim against a guarantor.(7) The creditor, therefore, must act quickly to collect a deficiency from a borrower, whereas timing is not so crucial concerning a guarantor.
It is important to note that the foregoing discussion applies only in circumstances of non-judicial foreclosures. The general five-year statute of limitations in Nebraska for written contracts applies to deficiency actions brought after a judicial foreclosure.(8)
Certain defenses are made available under the Act to co-borrowers in the context of deficiency actions, which are not similarly available to guarantors. This is because the Act only applies to actions concerning obligations secured by a deed of trust, such as a borrower’s obligations under a secured promissory note.(9) One significant right granted the borrower in the context of a deficiency action is that the court must determine the fair market value of the property foreclosed upon before entering a deficiency judgment against the borrower.(10) The court must then limit its judgment to the amount by which the outstanding indebtedness, plus interest and the costs and expenses associated with the foreclosure sale, exceeds the fair market value of the property as of the date of such sale.(11) There is no fair market valuation requirement in a deficiency action against a guarantor because the Act does not apply to an action based on a guaranty.(12)
Guarantors also have defenses that are not available to co-borrowers. However, the guaranty typically includes a myriad of waivers that effectively negate many of these defenses.
II. Choosing Between a Co-Borrower and a Guarantor
When deciding whether to have a third-party affiliated with the primary borrower act as a co-borrower or a guarantor, a good way to gauge the correct structure is to ask: who will receive and use the money? A simple example is a loan to a limited liability company with individual members holding all membership interests in the company. If the company, not its members, will receive all the loan funds directly and use the funds for its business operations, the company should be the sole borrower, and its members should guaranty the loan.
Should the creditor decide to have a third party act as a guarantor, it should seek to obtain an unlimited guaranty from the guarantor and, if more than one guarantor, have all the guarantors agree to be jointly and severally liable for the entire amount of the loan. This maximizes the recovery the creditor can obtain from each guarantor. In the event the creditor needs to seek repayment from the guarantors, it would then have the option of (i) filing a suit naming all the guarantors jointly, (ii) naming any one of them individually, or (iii) naming more than one, but not all, of the guarantors together. In any case, the creditor may obtain a judgment against any one or more of the guarantors for the entire amount of the debt still owed.
If the guarantors do not agree to an unlimited guaranty that makes them jointly and severally liable for the entire debt, the creditor could propose the guarantors still agree to joint and several liability but cap the recovery amount. The cap could be the same for each guarantor, or it could vary among the guarantors, and it could be set as a specific dollar amount or as a certain percentage of the loan. This would still allow the creditor the option of suing all the guarantors in one lawsuit, or each one individually. However, the amount the creditor could ultimately collect from each guarantor would then be limited by the relevant cap agreed to in the guaranty.
Austin S. Graves is an Associate Attorney at Baird Holm LLP in Omaha, Nebraska. His practice focuses on various aspects of corporate law.
(1)Boxum v. Munce, 16 Neb.App. 731, 740, 751 N.W.2d 657, 663 (2008) (citing National Bank of Commerce Trust & Sav. Assn. v. Katleman, 201 Neb. 165, 266 N.W.2d 736 (1978); In re Estate of Williams, 148 Neb. 208, 26 N.W.2d 847 (1947)).
(2)See Mutual of Omaha Bank v. Murante, 285 Neb. 747, 752, 829 N.W.2d 676, 681 (2013).
(3)Id. (citing NEBCO, Inc. v. Adams, 270 Neb. 484, 704 N.W.2d 777 (2005)).
(4)See Id. at 753-54, 829 N.W.2d at 681-82 (the Supreme Court of Nebraska found that the terms of a guaranty permitted the lender to enforce payment under the guaranty without first exhausting its remedies against the borrower).
(5)See First Nat. Bank of Omaha v. Davey, 285 Neb. 835, 839-40, 830 N.W.2d 63, 67 (2013).
(6)NEB. REV. STAT. §§ 76-1001–76-1018 (2020).
(7)NEB. REV. STAT. §§ 76-205(1) and 76-1013 (2020).
(8)Davey, 285 Neb. at 846-47, 830 N.W.2d at 71.
(9)Murante, 285 Neb. at 752, 829 N.W.2d at 681.
(10)NEB. REV. STAT. § 76-1013 (2020).
(12)Murante, 285 Neb. at 752, 829 N.W.2d at 681.