Pub. 9 2014-2015 Issue 6

www.nebankers.org 22 Extraordinary Service for Extraordinary Members. O NE OF A LENDER’S PRIMARY concerns whenmaking a loan is whether the lender is suffi- ciently protected in the event of a default. Lenders have various ways of reducing their risk, including requir- ing third-party guaranties. A guaranty is simply a promise to an- swer for another person’s debt, default, or failure to perform. 1 Stated another way, a guaranty is an undertaking by a guarantor to answer for payment of some debt, or performance of some contract, of another person in the event of default. 2 When the guaranty takes the form of a pledge of collateral, it is com- monly known as a hypothecation agree- ment. Typically, there is no question The Defense of “No Consideration” and Holding Guarantors to Their Contractual Obligations Kent Endacott , Endacott Peetz & Timmer PC LLO as to the binding effect of a guaranty. However, once there is a default and the guarantor is on the hook, you can bet the guarantor (or its counsel) will look for ways to invalidate the guaranty. One defense often argued by a guar- antor’s counsel—or by a competing creditor or perhaps a bankruptcy trust- ee—is that the guaranty fails for lack of consideration. Like any other contract, a guaranty or hypothecation agreement must be supported by consideration to be enforceable. Consideration, in the legal sense, means the existence of some benefit to one of the contract parties or a detriment to the other, which is sufficient enough to support the agreement between the parties. 3 While some guaranties are founded on separate consideration that flows to the guarantor, typically there is not a direct benefit to the guarantor, nor must there be. 4 The consideration usually consists of a benefit to the primary debtor or a detriment to the creditor. 5 The existence of consideration is important because, without it, a lender cannot enforce the guaranty. A guaranty without consideration is merely an unenforceable gratuitous promise, 6 and a guarantor who can successfully argue a failure of consider- ation may be able to overturn or delay enforcement of the guaranty. A guaran- tor will often claim, for example, that the guarantor did not receive the loan proceeds directly, and thus there was no consideration. 7 Or, a guarantor will reason that the consideration is “past consideration”—that the agreement was merely to perform one’s preexist- ing contractual obligations or to pay another’s existing debt. 8 This latter argument often arises where a lender has made subsequent loans to a debtor pursuant to a future advances clause. To avoid such a “consideration roadblock,” a lender should be well- informed as to just what constitutes sufficient consideration. When docu- mented correctly, courts have found that the renewal or extension of a note; the extension of the time for payment; the extension of additional credit; the creditor’s agreement to continue do- ing business with the primary debtor; the creditor’s compromise of a claim against the debtor; a reduction in the guarantor’s annual loan payments; and the release of a previous guaranty all constitute sufficient consideration to support the guaranty. 9 1 38 AM. JUR. 2D Guaranty § 1 (2010). 2 Id. 3 Hastings State Bank v. Misle, 282 Neb. 1, 9 (2011). 4 38 AM. JUR. 2D Guaranty § 29 (2010). 5 Id. In fact, the obligee’s reliance on the guaranty is a sufficient detriment. Id. 6 Anthony J. Jacob, Aric T. Stienessen & Jeremy D. Duffy, Enforcing the Commercial Guaranty Agreement, COM. L. NEWSL., Winter 2011, at 2, 4, available at http://apps.americanbar.org/buslaw/committees/CL190000pub/newsletter/201112/201112_commercial_law _newsletter.pdf. 7 Id. at 2. 8 38 AM. JUR. 2D Guaranty § 31 (2010). 9 Id. § 29. In addition to these examples, a key point to keep in mind is that while some guaranties are founded on separate consideration than the underlying credit transaction, which flows to the guarantor, the guarantor need not receive a direct benefit for consideration to exist. Id. The consideration usually consists of a benefit to the primary debtor or a detriment to the creditor. Id. In fact, the obligee’s reliance on the guaranty is a sufficient detriment. Id.