Obligations reduced to a promissory note are often accompanied by a written guaranty.  The law treats the guaranty as an independent obligation.

A case recently decided by California’s First District Court of Appeal — Sterling Pacific Lending, Inc. v. Holman — addressed guaranty liability and the question of whether the assignment of a note automatically assigns the guaranty too.  While the case was not published (and therefore cannot be cited as precedent), it still provides useful guidance.

Facts: lender assigns note but not the related guaranty; sues to enforce guaranty

Sterling Pacific Lending, Inc. made a $1.3 million loan to borrower Aromas Heritage Oaks, LLC secured by a deed of trust on real property in Aromas, California.  Each of the LLC’s four members (including defendant Wayne Holman) signed a guaranty of the note.  The guaranties were made “for the benefit” of Sterling, and stated that each guarantor would pay “all amounts due under the Note.”

Soon after Sterling funded the loan, it sold interests in the note (totaling 99.2 percent) to several investors, retaining a .8 percent interest in the note for itself.  Sterling then entered into a loan servicing agreement with the investors.  The assignments of the note interests did not convey any rights under the guaranties.

Within two years, the loan fell into default.  Sterling, as the loan servicer, conducted a nonjudicial foreclosure sale of the property, leaving a deficiency under the note of around $1 million.

Sterling sued each of the guarantors under the guaranties to recover the deficiency.  Three of the guarantors settled with Sterling, leaving Holman as the lone defendant at the time of trial.

Trial court: Assignment of note impaired recovery on the guaranty

The trial court ruled that Sterling was entitled to recover only .8 percent of the outstanding loan deficiency “because that’s all it retained after having transferred fractionalized interests to other investors.”  The court then offset against that amount the entirety of the amounts received in settlement from the other guarantors, which far exceeded Sterling’s .8 percent share of the deficiency.

As such, the trial court’s judgment held that Sterling would recover nothing on the guaranty, and awarded Holman $267,000 in attorney fees as the prevailing party.

Sterling appealed.

Court of Appeal: reversed; guaranty is an independent obligation

The Court of Appeal reversed, holding the trial court erred in failing to allow Sterling to recover the entirety of the loan deficiency from Holman (less the payments received in settlement from the other guarantors).

The court acknowledged that under California’s anti-deficiency statutes (including Code of Civil Procedure section 580d), the nonjudicial foreclosure sale of the property securing the note extinguished any further obligations of the borrower LLC under the note.  Neither Sterling nor any of its investors had any right to recover under the note, and Sterling did not contend otherwise – it sued solely on the guaranties.

As to the guaranties, the court found the “law is clear” that “a loan guaranty creates an obligation independent of the debt secured that is not affected by the antideficiency statutes.”  As such, Sterling retained its ability to recover the unpaid note balance pursuant to the Holman guaranty.

The court found there was no evidence that Sterling transferred its rights in the guaranties to the investors or any other party.  To the contrary, Sterling’s principal testified that it intentionally retained full rights in the guaranties in order to carry out its duties as the loan servicer.

The court rejected Holman’s argument that Sterling’s assignment of interests in the note to the investors automatically transferred the interests in the guaranties.  No authorities supported such a “deemed transfer.”  The court also rejected Holman’s argument that the assignment of the note “discharged” the guaranty, finding the argument unsupported by case law.

Further, the court found there was no risk of “imposing a double liability for the same obligation” because the LLC’s obligations under the note (now owned mostly by the investors) had already been extinguished by the foreclosure sale, and the investors were not parties to the guaranty so could not separately enforce it against Holman.

The court concluded that “Sterling was entitled to the remedy specified by the guaranty, which is recovery of the entirety of the deficiency.”  The court ordered that judgment be entered against Holman for the full deficiency under the note, less the sums received in settlement from the other guarantors, with Sterling deemed the prevailing party for a potential award of costs and attorney fees.

Lesson

While the Sterling Pacific case was not published, it serves as a reminder that a guaranty creates an obligation independent of the note debt.  An assignment of a note doesn’t automatically assign the guaranty too.

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