Court Holds Guarantors Liable on Commercial Loan

In CADC/RAD Venture 2011 – I LLC v. Bradley, a California Appellate Court upheld the enforceability of commercial loan guarantees against the lenders. In CADC, Defendants sought to purchase undeveloped land in Napa, California, pursuant to an Internal Revenue Code Section 1031 Exchange. As part of the transaction, Defendants sought a loan in the amount of $2,100,000. However, Defendants transferred their interest in the property to a newly created LLC entitled Nohea Napa Gateway, LLC. Defendants were the managing members of that LLC. The purpose of the LLC was to protect the defendants against liabilities.

Several years later, there was a default on the loan and a foreclosure sale. The sale left $1,300,000 owing under the loans. The lender subsequently filed suit against the defendants for breach of written guarantees to recover on the loan deficiency. Defendants claim that the guarantees were unenforceable shams because the borrower and the guarantors are the same people/entity. Under anti-deficiency laws, a guarantor cannot be liable for a guarantee, if the guarantor and the borrower are one in the same.

The jury returned a verdict in favor of the defendants. The California Court of Appeals reversed, finding that the evidence did not support the jury’s finding that the guarantees were shams.

The Court held that if a borrower and a guarantor are the same, the guarantor is actually the principal obligor, and the guarantee is deemed unenforceable. That situation can happen where either: 1) the guarantor personally executes the underlying loan agreements or deeds of trusts; or 2) the guarantor is, in reality, the actual borrower under a different name by operation of a trust or corporate law, or other applicable legal principle.

In this case, the Court held that the defendants were not primary borrowers on the loan or deed of trust. Their LLC was the primary obligor. The Court held that the defendants may not take advantage of the corporate structure to subvert the anti-deficiency laws. Therefore, the Court found the guarantees to be valid and enforceable by the lender.

Shannon B. Jones, Partner, sbj@sbj-law.com