Then the California one-action and antideficiency laws add another layer of hurdles. California’s antideficiency laws protect the borrowers, in loans secured by California real property, from liability for any deficiency after the realty collateral is sold in a nonjudicial foreclosure (trustee’s sale). In other words, if the lender forecloses nonjudicially on a borrower’s property, it cannot go after the borrower for the deficiency. (There’s almost always a deficiency in commercial real estate foreclosures, as there are usually few bidders and the foreclosing lender very often is the sole – and successful – bidder. Everyone else has to pay cash, but the foreclosing lender just “pays” in some amount of their debt.)

Judicial foreclosures, on the other hand, generally (with a few exceptions) allow collection of any deficiency from the borrower. But lenders rarely use them, and prefer nonjudicial trustee's sales, for two reasons. First, trustee’s sales are much faster, often being completed in about 4 months. Second, nonjudicial foreclosures are much less expensive (requiring no court hearings). Enforcing lenders who follow the nonjudicial foreclosure path give up their right to a deficiency against the borrower, and so must look somewhere else for it – to the guarantors.

Under California case law, a guarantor is entitled to the same antideficiency protections as borrowers – unless the guarantor signs an effective waiver, in which case the lender can go after the guarantor for the balance, if the foreclosure sale doesn't fully pay off the secured debt. This is virtually always what the lender wants to do.

So what’s an effective waiver? That question troubled California courts for 15 – 20 years, resulting in a number of contradictory cases which set differing standards for how much detail was required – to make sure the guarantors were really understanding the consequences of the waivers they were signing. The California legislature finally provided some help by passing Civil Code Section 2856 in 1994. Section 2856 explicitly approves some kinds of guarantor waivers for anti-deficiency and related rights, providing "safe harbor" language for some, and at least acknowledging the possibility of others. So drafting enforceable guarantees in California real estate deals still requires careful writing. When deal documents come from outside of California, often the guarantees may omit the needed clauses, and have little chance of full enforcement here.

Other than omitting the necessary waiver terms, how else do guarantees get screwed up?

Guaranty is secured by the deed of trust. If the guaranty is secured by the deed of trust, then the guarantor is a primary obligor (like the borrower), and the guaranty is a secured obligation; so the guarantor will be entitled to antideficiency and one-action protections. It’s surprising how many documents we’ve seen lately, where a guaranty is defined as one of the “Loan Documents” – and where "all of the Loan Documents" are expressly secured by the deed of trust. A sharp guarantor’s counsel who notices this may wait until the lender completes nonjudicial foreclosure on the property, then convince a court that the lender has no further right to seek payment of the deficiency by enforcing the guaranty – or any other secured right. Oops.

Borrower and guarantor are jointly and severally liable. Sometimes a guarantor party is made a co-obligor, or jointly liable, in one or more of the set of related loan documents that define the deal. If the loan is secured by California real estate, that makes the “guarantor” a primary obligated party (like the borrower), not a secondary party, and as a result that person has non-waivable antideficiency rights, regardless of what the loan documents might say. No deficiency judgment can be collected after the nonjudicial trustee’s sale of the real property collateral. Oops again.

Disguised guaranty. Some loan documents use unusual descriptions or arrangements to document their credit support, avoiding the explicit name “Guaranty.” Wall Street sometimes supplies some interesting, creative naming alternatives. However, under California guaranty law, if it walks like a duck and quacks like a duck, it usually has to be enforced like a duck. So there's a significant risk that the drafters will not remember to include the California guarantee waivers, in these clever guaranty-like instruments, or may add the wrong parties to them. Again, either mistake may result in a complete defense to enforcement of the deficiency after a nonjudicial trustee’s sale of the real property collateral.

All of the above. Sometimes the foregoing defects may come forward in elegant tangles and combinations. Recently, we saw this come up in a “remargin agreement,” in which the borrower promised to “remargin” a construction loan near the end of its term, meaning, pay in more equity to ensure that the loan was in balance (had enough undrawn commitment left to complete the project). Supposedly this makes refinancing easier. The lender, no doubt seeking more security, included in the remargin agreement a lot of language suggesting that it also was intended as a guaranty, including those Section 2856 waivers, and had the guarantor sign it as well as the borrower. (Strike one.) Unfortunately for the lender, the document’s drafter made the borrower and guarantor jointly and severally liable for all obligations under the remargin agreement. (Strike two.) A separate loan document provision stated that the obligations of the borrower (including those under the remargin agreement) were secured by the deed of trust – as a result, due to joint and several liability, the borrower’s real property collateral was deemed to secure not only the borrower's obligations, but also to secure the guarantor's coextensive obligations under the remargin agreement/guaranty. (Strike three.)

The result of this overly-clever documentation was that the guarantor also was entitled to one-action and antideficiency protection. That came as a surprise to the lender, who had proceeded quickly with a nonjudicial foreclosure on the severely underwater shopping center, and had initiated litigation seeking an eight-figure deficiency judgment from the creditworthy guarantor – but was stopped cold by the court, after guarantor’s counsel pointed out that the loan's structure gave the guarantor a complete defense under the antideficiency and one action rules. (The lender could, of course, have pursued deficiencies against the borrower and the guarantor simply by pursuing a judicial foreclosure, but as noted above, lenders only very rarely do so due to the cost of the court proceedings required.)

The moral of these fables: Know who your guarantors are, versus your borrowers. Make sure your lawyers know as well, and know their California law, and draft accordingly.