Post-maturity effect of interest guaranties.

Interest guaranties play an important role today in numerous financial transactions, particularly in the area of real estate lending. Perhaps in an attempt to obtain financing in the first place, or to convince a real estate lender to extend more credit than it believes a particular construction project on completion will justify, or to salvage a troubled project, developers will often agree to guaranty interest payments to lenders.

As the real estate industry continues to suffer, it has become more and more common for lenders to seek payment under these interest guaranties for interest accruing both before and after the stated maturity of -- and after a default with respect to -- the underlying loan.

One of the peculiar characteristics of the law governing an interest guarantor's liability under an interest guaranty is that virtually all of the most relevant court rulings were issued a century or so ago. To determine a guarantor's liability, these cases must be carefully interpreted in light of modern day commercial transactions and the specific language commonly contained in current interest guaranties.

Interest Guaranties

An interest guaranty is a contract. As with other contracts, it should be read as a complete document, with all of its provisions given meaning. The meaning of those provisions, obviously, hinges on the intent of the contracting parties. Where the contract is clear and unambiguous on its face, the intent of the parties can be ascertained by the language employed in the contract. However, where the contract language is ambiguous, one must determine the intent -- and thereby interpret the contract -- by other means. Unfortunately, the intent of the parties to an interest guaranty all too often is ambiguous on the face of the document. Many times, in fact, neither the guarantor nor the lender actually considered a termination or cut-off point when the interest guaranty was originally prepared and executed.

Policy Concerns

Courts that have interpreted interest guaranties and refused to find the guarantors liable for post-maturity interest have sometimes fallen back on a number of policy arguments to uphold their position. For instance, they have expressed concern about compelling guarantors to pay interest indefinitely, or to pay both principal and interest to relieve themselves from the liability of paying interest if the lender chooses not to collect the debt by suing on the note, mortgage foreclosure or otherwise at maturity or on default. The potentially unlimited liability of a guarantor in that situation could amount to more than the principal. If such was the intent 6f the parties, these courts sometimes reason, why did the guarantors not agree to a full principal payment guaranty?

In addition, sometimes it is said that one of the purposes for an interest guaranty is to prevent the lender's foreclosure of a mortgage for non-payment of interest before the maturity of the note. A court that views this as the sole purpose for an interest guaranty should not be expected to extend its reach.

Also troubling some courts is the fact that recovery by the lender may prove difficult as a practical matter. Where interest after maturity is made payable quarterly or semi-annually, separate actions for each installment might be brought; but a bit more cumbersome and complex from a litigation standpoint to proceed on post-maturity interest that is continuously due and payable and that increases in amount each and every day. How often should the lender bring suit and covering what period or periods of accruing interest?

Modern Guaranties

Despite these concerns, however, it is important to recognize that even courts that have failed to interpret particular interest guaranties as applying to post-maturity interest often have recognized that a lender and a guarantor could have agreed to extend the guarantor's liability to cover that interest. Parties to a contract such as an interest guaranty have great flexibility to agree on terms. Provisions in interest guaranties that cover post-maturity interest should therefore be upheld if they are clear and unambiguous.

Thus, by way of example, if a note were to specify that the "borrower agrees to pay interest [at a specified rate] on the unpaid principal amount until such amount shall become due and payable (whether at stated maturity, by acceleration or otherwise) and thereafter [at a specified default rate] until paid in full", it would be clear that post-maturity (and post-default) interest was intended. If an interest guaranty were to expressly provide for "the prompt and complete payment when due" of all interest, expressly including interest at the specified default rate that accrues after maturity or after default, and were to specifically state that it remains in effect until the borrower's underlying obligations are satisfied and paid in full, it would be clear that the parties intended the guarantor to be responsible for the post-maturity (and post-default) interest. Based on the case law interpreting interest guaranties, this arrangement should be upheld.

Nonetheless, lenders should not overlook the arsenal of creative defenses that may be interposed to the guarantor's payment obligation. For example, if an underlying real estate loan were to mature, and as a result of the current real estate market the lender chose not to foreclose, but rather to collect interest from the interest guarantor while waiting for the market value of the mortgaged property to improve, the guarantor may raise a defense that the lender must promptly foreclose on the mortgaged property, or foreclose on such property prior to seeking payment under the guaranty. If the interest guaranty were to contain the waiver of defenses and events of discharge commonly found in sophisticited forms of guaranty, this defense should not be upheld. This is because the common defense and discharge waivers are typically upheld by modern courts. Guarantors, for instance, often agree to remain liable under their guaranties notwithstanding modifications to the underlying loan, extensions of time granted to the borrower, releases of collateral securing the loan or releases of the borrower from its obligations under the operative loan documents. They may and, in sophisticated guaranties, usually do agree to remain liable even if the underlying loan is non-recourse and the borrower is not personally liable under the loan documents. More to the point, they typically waive any failure, neglect, omission or delay on the part of the lender to realize on, take advantage of or protect or perfect in any collateral security for the loan, or to exercise any right or remedy with respect to the borrower's property. In addition, they typically waive any requirement that the lender "marshall" the borrower's assets or that the lender proceed against the borrower or its assets prior to proceeding against the guarantor. Clearly, if an interest guarantor executes a guaranty waiving any failure or delay by the lender in exercising any right or remedy with respect to the mortgaged property, and in fact agrees that such property can be released by the lender from the lien of the mortgage, it seems disingenuous for the guarantor to later argue that the lender must promptly foreclose on the mortgaged property.

In fact, in a recent case, the Federal Deposit Insurance Corporation was able to defeat a claim by two guarantors that it had breached the duty of good faith and fair dealing by its failure to promptly foreclose on property securing the underlying debt. The court ruled, in part, that the guaranties gave the FDIC the right to ignore the collateral and obtain a judgment against the guarantors for the full amount of the debt, even if the collateral might have been sold to satisfy part of the debt.