Summary of a Recent
Judicial Development in
Bankruptcy

Liability of Guarantor Dependent
on Guaranty Agreement

Gaby R. Jabbour
National AgLaw Center Research Assistant

In an action brought by the guarantors of a bankrupt debtor against a bank alleging that the bank's failure to perfect its security interest as to some assets of the debtor constituted a lack of good faith and fair dealing, the Missouri Court of Appeals has held that the guarantors were primarily liable on the debt and that the bank's failure to perfect a security interest in collateral did not constitute bad faith. Mercantile Bank, N.A. v. Loy, 77 S.W.3d 93, 93, 96 (Mo. Ct. App, 2002).

Ag Service Centers, L.C., debtor, which provided fertilizers and chemicals to farmers, filed for Chapter 11 bankruptcy. See id. at 95-96. Mercantile Bank of Western Missouri (Mercantile), creditor and respondent, provided financing for the debtor in return for the execution of two corporate promissory notes used as a capital line of credit in the total sum of $1,225,000. See id. at 95. Both notes "contained provisions for interest and attorney fees in the event of collection." Id. As a security, Mercantile "took security interests in . . . [the debtor's] 'inventory, motor vehicles, equipment, fixtures, accounts, and general intangibles.'" Id.

Each of the appellants, Michael F. Loy, Diane L. Loy, Timothy M. Loy, and Denise A. Loy, guarantors, signed a "Continuing Guaranty Agreement," (Agreement) that set out in part:

4. PRIMARY LIABILITY. Guarantor is primary liable under this Agreement, regardless of whether or not Bank pursues any of its remedies against Borrower, against any other maker, surety, guarantor or endorser of the Obligations or against any collateral securing the Obligations. .... 9. RELEASE OF COLLATERAL. Guarantor agrees that any collateral which secures all or part of the Obligations (Collateral) may be assigned, exchanged, released in whole or in part or substituted without notice to Guarantor and without defeating, discharging or diminishing the liability of the Guarantor. Guarantor's obligation is absolute and Bank's failure to perfect any security interest or any act or omission by Bank which impairs the Collateral shall not relieve Guarantor of Guarantor's liability under this Agreement.

Id. at 95-96.

Following the debtor's Chapter 11 filing, the bankruptcy trustee inspected the debtor's facilities at Lockwood, Pierce City, and Jasper, Missouri. See id. at 96. After the Jasper, Missouri inspection, "the trustee took the position that Mercantile was unperfected as to certain leasehold improvements at the Jasper, Missouri facility." Id. The creditor "did not contest the trustee's decision that certain assets at the Jasper facility were unperfected." Id. Following the bankruptcy judge's approval, "the trustee sold the assets" and the creditor "did not object to the sale of the assets at the Jasper facility." Id.

The creditor brought an action against the guarantors for the amounts each of them guaranteed. See id. at 94. The trial court ruled in favor of the creditor and against the guarantors, "jointly and severally, in the amount of $230,833.75 together with interest at the rate of 9.25% from and after July 13, 2001, and attorney fees of $31,220.97," and stated that "there was no evidence that Mercantile Bank acted in bad faith or in any way attempted to deceive Guarantors." Id. at 94, 96.

The guarantors appealed the trial court's decision to the Missouri Court of Appeals alleging that the trial court erred in "finding as valid the written waiver of surety defenses contained within their absolute guaranty," and that "despite the language of the . . . [agreement], Mercantile's failure to perfect its security interest as to assets in the Jasper, Missouri facility, together with its failure to contest the bankruptcy trustee's opinion that such assets should not be applied against the guaranteed debt, constituted a lack of 'good faith and fair dealing.'" Id. at 94, 96.

The appeals court stated that "[a] guaranty is a 'collateral agreement for another's undertaking, and is an independent contract which imposes responsibilities different from those imposed in the agreement to which it is collateral.'" Id. at 95 (citation omitted). It also stated that "[i]t is the guaranty contract itself which defines the obligations and rights of both the guarantor and guarantee" and that "[t]he liability of a guarantor is to be strictly construed according to the terms agreed upon, and a guarantor is bound only by the precise words of his contract, and no stretching or extension of terms can be indulged in order to hold the guarantor liable." Id. (citation and quotation omitted).

The court noted that "the disposition of this case is controlled by Lemay Bank & Trust Co. v. Lawrence, 710 S.W.2d 318 [(Mo. Ct. App. 1986)] and Commerce Bank of St. Louis v. Wright, 645 S.W.2d 17[(Mo. Ct. App. 1982)]." Id. at 96. In Lemay, several guarantors "executed a continuing guarantee relative to an existing debt, as well as future debts of a business partnership" that was similar to the continuing guarantee that was executed by the guarantors in the present case. See id. The guarantors in Lemay argued that they "had been released from their obligation under their continuing guaranty due to the bank's failure to preserve the loan collateral in question after the partnership had been dissolved." Id. In Lemay, the appeals court held that

[b]y the unambiguous terms of this agreement . . . [guarantors] assumed primary liability for the partnership's debts. [Guarantor's] obligation to repay those debts thus remained unaffected by acts or omissions of Lemay Bank in relation to the loan collateral. The evidence does not, moreover support a conclusion that Lemay Bank acted negligently or in bad faith in dealing with the collateral. The bank was never asked to repossess the collateral, nor was it under any affirmative obligation to do so.

Id. (quoting Lemay, 710 S.W.2d at 323).

In Commerce Bank, a bank that was a creditor of a bankrupt corporation brought an action against the guarantors of the bankrupt corporation's debt. See id. at 97. The guarantors in Commerce Bank, similar to the guarantors in the present case, argued that "their guaranty contract was discharged because the creditor bank had failed to satisfy the bankrupt corporation's debts out of the corporate assets, in which the creditor bank held a security interest." Id. (citing Commerce Bank, 645 S.W.2d at 19-20). In Commerce Bank the court held that the guarantors "had agreed 'by the terms of the guarantee set out above, to pay the debt regardless of any release of the corporation or use of the collateral'" and that the facts "would not support an accusation of 'bad faith or negligence.'" Id. (quoting Commerce Bank, 645 S.W.2d at 22).

In the present case the court stated that the agreement signed by the guarantors, which "expressly permitted Mercantile to release the collateral without discharging the liability of the Guarantors" was a "legal and enforceable" provision "as both Lemay Bank and Commerce Bank recognize[d]." Id. at 97. It also stated that "there was no specific allegation in the pleadings or evidence presented at trial that Mercantile failed to act in good faith or otherwise was negligent in dealing with the collateral once it became security for the loans." Id. It added that according to "the unambiguous terms of the guaranty agreement, Appellants assumed primary liability for the debts of . . . [the debtor]" and that "[a]s a general rule, where a guarantor 'assumes primary liability for the debt, that liability is unaffected by any acts or omissions of the creditor in relation to the loan collateral.'" Id. at 98 (citing Manzo v. Metro North State Bank, 759 S.W.2d 77, 81 (Mo. Ct. App. 1988)).

The court concluded that "[b]ecause [the] Appellants agreed to be primarily liable under the terms of the guaranty agreement, Mercantile did not have a duty to pursue other avenues of repayment . . ." and that "Mercantile was neither legally negligent in its disposition of the collateral in question nor did it act in bad faith by not attempting to prevent the bankruptcy trustee from selling the Jasper facility's assets or by not perfecting its security interest in that facility." Id.

The case was decided on June 12, 2002; this summary was posted April, 2003