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Loan Guaranties: Statutory and Legal Defenses Can Be Waived, But What About Equitable Defenses?

Guarantors of loans occupy a vulnerable position under California law.

While direct borrowers often benefit from California’s robust statutory anti-deficiency framework, those protections are often unavailable for guarantors.  That is because under Civil Code section 2856, most guarantor rights and defenses can be waived.  Unsurprisingly, most form guaranties contain comprehensive waivers.

While it is plain that most statutory and legal defenses can be, and regularly are, waived by guarantors, what about equitable defenses, such as unclean hands, estoppel, or laches?

A recent order from a federal court in the Northern District of California — GCCFC 2005-GG5 Hegenberger Retail Limited Partnership v. Arce — addressed the issue, and found that equitable defenses were not waived.

Facts: loan guaranty with typical waiver language

Three individuals guarantied a $10.5 million loan.

Events triggering the guaranty included the borrowers’ filing of voluntary bankruptcy petitions and failure to pay amounts due under the loan.

The borrowers defaulted and filed for bankruptcy, triggering the guaranty.  The lender sued the guarantors.

The guarantors asserted several equitable affirmative defenses based on the lender’s conduct, including waiver, estoppel, laches, unclean hands, and failure to mitigate damages.  The lender filed a motion to strike these affirmative defenses, arguing that the guaranty’s comprehensive waiver language eliminated these affirmative defenses.

The guaranty “absolutely, unconditionally, and irrevocably” guarantied prompt payment of the loan, and also provided that: “Guarantor also waives any right or defense based upon an election of remedies by Lender.”

District Court’s Order: no waiver of equitable defenses

The District Court rejected the lender’s argument.

The court, citing to the California opinion California Bank & Trust v. DelPonti, held that:

[P]ublic policy requires us to read Civil Code section 2856 in a manner that prevents one party from capitalizing upon its own fraud or willful misconduct. … A waiver of statutory defenses is not deemed to waive all defenses, especially equitable defenses, such as unclean hands, where to enforce the guaranty would allow a lender to profit by its own fraudulent conduct.

The court found that the language in the guaranty at issue, while broad, only expressed an intent to waive defenses in accordance with section 2856.  Thus, while the guarantors waived their statutory and legal affirmative defenses, they did not waive their equitable defenses focusing on the lender’s “bad faith and unjust enrichment.”

(The court did find that the guarantors needed to provide more detail for their equitable affirmative defenses, and granted them leave to do so.)

The court did not clarify whether more specific waiver language directly addressing equitable defenses would pass muster.  (Nor did the DelPonti opinion.)  But given the court’s public policy based reasoning, and the long-standing notion that one should not be able to disclaim one’s own wrongful conduct, the odds seem to favor such waiver language being ruled unenforceable.

Lesson

Based on the GCCFC and earlier DelPonti decisions, a standard loan guaranty’s waiver of rights will extend only to legal and statutory defenses.  Equitable defenses will remain available to the guarantor.

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