The “Sham Guaranty” Defense is Not Easy to Establish
Under California anti-deficiency law, borrowers enjoy robust protections. Guarantors — not so much. The statutory protections afforded to borrowers cannot be waived, while for guarantors, they can be (and almost always are) waived.
One of the few arrows in the quiver of a guarantor seeking to avoid liability on the underlying debt is the “sham guaranty” defense. Under that defense, the guarantor must establish that his status as a guarantor is a sham — i.e., that he was really just the borrower. Most often, this occurs when: (1) the guarantor personally executes the underlying loan agreements, or (2) the guarantor is, in reality, the principal obligor under a different name by operation of trust or corporate law.
Money and Dirt has previously described the uphill battle faced by guarantors seeking to rely on the sham guaranty defense:
A case recently filed by California’s Second Appellate District — NPI Debt Fund I, LP v. Brard — addresses the issue. While the opinion is unpublished and therefore not binding precedent, it still provides useful guidance.
Facts: guarantor signs personal guaranty on loan; later asserts “sham guaranty” defense to avoid payment
A lender made a loan of just over $1 million to borrower Belle Maison Partners, Inc. (“Belle Maison”). The loan was secured by a deed of trust (also signed by Belle Maison) on real property in Woodland Hills, California. Robert Brard signed a separate personal guaranty of the loan.
Belle Maison made regular payments on the loan, but defaulted when the balloon payment came due. Brard failed to pay on the guaranty.
The lender sued and eventually filed a motion for summary judgment. Brard asserted the “sham guaranty” defense, arguing “he was always the de facto principal obligor on the promissory note” and that Belle Maison existed “only to acquire title to the property and execute the note.” Brard argued that “Belle Maison had no other assets or liabilities, generated no income, had no employees, and conducted no other business.”
Trial court: summary judgment granted; sham guaranty defense rejected
The trial court granted the lender’s motion for summary judgment, finding Brard’s evidence failed to support his arguments.
Court of Appeal: affirmed; sham guaranty defense fails
The Court of Appeal affirmed, holding summary judgment for the lender was properly granted.
The court noted that “when there is adequate legal separation between the borrower and the guarantor, e.g., through the appropriate use of the corporate form, the sham guaranty defense generally will not apply.”
The court held that Brard presented no credible evidence supporting his sham guaranty defense. His only evidence consisted of “one scant declaration,” where he stated the lender’s agent told him it did not lend on owner-occupied properties and so he would need to set up a business entity to obtain financing. This, however, was not enough to establish the sham guaranty defense.
The court noted that while Brard signed the note and deed of trust, he did so only in his capacity as the CEO of Belle Maison, not in his personal capacity. And there was no evidence that showed “an absence of legal separation between him and the entity such that he was in reality the principal obligor. The mere fact an entity was set up in connection with the payment of the loan does not show the sham guaranty defense necessarily applies.”
Further, most of the evidence Brard pointed to involved an LLC that he supposedly set up for the loan transaction. But, the court noted, “Belle Maison is a corporation, not a limited liability company.”
Lesson
The Brard opinion shows that the sham guaranty defense is difficult to establish. Merely setting up an entity to be the borrower is usually not sufficient.