Guarantors of a Construction Loan were Exonerated From Liability by a Bank's Misconduct Under the Loan Agreement, Notwithstanding the Broad Waiver Provisions in the Guarantees

December 21, 2014 | Bulletin No. 1167921.1

California Bank & Trust's predecessor bank ("Bank") granted a $22.5 million construction loan to Five Corners Rialto, LLC ("Five Corners") to develop a 70-unit townhome project in two phases.  Two principals of Five Corners guaranteed the loan.  When Phase 1 of the project was nearly complete, the Bank stopped funding approved payments thereby preventing completion and sale of Phase 1 units.  Apparently, Five Corners was not in compliance with the loan to value ratio covenant under the loan agreement but the Bank never properly notified the borrower and the guarantors of this default.  California Bank & Trust v. Del Ponti (December 9, 2014, E053187) ___ Cal.App.4th ___).

After the loan matured, the Bank, the borrower, and the guarantors agreed to a global strategy to complete construction of the Phase 1 units and to market them for sale.  The Bank was actively involved in implementing this strategy.  Despite this global strategy, the Bank nonjudicially foreclosed on the project.  Thereafter, the Bank filed a lawsuit to, among other things, collect the deficiency amount of the loan from the guarantors.  This case involved a number of other legal issues regarding the construction loan and the Bank's liability for the general contractor's advances to subcontractors to complete Phase 1.  However, only the issue of the guarantors' liability was certified for publication. 

The trial court granted judgment in favor of the guarantors and exonerated them from liability under their guarantees.  The trial court concluded that the Bank failed to provide the required 15-day notice to cure under the loan agreement prior to executing the notice of default and withheld funds to pay approved fund requests, which doomed the project, and constituted a material breach under the loan agreement.  Further, the trial court found that the Bank led the guarantors to believe they would be released from their guarantees if they performed all of the items in the global strategy, which they did.

On appeal, the Bank argued that the guarantors waived all their defenses under the guaranty agreements. The Fourth District Court of Appeal affirmed the trial court's judgment.  It held that a guarantor's waiver of defenses is limited to legal and statutory defenses expressly set out in the guaranty agreement. 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 or willful misconduct.  The Appellate Court opined that in all suretyship and guaranty relations, the creditor owes the surety a duty of continuous good faith and fair dealing, a duty that cannot be waived.  The Appellate Court noted that public policy required it to read the authorized waiver provisions of Civil Code section 2856 in a manner that prevents one party from capitalizing upon its own fraud or willful misconduct.

Questions

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Bruce A. Scheidt or Bruce A. Emard | 916.321.4500