Facts: A group of developers formed a limited liability company (LLC) and limited partnership. Under the names of the entities, the developers obtained two loans to purchase multiple commercial properties with a lender who previously funded similar projects with identically structured loans. The developers entered into continuing commercial guaranties for each loan, securing the loans with different commercial properties owned by the developers and holding the developers personally liable for all the loan debt, regardless of which LLC or limited partnership signed for the loan. The loans were later sold to a successor lender on the secondary mortgage market. The developers defaulted on both loans and the successor lender foreclosed on the separate commercial properties which secured the loans, resulting in insufficient funds to cover the balance remaining on the loans in default.
Claim: The successor lender sought to recover the amount of outstanding debt from the developers under the continuing commercial guaranty, claiming the developers were personally liable as guarantors since the developers signed continuing commercial guaranties for both loans.
Counter claim: The developers claimed anti-deficiency law protects them from the successor lender’s claims as the guaranties were shams, since the developers’ close relationship with the loan officer who drew up the loan paperwork shifted their position from guarantor — a position imposing personal liability for all debt undertaken by themselves and the corporate entities they created — to obligor — a position with no personal liability for debt undertaken by any of their entities.
Holding: A California court of appeals held the developers were personally liable for the deficiency since the guaranties were not shams structured by the lender to avoid anti-deficiency law, as the developers signed the continuing guaranties with full knowledge of the guaranty stipulations. [California Bank & Trust v. Lawlor (December 24, 2013) _CA4th_]
Editor’s note — Here, the developers, as borrowers, created numerous corporate entities to shield themselves from personal liability. Due to this protection, had they not signed the continuing guaranties, they would not have been personally liable for any deficiencies on the loans.
For a guaranty to constitute a “sham guaranty” as argued by the developers, a guarantor must establish the continuing guaranty agreement was deliberately engineered by the lender to cast an obligor in the role of a guarantor with the intent of circumventing anti-deficiency law. However, the developers formed the entities prior to obtaining financing. Thus, the developers did not form the LLC and limited partnership at the request of the original lender in a ruse to avoid anti-deficiency protection and impose personal liability on the developers, regardless of their preexisting relationship.
Simply, borrowers cannot create numerous separate entities to shield themselves from personal liability, while concurrently claiming they are not distinct from the entity for the purpose of avoiding being a guarantor personally liable for the loans. You can’t have it both ways, folks.