The prudent broker correctly advises their seller that including the third party as a co-owner of the property and signor of the carryback note and trust deed adds no assurance anyone will repay the debt.

A carryback note secured solely by the property sold is a nonrecourse debt, legally called purchase-money paper. On nonrecourse debt, the seller is bared from enforcing collection against the buyer for any deficiency in the property’s value at the time of foreclosure, called anti-deficiency protection. [Calif. Code of Civil Procedure §580b]

Since the third party joins the buyer on title as co-owner of the property, the third party has the same anti-deficiency protection as the buyer in the case the seller judicially forecloses on the property and attempts to obtain a deficiency judgment.

Thus, the existence of the third party adds nothing to the seller’s ability to enforce collection of money on their carryback note when the third party becomes a co-owner of the property. The seller’s only resort in the event of a default is the same as it was before — foreclose on the property sold  and recover nothing from the third party.

A seller, to avoid the third party’s co-ownership of the property with the buyer, may consider the liability of the third party as a co-signor on the note. As a co-signor, the third party does not sign the trust deed since they will not take title.

Instead, the third party signs only the note as an additional maker, becoming personally liable for payment of the debt — a situation legally known as an accommodation party.

An accommodation party is an individual who:

• signs a note to incur liability for payment of the debt evidenced by the note and primarily owed by another; and
• receives no direct benefit from the debt. [Calif. Commercial Code §3419(a)]

On a default in payment, the carryback seller may make a demand on the co-signor for payment of the debt in full. On receiving the demand for payment, the co-signor may require the carryback seller to first foreclose on the property, called the one-action, security-first defense, since the debt is secured by real estate. [CCP §726]

However, when the carryback seller forecloses by trustee’s sale, the nonjudicial foreclosure relieves both the buyer and co-signor from liability for any deficiency due to a decreased value in the property and the seller’s underbid at the trustee’s sale to demonstrate they have incurred a loss. Thus, a deficiency judgment is barred after a nonjudicial foreclosure sale. [CCP §580d]

Similarly, when the carryback seller judicially forecloses, they are still barred from recovering any deficiency from the co-signor since carryback paper secured only by the property sold is nonrecourse paper. [CCP §580b]

Anti-deficiency defenses are equally available to the co-signor since the note signed by the co-signor evidences a debt secured by real estate.

Only when recourse paper is judicially foreclosed may the mortgage holder seek a deficiency judgment against both the borrower and co-signor.

Like the third party who signs the note and trust deed as a buyer of the property, the third party who does not become a buyer and only co-signs the carryback note adds nothing to the seller’s ability to collect the entire amount due on the carryback note from the third party.

However, when a co-signor pays off the note on demand from the seller, the co-signor has the right to an assignment of the note and trust deed, called equitable subrogation. As the assignee and holder of the note and trust deed, the co-signor may then enforce the note and trust deed by foreclosing on the property. [Com C §3419(e)]

The carryback seller’s best approach for recovery of the amounts due on the nonrecourse note when the property value drops due to market conditions is to obtain a separate personal guarantee from the third party.

With a personal guarantee, the third party does not become a co-owner or co-signor. Instead, as a guarantor, they become personally responsible under a separate agreement when the buyer defaults. On a default, they pay the seller on demand a sum equal to all amounts due on the note, and do so before any foreclosure sale.

A guarantee is an independent promise. It is an obligation of one person — a third party — to pay the entire debt owed by another person — the buyer — in the case of a carryback sale. [See RPI Form 439]

Thus, a guarantee is a separate obligation from the note and trust deed. Also, few defenses are available to the guarantor to avoid payment on the guarantee.

The Guarantee Agreement – For Promissory Note published by RPI (Realty Publications, Inc.) is used by a mortgage broker, transaction agent or escrow officer when originating a mortgage for a lender or carryback seller which will be guaranteed by a third party. The Guarantee Agreement is used to document the commitment of the third party for full payoff/purchase of the mortgage on a default in its terms. [See RPI Form 439]

Since a guarantee is itself a separate obligation to pay money, its performance may also be secured by a trust deed on real estate owned by the guarantor. [See RPI Form 451]

Editor’s note — Third-party guarantees are not to be confused with guarantee agreements executed by the seller of an existing note, or by a broker on a mortgage they arranged or assignment of a mortgage they negotiated.

A buyer or owner who is primarily obligated as the payor on a note cannot themselves guarantee the note they have signed. A buyer’s or owner’s signature on a guarantee agreement adds nothing to their obligation — they already owe the money under the note, and thus no greater commitment is created.

However, limited partners, limited liability company (LLC) managers and members, and corporate officers and stockholders commonly guarantee loans made to their business entities. Limited partners, LLC managers and members, and corporate officers are not persons initially liable for the debts of their respective entities.

For example, a note executed by a corporation is personally guaranteed by one of the corporate officers under a guarantee agreement naming them individually as the guarantor. The officer on signing enters their corporate title following their signature on the guarantee agreement. [See RPI Form 439]

When the corporation defaults on the note, the mortgage holder makes a demand on the officer under the guarantee agreement to pay the amount which remains unpaid on the note.

Here, the corporate officer is held to have personally guaranteed the note as a third party since that is the only reasonable interpretation of the guarantee agreement which named them individually as the guarantor. As a third-party guarantor, the officer becomes personally liable for payment of an amount equal to the entire remaining debt. In turn, on payoff, the corporate officer is assigned the note and trust deed since, in essence, a guarantee is an agreement to purchase debt on default. [Home Federal Savings & Loan Association v. Ramos (1991) 229 CA3d 1609]

Similarly, and owner of income-producing property may seek the same default protection on a rental or lease agreement from a third party. On locating a prospective tenant for a rental unit, the landlord, leasing agent or property manager establishes the prospect’s creditworthiness before entering into either a rental or lease agreement. This is accomplished by requiring the tenant to fill out a credit application. [See RPI Form 302]

The credit application is referenced and attached as an addendum to any rental or lease agreement entered into by the landlord and tenant. [See RPI Form 550 and 551]

The application is part of the leasing process which persuades the landlord to accept the applicant as a tenant.

Initially, the landlord uses the authorization provided by the tenant on the application to verify the tenant’s:

• rental history;
• employment;
• credit standing; and
• check-writing history.

When a prospective tenant has a poor credit rating (or no credit rating at all) but meets the landlord’s income requirements, the landlord may seek assurances in addition to the maximum security deposit allowed. These assurances include:

• a co-signer on the lease; or
• a guarantee agreement signed by a creditworthy person. [See RPI Form 553-1]

The Guarantee Agreement – For Rental or Lease published by RPI is used by a leasing agent, property manager or landlord when entering into a rental or lease agreement with a prospective tenant to document a third party’s guarantee for the payment of rent or other monetary obligation arising out of a default in a rental or lease agreement. [See RPI Form 553-1]

With third-party assurances, the landlord will receive full performance on the lease agreement from a third party if the tenant defaults on their rent or otherwise causes the landlord to incur a loss exceeding the security deposit. On a default by the tenant, the landlord may hold the co-signer liable, or collect their losses from the guarantor.