Daily Development for Wednesday, December 8, 2004
by: Patrick A. Randolph, Jr.
Elmer F. Pierson Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin Kansas City, Missouri dirt@umkc.edu
GUARANTORS; INDEBTEDNESS; MERGER: Guarantor of debt who is also a general
partner of the debtor entity may pay debt and obtain rights under the note and
compel contribution from other guarantors. The debt is not extinguished when
paid by guarantor if guarantor is “acquiring the note as a co-guarantor” rather
than paying off the debt in its capacity as primary debtor.
Byrd v. The Estate of H.G. Nelms, 2004 Tex. App. LEXIS 10351 (Tex. App.
11/17/04)
Byrd, Nelms and others acquired an office building in 1981 in a capacity that
the court describes as “co-venturers.” [There is no legal concept in most
American jurisdictions of a “co-venture” and normally such a relationship is
deemed the equivalent of a general partnership - nothing in the case suggests
otherwise here.]
The venture executed a note for $2.25 million and the various “co-venturers”
guaranteed the note. [The court does not indicate whether the note was a
non-recourse note or, if not, why it was deemed necessary for the co-venturers
to guarantee it. As this was prior to the Tax Reform Act of 1986, there may have
been an effort here for the co-venturers to leverage their depreciation
deductions by making the note non-recourse.]
Five years later, several of the co-venturers, including Byrd, conveyed their
interests to the other co-venturers. In the end only Nelms and one other, Nazro,
owned interests in the venture, and all the other co-venturers were gone. But
none of the co-venturers revoked their guaranty. [Undoubtedly the lender would
have frowned upon any attempt to do this.]
Seven years after that, in 1992 [remember those days?] the remaining co-venturers
arranged to sell the building for $1.1 million, leaving a balance on the
original note of just over $1 million. The two remaining co-venturers entered
into an agreement that they were each liable to the other for their respective
halves of this debt, and Nazro paid his half in cash to the bank. Nelms,
however, executed an installment note for his half, and shortly thereafter paid
the lender the principle and interest on the note in exchange for a conveyance
to Nelms of the note. A year after that, Nelms sued the other guarantors for
contribution on the note.
In what the dissenting Chief Judge of the Texas appeals court characterized as a
case of first impression, the trial court ruled that Nelms was entitled to show
to the jury that he had paid of the debt as a co-guarantor, rather than as a
principle, and therefore was entitled to contribution from his co-guarantors,
even though normally a debt is extinguished when paid by a principle obligor and
that obligor has no claim from guarantors. The jury found for Nelms - concluding
that Nelms did obtain the note from the bank as a co-guarantor, rather than as a
principle, and therefore was entitled to contribution from the other
co-guarantors.
Assuming that Nelms was entitled to make a showing that he was not acting in the
capacity as a principle on the debt, the court acknowledges that the evidence on
the point was “conflicting.” For instance, around the time of conveyance the two
remaining co-venturers had caused to be formed a new debtor entity - a
corporation called Buffalo Speedway Investments. In the tax returns for that
year, each of the partners was credited with a capital contribution in the
debtor entity representing their assumption of the debt owed after the sale of
the property. The entity took a $1 million loss in that year when the building
was sold for one half the $2 million debt, and presumably each of the co-venturers
obtained the benefit of a substantial tax loss.
As indicated, the court held that the jury could properly find that Nelms had
acquired the note in his individual capacity as a co-guarantor rather than in
his capacity as a co-owner of the debtor entity, and that therefore he was
entitled to contribution from his other co-guarantors.
The dissenting opinion in this three judge panel - written by the Chief Justice
of the appeals court, simply expressed amazement and puzzlement as to what the
judge’s colleagues did.
“[T]he most significant issue in this case is a question of first impression
regarding the merger of legal rights and obligations - the right to receive
payment and the obligations to pay. In particular, what is the proper result
when the entity that owes a debt is a joint venture and a general member of the
joint venture, who is also a co-surety guaranteeing payment of the note,
subsequently acquires ownership of the note. . . .But the purpose of the
secondary obligation is to stand *behind* the obligation of the principal
obligor to perform the underlying obligation. . . .
Can an entity owe itself money, guarantee payment of the debt itself, default on
the debt, and then collect any part of the debt from a co-surety? I have seen
nothing to indicate that is, or should be the law, that is, until this Court’s
opinion.”
Comment 1: The editor concurs with the Chief Justice. This was a commercial
venture, and presumably the other partners who transferred their interests to
Nelms and his remaining partner were not just making gifts to them of their
interest, backed by their guarantees. Whether cash changed hands (the court does
not describe whether there was any consideration), clearly the choice to leave
Nelms and his partner with the building, rather than liquidating and taking
their lumps at that point, represented a decision that the two remaining
partners would remain conducting the business for better or worse.
It strikes the editor as bizarre to view Nelms as having the capacity to turn
back on his former partners almost a decade later and demand contribution, when
there is no indication that the parties had ever agreed upon such a course. (The
defendant former co-venturer in fact testified that in exchange for his
agreement to pay property taxes, Nelms verbally agreed to release his guarantee,
but never did.)
Comment 2: Although the editor posited the notion that the parties originally
had taken out the original loan on a non-recourse basis note that in the end the
tax returns, at least, suggested that the remaining co-venturers had assumed the
debt when they formed Buffalo Speedway Investments. The court makes nothing of
this. Should it?
Items reported here and in the ABA publications are for general information
purposes only and should not be relied upon in the course of representation or
in the forming of decisions in legal matters. The same is true of all commentary
provided by contributors to the DIRT list. Accuracy of data and opinions
expressed are the sole responsibility of the DIRT editor and are in no sense the
publication of the ABA.
Parties posting messages to DIRT are posting to a source that is readily
accessible by members of the general public, and should take that fact into
account in evaluating confidentiality issues.
ABOUT DIRT:
DIRT is an internet discussion group for serious real estate professionals.
Message volume varies, but commonly runs 5 15 messages per work day.
Daily Developments are posted every work day. To subscribe, send the message
subscribe Dirt [your name]
to
listserv@listserv.umkc.edu
To cancel your subscription, send the message signoff DIRT to the address:
listserv@listserv.umkc.edu
for information on other commands, send the message Help to the listserv
address.
DIRT has an alternate, more extensive coverage that includes not only commercial
and general real estate matters but also focuses specifically upon residential
real estate matters. Because real estate brokers generally find this service
more valuable, it is named “BrokerDIRT.” But residential specialist attorneys,
title insurers, lenders and others interested in the residential market will
want to subscribe to this alternative list. If you subscribe to BrokerDIRT, it
is not necessary also to subscribe to DIRT, as BrokerDIRT carries all DIRT
traffic in addition to the residential discussions.
To subscribe to BrokerDIRT, send the message
subscribe BrokerDIRT [your name]
to
listserv@listserv.umkc.edu
To cancel your subscription to BrokerDIRT, send the message signoff BrokerDIRT
to the address:
listserv@listserv.umkc.edu
DIRT is a service of the American Bar Association Section on Real Property,
Probate & Trust Law and the University of Missouri, Kansas City, School of Law.
Daily Developments are copyrighted by Patrick A. Randolph, Jr., Professor of
Law, UMKC School of Law, but Professor Randolph grants permission for copying or
distribution of Daily Developments for educational purposes, including
professional continuing education, provided that no charge is imposed for such
distribution and that appropriate credit is given to Professor Randolph, DIRT,
and its sponsors.
DIRT has a WebPage at:
http://cctr.umkc.edu/dept/dirt/
-----
To be removed from this mailing list, please go to
http://listserv.umkc.edu/listserv/wa.exe?SUBED1=BROKERDIRT&A=1.
or send an email message to the address listserv@listserv.umkc.edu, with the
text SIGNOFF BROKERDIRT in the body of the message. Problems or questions should
be directed to manager@listserv.umkc.edu.