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?

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