In the recent case CoastalStates Bank v. Hanover Homes of South Carolina, LLC, et al., the South Carolina Court of Appeals issued a potentially game changing opinion on the consequences that a bank’s settlement with a borrower and one guarantor has on the bank’s claims against a non-settling guarantor. This ruling potentially alters the banking landscape, likely necessitating drafting changes to current form guarantees, as well as changes in the way banks negotiate settlements, and how those settlements are drafted.
In mid-2007, Hanover Homes, a real estate development company, obtained three loans from CoastalStates Bank. Two of the loans were secured by liens on two spec homes and the third, largest loan was secured by a lien on 21 vacant lots. Hanover’s principals, George Cosman and Phillip Petrozzelli, signed individual personal guarantees for each loan. The guaranties were standard commercial guaranties used throughout the banking industry, and contained the usual “absolute and unconditional” clauses, as well as broad waiver language.
Hanover Homes began to struggle financially in late 2008, but managed to hang on and get the loans renewed in late 2009. After the renewal, Cosman claimed to have negotiated with the bank and obtained releases for himself and Petrozzelli on two of their three guarantees. Also at this time, the bank approved a few short sales of a portion of the collateral.
While Cosman was apparently willing to watch out for his business partner in their dealings with CoastalStates Bank, the reverse appears not to have been the case. In October, 2010, Petrozzelli and the borrower entered into an agreement with the CoastalStates Bank whereby, in exchange for their cooperation in liquidating the remainder of the collateral, the bank agreed to release Petrozzelli and Hanover Homes from any further liability, but expressly reserved the right to pursue all available remedies against Cosman. Cosman was apparently completely unaware of the agreement.
After the settlement, Hanover Homes liquidated the remainder of the bank’s collateral via short sales, leaving the bank with a deficiency balance of over $3 million. Hanover Homes and Petrozzelli walked away from this liability pursuant to the agreement, but the bank sued Cosman for the remaining deficiency.
Cosman vigorously contested his liability to CoastalStates Bank and asserted numerous claims against both the bank and Petrozzelli. The bank moved for, and obtained, summary judgment on its guaranty claims against Cosman. Cosman appealed.
On appeal, Cosman raised three arguments in support of his theory of non-liability under the guaranties: (i) statute of limitations; (ii) satisfaction of the borrower’s liability; and (iii) breach of contract. The South Carolina Court of Appeals rejected the statue of limitations claim, finding that CoastalStates Bank’s suit was not time barred. However, the court agreed with Cosman that his guaranty could “reasonably be read,” to limit his liability to “all liabilities and obligations of the borrower to the bank.” In other words, under this language, so long as Hanover Homes owed the bank money, Cosman was on the hook.1
The appellate court found that because Hanover Homes' liability to the bank was satisfied when the bank accepted the short sale proceeds in “full and final payment” of the debt, it was “reasonable” to conclude that Cosman’s liability on the guaranty ended then as well. As such, the appellate court held the trial court committed reversible legal error, when it ruled that Cosman’s liability “was not extinguished as a matter of law” by the bank’s earlier release of Hanover Homes and Petrozzeli. The appellate court reversed the summary judgment order in favor of CoastalStates Bank, and sent the case back to the trial court for further proceedings.
This ruling could be considered a game changer. Some may consider this opinion to be not a big deal, being that the appellate court did nothing but reverse a summary judgment order because of an ambiguity the court found in the documents that the trial court had missed. The problem with this view is that, before this opinion, most attorneys likely would have told you that there was no ambiguity in the documents, and that the guaranty and the agreement were clear, and capable of only one interpretation - under all readings of the document, Cosman remained on the hook. Thus, the finding of ambiguity in these “standard” documents is troubling in and of itself.
However, another view of this opinion is that, at best, the Court of Appeals has called into doubt the enforceability of guaranties and settlement agreement as they presently exist, and banks and their advisors would be well advised to keep a close eye out on this case. Additionally, lenders might consider re-examining their form documents and practices in preparation for a potential flood of challenges by disgruntled guarantors.
1 The Court distinguished the wording of the Cosman guaranty from a guaranty that provides for an unconditional agreement to pay "all sums due" and "all losses [suffered]." This language, they found, makes the guarantor liable for any “loss,” suffered by the lender because of the borrower, without regard to the continuing liability of the borrower.