A FEW THOUGHTS ON GUARANTY AGREEMENTS

Several cases arising out of bankruptcy courts over the past few years have affected the rights of lenders and guarantors. Most lenders have updated their guaranty agreements as these cases have been decided, but we thought it would be helpful to summarize several of the decisions and our recommendations with respect to guaranty agreements, so that you may make sure that these points have been considered. In addition, we will offer a few other thoughts on the use of guaranty agreements in general.

Discharge of Borrower. All guaranty agreements should certainly remain effective with respect to the discharge of the borrower's underlying obligations in bankruptcy. After all, the potential bankruptcy of the borrower is the number one concern of a lender when obtaining the guaranty of a third party. Guarantors have successfully argued, however, that post-petition interest and other charges accruing after the filing of a bankruptcy petition are not enforceable against the guarantor, if such expenses have been discharged as to the borrower. The issue arises with respect to unsecured or undersecured claims, in which case post-petition interest generally is disallowed by the bankruptcy courts. The guarantors argue that because the borrower has no obligation for post-petition interest, there is no obligation to be covered by the guaranty agreement.

For that reason, we suggest that guaranty agreements contain language similar to the following: "The Guaranteed Obligations include, without limitation, interest, attorneys' fees and other charges on any debt or obligation of the Borrower accruing after the filing of a petition under any chapter of the Federal Bankruptcy Code by or against the Borrower, and any loans or other credit extended to the Borrower after the filing of any such petition, notwithstanding the release of the Borrower from the performance or observance of any of its agreements, covenants or obligations by operation of law."

"Revival" of Guaranty in the Event of Preference or Fraudulent Transfer. A guarantor's obligations generally are released upon satisfaction of the borrower's obligations to the lender. In the event that all or a portion of any payment received by a lender must be disgorged, due to its treatment as a preference or fraudulent transfer in connection with a subsequent bankruptcy of the borrower, the guaranty agreement should provide that the guarantor's obligations are revived as if the obligations never had been released.

Waivers of Subrogation and Defenses. Most lenders added a waiver of subrogation clause to their guaranty agreements as a result of the 1989 DePrizio case, which extended the preference period from 90 days to one year if the loan was guaranteed by an insider of the borrower. As mentioned in the November issue of this newsletter, the DePrizio case was effectively overruled by the Bankruptcy Reform Act of 1994, thus subrogation waivers are no longer necessary. The guaranty agreement still should contain waivers by the guarantor of defenses that the borrower may assert against the lender, together with defenses based on the guarantor's own rights under suretyship law.

We suggest language such as the following: "Guarantor hereby waives all defenses based upon suretyship or impairment of collateral, together with any defenses that the borrower may have or assert with respect to the guaranteed obligations, including, but without limitation, discharge in bankruptcy, failure of consideration, breach of warranty, statute of frauds, statute of limitations, accord and satisfaction, waiver, release, usury, lack of legal capacity, lender liability, and fraud or misrepresentation." Without the foregoing waiver, the guarantor merely steps into the shoes of the borrower and has available to it all of the foregoing defenses.

Jurisdiction and Venue. The guaranty agreement should state that the borrower submits to the jurisdiction of courts in the State of Alabama, and that any lawsuit arising out of the debt or the guaranty may be asserted in the lender's local courts. Alabama courts have held that it is reasonable for an out of state guarantor to expect to be sued in Alabama on an obligation relating to a debt incurred in Alabama. The jurisdiction and venue provisions mentioned above thus should be upheld by Alabama courts and will render any collection litigation more efficient if all parties can be sued in one location.

Continuing Guaranty Agreements. Most form guaranties are of a continuing nature, providing that any existing or future obligations of the borrower are covered by the guaranty agreement. With respect to guarantors who are insiders of the borrower, new guaranty agreements should not be necessary as future obligations are incurred. Despite the continuing nature of the form agreements, however, we recommend that guarantors, especially guarantors who are not insiders of the borrower, acknowledge the incurring of future indebtedness and further acknowledge that the guaranty agreements remain in full force and effect. New guaranty agreements need not be executed, but rather a short form of certificate or letter from the guarantor is sufficient to defeat a subsequent argument by the guarantor that the new obligations were not contemplated by the previously-executed guaranty agreement.

Address of Guarantors. Especially in the case of non-insider guarantors, the lender should always obtain the home address of each guarantor. Not surprisingly, it is extremely difficult to find some of these parties when the deal goes south, especially if the only address and phone number for a guarantor is the same as that of the borrower.

STANDBY LETTERS OF CREDIT AS GUARANTIES

The 1993 revisions to the Uniform Customs and Practice for Documentary Credits (ICC Publication Number 500) became effective in January of last year. Because standby letters of credit often are used as guaranties, we thought it would be appropriate to point out a few of the 1993 changes to the UCP that should be considered when taking a letter of credit in lieu of a guaranty.

One of the most important changes with respect to standby letters of credit is that letters of credit no longer are deemed revocable. Under the prior version of the UCP, any letter of credit was revocable by the issuer at any time, unless the letter of credit specifically stated that it was irrevocable. The 1993 UCP reverses that presumption, thus a statement as to irrevocability no longer is required as long as the new letter of credit specifically adopts the 1993 UCP. Since the UCP is not a statute, but rather is a set of rules that is adopted into a letter of credit as a matter of contract law, the letter of credit should contain the following sentence: "This letter of credit is subject to the Uniform Customs and Practice for Documentary Credits (1993 Revision), International Chamber of Commerce Publication Number 500."

For more than 10 years, issuers have been referring to the 1983 revision to the UCP, which was publication number 400. The biggest mistake that can be made is to continue to incorporate the 1983 UCP into a letter of credit while deleting the statement of irrevocability. If the letter of credit states that it is governed by the 1983 UCP, rather than the 1993 UCP, the old rules will apply and the credit will be revocable, unless otherwise specified. A majority of the letters of credit that we have seen over the past few months continue to refer to the 1983 UCP. We believe it is quite important that lenders be on the lookout for this important phrase in any letters of credit that are accepted or issued, and make sure that the credit refers to the 1993 UCP, Publication Number 500.

The 1993 UCP also requires that the place of presentation of the letter of credit be stated in the document. This phrase can be combined with the expiration date by using a phrase such as "This letter of credit is to be presented at our counters by July 15, 1995 (the Expiration Date)."

The time within which the issuer of a letter of credit must make payment or dishonor a draw has been clarified under the new rules. The 1983 UCP stated that the decision to pay or dishonor must be made "within a reasonable time" after receipt of the applicable documents. Most issuers deemed a "reasonable time" to be three business days. The new rules state that payment or dishonor must be made within a reasonable time, not to exceed seven banking days. This does not mean that an issuer automatically has seven banking days to make payment of a clean draw request, but rather that seven banking days is the outside time within which the decision must be made. The beneficiary of a letter of credit still may insist that the payment be made within a reasonable time, which in most cases is one or two days after presentation of conforming documents.