Lenders Beware - Ohio Appellate Decision Impacts Guaranties

A recent opinion from the First Appellate District of Ohio is noteworthy for lenders for two reasons: (1) what language not to insert in a guaranty; (2) what information potentially needs to be relayed to a potential guarantor based on this decision.

In The Huntington National Bank v. Schneider, C-230072 (December 29, 2023) the Court was asked to review a grant of summary judgment in favor of a lender on a guaranty executed in support of a $75 million credit facility between numerous lenders and borrowers relating to the operation of seven skilled-nursing facilities.

The guaranty included a standard provision whereby the guarantor agreed that his liabilities and obligations under the guaranty were absolute and unconditional “irrespective of any lack of validity or enforceability of the Credit Agreement, any note, any Loan Document or any other agreement, instrument or document evidencing the Debt or related thereto, or any other defense available to Guarantor in respect of this agreement.” However, a subsequent amendment resulted in a reaffirmation of the guaranty that included the following language: “the undersigned hereby waive[s] and release[s] Agent and the lenders * * * from any and all claims, offsets, defenses and counterclaim of which the undersigned is aware . . .” (emphasis added).

Finding that the subsequent and more specific waiver controlled, the Court ruled that the guarantor waived only known defenses and that genuine issues of material fact remained as to guarantor’s knowledge of his defenses.

The Court also addressed the claim of the guarantor that the lender owed him a duty of disclosure, as he was a surety under the agreement as opposed to a guarantor. Finding that the liability of the guarantor was primary with the borrower as opposed to secondary if the borrower did not perform, the Court agreed that the guarantor was a surety. The ramifications of this distinction, as seen below, are massive for all lenders.

As a surety, the guarantor argued that the lender had a duty to disclose adverse facts not available to him that materially increased his risk beyond that which the lender had reason to believe he intended to assume. The lender argued that even if the guarantor was a surety, it had no duty to conduct underwriting and present the guarantor with a risk analysis prior to execution of the guaranty.

The Court framed the elements of a lender’s duty to a surety in this context as: (1) the creditor knows facts which materially increase the risk beyond that which the creditor has reason to believe the surety intends to assume; (2) the facts are unknown to the surety; (3) the creditor has reason to believe the facts are unknown to the surety; and, (4) the creditor has a reasonable opportunity to communicate the facts to the surety.

Construing the record, the Court found that a reasonable fact finder could find the elements were met to prove a material nondisclosure, which could invalidate the guaranty. Key facts involved in this conclusion were: (1) the credit agreement, arising out of a syndication, required the lender to evaluate and certify the solvency and financial condition of the borrowers, guarantors, and the value of the collateral; (2) half of the borrowers were not owned or controlled by the guarantor and he claimed, via affidavit, to know nothing of their affairs; (3) the record could be read to support that the lender was aware of adverse facts concerning the entities that the guarantor did not control. Based on these conclusions, the Court reversed the judgment and sent it back to the trial court. It remains to be seen if the lender will seek to have this decision reviewed by the Ohio Supreme Court.

The old adage about bad facts making bad law may apply here. The lender had a pre-existing relationship with the borrower who just happened to be controlled by someone now doing prison time for an immense fraud. A different result may have occurred if the loan to the borrower was a brand-new extension of credit with no prior history with the borrower.

Takeaways for lenders: (1) avoid linking any waiver to known claims/defenses; (2) be extra cautious if you have a new extension of credit with a new, unrelated guarantor where you have a pre-existing relationship with the borrower; and (3) include language in the guaranty that expressly states something to the effect that the guaranty is not to be construed as a surety relationship and that the lender has no duty to disclose facts related to the operations of the borrower.