The laws applying to personal guarantees have been shifted a bit by the recent case of JP Morgan Chase Bank, NA v. Earth Foods, Inc. (2nd Dist. Doc No. 2-07-0045). In JP Morgan, a defendant who had signed a personal guarantee to a bank for loans advanced to a business wanted to avail himself of a statute that specifically referenced sureties and not guarantees. The business he guaranteed had defaulted in its principle contract with the bank and the bank sought to get the money through the guarantee since no money could be had from the now defunct business. Prior to the business getting a notice of default, the guarantor sent a letter to the bank that warned the business was depleting its inventory which was collateral for the loan and demanded that the bank take action. If the statue applied, then he would potentially have a defense to the bank’s suit against him on the note where he had arguably complied with the statute. If the statute didn’t apply, he would have no defense to the bank’s demand that he honor the guarantee.
The dispute centered around the interpretation of the Sureties Act (740 ILCS 155):
Sec. 1. When any person is bound, in writing, as surety for another for the payment of money, or the performance of any other contract, apprehends that his principal is likely to become insolvent or to remove himself from the state, without discharging the contract, if a right of action has accrued on the contract, he may, in writing, require the creditor to sue forthwith upon the same; and unless such creditor, within a reasonable time and with due diligence, commences an action thereon, and prosecutes the same to final judgment and proceeds with the enforcement thereof, the surety shall be discharged; but such discharge shall not in any case affect the rights of the creditor against the principal debtor.
The guarantor argued that the sureties act applied to his personal guaranty and that he had an arguable defense to the bank’s attempt to collect on the guaranty because he had complied with the statute and sent the note. The trial court disagreed and denied him this defense in granting summary judgment for the bank on the grounds that the defendant was a guarantor and not a surety. The guarantor appealed and the appellate court issued its determination and after a long recitation of the possible differences between the both guarantors and sureties (an history and discussion worth reading), held that a guarantor was the same as a surety for the purposes of the act and that the defendant could assert the defense.
While the question didn’t seem to hinge on too many specifics in the actual contracts between the two parties, the court did take time to note that any legal distinction between the two was nullified by the terms of the contract at issue which allowed that the creditor could pursue the guarantor without first pursuing the principal. (This is important given that the classical difference between a surety and a guarantor involved the surety’s obligation as joint and several and the guarantor’s obligation as derivative and actionable only when the principal cannot pay).
The lesson is to know your rights and make sure you’re on top of them in sending the right messages to your creditors if you are a guarantor and in protecting yourself by trying to contract around this statute if you are a creditor.
Additionally, the application of the Act to guarantees raises a few more questions than answers, for instance, does the case apply only to personal guarantees, or can we extend the act to multiple types of sureties from people and from corporations? What about in the construction context? Does this change the nature of surety bonds in the state? Can we apply this case to those who contract to ensure the work of another? Has the distinction between these two words been done away with?
With all this in mind, we thought it might be worthwhile to see where some other statutes have made or obviated the distinction and if it becomes a functioning rule, where the Illinois legislature might need to clean house a little:
Section 49 of the Illinois Credit Union Act (205 ILCS 305) lists the terms as separate and distinct when defining a “security” under the Act but does not explain that distinction:
Security. In addition to generally accepted types of security, the endorsement of a note by a surety, comaker or guarantor, or assignment of shares or wages, in a manner consistent with the laws of this State, shall be deemed security within the meaning of this Act. A credit union shall give each surety, guarantor or comaker a copy of the instrument evidencing the indebtedness. The adequacy of any security shall be determined by the Credit Committee, credit manager or loan officer, subject to this Act and the bylaws of the credit union. The surety, guarantor or comaker may, but need not, be a member of the credit union making the loan.
In defining the operations of certain insurers and companies, the Illinois Insurance Code (215 ILCS 5) notes the distinction at Section 4 Class 2 (g) and at Section 121-3(b):
(g) Fidelity and surety. Become surety or guarantor for any person, copartnership or corporation in any position or place of trust or as custodian of money or property, public or private; or, becoming a surety or guarantor for the performance of any person, copartnership or corporation of any lawful obligation, undertaking, agreement or contract of any kind, except contracts or policies of insurance; and underwriting blanket bonds. Such obligations shall be known and treated as suretyship obligations and such business shall be known as surety business.
(b) The making of or proposing to make, as guarantor or surety, any contract of guaranty or suretyship as a vocation and not merely incidental to any other legitimate business or activity of the guarantor or surety.
Article XV part 12 of the Mortgage Foreclosure Act (735 ILCS 5/15‑1204) defines a “Guarantor” in terms that include a surety agreement:
Sec. 15‑1204. Guarantor. "Guarantor" means any person who has undertaken to pay any indebtedness or perform any obligation of a mortgagor under a mortgage or of any other person who owes payment or the performance of other obligations secured by the mortgage, which undertaking is made by a guaranty or surety agreement of any kind.
The General Definitions and Principles of Interpretation Section of the Uniform Commercial Code (810 ILCS 5/1-201(39)) settles the matter within the code by defining the two congruously:
(39) "Surety" includes a guarantor or other secondary obligor.
However, it is likely that you can still waive the provisions of this act through language in your surety/guarantee. City National Bank of Murphysboro, Il. v. Reiman, 236 Ill.App.3d 1080 (5th Dist., 1992). You’d just want to make sure you’re doing that explicitly. And if you find yourself as a surety or guarantor, you may want to take a stab at complying with the provisions of the Act when you become aware that the entity you’ve vouched for will be running into financial troubles in the immediate future. Who knows, maybe some clever attorneys with willing clients might see if the act could be extended to other types of financial backing.
As always, having a surety or personal guaranty gets you one step closer to an actual payment, especially in a market where shell LLCs are created and dissolved for the simplest of transactions… and being aware of this new information should help you negotiate a better deal.
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