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US structured finance

Liability of guarantor

Will the creditor's release of a debtor operate as a discharge of those parties, such as a guarantor, who are secondarily liable on the debt? Under US law the release of the debtor will ordinarily discharge the guarantor.

It is for this reason that most commercial guarantees contain a general waiver of defences by the guarantor. The US Court of Appeals for the Second Circuit held on August 9 in Compagnie Financiere de CIC et de L'Union Europeenne v Merrill Lynch, Pierce, Fenner & Smith, that such a general waiver of defences prevents discharge of the guarantor even though the waiver does not expressly mention release of the debtor.

Compagnie Financiere de CIC et de L'Union Europeenne (CFC) had made a loan to Prodipe to develop a resort in Mexico. The loan was guaranteed by Prodipe's president, Alejardro Weinstock. The guarantee agreement signed by Weinstock was governed by New York law.

After Prodipe defaulted on the loan, CFC acquired voting control over the company and then sold it to a third party. CFC and the new owners released Prodipe from all debts relating to the resort in Mexico. However, the release did not cover Weinstock. Instead, CFC brought an action in federal court asking for a declaratory judgment that securities and funds held in an escrow account at Merrill Lynch to secure Weinstock's guarantee not be released by the securities firm. This action required the federal court to determine the continuing validity of Weinstock's guarantee.

The guarantee agreement, which was assignable by CFC, contained the following general waiver clause:

[t]he Guarantors hereby agree that their obligations hereunder shall be unconditional and irrevocable, irrespective of the validity, legality or enforceability of the Loan Agreement, the absence of any action to enforce the same, the recovery of any judgment against the Borrower ... or any other circumstances which might otherwise constitute a legal or equitable discharge [or] defence [of] a guarantor. .

The Second Circuit held that under New York law the waiver of "all legal or equitable ... defence[s]" was broad enough to encompass release of the primary debtor. It was not necessary for this contingency to be specifically included. Applying principles of surety law, the court concluded that the release of Prodipe did not affect Weinstock's subrogation rights against Prodipe.

The Second Circuit's decision in this case represents an important affirmation of waiver and consent clauses typically found in commercial guarantees. A guarantor can agree in advance to relinquish its defences to an action on the guarantee. However, notwithstanding the holding in this case, banks and other lenders should carefully draft waiver clauses to be included in guarantees to assure that they cover all foreseeable contingencies such as release of the debtor.

Robert S Rendell

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