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July 20, 2011

Firm News for July 2011: Best Practices: Requiring California Limited Partnerships and California Revocable Trusts to Guaranty SBA Loans

By Starfield & Smith

As many lenders who participate in the SBA’s 7(a) loan program are aware, each holder of at least 20% of the borrower, operating company, or eligible passive company must guarantee an SBA loan. If either the borrower, eligible passive company, or operating company is a trust or limited partnership, in many cases the lender will be required by SBA regulations to have the trustor (or settlor) or general partner guarantee the loan and execute SBA’s Form 148 Unlimited Guarantee. In the context of an SBA loan for which California real estate is pledged as collateral, the enforceability of the guarantee of a trustee of a California revocable trust or the general partner of a California limited partnership may present complex questions involving a complicated intersection of California law and SBA regulations.

California law is notoriously complex in the context of pursuing remedies against borrowers or guarantors when California real property is taken as collateral, especially if a lender elects to pursue a nonjudicial foreclosure. Section 726 of the California Code of Civil Procedure (the “One Action Rule”), Sections 580(a), 580(b), and 580(d) of the California Code of Civil Procedure (which contain California’s anti-deficiency laws), contain provisions related to the enforcement of obligations secured by real property, including provisions that relate to and specify the procedures for the sale of encumbered property, the application of proceeds, and the calculation, availability and procedures for obtaining a deficiency judgment. In many cases, California law provides for statutory waivers by guarantors of the rights and defenses in California Civil Code Sections 2787 to 2855 as well as rights which a guarantor may have because the Loan is secured by real property, including any rights or defenses based upon Section 580(a), 580(b), 580(d), or 726 of the California Code of Civil Procedure. In fact, the 7(a) Loan Authorization Boilerplate includes a form waiver of those rights as a requirement for inclusion in any guarantee where the guarantor is a resident of California.

Unfortunately, these statutory waivers have been found to be unenforceable where the guarantor is considered subject to “unlimited liability” for the underlying debt because of its status as the “alter ego” of another obligor. In such cases, courts have found there to be no “true guarantor” and have considered the guarantee a “sham guarantee.” Where the general partner of a limited partnership guarantees a loan either extended to or guaranteed by the limited partnership either the above-referenced waivers or the guaranty itself, or both, may be unenforceable. Riddle v. Lushing, 203 Cal.App.2d 831, 832-34 (1962). In addition, California courts have held that where an individual guarantor was also the trustor (or settlor), and beneficiary of a California trust which was also the borrower, the guarantee was found to be unenforceable on the grounds that the rights and defenses referenced above could not be effectively waived as the guarantor was the alter-ego of the borrower. Torrey Pines Bank v. Hoffman, 231 Cal.App.3d 308 (1991).

On the other hand, California’s One Action Rule, as well California’s anti-deficiency and other laws which could limit the enforceability of a guarantee, might be subject to federal preemption in the context of an SBA loan. A series of federal case law opinions, including U.S. v. Yazell, 382 US 341 (1966), U.S. v. Stewart, 523 F.2d 1070 (1975), U.S. v. MacKenzie, 510 F.2d 39 (9th Cir. 1975), U.S. v. Gish, 559 F.2d 572 (1977), United States v. Kimbell Foods, 440 U.S. 715 (1979), provides little consistent guidance on the question of whether or not a 7(a) lender seeking to pursue remedies against a California guarantor who is the general partner of a limited partnership, or the trustor (or settlor) of a revocable trust, may be prohibited from enforcing the guarantee if the lender has already pursued other remedies. It is worth noting that federal law at 13 CFR 101.106(d) currently states that “[n]o person, corporation, or organization that applies for and receives any benefit or assistance from SBA, or that offers any assurance or security upon which SBA relies for the granting of such benefit or assistance, is entitled to claim or assert any local or state law to defeat the obligation incurred in obtaining or assuring such Federal benefit or assistance.” Furthermore, the following language is included in all documents evidencing or securing the obligations under an SBA loan: “When SBA is the holder, the Note and this Guarantee will be construed and enforced under federal law, including SBA regulations. Lender or SBA may use state or local procedures for filing papers, recording documents, giving notice, foreclosing liens, and other purposes. By using such procedures, SBA does not waive any federal immunity from state or local control, penalty, tax, or liability. As to this Guarantee, Guarantor may not claim or assert any local or state law against SBA to deny any obligation, defeat any claim of SBA, or preempt federal law.” Accordingly, lenders should be mindful of the fact that enforcement of its California guarantees may be subject to challenge in certain circumstances; lenders should always seek the guidance of SBA-experienced counsel when closing, servicing, and liquidating an SBA loan, in addition to engaging experienced local counsel when pursuing any remedies under the terms of the relevant loan documents.

For more information on this and other issues related to SBA rules, policies, and regulations, contact the author at cevans@starfieldsmith.com or 215-542-7070.