A Guarantor's Waiver of Defenses Doesn't Protect a Bank From Its Own Misconduct

A recent decision was issued by a California appellate court that, while not controlling in the State of Ohio, is worth mentioning as it could prove useful to guarantors in other jurisdictions in similar straits. In California Bank & Trust v Thomas Del Ponti, the trial and appellate courts refused to deem the waiver of statutory defenses that are typical in loan and guaranty agreements as waiving ALL defenses, particularly equitable defenses, if the result of enforcing the guarantee would be the unjust enrichment of the bank.
The above case involved a construction loan by California Bank & Trust’s predecessor-in-interest, Vineyard Bank. The loan was for the construction of townhome project in two phases, and was guaranteed by two principals of the developer.  About the time the first phase was nearly complete, the bank stopped funding the construction draws, which prevented the construction on the first phase from being completed, and obviously resulted in a developer default under the loan.
The bank eventually reached a deal with the developer and required the general contractor to complete phase one so it could sell completed townhome units at auction. However, the bank wanted the subcontractors to take a haircut on their invoices and release their mechanics liens. The general contractor instead paid the subcontractors out of its own funds so the units could proceed to auction lien-free. Despite all of this, the bank proceeded to foreclose on the developer and sold the units through a trustee sale. It then sued both the developer and guarantors through California Bank & Trust, as its assignee, to seek payment on the deficiency balance. The general contractor joined the fun and sued both the bank and the developer due to breach of contract and seeing restitution the losses it suffered.
The court consolidated the bank and contractor cases and found against the bank on both holding that the bank breached the assigned construction contract AND breached the loan agreement with the developer, absolving the guarantors of liability.
The bank appealed claiming that the guarantors’ waived of all of their defenses in the guaranty agreements. The appellate court disagreed. The guaranty agreements did not expressly waive the bank’s own misconduct and the court was not about to read that into the agreement.  The court held that to enforce such a sweeping interpretation would violate public policy as it would result in the guarantors’ being forced to pay the deficiency balance on the note to the bank when it was the bank who willfully breached the loan agreement causing the default.
This action would likely play out the same way in most courts in Ohio or elsewhere in the Midwest. The courts expect all parties in a transaction to act in good faith, and absent an express language the states otherwise, typically won’t stand for a party to be unjustly enriched by its own misconduct.

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