Co-Borrower or Guarantor? A Distinction with a Difference
As is common in life and business, routine and habit often dictate—the lending context is no exception. Many banks utilize either a co-borrower or guarantor structure as a matter of course without considering the specific circumstances of each loan. The recent Minnesota Court of Appeals decision in Andrews v. Bruntjen, A13-0815 (Minn. App. Mar. 10, 2014), which
discussed critical distinctions between co-borrowers and guarantors, serves as a reminder to banks to closely consider such distinctions when structuring loans.
In Andrews v. Bruntjen, the appellant, a co-borrower under a loan, argued that he was not obligated to repay the loan that was subsequently modified because he was acting as a guarantor rather than a co-borrower. Although rejected by the Court, this argument highlights a significant distinction between a guarantor and co-borrower under Minnesota law. Specifically, a co-borrower may remain primarily liable under a loan even if another co-borrower alters certain terms of the loan or releases certain collateral securing the loan.
Another important distinction to remember is that a co-borrower is primarily liable for the debt from its inception. In contrast, a guarantor is not liable unless the underlying borrower defaults and, depending on the terms of the guaranty, the lender pursues collection efforts against the borrower. As such, a lender pursuing a guarantor must typically engage in a two-step legal process of proving a default by the borrower and establishing the guarantor’s liability under the guaranty.
However, it is important to note that most guaranties contain a myriad of express waivers of defenses (i.e. release of collateral, release of co-borrower or guarantor, modification of loan terms, etc.), thereby streamlining recovery from a guarantor that is secondarily liable. Most promissory notes do not contain similar language, and therefore a borrower retains the right to assert a litany of applicable defenses to delay or attempt to avoid liability. Even if a lender sought to include certain waiver language in its standard promissory note form, there is an open question whether courts would enforce certain waiver provisions against co-borrowers. Indeed, courts may tend to enforce the substantive nature of the transaction rather than the form the lender has chosen to structure the transaction.
An additional distinction warranting consideration is that a lender utilizing foreclosure by advertisement retains the right to pursue a guarantor for a deficiency judgment. However, in a foreclosure by advertisement, the right to pursue a deficiency is waived as to any borrower.
While this article only addresses some of the critical distinctions between co-borrower and guarantor structures, these differences implicate underwriting, securitization, loan modifications, default, and collection. Accordingly, banks should determine the appropriate structure on a case-by-case basis for each transaction at hand rather than adhering to one particular structure as a matter of course. When it comes to co-borrower versus guarantor, it is a distinction with a difference.
Tips for Lenders
1. Consider co-borrower vs. guarantor structure on a case-by-case basis.
2. Understand the distinct potential defenses available to co-borrowers vs. guarantors under Minnesota law.
3. Structure loan documents to protect the bank’s ability to collect from a co-borrower or guarantor while mitigating unnecessary legal or business issues.