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Excluding Personal Residence from Guaranty Does Not Exclude Proceeds from Residence’s Sale, Unless the Exclusion Expressly States So.

Series AGI W. Linn of Appian Grp. Investors DE LLC v. Eves 158 Cal. Rptr. 3d 193 (Cal. Ct. App. 2013).

In an interesting California Court of Appeal case decided June 14, 2013, the Court examined what appeared to be an issue of first impression, not only in California, but in the entire country.  If a surety specifically excludes a specified asset from a continuing guaranty, are the proceeds from the sale of that asset still excluded when the surety is called to answer for its guaranty?

The Court’s answer: NO.

Guarantor Robert Eves appealed from pre-judgment writ attaching the proceeds from the sale of his personal residence.   His personal residence was excluded from the Continuing Guaranty he signed which guaranteed a $3.1 million commercial loan.  The loan was secured by a deed of trust, which was junior to another deed of trust held by a financial institution that had loaned the borrower $18.4 million.

Contemporaneously with the loan, Eves executed a “Continuing Guaranty” by which he “unconditionally guarantees and promises to pay Lender  … any and all indebtedness … of Borrower to Lender.”   A “Guaranty of Loan Addendum” setting out seven categories of assets as “Schedule 1,” added: “The following assets are excluded from the Robert J. Eves personal Guaranty: … The personal residence of Robert J. Eves at Via Regina, 27 Moltrasio, Como, Italy and its contents.

The senior deed of trust was extinguished when the senior lender foreclosed.  Borrower made no payments on the loan, and Eves refused to honor his guaranty. Lender filed a lawsuit against Eves and applied for a prejudgment order of attachment under California Code Civ. Procedure  § 484.010) seeking to attach, among other items, the proceeds from the sale of Eve’s Como residence.  Eves opposed the part of the application aimed at “proceeds from the sale” of the Como house, which “[b]y the terms of the personal guarantee upon which plaintiff’s application for attachment … is based … are ‘excluded’ from attachment.”

Eves based his argument on his reading of the guaranty’s paragraph 13:  Limitation of Recovery.

 Notwithstanding the foregoing, the personal Guaranty of Eves may only be collected from assets not expressly excluded, as provided in the Asset Exclusion Schedule for Eves is attached hereto as Schedule 1; provided such limitation shall be inapplicable in the event Eves or any affiliate of Eves supplements or enhances in any material manner any Excluded Asset but only to the extent of such supplement or enhancement.

In a supporting declaration, Eve’s stated that the proceeds of the sale were all cash, that no part of the proceeds had ever been comingled with any other funds and that proceeds had always been easily identifiable because they have been in segregated accounts.  The apparent purpose of this explanation was to buttress Eves’ claim that “where collateral is sold, the secured creditor’s security interest automatically attaches to the proceeds of sale. California Commercial Code § 9315(a)(2) (“A security interest attaches to any identifiable proceeds of collateral.”)  And, hence, if an interest is excluded, so should the proceeds from that interest.

The trial court denied Eves’ claim of exemption for the Como residence proceeds and granted the lenders’ application for an order of attachment. Eves appealed.

The Court of Appeal analyzed the issue as simply one of contractual interpretation.  After looking at fairly comprehensive definitions of the term “proceeds” contained in various loan documents, the Court of Appeal concluded that the lender, borrower and Eves adequately understood the concept of “proceeds” as it applied to the loan/guaranty transaction.  The Court also noted that the Continuing Guaranty’s schedule of excluded assets showed that some care was given to the description of the excluded assets. The Court also observed the foresight to avoid the exclusion of any enhancement to the excluded asset.  The Court then concluded that if Eves meant to anticipate the liquidation or sale of an excluded asset, all he had to do was insert language to cover that contingency.  Therefore, Eves was bound by the guaranty’s plain language limiting the exemption from attachment to assets “expressly excluded … in the Asset Exclusion Schedule,” namely the Como residence but not the proceeds therefrom.  Nothing about proceeds from the sale of excluded assets was “clearly stated” or “expressly” provided in the guaranty. The Court opined that to read the Guaranty’s exclusion to encompass proceeds from the sale of that asset—is a distortion of the natural meaning of the language chosen by the parties.

Lesson:  Anticipate the potential sale of an excluded asset (or conversion to a replacement asset).  Here, the guarantor likely thought that the proceeds would be protected if he sold the protected asset.  But the Court looked for express language covering that contingency.  This is another warning to the general perils of drafting and the need to think through a transaction as deeply as possible.