Unmitigated Waivers: Guarantors Remain Liable Despite 4-Year Delay in Foreclosure Sale

If a lender delays foreclosure allowing years of default interest to accrue such that a guarantor’s obligation increases from $6 million to $12 million, should the guarantor remain on the hook for the full $12 million?  In Pi’ikea, LLC v. Williamson, 683 Ariz. Adv. Rep. 32 (Ct. App. 2014), the Arizona Court of Appeals recently confirmed that if the guarantor waived the “mitigation of damages” or “impairment of collateral” defense in its guaranty contract, then the answer is an unmitigated YES.

The Facts

In 2004, TBM Equities, LLC borrowed $5,922,000 to build an apartment complex in Tucson, AZ.  The lender secured the loan with the apartment complex, and the Williamsons guaranteed the repayment of the loan.

The loan matured in December 2008, but neither the borrower, nor guarantors repaid the loan.  At the time the loan matured, the apartment complex was worth approximately $10,200,000, and the amount of the debt owed was only $5,900,000.  In other words, had the lender foreclosed immediately when the default occurred, the lender would have likely been made whole by the foreclosure of its collateral and the guarantors would have owed nothing.  But that did not happen – not by a long shot.

After the loan matured, the original lender was placed into receivership by the FDIC. The FDIC, in turn, sold the loan to Pi’ikea.  Pi’ikea eventually completed a trustee’s sale of the apartment complex in August 2012 – nearly four years after the default.  Default interest had been accruing the entire time.  Pi’ikea then sued the Williamsons for a remarkable $9,170,950 deficiency.

The Legal Issue

In the trial court, the Williamsons argued that the “mitigation of damages” and “impairment of collateral” doctrines prevented Pi’ikea from recovering on the guaranty.  The “mitigation of damages” doctrine provides, generally, that a party who is harmed by a breach of contract must act reasonably so as to not exacerbate their damages.  In the secured creditor context, the “impairment of collateral” doctrine provides that if a lender impairs the value of its collateral, it cannot recover that lost value from the guarantor.  Based on these principles, the Williamsons argued that Pi’ikea should not recover anything on the guaranty, because had the lender foreclosed back in 2008/2009, there would have been no damages.  The trial court disagreed and entered the $9 million judgment against the Williamsons.

On appeal, the Williamsons argued that the lender had an obligation to elect a remedy in a timely manner given its knowledge that its collateral was decreasing in value due to the down real estate market.  The Court of Appeals rejected this argument, because: (i) lenders may elect the remedy of their own choosing, and, in any event, (ii) the guaranty contract provided for a waiver any right the guarantors had to assert a “mitigation” or “impairment” defense.  Thus, the Court of Appeals affirmed the $9 million judgment, and granted the lender its attorneys’ fees and costs on appeal.

The Significance

While the outcome may seem unfair to the guarantors, when a guarantor “guarantees” that a debt will be repaid, courts will enforce that guarantee.  The Williamsons argued to the Court of Appeals it was unreasonable for this lender to wait four years before foreclosure, and that if the Court of Appeals approved of this lender’s tactic, then this ruling could potentially enable lenders to sit on their remedies and allow default interest to turn a $6 million guaranty into a $60 million obligation.  The Court of Appeals was not persuaded by this argument since the guarantors agreed that the lender could do just that in the guaranty contract.  At the end of the day, lenders – not debtors – get to choose their own remedies.