Credit Where Credit Is Due? Rethinking Strategies for Foreclosure Sales, Credits, and Guaranties
In commercial lending transactions, lenders often secure the loan with a mortgage on the business real property. In the event of a default under the loan documents, the lender may elect to foreclose the mortgage securing the loan. The amount paid at the foreclosure sale confirmed by the court (determined by the court to be “fair value” for the property) is generally credited against the borrower’s loan balance.
Typically, in addition to a mortgage on the business property, lenders also require a personal guaranty from the business owners of a closely held business, where the owners personally agree to repay the loan if the borrower does not. These collateral agreements provide additional collection options in the event the borrower is unable to pay back the loan as agreed. But does a guarantor also receive a credit when the mortgaged property is sold? And if so, is it the same credit applied against the borrower’s loan balance?
Last year, the Wisconsin Supreme Court decided a case relating to the application of the credit arising from a foreclosure sale that could impact how lenders decide to document and then enforce transactions involving a mortgage on real property and a personal guaranty that also supports the debt secured by the mortgaged property.
In Horizon Bank v. Musikantow, the Supreme Court ruled that while Wis. Stat. §846.165 governs the fair value determination necessary to confirm a sheriff’s sale, the terms of the guarantor’s guaranty govern the credit to be applied to the guarantor’s liability, and thus a guarantor’s credit might differ from the proceeds of the sheriff’s sale credited to the borrower’s loan balance. Therefore, a trial court can make one determination of fair value for purposes of confirmation of the sheriff’s sale of the real property, and then make a separate determination of the amount of the credit from the sale to be applied to the guarantor’s obligations.
In light of this decision, lenders and their counsel need to consider carefully several issues:
- whether to revise the language in guaranties in Wisconsin specifically to address the credit arising from the liquidation of real estate collateral;
- if litigation is required, whether to combine a foreclosure action with an action for a money judgment against a guarantor or to sue the guarantor separately; and
- if proceeding on the foreclosure claim alone first, or together in one action on the guaranty claim, whether to retain the deficiency against the borrower liable on the mortgage note and allow a longer redemption period, thereby maintaining a specific monetary claim against the borrower after the sale is confirmed.
The Horizon Bank Case
Allen Musikantow owned a Door County mansion through his limited liability corporation (LLC), Marshall’s Point Retreat. To secure a $4 million loan, the LLC granted a mortgage on the property, and Musikantow signed a personal guaranty as further security. When the loan was not repaid at maturity, Horizon Bank filed a foreclosure action, together with a claim on the guaranty. Horizon Bank waived any deficiency claim against the LLC to obtain the shortened redemption period allowed under Wisconsin foreclosure law.
In response to the complaint, Musikantow and his LLC quickly stipulated to judgment of foreclosure and a monetary judgment on the guaranty, and also agreed to a prompt sheriff’s sale of the property, essentially foregoing any substantial redemption period. The stipulation also provided that the proceeds of the sheriff’s sale of the property would be applied as credit on the monetary judgment on the guaranty.
At sheriff’s sale, the bank was the only bidder with a bid of $2.25 million. At the confirmation hearing, Musikantow offered not to contest that the bid was fair value for the purposes of confirmation, so long as the court did not bind him to that amount as the credit to be applied on his guaranty judgment. The bank argued that the bid was fair value for the purposes of confirmation, and also argued that the sale price, if confirmed, would be the only credit available to apply against the judgment on the guaranty.
The trial court adopted Musikantow’s approach. It ruled that the credit bid was fair value and confirmed the sale, but declined to apply the confirmed sheriff’s sale price as the credit on the guaranty judgment, instead deferring determination of the credit for a later proceeding.
Horizon Bank appealed, and the Wisconsin Court of Appeals ruled that the parties’ stipulation controlled the amount of the credit on the guaranty judgment, so Musikantow was entitled only to credit for the $2.25 million confirmed sheriff’s sale amount. However, Musikantow further appealed to the Wisconsin Supreme Court, which reversed the Court of Appeals decision. First, the Supreme Court majority ruled that although the foreclosure statutes control the application of the confirmed sheriff’s sale price to the debt owed by the borrower, the statutes did not expressly control the credit that might be applied under a guaranty.
Building on the S.J. Boyer decision that held that guaranty liability is separate from the debt secured by the mortgage, the majority ruled that the amount of the credit should be governed by the guaranty agreement. The Supreme Court also held that the parties’ stipulation did not conclusively determine the credit, stating that, although the stipulation provided that the proceeds of the sale would be applied to the judgment on the guaranty, the stipulation did not say that the proceeds of the sale would be “the sole credit.” The majority reached this conclusion even though, as the dissent pointed out, the stipulation had no other provision that suggested the guarantor was entitled to any additional credit.
Despite these rulings, the Supreme Court did not proceed to the next step and review the guaranty to determine what credit might be required under the language of the guaranty. Instead, the Supreme Court remanded the case to the trial court for further proceedings. The Supreme Court also specifically approved, on the facts of this case, that the trial court had the discretion to separate the confirmation of sale determination from the determination of the amount of the sale credit on the guaranty.
Considerations for Lenders
Because the Supreme Court concluded that the guaranty contract controls the guarantor’s liability and any credit from a foreclosure sale, lenders should consider whether the language in their guaranties sufficiently addresses the question presented. In most cases, guaranties of payment specifically provide that the measure of liability is the extent of the borrower’s debt to the lender, and include broad waivers by the guarantor, including waivers of any allegations of impairment of collateral.
Arguably, this broad language dictates that the only credit available after the sale of collateral is the confirmed sale price, i.e. the proceeds actually received by the lender at the sale from either the lender’s credit bid or a cash bid of a third-party bidder. Still, a review of guaranty language in advance of litigation, or prior to execution if possible, is warranted. Working closely with experienced lender counsel, a lender can determine whether it might be worthwhile to include language specifically binding the guarantor to a judicial determination of fair value for the liquidation of collateral as the amount of any credit on the guaranteed debt.
Second, if already executed and depending on the facts of each case, a lender might separate a guaranty claim from the foreclosure claim and sue on the guaranty first. The lender could obtain a full judgment against the guarantor for all amounts due and then completely exhaust all collection efforts against the guarantor, before proceeding against the property. At that point, the amount of the guarantor’s credit from the foreclosure sale will take on less importance. However, whether this is worthwhile may depend on whether the guarantor has available assets to apply to the judgment, or whether it might be expeditious to foreclose on the real property first.
Finally, if proceeding on the foreclosure claim first, or at the same time as the guaranty claim, lenders should consider whether to retain a deficiency claim against the borrower, even though the redemption period might be extended. Although not expressly commented on by the Horizon Bank majority, they may have been influenced because the deficiency against the borrower in that case had been waived so the borrower had no motivation to contest the amount bid at the foreclosure sale. On the other hand, if a deficiency is preserved and, if the sale is confirmed, the court will determine the deficiency liability of the borrower at a specific amount.
Arguably, such a specific finding and judgment against the borrower could support a finding that a guarantee of payment should, by its terms, dictate that the guarantor’s liability is for the same amount. As long as the guarantor is a party to the action and has notice of the sale and the confirmation hearing, the guarantor will have fair notice and opportunity to contest the fair value finding. Considering the relatively short additional time that a bank has to wait if the right to a deficiency is preserved, having that additional monetary judgment against the borrower may be a worthwhile consideration.
In the end, the Horizon Bank decision may not change the outcome of final collection of amounts from guarantors. No definite Wisconsin law currently entitles a guarantor to a specific credit different from that granted to a borrower, especially where a guarantee of payment is at issue. However, there may be a few new considerations of the best process and practices to follow to address the Supreme Court’s ruling in the Horizon Bank case.
To further discuss the impact of and the decision in Horizon Bank and how you might proactively address transactions or litigation involving mortgages and guaranties, contact KMK attorneys Samuel C. Wisotzkey or Melinda Bialzik at (414) 962-5110 or via email at email@example.com or firstname.lastname@example.org.
Kohner, Mann & Kailas, S.C. (KMK) is a value-driven law firm, offering unsurpassed legal expertise in the practice areas of business and financial services, business litigation, and commercial collections. KMK combines the resources necessary to serve the complex needs of its Fortune 500 clients with the personal care and superior customer service expected by all its clients. Founded in Milwaukee in 1937, KMK has successfully developed a local, national, and international reputation for legal excellence, continually recognized by U.S. News & World Report as one of the nation’s Best Law Firms. For more information, visit www.kmksc.com.