«JOURNAL OF LAW, ECONOMICS & POLICY VOLUME 10 SPRING 2014 NUMBER 2 EDITORIAL BOARD 2013-2014 Steve Dunn Editor-in-Chief Crystal Yi Meagan Dziura Sarah ...»
While this result conforms to the Supreme Court’s requirement that the SCRA be liberally construed to protect the interest of servicemembers,83 79 The opposite scenario, that a liability bears interest in excess of 6% before the liability is incurred, is implausible; a liability that does not exist cannot bear interest at any rate.
80 Def.’s Mem. in Supp. of Summ. J. Ex. I, Newton v. Bank of McKenney, 2012 WL 1752407
liberal construction does not require a court to rewrite the SCRA or insert language into the SCRA that does not exist.84 The principal technical virtue of this rule is that it eliminates any potential arbitrary difference in treatments between various forms of guaranty, surety, and cosigner liability. For example, Cathey held that a cosigner of a loan is entitled to the benefit of § 527 of the SCRA because the cosigner has incurred liability on the loan in the same manner as the other borrower on the loan.85 The purpose of the loan, however, was to fund the Catheys’ corporation.86 The corporation used the funds, the corporation was responsible for making payments on the loan, and, most importantly, the objective of the bank in requiring the Catheys to cosign the loan was to obtain their personal guarantees—“The Bank, however, candidly admits that without the personal guarantees of the Catheys that neither the Bank nor the Small Business Administration would have loaned money to the plaintiff’s corporation.”87 Therefore, while the form of the Catheys’ liability was undoubtedly that of a cosigner, the expectation of the parties was that the Catheys would pay only if the corporation could not.
While the servicemember in Cathey was a cosigner, the servicemember in Newton did not cosign the corporation’s loan; she executed only a personal guaranty agreement.88 While the court describes the technical distinction that exists in Virginia law between primary liability (such as that of a cosigner) and secondary liability (such as that of a guarantor), the practical effect of both forms of liability is the same—the individuals promise to pay the loan if the corporation does not.89 The Newton court also draws an additional distinction between the liability incurred by a surety (primary liability) and a guarantor (secondary liability).90 While these technical distinctions certainly exist in Virginia and other jurisdictions, the practical effect is the same regardless of how the relationship is labeled— the corporation is the party that ought to perform, but if the corporation does not perform, then the lender has recourse against the parties that have promised to perform if the corporation does not.91 In fact, the Restatement and some jurisdictions acknowledge that the distinction is, at most, techNewton, 2012 WL 1752407, at *6 (“[L]iberal interpretation does not allow the Court to insert language that does not exist, or to ignore language that does.”). By refusing to “amend the definition of ‘servicemember’ to include closely-held corporations,” the Newton court demonstrates that the Supreme Court’s requirement of liberal construction does not require courts resolve all genuine questions of law under the SCRA in favor of the servicemember. Id.
85 Cathey v. First Republic Bank, No. 00-2001-M, 2001 WL 36260354, at *4 (W.D. La. July 6, 2001).
86 Id. at *1.
87 Id. at *3.
88 Newton, 2012 WL 1752407, at *7.
89 Id. at *7–8.
91 See RESTATEMENT (THIRD) OF SURETYSHIP & GUARANTY § 1 (1996).
nical and of limited relevance to the overall nature of the relationship; in some cases the distinction is completely abolished.92 While § 527 of the SCRA is silent regarding any distinctions between these different relationships, the provisions of § 513 explicitly apply to “a surety, guarantor, endorser, accommodation maker, comaker, or other person who is or may be primarily or secondarily subject to the obligation,” suggesting that at least in the context of § 513 the distinction between these relationships is irrelevant.93 While a court adopting this rule would eliminate the arguably arbitrary distinction between cosigner, surety, and guarantor liability suggested by Cathey and Newton, adoption of this rule would be incorrect. First, while the distinction between cosigner, surety, and guarantor may be arbitrary in some circumstances, these are in fact distinct relationships with distinct theories of liability. Even if the cosigner, surety, and guarantor all have the same intent—to pay if the borrower does not—the lender has distinct legal rights depending on which form has been chosen.94 Crucially, a guarantor’s liability is distinct from the cosigner or surety’s liability because it is separate from the borrower’s liability, whereas a cosigner or surety is jointly liable along with the borrower.95 A cosigner or surety is primarily liable jointly with the borrower and promises to make the same performance that the borrower does—to pay the loan according to its terms—while a guarantor, on the other hand, simply promises to perform if the borrower does not.96 While the Supreme Court has stated that the SCRA is to be liberally 92 See Souza v. Westlands Water Dist., 38 Cal. Rptr. 3d 78, 95 n.6 (Cal. Ct. App. 2006) (“A guarantor is a surety.”); Marett v. Brice Bldg. Co., 603 S.E.2d 40, 42 (Ga. Ct. App. 2004) (“Contracts of suretyship and guaranty are indistinguishable.”); Wooley v. Lucksinger, 7 So. 3d 660, 664 (La. Ct. App.
2008) (“A contract of guaranty is equivalent to a contract of suretyship.”); 38 AM. JUR. 2D Guaranty § 10 (2010) (“There are many similarities between a guaranty and suretyship, centering on the fact that both the guarantor and the surety have promised to answer for the debt or default of a third person, and both are accessory contracts.”); RESTATEMENT (THIRD) OF SURETYSHIP & GUARANTY § 15 (describing guaranty, surety, and cosigner relationships all as involving “a secondary obligor who is subject to a secondary obligation....”). An accessory contract is a contract “entered into primarily for the purpose of carrying out a principal,” related contract. BLACK’S LAW DICTIONARY, supra note 44, at 366.
93 50 U.S.C. App. § 513 (2006) (providing that a court granting a servicemember relief in the form of a stay of proceedings or vacation of a default judgment may grant the same relief to any party secondarily liable on the same civil obligation); see also Robert H. Skilton, The Soldiers’ and Sailors’ Civil Relief Act of 1940 and the Amendments of 1942, 91 U. PA. L. REV. 177, 182 (1942) (describing that the 1942 amendments to the SSCRA extended the § 513 protections to “accommodation co-makers” in response to In re Itzkowitz, 30 N.Y.S.2d 336 (N.Y. Sup. Ct. 1941), which had drawn a distinction between a co-maker and a surety, guarantor, or endorser when applying § 513).
94 38 AM. JUR. 2D Guaranty § 10 (“A creditor may look to the surety for immediate payment on the debtor’s default, without first attempting to collect from the debtor, while the creditor must first seek payment from the debtor before going after a guarantor.”).
95 See RESTATEMENT (THIRD) OF SURETYSHIP & GUARANTY § 15; 38 AM. JUR. 2D Guaranty § 10.
96 “[T]he guarantor promises to perform if the principal does not. By contrast, a surety promises to do the same thing that the principal undertakes.” Mercy Med. Ctr., Inc. v. United Healthcare of the 2014] BETTING THE FARM 429 construed to accomplish its purpose, a court adopting this rule to avoid the distinction between cosigner, surety, and guarantor liability would be inserting language into the SCRA that is inconsistent with established law.97 A second technical issue with this rule is that a court adopting this rule would allow a guarantor to receive the benefit of § 527 before the guarantor becomes liable to make any payment on the loan. Under this rule, a servicemember guarantor has incurred a liability bearing interest in excess of 6% when she executes the guaranty agreement and therefore would qualify for the benefit of § 527 when she enters military service. This result holds whether the corporate borrower has defaulted or not—for purposes of § 527, this rule holds that liability has already been incurred before default.
Therefore, a court adopting this rule would allow a guarantor to request the 6% interest rate limitation for a loan that the corporation is still paying in accordance with the loan’s terms, thereby allowing the corporation to receive the benefit of § 527.98 This is precisely the result from Linscott that is criticized by the court in Newton as irreconcilable with the text of the SCRA and basic corporation law.99 A rule recognizing that a liability bearing interest in excess of 6% is incurred when the guaranty agreement is executed has some appeal because it supports the purpose of the SCRA and eliminates a potentially arbitrary distinction between cosigner, surety, and guarantor liability. Courts should not adopt this rule, however, because it results in a corporation being able to take advantage of the SCRA and ignores the legal distinction between a cosigner or surety’s primary liability and a guarantor’s secondary liability.
2. Rule 2: Guarantor Incurs Liability When Guaranty is Executed, but the Liability Bears Interest in Excess of 6% When Borrower Defaults Under this rule, a servicemember guarantor incurs a liability for purposes of § 527 when she executes a guaranty agreement, but that liability does not bear interest in excess of 6% until the borrower defaults and the guarantor is called on to satisfy the borrower’s debt. Prior to the borrower’s Mid-Atlantic, Inc., 815 A.2d 886, 899 (Md. Ct. App. 2003) (alteration in original) (quoting Gen. Motors Acceptance Corp. v. Daniels, 492 A.2d 1306, 1310 (Md. 1985)); 38. AM. JUR. 2D Guaranty § 10.
97 See Newton v. Bank of McKenney, no. 3:11cv493-JAG, 2012 WL 1752407, at *6 (E.D. Va.
May 16, 2012) (“[L]iberal interpretation does not allow the Court to insert language that does not exist, or to ignore language that does.”).
98 A court applying this rule would only have to inquire into whether and when the guaranty was executed and at what interest rate the loan accrued interest after the servicemember entered active military service. This analytic framework would require no inquiry into whether the lender had requested payment from the guarantor or whether the corporation had paid the loan in accordance with its terms.
99 See Linscott v. Vector Aerospace, No. CV05-682-HU, 2006 WL 1310511, at *4 (D. Or. May 12, 2006); Newton, 2012 WL 1752407, at *6–7.
default, the guarantor has only a conditional obligation and no specific financial obligation that accrues interest; the interest is accruing to the separate obligation of the borrower. In fact, if the borrower makes payments sufficient to reduce the principal owed on the loan prior to defaulting, the guarantor’s conditional liability accrues interest at a rate less than 0% because the amount of her liability is decreasing with each payment by the borrower that reduces the principal owed.100 If a court examining the facts from Newton were to adhere to this rule, the court would find, as it would under Rule 1, that Ms. Newton incurred a liability when she executed the guaranty and that this occurred prior to her military service, as required by § 527.101 Unlike Rule 1, the court would find that Ms. Newton’s liability did not begin to bear interest, at any rate, until her corporation defaulted and she became obligated to pay the loan.
Section 527 would not apply to any interest accrued on the loan before the corporation defaulted because, prior to the default, Ms. Newton’s liability did not bear interest in excess of 6%. However, Ms. Newton could claim the benefit of § 527 for any interest that accrued at a rate in excess of 6% after the corporation defaults because the liability that she incurred prior to her military service (when she executed the guaranty) would then be bearing interest in excess of 6%.
The primary virtue of this rule is the sensible result: it allows the servicemember guarantor to claim the 6% interest rate cap of § 527 for the interest that accrues after the borrower defaults, while having no effect on the interest that accrued before the borrower defaults. This result is consistent with the Supreme Court’s requirement that the SCRA be liberally construed to the benefit of the servicemember.102 This is in contrast to the somewhat harsh alternative of barring an active-duty servicemember from claiming the benefit of § 527 even after her financial liability on the guaranty has been fixed by the borrower’s default.103 While this rule relies on an application of § 527 that is not grounded in case law, it does align with how other liabilities may be treated under § 527.
Consider, for example, a servicemember who makes a purchase using a credit card prior to entering active military service. At the moment of purchase, the servicemember has incurred a liability to pay the credit card account according to its terms.104 The terms of the account may include a 100 See, e.g., N. Gregory Mankiw, Maybe the Fed Should Go Negative, N.Y. TIMES, Apr. 19, 2009, at BU7 (“Why not lower the target interest rate to, say, negative 3%? At that interest rate, you could borrow and spend $100 and repay $97 next year.”).
101 Newton, 2012 WL 1752407, at *3; Def.’s Mem. in Supp. of Summ. J. Ex. I, Newton, 2012 WL 1752407 (No. 3:11cv493-JAG).
102 Boone v. Lightner, 319 U.S. 561, 575 (1943).
103 See supra Part II.A.3.