Carefully secure your warranty now
California’s 2021 homestead exemption increase to $ 600,000 will change the legal and economic relationship of guarantors with their lenders and sellers who make loans or sell goods or services on credit. Before examining this significant change in the California homestead exemption and its effect on warranties, some perspective is needed on the warranties themselves.
In the Stone Age, when business loans were signed in a conference room with all parties present and exchanging jokes, I watched a borrower’s principal sign a personal guarantee and wondered how this was really significant when the loan amount probably exceeded everyone’s equity. in the room. After almost everyone had left and the ink dried on the loan documents (my main job was to keep the documents, especially the promissory note), I put this question to my supervising lawyer. Without hesitation, he explained, “You just don’t understand. First, a surety is a fool with a fountain pen. Never sign one. Second, the bank really never wants to apply that guarantee. If the loan starts to have problems, the bank wants to force the guarantor to say to his wife, “Honey, we have a problem and we risk losing the house”. The risk of this dinner conversation is what prompts the borrower to act sensibly. This is the real value of most guarantees. “
Clearly, my cynical mentor’s point of view oversimplified the risks and rewards of commercial loan guarantees and supplier credit to businesses. Some creditors sue to collect personal collateral. Because requiring a guarantee can be an abuse of the parties’ unequal bargaining power when a loan is granted and some guarantors do not understand the seriousness of signing a guarantee, California law provides a long list of defenses and statutory protections for guarantors. Cal. Civ. Code 2787-2855. California courts have rendered a myriad of decisions involving guarantor defenses. See, for example., Bloom vs. Bender, 218 Cal. 2d 793 (1957); Engelman vs. Bookasta, 264 Cal. App. 2d 915 (1968); Wiener vs. Winkle, 273 Cal. App. 2d 774 (1969). But because of the usefulness of guarantees to lenders, sellers, homeowners, and others, guarantees are considered essential to the availability of credit for businesses and other limited liability entities, California courts generally apply. Mariner Savings vs. Neil, 22 Cal. App. 3d 232 (1973). California law even provides the appropriate language for waiving guarantor defenses. Cal. Civ. Code 2856 (d).
Because of the perceived importance of making a “real person” responsible for loans or credits granted to limited liability entities, guarantees are often included in contracts which, on the face of it, do not qualify as personal guarantees. The language of the guarantor is often included in real estate leases, equipment leases, conditional sales contracts and supply contracts with suppliers. California law broadly defines a surety or surety as any person who promises to answer for the debt, default, or miscarriages of others. Cal. Civ. Code 2787. Thus, courts and legislatures grapple with the dueling considerations of possible unfairness but the economic importance of guarantees. All of this brings me back to my mentor’s belief that the real value of a guarantor is the specter of that uncomfortable conversation that “we have a problem and could lose the house” which can motivate a reasonable resolution of a loan. to an otherwise limited liability borrower.
As of January 1, 2021, that conversation has changed. California has raised the homestead exemption from $ 100,000 for most married couples to a maximum of $ 600,000 in counties with the most expensive real estate. (Cal. Code of Civ. Proc. 704.730) The amendment, which was consolidated within days in the 1885 Assembly Bill before the legislature adjourned in August 2020, increased the exempt amount of judgments from creditors at least $ 300,000, and up to $ 600,000 in counties where that is the median price of a home. The amount is adjusted annually to take inflation into account as of January 1, 2022. The amount of the exemption is determined in the year in which the exemption is requested.
The exemptions, of course, presuppose that the creditor has obtained a judgment and seeks to enforce it against the judgment debtor’s residence, but the exemptions do not apply to consensual liens, such as the borrower’s real estate mortgage, home equity loan or other voluntary privileges approved by the owner of the property fee. Thus, the main target of the increased exemption is a non-consensual privilege such as those created by judgments. Thus, if the guarantor (usually the principal of a company that has signed a guarantee for the construction lease of his company, supply contracts with the supplier or the bank loan) owns a $ 3 million house with a first traditional mortgage and a second mortgage securing a home equity line of credit. at a total of $ 2.5 million, his $ 500,000 of accumulated equity is fully protected against judgment creditors thanks to the new $ 600,000 exemption.
Whether increasing the landholding exemption to $ 600,000 is a good policy is obviously left to the legislature. Creditors, however, should be aware that securing the principal of a business as collateral for a real estate lease, supplier supply contract, or bank loan does not create the same incentives. than before the modification of the law of 2021. How to approach this new reality, if the guarantee had a meaning for the economy of the granting of credit? Since an exemption does not protect the judgment debtor from consensual privileges, the creditor will have to consider a consensual lien to avoid the effect of the increased exemption. For most creditors, their immediate interest may turn to a secondary trust deed on the residence. It’s probably bad instinct. There are other issues with taking real estate guarantees, including California’s Deficiency Protection and One Action. Cal. Civ. Code Proc. 726 (One Action) and 580 (Anti-deficiency). Not only is the creditor then looking at the existing trust deeds and property taxes that take precedence over the new trust deed, but the creditor’s rights are limited by the procedural requirements of the single action rule coupled with the limitations. of the law against deficiencies. Savvy lawyers often advise their clients not to take out real estate collateral, however superficially tempting and easy it may sound, because of these practical and legal limitations.
But there is another practical approach. The best option is often to secure the collateral with assets other than real estate. In the past, underwriting and diligently in this regard seemed to be more difficult than warranted, but the increased exemption of $ 600,000 for family properties, coupled with the One Action Rule and anti-disability limitations, changes the analysis. . The creditor or lender has likely obtained the financial statement of the principal, and there may be separate non-real estate assets that would constitute significant collateral to secure performance of the collateral. However, this analysis must also recognize other exemptions, such as the exemptions created for pensions and retirement accounts protected by ERISA, as well as dozens of other exemptions. But there can be several types of assets that make sense as non-exempt collateral, like that much-loved Jackson Pollack painting, the 1972 Porsche, or a no-pension brokerage account, that would spark a conversation starting with: ” I have a problem and we could lose the artwork in the den. Again, the creditor should carefully consider all available exemptions from the enforcement of judgments, but this is the new reality in 2021, and personal property collateral assessed by the guarantor may be the best approach to consider, despite the additional underwriting and diligence required by property guarantees.
It is true that most creditors and banks do not want to put up collateral; they just want to motivate the principal of a business not to rely on the limited liability nature of their business to act unreasonably when trying to resolve a bad loan or credit. The dramatic increase in California’s homestead exemption to $ 600,000 makes this analysis more urgent and legally more complex than ever.
Copyright © 2020, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume XI, Number 67