Absolute And Unconditional Guarantees Under New York Law

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1 Absolute And Unconditional Guarantees Under New York Law By Steven P. Caley and Philip D. Robben * This article is republished with permission from the July 2003 edition of The Metropolitan Corporate Counsel. In a variety of commercial transactions from lending to leasing a creditor often seeks the security of a third-party s guarantee of payment in the event the primary creditor defaults. Naturally, creditors often seek a guarantee which is iron clad, with the hope that should resort to the guarantee be required, payment will be made quickly and without entanglement in litigation. Fortunately for creditors, New York law recognizes that a properly drafted guarantee frequently can operate as an absolute and unconditional obligation. Several decisions of the federal courts sitting in New York, however, have complicated the matter and present challenges for one seeking to draft an absolute and unconditional guarantee. I. New York Case Law Under New York law, if a contract provides that all of the parties agreements are merged in the written contract, parol evidence is not admissible to vary the terms of the fully integrated contract. 1 New York courts, however, historically have been hostile to attempts by those who commit fraud to use the courts to validate and protect ill-gotten gains. As the New York Court of Appeals noted in its 1957 decision in Sabo v. Delman, a general merger clause is ineffective to exclude parol evidence to show fraudulent inducement. 2 Two years later, in Danann Realty Corp. v. Harris, 3 the Court of Appeals distinguished its decision in Sabo, and held that where a merger clause specifically states that a party was not acting in reliance on representations as to the matters which form the basis for the party s claim of fraudulent inducement, the merger clause would defeat the fraud claim by eliminating the plaintiff s ability to establish reliance, one of the essential elements of fraud. Over 25 years later, the Court of Appeals decided Citibank, N.A. v. Plapinger, 4 the seminal New York decision concerning the validity and enforceability of guarantees which are absolute and * Steven P. Caley is a Partner and Philip D. Robben is an Associate in the firm of Kelley Drye & Warren LLP. The authors were part of the team of Kelley Drye attorneys that represented JPMorgan Chase Bank in JPMorgan Chase Bank v. Liberty Mutual Insurance Company, discussed herein. The authors gratefully acknowledge the assistance of associate Damon Suden in the preparation of this article.

2 unconditional by their terms. In Plapinger, five banks sued several defendants for millions of dollars owed under the defendants guarantees. Those guarantees stated that they were absolute and unconditional, and further stated that the absolute and unconditional nature of [the] guarantee was irrespective of (i) any lack of validity * * * of the * * * [loan guaranteed] * * * or any other agreement or instrument relating thereto, or (vii) any other circumstance which might otherwise constitute a defense to the guarantee. 5 In response to the banks claims, the defendants alleged that they had been fraudulently induced to sign the guarantees by certain alleged misrepresentations. The Court of Appeals noted that, in Plapinger, unlike Danann Realty, the defendants had not in the plainest language announced and stipulated that [they were] not relying on any representations as to the very matter as to which [they] now [claim they were] defrauded. 6 The Court, however, crafted an alternative basis for decision. In affirming the judgment for the plaintiff banks, it found that the clause under consideration was the result of extended negotiations between sophisticated business people, such that it was unrealistic to expect specificity in the waiver, especially since the parties denominated the guarantee unconditional. 7 Since the Court of Appeals s decision, New York State courts have repeatedly enforced Plapinger type guarantees. 8 In those state court decisions to the contrary, typically, either the form of guarantee was distinguishable or the language of the opinion was dicta. 9 However, several federal decisions since Plapinger arguably construe New York law more narrowly than the New York State Courts. II. Federal Decisions The leading federal decision in this area is the Second Circuit s opinion in Manufacturers Hanover Trust Co. v. Yanakas. 10 There, even though the guarantee at issue provided that it was absolute and unconditional, the Second Circuit reversed a grant of summary judgment to the plaintiff bank. The Second Circuit focused on three factors which it held took the Yanakas guarantee out of the Plapinger rule: (a) (b) (c) the Yanakas guarantee was generalized boilerplate, contained in a standard form, over which their was no evidence of any negotiations between the parties; the Yanakas guarantee did not purport to waive any defenses to its own validity, but was only an absolute and unconditional guarantee as to the validity of the underlying debt; and the Yanakas guarantee contained no disclaimer of the existence of or reliance upon representations by the bank and no blanket disclaimer of the type found in Plapinger as to any other circumstance which might otherwise constitute a defense to the Guarantee. 11 After Yanakas, the Second Circuit again had a chance to address the Danann Realty-Plapinger line of cases in Turkish v. Kasenetz. 12 Although that case did not involve a guarantee, the defendants argued that under Yanakas and Danann Realty, the language of the agreement under consideration barred plaintiffs reliance on allegedly false statements. The Second Circuit,

3 however, held that reliance upon the representations was not precluded under the Plapinger rule because, inter alia, the alleged misrepresentations were not extrinsic, oral representations, but rather written representations in the contract itself. 13 There have been subsequent decisions from courts within the Second Circuit that have followed Turkish in this regard. 14 An expansive application of these principles is illustrated by the Southern District decision in JPMorgan Chase Bank v. Liberty Mutual Insurance Company. 15 In that case, the plaintiff bank, as agent for two Mahonia companies, initiated an action against eleven insurance companies that had issued six surety bonds in favor of Mahonia. The bonds were obtained by Enron Corp. and guaranteed the obligations of two Enron subsidiaries under six prepaid forward contracts for the sale of oil and gas to Mahonia, as well as Enron Corp. s obligation to make payment under a corporate guarantee in the event of a subsidiary s default. Each of the bonds contained language virtually identical to the guarantee language in Plapinger. 16 Following Enron defaults and the failure of the insurance companies to make payment under the surety bonds, plaintiff filed suit and immediately moved for summary judgment. The defendants responded with allegations that the bonded transactions were not really sales of commodities, but disguised loans, and that Mahonia and plaintiff allegedly had misrepresented or fraudulently concealed this. The district court denied plaintiff s motion, and permitted defendants to pursue discovery. 17 Similar to Turkish, the court concluded that, nothing in the doctrine of Plapinger precludes a defense of fraudulent inducement or concealment premised on fraudulent misrepresentations in the Bonds themselves. 18 The court, however, did not point to any explicit misrepresentation in the Bonds. Instead, it found that, each of the Bonds was premised upon Mahonia s having entered with Enron into a gas or oil Inventory Sale Contract, and each stated that once the commodity is fully delivered, the surety would have no further obligations. 19 Based upon this, the Court found it implicit in the Bonds, that the sureties are being asked to insure the sale and future delivery of a commodity, rather than being asked to insure, unlawfully, a disguised loan transaction. 20 In a recent decision, Judge Marrero of the Southern District of New York declined to follow Liberty Mutual. That case, Valley National Bank v. Greenwich Insurance Company, 21 also involved allegations by insurance companies that they had been defrauded into issuing surety bonds that were absolute and unconditional according to their terms. Indeed, as in Liberty Mutual, the insurance companies alleged that the bond was fraudulently obtained in connection with a disguised loan. The Greenwich Insurance Court, however, granted summary judgment to the plaintiff bank based upon the bond language. The result and language of the decision suggests that the Greenwich Insurance Court may have viewed the Liberty Mutual decision as an anomaly, because of the notoriety surrounding the collapse of Enron. 22 III. Drafting The Absolute And Unconditional Guarantee The decisions discussed above provide some guidance on drafting guarantees so as to increase the chances of enforcement. While nothing can ensure that a court will enforce a given guarantee, and strong indicia of fraud may give a court pause before enforcing even the most carefully worded guarantee, there are several points which any drafter should consider.

4 A. Absolute and Unconditional The most basic feature the guarantee should possess is an explicit statement that the guarantee is absolute and unconditional. B. Waiver of All Defenses The guarantee should also contain language affirming the enforceability of the guarantee despite any other circumstance which might otherwise constitute a defense to the guarantee. Not only was such language included in the Plapinger guarantee, but the Yanakas Court explicitly relied, in part, upon the absence of such language in refusing to enforce the expressly absolute and unconditional Yanakas guarantee. C. No Representations in the Guarantee In light of Turkish and its progeny, the guarantee should avoid any representation which could later form the basis of a fraudulent inducement defense. Of particular importance, the guarantee should avoid incorporating or referencing any representations made in connection with the principal obligation, since a court may hold that those representations are thereby incorporated by reference into the guarantee. D. Express Disclaimer of Reliance on Representations Given the Liberty Mutual Court s reliance on implicit representations, drafters would also be well-advised to include language in any guarantee explicitly stating that the guarantor, in providing the guarantee, is not relying on any explicit or implicit representations by anyone whether oral or in any writing. Such disclaimers of reliance should be as specific as possible to bring the waiver within both Danann Realty and Yanakas. E. Negotiated Guarantee Wherever possible, the use of boilerplate, pre-printed form guarantees should be avoided, and the guarantee should be tailor-made for the particular transaction. If the guarantee is the product of negotiations, it may increase likelihood that a court will find it absolute and unconditional. F. Choice of Law/Choice of Forum Because Danann Realty and Plapinger arose under New York law, the guarantee should include a New York choice of law clause. Furthermore, given the arguably more limited interpretation of this rule in the federal courts in New York, it may be useful to include a choice of forum clause providing for a New York State court as the exclusive forum for any litigation arising from the guarantee See, e.g., Fogelson v. Rackfay Construction Co., 300 N.Y. 334, 340, 90 N.E.2d 881, 884 (1950). 3 N.Y.2d 155, 161, 143 N.E.2d 906, 909, 164 N.Y.S.2d 714, (1957). 5 N.Y.2d 317, 157 N.E.2d 597, 184 N.Y.S.2d 599 (1959). 66 N.Y.2d 90, 485 N.E.2d 974, 495 N.Y.S.2d 309 (1985).

5 Id. at 95, 485 N.E.2d at 977, 495 N.Y.S.2d at 312. Id. at 95, 485 N.E.2d at 976, 495 N.Y.S.2d at 311 quoting Danann Realty Corp. v. Harris, 5 N.Y.2d 317, 320, 157 N.E.2d 597, 599, 184 N.Y.S.2d 599, 602 (1959). Id. at 95, 485 N.E.2d at 977, 495 N.Y.S.2d at 312. See, e.g., Preferred Equities Corp. v. Ziegelman, 190 A.D.2d 784, 593 N.Y.S.2d 548, 549 (2d Dep t 1993); Banco Do Estado De Sao Paulo, S.A. v. Mendes Junior Int l Co., 249 A.D.2d 137, 138, 672 N.Y.S.2d 28, 29 (1st Dep t 1998). See, e.g., Goodridge v. Fernandez, 121 A.D.2d 942, , 505 N.Y.S.2d 144, 147 (1st Dep t 1986) (dicta); Contra, Goodridge v. Harvey Group, Inc., 728 F.Supp. 275, (S.D.N.Y. 1990); see Generale Bank v. Wassel, 779 F. Supp. 310, 319 (S.D.N.Y. 1991) ( Given the ultimate holding in [the federal court decision in] Goodridge, that the disclaimer was valid and binding, and the sweeping interpretation Plapinger has been given in recent years, it is clear that the Appellate Division s Goodridge dicta is not a strong precedent on which a party should rely. ); GTE Auto. Elec. Inc. v. Martin s Inc., 127 A.D.2d 545, , 512 N.Y.S.2d 107, 108 (1st Dep t 1987) (distinguishing language in the notes at issue from that in the Plapinger guarantee). 7 F.3d 310 (2d Cir. 1993). Id. at F.3d 23 (2d Cir. 1994). Id. at 28. See, e.g., JPMorgan Chase Bank v. Liberty Mut. Ins. Co., 189 F. Supp.2d 24, 27 (S.D.N.Y. 2002) (discussed infra); Banque Franco-Hellenic De Commerce Int l Et Maritime, S.A. v. Christophides, 905 F. Supp. 182, 192 (S.D.N.Y. 1995). 189 F. Supp. 2d 24 (S.D.N.Y. 2002) (Rakoff, J.). Id. at 27. JP Morgan vigorously disputed defendants allegations and asserted a number of defenses. Following a month-long trial, the case settled shortly before it was to be submitted to the jury. 189 F.Supp.2d at 27. Id. at Id. at 28. No. 02 CV 5069 (VM), 2003 WL (S.D.N.Y. April 1, 2003). Id. at *10.