October 13, 2016
Authored by: Bryan Cave Leighton Paisner
Bryan Cave LLP recently served as counsel for amicus curiae California Bankers Association (“CBA”) and helped score a victory in an important California appellate case of great interest to the banking industry, LSREF2 Clover Property 4 LLC v. Festival Retail Fund 1 357 N. Beverly Drive LP (Second District, California Court of Appeal case number B259937).
The trial court had ruled that the guarantor of a commercial loan was excused from performance on the grounds that the guaranty was a “sham,” structured by the lender to circumvent California’s anti-deficiency laws. The guarantor essentially argued that there was no legal separation between it and the borrower because it was the borrower’s “alter ego,” and as support they identified evidence that the two entities failed to observe basic corporate formalities. According to the guarantor, it should be excused from its obligations because it was essentially the same as the borrower, and thus protected by California’s anti-deficiency laws.
In its amicus brief, the CBA raised two principal arguments, both of which were adopted by the court of appeal in its published opinion reversing the trial court’s judgment in favor of the guarantor Festival Fund.
The CBA first argued that there was no evidence to support a “sham guarantee” finding because the undisputed evidence showed that the borrower Festival 357, its general partner FRF1, and the guarantor Festival Fund, were separate legal entities formed prior to any involvement with the lender. The court of appeal adopted this argument in holding that “in this action, there was no basis to find that the Bank had a role in the formation of Festival Fund or its affiliated entities, and no evidence to support a conclusion that the entities were designed by the lender to conceal the identity of the primary obligor.” (Op. at pg. 11.)
The CBA also argued that the lower court erred by allowing the guarantor to invoke the alter ego or “unity of interest” doctrine because those doctrines permit an affirmative cause of action by a third party against a corporate creditor, not a defense that can be asserted by a corporation or its alter egos to evade liability to a third party. Thus, the CBA argued, the lower court’s ruling allowing guarantor Festival Fund and the borrower’s general partner FRF1 to affirmatively disclaim their otherwise separate corporate existences, based on their own failures to observe corporate formalities, was not supported by any evidence of inequity to a third party creditor, as required for either doctrine to apply. The court of appeal adopted this argument in holding that “[t]o allow a guarantor to avoid its obligations simply because the debtor’s general partner—which is owned entirely by the guarantor—avoided complying with corporate necessities would work an absurdity. Guarantors could choose to avoid liability by instructing their affiliated companies to disregard corporate formalities. If an alter ego (or single business enterprise) defense applied in these situations, it would promote an inequitable result, exactly what the doctrine is designed to avoid.” (Op. at pgs. 15-16.)
By defeating the “sham guarantee” defense in this important case, the CBA and its counsel, Bryan Cave, have helped the banking industry avoid a disastrous result that would have devalued commercial guarantees and likely restricted the availability of commercial lending in the State of California.