Executive Summary
This memorandum addresses the rights and liabilities of a guarantor following a
nonjudicial foreclosure of collateral securing the note. While a lender is estopped from seeking a
deficiency judgment against a guarantor following a nonjudicial foreclosure, this rule can and
frequently is waived by the guarantor, thus affording the guarantor little practical protection
against a deficiency judgment.
There are, however, certain defenses available to the guarantor, the most important being
the “sham” guaranty defense. Where an individual guarantees a note on which he or she is
personally liable, or where the facts and circumstances show that the guarantor is essentially the
primary obligor, the purported guaranty will be disregarded and the purported guarantor will be
protected by the antideficiency laws.
There are statutory protections, such as the requirement that the guarantor’s obligation be
no greater than the borrowers, or that the guarantor can force the lender to go after the security
first, but these provisions can and are frequently waived. However, with regard to the waiver of
the antideficiency statutes and the guarantor statutes, it is possible to argue that the language
used is insufficiently explicit. There are also basis contract defenses such as fraud or undue
influence that could be available to the guarantor.
Application of Antideficiency Statutes to Guarantors under CCP §§ 580b and 580d;
Waiver of the Gradsky Rule
Code of Civil Procedure section 580d provides that “[n]o judgment shall be rendered for
any deficiency upon a note secured by a deed of trust or mortgage upon real property . . . in a
case in which the real property . . . has been sold by the mortgagee or trustee . . . .” While
section 580d is no bar a deficiency suit against a guarantor, such a suit is barred by principles of
estoppel where the creditor nonjudicially forecloses on the property.1 As explained in Union
Bank v. Gradsky:
1
It is important to note the laws of state in which the collateral is located. While the majority view is that
antideficiency statutes do not apply to guarantors, certain state, including Nevada and Arizona have held that the
deficiency statutes do apply to guarantors—at least in certain respects. See, First Interstate Bank of Nevada v.
Shields (1986) 102 Nev. 616 (bar against deficiency actions apply to actions against guarantors); First Interstate
Bank of Arizona v. Tatum and Bell Center Associates (1991) 170 Ariz. 99 (fair market value limitation applies to
Upon the bank’s election to pursue a remedy which destroys both the security and
the possibility of the surety’s reimbursement from the principal debtor, the
creditor is thereafter estopped from pursuing the guarantor for a deficiency
following a nonjudicial sale of the security. The result follows not because section
580d of the Code of Civil Procedure prevents recovery of a deficiency judgment
against the guarantor, but because the section prevents a deficiency judgment by
the guarantor against the debtor. 265 Cal. App. 2d 40, 46-47.
The estoppel defense rests in part on the fact that by nonjudicially foreclosing, the lender
precludes the guarantor from judicially foreclosing on the borrower and seeking a deficiency
judgment under Code of Civil Procedure section 726. Therefore, in the situation of a purchase
money mortgage, where a deficiency judgment is never available by operation of section 580b,
estoppel is no bar to a suit against the guarantor. Bauman v. Castle (1971) 15 Cal. App. 3d 990.2
A purchase money mortgage within the purview of section 580b can arise either where the seller
takes a note and deed to secure payment of the purchase price, or where a third party lender
grants a purchase money mortgage on an owner occupied residential dwelling with no more than
four families.
Despite the rule of Gradsky, the court in that case greatly limited the extent of its holding
by recognizing that the guarantor can by waive the estoppel defense, provided the waiver is
explicit. Gradsky, 265 Cal. App. 2d at 48. Accordingly, nearly all guarantees now contain
Gradsky waivers and fair market value waivers.
Defenses Available to Guarantors
Sham Guarantees. Courts will not honor so-called “sham” guarantees in which an
individual essentially guarantees his own loan. In Riddle v. Lushing (1962) 203 Cal. App. 2d
831, the court refused to enforce the guarantees of two partners who purportedly guaranteed a
loan made to their general partnership. The court there reasoned that:
Since defendants were already primary obligors, both jointly and severally, they
could not also be surities or guarantors of the partnership note. The purported
guaranty added nothing to the primarly liability which arose when the partners
executed the note in the name of the partnership. As primary obligors they are
guarantors). Note, however, that it remains an open issue whether the antideficiency statutes can be waived by the
guarantor in these jurisdictions. As far as other western states are concerned, Oregon and Utah each hold that the
antideficiency statutes do not apply to guarantors. First Sec. Bank of Idaho v. Gaige (1988) 115 Idaho 172; Summer
v. Enercon Development Co. (1989) 307 Or. 579.
Bauman is limited to section 580b, and should not be read to void the estoppel defense if the creditor’s nonjudicial
foreclosure was not prejudicial to the guarantor. For example, a creditor’s argument that the debtor was insolvent
and therefore any deficiency rights the guarantor might have had were worthless and therefore barred the estoppel
defense, was rejected in Consolidated Capital Income Trust v. Khaloghli (1986) 183 Cal. App. 3d 107, 115, where
the court held that such a rule would “swallow up Gradsky.”
2
entitled to the benefits and protection of said section 580b. The purported
guaranty was a part of, and entirely dependent upon, the note and deed of trust,
and it cannot be enforced as an independent agreement. Id. at 834.
In Valinda Builders, Inc. v. Bissner (1964) 230 Cal. App. 2d 106, defendants, a husband
and wife, purchased land from the plaintiff for purposes of constructing a subdivision. The
plaintiff took a purchase money note and deed of trust and subordinated to a construction lender.
The defendants organized a corporation (Trend) by contributing $200. Trend took title to the
land and executed the note and deed in favor of the plaintiff. The plaintiff required the
defendants to personally guarantee the note to the corporation. The enterprise ultimately failed
before the construction was completed, and plaintiff’s subordinated deed was wiped out after the
senior construction lender foreclosed.
In plaintiff’s action to enforce the guarantee, the court framed the issue as follows, “[t]he
contract of sale provided that defendants guaranteed performance of the contract of purchase and
payment of the purchase money note and the ultimate question is whether this was a guarantee of
the obligation of another, Trend, or merely a promise of defendants to pay what they already
owed, and in no sense a contract of guaranty.” Id. at 108 (emphasis added).
The court found that the guarantee was a sham guarantee, and refused to enforce it. The
court reasoned that:
There was no evidence that Trend was anything other than an instrumentality used
by the individuals or that defendants were ever removed from their status and
obligations of purchasers. Section 2787 of the Civil Code defines a surety or
guarantor as one who promises to answer for the debt, default or miscarriage of
another, or hypothecates property as security therefor. The only debt in existence
at the time of the contract was the promise of defendants to pay for the property.
There was nothing in the agreement to suggest, nor is it contended that there was
a plan that defendants would be supplanted as purchasers by any independent,
responsible entity. Manifestly, the alleged guaranty of defendants was no more
than a promise to pay their own debt, and the only other debt that became owing
for the purchase price was the obligation of Trend, a mere shell of a corporation.
Aside from the funds that were borrowed, defendants personally contributed the
only funds that went into the venture. Id. at 110 (emphasis added).
As demonstrated above, the sham guarantee doctrine comes into play when the party
executing the note and deed of trust is either the same as the guarantor or an instrumentality or
alter ego of the guarantor. While various formulations have been put forth, the question boils
down to whether “the supposed guarantors [are] nothing more than the principal obligors under
another name.” River Bank America v. Diller (1995) 38 Cal. App. 4th 1400, 1422-23.
The issue is generally one of facts and circumstances, although a guaranty is per se a
sham where an individual guarantees a note on which he is personally liable, as in the case of a
general partner guarantying a note to the partnership. Union Bank v. Dorn (1967) 254 Cal. App.
2d 157 (invalidating purported guarantee of individuals who were also the general partners in the
debtor-limited partnership); Diller, 38 Cal. App. 4th at 1422 (invalidating purported guaranty of
principles of the corporate general partner in a limited partnership); In re Prestige Ltd.
Partnership-Concord (Bkrtcy. N.D. Cal. 1997) 205 B.R. 427 (same).
However, where the debtor entity is a limited liability entity, the following facts are
relevant in determining whether the guarantee is a true guarantee or a sham: (1) the borrower is
an entity related to or controlled by the guarantor, (2) the borrower entity was not a preexisting
entity, but was created specifically for the loan transaction in question, (3) the lender relies on
the financial records and bona fides of the guarantors as opposed to the borrower, (4) the
borrower is undercapitalized, (5) the guarantors initially intended to purchase the property in
their own name, but the borrower wanted a different entity, (6) the guarantors are the officers or
partners in the borrowing entity. See generally, Diller, 38 Cal. App. 4th at 1422-24. This list is
by no means exclusive. Furthermore, the fact the guarantors would be personally shielded from
liability by virtue of the separate existence of the corporate borrower is of no effect. Id.
Inadequate Waiver. As discussed above, the estoppel defense can be waived by the
guarantor (the “Gradsky waiver”). In Gradsky, the guarantee provided that the guarantor waived
“any right to require the holder . . . to proceed against the maker or against any other person or to
apply any security it may hold or to pursue any other remedy.” Id. at 42. The court held that this
waiver was insufficient and suggested in dicta that a proper waiver would include both the
waiver of the “guarantor’s defense based upon an election of remedies which destroys the
guarantor’s subrogation rights and his right to proceed against the principal obligor for
reimbursement.” Id. at 48.
Cathay Bank v. Lee (1993) 14 Cal. App. 4th 1533 involved the degree of specificity
needed for a proper Gradsky waiver. The court applied an incredibly strict standard, holding that
the following Gradsky waiver was not sufficiently explicit and therefore of no effect:
Guarantor authorizes bank at its sole discretion. . . to: . . . exercise any right or
remedy it may have with respect to the Credit or any collateral securing the
Credit. . . including. . . exercise of power of sale. . . and Guarantor shall be liable
to Bank for any deficiency resulting from the exercise by it of any such remedy,
even though any rights which Guarantor may have against others might be. . .
destroyed. Id. at 423.
After a host of similar cases, the California Legislature responded to the lenders’
concerns and enacted Civil Code section 2856(d) which sets forth a proper Gradsky waiver:
The guarantor waives all rights and defenses arising out of an election of remedies
by the creditor, even though that election of remedies, such as a nonjudicial
foreclosure with respect to security for a guaranteed obligation, has destroyed the
guarantor's rights of subrogation. Cal. Civ. Code § 2856(d).
Furthermore, Civil Code section 2856(c) provides safe harbor language for a waiver of
the Code of Civil Procedure section 726 fair value limitation. It provides that:
The guarantor waives all rights and defenses that the guarantor may have because
the debtor's debt is secured by real property. This means, among other things:
(1) The creditor may collect from the guarantor without first foreclosing
on any real or personal property collateral pledged by the debtor.
(2) If the creditor forecloses on any real property collateral pledged by the
debtor:
(A) The amount of the debt may be reduced only by the price for
which that collateral is sold at the foreclosure sale, even if the collateral is
worth more than the sale price.
(B) The creditor may collect from the guarantor even if the
creditor, by foreclosing on the real property collateral, has destroyed any
right the guarantor may have to collect from the debtor.
This is an unconditional and irrevocable waiver of any rights and defenses the
guarantor may have because the debtor's debt is secured by real property. These
rights and defenses include, but are not limited to, any rights or defenses based
upon Section 580a, 580b, 580d, or 726 of the Code of Civil Procedure.
Guarantees that do not contain this safe harbor language may be suspect to attack based
on the older case law requiring the waivers to be incredibly specific. See, Bank of So. California
v. Dombrow (1995) 46 Cal. Rptr. 2d 656 (ordered not published) (fair market waiver);
Resolution Trust Corp. v. Titan Financial Corp. (9th Cir. 1994) 22 F.3d 923, 925 (Gradsky
waiver). They may also be subject to attack based on their failure to follow the precise language
mandated by the statutes. As a practical matter, most commercial lenders have incorporated this
language into their guarantees.
Statutory Protections. Civil Code section 2809 provides that the obligation of a
guarantor or surety “must be neither larger in amount nor in other respects more burdensome
than that of the principal.” Civil Code section 2845 provides that a surety may require the
creditor to proceed against the principal, or to pursue any other remedy in the creditor’s power
which the surety cannot pursue, and if the creditor neglects to do so, the surety is exonerated “to
the extent to which the surety is thereby prejudiced.”
These protections, like the Gradsky rule, can be (and frequently are) waived. Gradsky,
265 Cal. App. 2d at 43, fn.3. As with the Gradsky waiver, the guarantor can claim the waiver
was not sufficiently explicit, but may face an uphill battle in that regard. See, e.g. Mariners Sav.
& Loan Ass’n. v. Neil (1971) 22 Cal. App. 3d 232, 236.
Contract Defenses. A guarantee is a contract and is subject to the same contract
defenses such as fraud, misrepresentation, duress, undue influence, mistake, illegality and the
statute of frauds. Law of Distressed Real Estate § 43:3. For example, a waiver of antideficiency
protection contained in the mortgage signed only by the debtor will not bind the guarantor. See,
Anderson Bros. Bank v. Adams (1991) 305 S.C. 25.