waiver of anti-deficiency protection
This Article was originally published by Building Savvy Magazine (2014)
Most builders are all-too-familiar with the phrase, “Of course we will need a personal guarantor on this note.” Builders in Texas are often expected to ensure the debts of their companies, making them “personal guarantors” for those debts. This practice is not only common in the construction industry, it is expected. But, a bank would never pass up the deep pockets of a business to pursue the personal assets of the individual guarantor, right? Wrong. In Texas, when a personal guarantor waives certain rights under a note, without the same being waived by the guarantor’s company, the bank is left with only one option: sue the individual, not the company!
Texas is generous in protecting borrowers from the sometimes-shady acts of creditors. One of these generosities is Texas’s enactment of anti-deficiency laws. These laws, for example, prevent a bank from foreclosing on a $1-million note secured by property with a fair market value of $1 million, purchasing the property at its own foreclosure sale for $400,000, and then suing the borrower for the $600,000 “deficiency.” The rationale is that, through foreclosure, the bank has recaptured the full amount of the debt—$1 million worth of assets—regardless of the amount it received at foreclosure. A bank is therefore prevented from collecting the same debt twice (i.e., obtaining property at a discounted rate plus a deficiency judgment). Unfortunately however, Texas’s strong preference for “freedom of contract” has allowed banks to utilize language to waive this anti-deficiency protection.
This type of waiver is particularly dangerous for personal guarantors. For instance, imagine that in the situation above, the bank had allowed the original borrower to retain its anti-deficiency protection but had required the personal guarantor to waive the same protection. After foreclosure, the borrower would owe nothing due to the anti-deficiency laws because the bank has received $1 million worth of assets. Technically, however, a “deficiency” still exists on the note because the bank received only $400,000 at foreclosure, which is $600,000 less than the original debt. It is important to understand that nothing prevents the bank from collecting the $600,000 deficiency from the personal guarantor if the guarantor has waived his or her anti-deficiency protection.
So although a guarantor is usually liable only for the amount owed by the original borrower, which in this case is $0, without anti-deficiency protection, the guarantor remains on the hook for the full $600,000 deficiency. It is still unclear whether a court would allow the borrower—the guarantor’s company—to intervene in a suit against the guarantor and assert these anti-deficiency laws on the guarantor’s behalf. It is clear, though, that personal guarantors should seek to avoid this situation altogether. If the bank allows a company to retain its anti-deficiency protection, the personal guarantor should insist that he or she be allowed to do so as well.
Kyle B. Fonville is an associate with Decker, Jones, McMackin, McClane, Hall & Bates, P.C. in Fort Worth. His practice focuses primarily on civil and commercial litigation, including construction matters, and appellate law. He can be reached by phone at 817.336.2400 or by email at firstname.lastname@example.org.
Stephen L. Polozola is a partner with Decker, Jones, McMackin, McClane, Hall & Bates, P.C. in Fort Worth. His practice focuses primarily on construction law matters. He can be reached by phone at 817.336.2400 or by email email@example.com.