How a Guarantor Became a Surety

Originally published in The Docket, March 2009
By Mark A. Van Donselaar

A long-time business client calls you with a question about a contract that he is about to enter into on behalf of his business. The party with whom he is contracting is demanding that the contract include either your client’s personal guaranty, or that your client act as a surety for any debt owed under the contract. Being a layman, your client does not know the difference between a personal guaranty and a surety, so he wants you to explain the difference. This article will do just that, while focusing on the recent Second District Appellate Court case, JP Morgan Chase Bank, N.A. v. Earth Foods, Inc.,¹ which blurs the line between the two. (The Illinois Supreme Court granted leave to appeal on January 28, 2009.)

“There is substantial distinction between the liability of a surety and that of a guarantor. A surety’s undertaking is an original one, by which he becomes primarily liable with the principle debtor, while a guarantor is not a party to the principal obligation and bears only a secondary liability.”² Stated somewhat differently, the distinction between a suretyship and guaranty is that “a surety is in the first instance answerable for the debt for which he makes himself responsible, while a guarantor is only liable where default is made by the party whose undertaking is guaranteed.”³ A contract is “one of suretyship when one obligates himself to pay the obligee, absolutely and wholly, without the necessity that the obligee exhaust his remedies against the principal before proceeding against the surety.”⁴ A guaranty is “an undertaking to be responsible for the performance of an obligation of a third person upon his failure to perform it.” ⁵

Whether the obligation assumed by a party is that of a guarantor or a surety “is to be determined by the intent of the parties as collected from the language of the instrument and the circumstances attending its execution.”⁶ Where the express terms of the instrument are ambiguous, “the parties’ intentions can be determined from their declarations and conduct andfrom the surrounding circumstances.”⁷ Where the terms of the instrument are unclear and there are questions of the parties’ intent, parole evidence may be used to determine whether the contract at issue is a surety or a guaranty.⁸

The word “guarantee” is frequently used interchangeably with the word “surety.”⁹ “The  terms ‘suretyship’ and ‘guaranty’ are often confounded from the fact that the guarantor is in common acceptation a surety for another.”¹⁰ Thus, the determination of whether a contract is a surety or a guaranty does not depend upon technical language, such as security, surety, guaranty, or guarantee, which may be used in the contract.¹¹ To ignore the circumstances in which such terms are used attaches too much importance to them.¹² It is the nature of the obligation, whether primary, which would indicate a surety, or secondary, which would indicate a guaranty that is the determinative factor for distinguishing between a surety and a guaranty.¹³

Perhaps the most significant distinction between a guaranty and a surety is that a surety may avail himself of the protections afforded by the Sureties Act.¹⁴ The Sureties Act was first passed in 1874.¹⁵ Section 1 of the Act provides:

When any person is bound, in writing, as surety for another for the payment of money, or the performance of any other contract, apprehends that his principal is likely to become insolvent or to remove himself from the state, without discharging the contract, if a right of action has accrued on the contract, he may, in writing, require the creditor to sue forthwith upon the same; and unless such creditor, within a reasonable time and with due diligence, commences an action thereon, and prosecutes the same to final judgment and proceeds with the enforcement thereof, the surety shall be discharged; but such discharge shall not in any case affect the rights of the creditor against the principal debtor.¹⁶

In Wurster et.al. v. Albrecht¹⁷ the Appellate Court for the Second District examined the section of the Sureties Act quoted above and found that if not for the statutory provision, the holder of the note would not be required to comply with the surety’s demand to sue. However, the “statute was undoubtedly enacted for the purpose of compelling diligence by a creditor to the end that a surety may be protected against loss.”¹⁸ Thus, if demand is made by the surety under the provisions of the Section 1 of the Sureties Act and a lawsuit is not diligently brought by the creditor, then the surety may be protected from liability to the creditor.

It was not until the Second District Appellate Court’s decision in JP Morgan Chase Bank, N.A. that the protections of the Sureties Act have been extended to apply to a guarantor. The facts of JP Morgan Chase Bank, N.A. are stated fairly simply: the plaintiff in the case extended a line of credit to the primary defendant, Earth Foods, Inc. (Earth Foods), which was “personally guaranteed” by three co-owners of Earth Foods.¹⁹ The defendants sent the plaintiff a  letter in which they warned that Earth Foods was depleting its inventory and demanded that the plaintiff take action. When the plaintiff filed suit against Earth Foods and the co-guarantors, the co-guarantors responded by asserting an affirmative defense based on the protections found in Section 1 of the Sureties Act.

The circuit court granted the plaintiff’s motion for summary judgment on the ground that defendants were guarantors, not sureties, and, therefore, the Sureties Act did not apply. On appeal, the defendants argued, in part, that the circuit court erred when it found that the provisions of the Sureties Act did not apply. The Plaintiff countered with its successful argument in the circuit court that the Sureties Act did not apply because the defendants were guarantors, not sureties.

For its analysis, the appellate court turned to Black’s Law Dictionary for the definition of “surety,” which it found to be “[a] person who is primarily liable for the payment of another’s debt or the performance of another’s obligation.”²⁰ The court quoted further from Black’s, noting that “[a] surety differs from a guarantor, who is liable to the creditor only if the debtor does not meet the duties owed to the creditor; the surety is directly liable.”²¹ The appellate court reasoned that the definitions found in Black’s Law Dictionary supported the plaintiff’s argument that sureties are distinct from guarantors.²²

However, that did not end the court’s examination of the relationship between sureties and guarantors, though it did seemingly end any chance the plaintiff had of prevailing. The court went on to state that “the dictionary definition [of the term surety] does not in this case provide the ‘popularly understood’ meaning of the term.”²³ After alluding to the fact that it did not agree with the definition of the word “surety” found in Black’s Law Dictionary, the court set out on an extended analysis of the use of the words surety and guaranty.

As part of its analysis, the court found that “[t]he terms suretyship and guaranty are often confounded from the fact that the guarantor is in common acceptation a surety for another, and thus the word guarantee is frequently used interchangeably with the word surety.”²⁴ The court continued its analysis and found Illinois cases that have used the term surety in a general sense and those that have used the term in a specific sense.²⁵ Used in its general sense, the term surety has been used to describe “a relationship in which a person undertakes an obligation of another who is also under an obligation or duty to the creditor/obligee.”²⁶ Used more specifically, surety has been used to describe a contract in which the surety is in the first instance answerable for the debt for which he makes himself responsible, as opposed to a guarantor, who is only liable where default is made by the party whose undertaking is guaranteed.²⁷ Accordingly, the court concluded that the term surety “has more than one popularly understood meaning.”²⁸ The term surety could refer to any situation in which a person agreed to be held liable for the debt of another, whether the liability was primary or secondary.²⁹ It could also be used to refer strictly to a surety, who is primarily liable.³⁰

The court continued its examination to focus on when liability attaches to either a surety or a guaranty. A surety is primarily liable as though there is joint and several liabilities with the principal.³¹ The exact moment that a guarantor becomes liable for the debt of the principal is less certain.³² Some cases stand for the proposition that a guarantor’s liability is only triggered after the creditor has proceeded against the principal and failed to receive full satisfaction.³³ Other authority holds that a guarantor’s liability is triggered by the principal’s default, regardless of attempts by the creditor to recover from the principal.³⁴ The court found the position that imposes liability regardless of the creditor’s collection efforts to be the more persuasive position.³⁵ In light of its determination that liability is imposed against a guarantor upon the principal’s default, regardless of attempts against the guarantor’s principal, the Court reasoned that any differences between primary liability of a surety and secondary liability of a guarantor appear to be only academic.³⁶

After the analysis described above, the Court circled back to the issue of whether the legislature intended to distinguish between a surety and a guaranty or whether the legislature meant to use the term surety in its general sense to describe both surety and guaranty scenarios. The court concluded that based upon the intertwined use of the terms guaranty and surety and the confusion surrounding the use of the term surety, the “legislature did not mean to draw the type of precise distinctions we discussed above, but instead used the word in its general sense.”³⁷ That court offered no authority for its determination of what the legislature intended.

It would seem that the very essence of the legislature is to make precise distinctions between divergent positions in the statutes that it enacts. Certainly, some statutes allow for more than one reasonable interpretation. However, where the legislature has specifically used a single, precisely defined term and left out another related, yet distinctly different, term, it would seem  that the statute should be read to include only the term that has been used to the exclusion of the unused term.

An example of the fine distinctions made by the legislature and enforced by the appellate court is demonstrated in Micro Switch Employees’ Credit Union v. Collier.³⁸ In that case, the plaintiff loaned $7,300 to the defendant for him to purchase a car from a car dealer. The defendant fell into arrears, so the plaintiff repossessed the car and filed suit for certification of title and judgment in the amount owed on the loan. The circuit court granted judgment in the plaintiff’s favor, and the defendant appealed arguing that the Motor Vehicle Retail Installment Sales Act (“MVRISA”) applied to the transaction and that the plaintiff violated the provisions of the MVRISA with respect to the notice required to be provided to the defendant.

On review, the appellate court found that the MVRISA did not apply to the transaction because it only applied to purchasers of automobiles who buy from a dealer under a retail installment transaction.³⁹ The court ruled that the plaintiff was not a retail seller under the definitions of the MVRISA because it was not engaged in the business of selling motor vehicles.⁴⁰ Additionally, the defendant paid the automobile dealer the total amount of the purchase in a single payment, so the transaction at issue did not fit the definition of a retail installment transaction.⁴¹

Despite the fact that the definitions found in MVRISA clearly did not support its applicability to the scenario at hand, the defendant in Micro Switch Employees’ Credit Union continued to argue that the statute should apply to his situation because the purpose of the MVRISA was “to protect the buyer from the myriad of oppressive practices which, under the best of circumstances, seems to characterize installment selling.”⁴² But the court remained firm in its holding that the statute did not apply. “While the purpose of [MVRISA] may seem to warrant including agencies like Micro Switch which make installment loans for car purchases, it is clear that the legislature has chosen to include only retail sellers and sales finance agencies. The language of the statute is clear and precise. Had the legislature intended to include lenders such as the plaintiff, it would have done so. Where the language of the Act is certain and unambiguous, the only legitimate function of the courts is to enforce the law as enacted by the legislature.”⁴³

Though the language of the statute at issue in Micro Switch Employees’ Credit Union may not have the history of double use that the term surety has, it is difficult to determine how the language of the Sureties Act is any less certain than that of the MVRISA that would prompt the court to step outside of the clear language of the statute and apply it to guarantors as well as sureties.

As support for its decision, the court notes that the Sureties Act was created “to compel diligence by a creditor to make certain a surety is protected against loss” and that such purposes would be better served by extending such protections to guarantors and sureties.⁴⁴ The court continued, “Given the [Sureties] Act’s purpose, which applies to sureties and guarantors alike, and given the exceptionally close relationship between those two terms, we agree with defendant’s position that the legislature must have intended the word ‘surety’ in the [Sureties] Act to encompass a guarantor.”⁴⁵ The court did not make reference to any Illinois authority for its determination that the Sureties Act should apply to guarantors as well as sureties. However, it did refer to a decision from the First Circuit of the United States Court of Appeals that interpreted the Sureties Act and found that is applied to guarantors and sureties alike.

When asked by a client for advice regarding surety and guaranty agreements, the Illinois practitioner would be wise to advise his clients as to the differences between sureties and guarantees as they relate to the applicability of the Sureties Act. Additionally, as long as JP Morgan Chase Bank, N.A. remains authority, clients should also be counseled that a court may determine that the Sureties Act applies to both surety and guaranty agreements.