November 2, 2023
By: William L. Hallam
The scenario is fairly common. A bank makes a loan to a business. The owners of the business guarantee the loan. The business defaults. The owners blame each other for the failure of the business. When the bank demands payment of the loan, the more liquid owner who realizes that the bank is going to collect the entire loan balance from him, forms a new entity to buy the loan from the bank instead of paying the loan. The new entity, standing in the bank’s shoes, then sues the other owner on his guaranty.
This scenario, with a few twists, played out in the Intermediate Appellate Court of West Virginia in PITA, LLC v. Segal. In Segal, Centra Bank made a $3 million loan to Protea Biosciences, Inc. Three of the owners of Protea, Puskar, Harris, and Hostler, each simultaneously signed a guaranty in the principal amount of $1 million. Later, a fourth owner, Segal, signed a $1 million guaranty identical in form to the guaranties signed by Puskar, Harris, and Hostler. Each guaranty contained common provisions in which the guarantors waived defenses based on impairment of collateral, release of the borrower or other guarantors, and modification of the loan terms without their consent.
One year after the initial guaranties were signed, Puskar’s Revocable Trust executed a $3 million guaranty of the loan to Protea. The Puskar Trust also pledged shares of stock to Centra Bank to secure Centra Bank’s loan to Protea and loans to two other borrowers that the Puskar Trust had guaranteed. Centra Bank, the Puskar Trust, Puskar, Harris, Hostler, and Segal entered into a Change In Terms Agreement in which Puskar, Harris, Hostler, and Segal acknowledged that their respective guaranties of the Protea loan remained in effect and agreed that the terms could not be contradicted by evidence of any prior, simultaneous, or subsequent oral agreement.
Protea defaulted on the Centra Bank loan and filed for bankruptcy. The Puskar Trust formed PITA, LLC. PITA, LLC purchased the Protea loan from Centra Bank’s successor, United Bank, for the balance outstanding on the loan with funds provided by the Puskar Trust. PITA then released the collateral that the Puskar Trust had pledged to secure the Protea loan. PITA, LLC sued Harris, Hostler, and Segal on their guaranties. The Puskar Trust sued them for contribution. Harris and Hostler settled, with each agreeing to pay PITA, LLC $537,500. PITA, LLC’s and the Puskar Trust’s litigation against Segal proceeded.
Exactly what relief PITA, LLC sought on its breach of contract claim in the trial court is unclear. Based on the Appellate Court’s statement that “PITA is not seeking to recover more than Segal’s contributive share,” PITA, LLC apparently did not contend that it was entitled to recover the full principal balance outstanding on the loan from Segal. However, PITA, LLC definitely sought accrued interest, and attorneys’ fees in a breach of contract action against Segal based on his guaranty that it had purchased from United Bank. The trial court held that PITA, LLC had no breach of contract claim at all and granted Segal summary judgment on the breach of contract claim. However, it granted the Puskar Trust summary judgment on its contribution claim. Both PITA, LLC and Segal appealed to the Intermediate Appellate Court.
Although it said that it did not need to determine whether PITA, LLC was the alter-ego of the Puskar Trust because PITA, LLC was only seeking to recover Segal’s contributive share and noted that “the corporate veil should not be lightly disregarded,” the Intermediate Appellate Court analyzed the breach of contract claim as if PITA, LLC was the same as the Puskar Trust thar guaranteed the Protea loan. The Court said that the case law is split, with some courts permitting a guarantor to sue a co-guarantor under a guaranty of a purchased loan for breach of contract and others holding that a guarantor who purchases a loan may only sue a co-guarantor for contribution. Furthermore, the Court said that courts that permit a breach of contract action “typically limit the plaintiff’s recovery to the contributive share it would be entitled to in an action for contribution.”
The Intermediate Appellate Court adopted a hybrid approach, limiting PITA, LLC’s primary breach of contract recovery to the contributive share the Puskar Trust would have been entitled to in an action for contribution, but permitting PITA, LLC to recover interest at the rate provided for in the promissory note, late charges, and attorneys’ fees provided for guaranty as well. The Court justified the additional awards based on contract by saying that “If Segal had wanted to avoid liability for contractual interest, late charges, and attorneys’ fees, he could have paid his contributive share (or any part of it not in dispute) when asked to do so, or negotiated an acceptable settlement, instead of litigating this matter for five years.” Accordingly, the Appellate Court reversed the trial court’s granting of summary judgment to Segal on PITA, LLC’s breach of contract claim.
While limiting PITA, LLC’s base recovery before interest, late charges, and attorneys’ fees to what the Puskar Trust could have recovered in an action for contribution, the Court said that the trial court had erred in granting summary judgment to the Puskar Trust on its contribution claim because an action for contribution by the Puskar Trust was premature. The Court said that the Puskar Trust “did not pay any money to satisfy the Protea loan, either in whole or in part.” The Court continued:
The loan was not extinguished; it was assigned to PITA, which then sued Segal on his guaranty. The Trust was not entitled to contribution against Segal because it had not paid more than its contributive share. Indeed, at this point, it has not paid anything to satisfy the Protea obligation.
Accordingly, the Appellate Court reversed the trial court’s granting of summary judgment to the Puskar Trust on its contribution claim.
The Court rejected arguments by Segal that he should be released from liability under his guaranty because PITA, LLC had released the shares of stock that had been pledged by the Puskar Trust as collateral for the Protea loan. The Court said that the waivers of defenses in Segal’s guaranty, which Segal’s banking law expert had acknowledged “was a standard industry form with commonly used waivers,” were enforceable under West Virginia law.
The Court then addressed how Segal’s “contributive share” should be calculated. Apparently assuming that the guaranty by the Puskar Trust superseded the guaranty by Puskar individually, Segal argued that since he, Harris, and Hostler had each signed $1 million guaranties and the Puskar Trust had signed a $3 million guaranty for a total of $6 million in guaranties, his contributive share should be 1/6 of the balance due on the loan. PITA, LLC, on the other hand, argued that since Segal’s guaranty and the Puskar Trust guaranty were the only remaining guaranties, Segal’s contributive share should be ½ of the loan balance.
Citing to the Restatement (Third) of Suretyship and Guaranty, the Court said that, as a general rule, guarantors are responsible for equal shares of the guaranteed debt, but that “if it can be shown that the co-obligors have by agreement made a different allocation as to their liability inter se or one or more of the co-obligors have received a disproportionate benefit from the transaction, then disproportionate contribution may be allowed.” According to the Court, to overcome the presumption that the guarantors share the liability equally, “the party asserting that contributive shares should not be equal has the burden of proving by a preponderance of the evidence that a different allocation is required by an express or implied agreement, or by equitable circumstances.”
Segal argued that the execution by the Puskar Trust of a $3 million guaranty when he and the other individual guarantors had signed $1 million guaranties established that the guarantors had agreed to non-equal shares of the debt. The Court rejected this argument, saying that “The relationship of guarantor to obligee is different from the relationship between co-obligors.” “Accordingly, it does not make sense to automatically assume that differing amounts in guaranties indicate an agreement among co-obligors to define contributive shares among themselves.” The Intermediate Appellate Court remanded the case to the trial court to calculate Segal’s contributive share.
The Segal opinion raises many questions. For example, when the Intermediate Appellate Court expressly stated that PITA, LLC did not pay off the Protea loan, but bought it, and that the corporate veil should not be disregarded lightly, why was it appropriate to analyze PITA, LLC’s claim as if PITA, LLC was a co-guarantor when the Puskar Trust was the guarantor? Even if PITA, LLC and the Puskar Trust were appropriately considered alter-egos, if the Puskar Trust had no contribution claim because it had not yet paid any portion of the debt and PITA, LLC was limited to recovering on its breach of contract claim what the Puskar Trust could recover in a contribution action, how could PITA, LLC recover anything on its breach of contract claim? If there are two distinct lines of cases governing what a guarantor may recover from a co-guarantor after buying a loan from the lender, why create yet a third line of cases by limiting the guarantor-loan buyer’s primary recovery to the other guarantor’s contributive share, but also allowing recovery of contractual interest and attorneys’ fees? Perhaps the Supreme Court of Appeals of West Virginia will answer some or all of these questions in a further appeal. Or perhaps not.