{"id":103,"date":"2014-09-17T00:42:06","date_gmt":"2014-09-17T00:42:06","guid":{"rendered":"https:\/\/courses.candelalearning.com\/buslegalenv\/?post_type=chapter&#038;p=103"},"modified":"2015-04-20T19:42:58","modified_gmt":"2015-04-20T19:42:58","slug":"11-4-suretyship","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/chapter\/11-4-suretyship\/","title":{"raw":"Suretyship","rendered":"Suretyship"},"content":{"raw":"<div class=\"bcc-box bcc-highlight\">\r\n<h3>Learning Objectives<\/h3>\r\nBy the end of this section, you will be able to:\r\n<ul id=\"mayer_1.0-ch52_s02_l01\" class=\"im_orderedlist\">\r\n\t<li>Understand what a surety is and why sureties are used in commercial transactions.<\/li>\r\n\t<li>Know how suretyships are created.<\/li>\r\n\t<li>Recognize the general duty owed by the surety to the creditor, and the surety\u2019s defenses.<\/li>\r\n\t<li>Recognize the principal obligor\u2019s duty to the surety, and the surety\u2019s rights against the surety.<\/li>\r\n\t<li>Understand the rights among cosureties.<\/li>\r\n<\/ul>\r\n<\/div>\r\n\r\n<div id=\"mayer_1.0-ch28_s04_s01\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Definition, Types of Sureties, and Creation of the Suretyship<\/h2>\r\n<div id=\"mayer_1.0-ch28_s04_s01_s01\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Definition<\/h3>\r\nSuretyship is the second of the three major types of consensual security arrangements noted at the beginning of this chapter (personal property security, suretyship, real property security)\u2014and a common one. Creditors frequently ask the owners of small, closely held companies to guarantee their loans to the company, and parent corporations also frequently are guarantors of their subsidiaries\u2019 debts. The earliest sureties were friends or relatives of the principal debtor who agreed\u2014for free\u2014to lend their guarantee. Today most sureties in commercial transaction are insurance companies (but insurance is not the same as suretyship).\r\n\r\nA <span class=\"im_margin_term\"><span class=\"im_glossterm\">surety<\/span><\/span> is one who promises to pay or perform an obligation owed by the <span class=\"im_margin_term\"><span class=\"im_glossterm\">principal debtor<\/span><\/span>, and, strictly speaking, the surety is primarily liable on the debt: the creditor can demand payment from the surety when the debt is due. The creditor is the person to whom the principal debtor (and the surety, strictly speaking) owes an obligation. Very frequently, the creditor requires first that the debtor put up collateral to secure indebtedness, and\u2014in addition\u2014that the debtor engage a surety to make extra certain the creditor is paid or performance is made. For example, David Debtor wants Bank to loan his corporation, David Debtor, Inc., $100,000. Bank says, \u201cOkay, Mr. Debtor, we\u2019ll loan the corporation money, but we want its computer equipment as security, and we want you personally to guarantee the debt if the corporation can\u2019t pay.\u201d Sometimes, though, the surety and the principal debtor may have no agreement between each other; the surety might have struck a deal with the creditor to act as surety without the consent or knowledge of the principal debtor.\r\n\r\nA <span class=\"im_margin_term\"><span class=\"im_glossterm\">guarantor<\/span><\/span> also is one who guarantees an obligation of another, and for practical purposes, therefore, <em class=\"im_emphasis\">guarantor<\/em> is usually synonymous with <em class=\"im_emphasis\">surety<\/em>\u2014the terms are used pretty much interchangeably. But here\u2019s the technical difference: a surety is usually a party to the original contract and signs her (or his, or its) name to the original agreement along with the surety; the consideration for the principal\u2019s contract is the same as the surety\u2019s consideration\u2014she is bound on the contract from the very start, and she is also expected to know of the principal debtor\u2019s default so that the creditor\u2019s failure to inform her of it does not discharge her of any liability. On the other hand, a guarantor usually does not make his agreement with the creditor at the same time the principal debtor does: it\u2019s a separate contract requiring separate consideration, and if the guarantor is not informed of the principal debtor\u2019s default, the guarantor can claim discharge on the obligation to the extent any failure to inform him prejudices him. But, again, as the terms are mostly synonymous, <em class=\"im_emphasis\">surety<\/em> is used here to encompass both.\r\n<div id=\"mayer_1.0-ch28_s04_s01_s01_f01\" class=\"im_figure im_large im_editable im_block\">\r\n\r\n<span class=\"im_title-prefix\">Figure 11.6<\/span> Defenses of Principal Debtor and Surety\r\n\r\n<a href=\"https:\/\/textimgs.s3.amazonaws.com\/buslegalenv\/section_14\/0f088e27f167ebae2a0a9415a0c3f706.jpg\" target=\"_blank\"><img src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images-archive-read-only\/wp-content\/uploads\/sites\/140\/2014\/09\/20045927\/sm_0f088e27f167ebae2a0a9415a0c3f706.jpg\" alt=\"\" \/><\/a>\r\n\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\n&nbsp;\r\n<div id=\"mayer_1.0-ch28_s04_s01_s02\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Types of Suretyship<\/h2>\r\nWhere there is an interest, public or private, that requires protection from the possibility of a default, sureties are engaged. For example, a landlord might require that a commercial tenant not only put up a security deposit but also show evidence that it has a surety on line ready to stand for three months\u2019 rent if the tenant defaults. Often, a municipal government will want its road contractor to show it has a surety available in case, for some reason, the contractor cannot complete the project. Many states require general contractors to have bonds, purchased from insurance companies, as a condition of getting a contractor\u2019s license; the insurance company is the surety\u2014it will pay out if the contractor fails to complete work on the client\u2019s house. These are types of a <span class=\"im_margin_term\"><span class=\"im_glossterm\">performance bond<\/span><\/span>. A judge will often require that a criminal defendant put up a bond guaranteeing his appearance in court\u2014that\u2019s a type of suretyship where the bail-bonder is the surety\u2014or that a plaintiff put up a bond indemnifying the defendant for the costs of delays caused by the lawsuit\u2014a <span class=\"im_margin_term\"><span class=\"im_glossterm\">judicial bond<\/span><\/span>. A bank will take out a bond on its employees in case they steal money from the bank\u2014the bank teller, in this case, is the principal debtor (a <span class=\"im_margin_term\"><span class=\"im_glossterm\">fidelity bond<\/span><\/span>). However, as we will see, sureties do not anticipate financial loss like insurance companies do: the surety expects, mostly, to be repaid if it has to perform. The principal debtor goes to an insurance company and buys the bond\u2014the suretyship policy. The cost of the premium depends on the surety company, the type of bond applied for, and the applicant\u2019s financial history. A sound estimate of premium costs is 1 percent to 4 percent, but if a surety company classifies an applicant as high risk, the premium falls between 5 percent and 20 percent of the bond amount. When the purchaser of real estate agrees to assume the seller\u2019s mortgage (promises to pay the mortgage debt), the seller then becomes a surety: unless the mortgagee releases the seller (not likely), the seller has to pay if the buyer defaults.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch28_s04_s01_s03\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Creation of the Suretyship<\/h2>\r\nSuretyship can arise only through contract. The general principles of contract law apply to suretyship. Thus a person with the general capacity to contract has the power to become a surety. Consideration is required for a suretyship contract: if Debtor asks a friend to act as a surety to induce Creditor to make Debtor a loan, the consideration Debtor gives Creditor also acts as the consideration Friend gives. Where the suretyship arises <em class=\"im_emphasis\">after<\/em> Creditor has already extended credit, new consideration would be required (absent application of the doctrine of promissory estoppel<span id=\"mayer_1.0-fn28_062\" class=\"im_footnote\"><em class=\"im_emphasis\">American Druggists\u2019 Ins. Co. v. Shoppe<\/em>, 448 N.W.2d 103, Minn. App. (1989).<\/span>). You may recall from the chapters on contracts that the promise by one person to pay or perform for the debts or defaults of another must be evidenced by a writing under the statute of frauds (subject to the \u201cmain purpose\u201d exception).\r\n\r\nSuretyship contracts are affected to some extent by government regulation. Under a 1985 Federal Trade Commission Credit Practices Rule, creditors are prohibited from misrepresenting a surety\u2019s liability. Creditors must also give the surety a notice that explains the nature of the obligation and the potential liability that can arise if a person cosigns on another\u2019s debt.<span id=\"mayer_1.0-fn28_063\" class=\"im_footnote\">Here is an example of the required notice: Federal Trade Commission, \u201cFacts for Consumers: The Credit Practices Rule,\u201d <a class=\"im_link\" href=\"http:\/\/www.ftc.gov\/bcp\/edu\/pubs\/consumer\/credit\/cre12.shtm\" target=\"_blank\">http:\/\/www.ftc.gov\/bcp\/edu\/pubs\/consumer\/credit\/cre12.shtm<\/a>.<\/span>\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch28_s04_s02\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Duties and Rights of the Surety<\/h2>\r\n<div id=\"mayer_1.0-ch28_s04_s02_s01\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Duties of the Surety<\/h3>\r\nUpon the principal debtor\u2019s default, the surety is contractually obligated to perform unless the principal herself or someone on her behalf discharges the obligation. When the surety performs, it must do so in good faith. Because the principal debtor\u2019s defenses are generally limited, and because\u2014as will be noted\u2014the surety has the right to be reimbursed by the debtor, debtors not infrequently claim the surety acted in bad faith by doing things like failing to make an adequate investigation (to determine if the debtor really defaulted), overpaying claims, interfering with the contact between the surety and the debtor, and making unreasonable refusals to let the debtor complete the project. The case <em class=\"im_emphasis\">Fidelity and Deposit Co. of Maryland v. Douglas Asphalt Co.,<\/em> in Section 11.5 \"Cases\", is typical.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch28_s04_s02_s02\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Rights of the Surety<\/h3>\r\nThe surety has four main rights stemming from its obligation to answer for the debt or default of the principal debtor.\r\n<div id=\"mayer_1.0-ch28_s04_s02_s02_s01\" class=\"im_section\">\r\n<h4 class=\"im_title im_editable im_block\">Exoneration<\/h4>\r\nIf, at the time a surety\u2019s obligation has matured, the principal can satisfy the obligation but refuses to do so, the surety is entitled to <span class=\"im_margin_term\"><span class=\"im_glossterm\">exoneration<\/span><\/span>\u2014a court order requiring the principal to perform. It would be inequitable to force the surety to perform and then to have to seek <span class=\"im_margin_term\"><span class=\"im_glossterm\">reimbursement<\/span><\/span> from the principal if all along the principal is able to perform.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch28_s04_s02_s02_s02\" class=\"im_section\">\r\n<h4 class=\"im_title im_editable im_block\">Reimbursement<\/h4>\r\nIf the surety must pay the creditor because the principal has defaulted, the principal is obligated to reimburse the surety. The amount required to be reimbursed includes the surety\u2019s reasonable, good-faith outlays, including interest and legal fees.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch28_s04_s02_s02_s03\" class=\"im_section\">\r\n<h4 class=\"im_title im_editable im_block\">Subrogation<\/h4>\r\nSuppose the principal\u2019s duty to the creditor is fully satisfied and that the surety has contributed to this satisfaction. Then the surety is entitled to be subrogated to the rights of the creditor against the principal. In other words, the surety stands in the creditor\u2019s shoes and may assert against the principal whatever rights the creditor could have asserted had the duty not been discharged. The right of <span class=\"im_margin_term\"><span class=\"im_glossterm\">subrogation<\/span><\/span> includes the right to take secured interests that the creditor obtained from the principal to cover the duty. Sarah\u2019s Pizzeria owes Martha $5,000, and Martha has taken a security interest in Sarah\u2019s Chevrolet. Eva is surety for the debt. Sarah defaults, and Eva pays Martha the $5,000. Eva is entitled to have the security interest in the car transferred to her.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch28_s04_s02_s02_s04\" class=\"im_section\">\r\n<h4 class=\"im_title im_editable im_block\">Contribution<\/h4>\r\nTwo or more sureties who are bound to answer for the principal\u2019s default and who should share between them the loss caused by the default are known as <span class=\"im_margin_term\"><span class=\"im_glossterm\">cosureties<\/span><\/span>. A surety who in performing its own obligation to the creditor winds up paying more than its proportionate share is entitled to <span class=\"im_margin_term\"><span class=\"im_glossterm\">contribution<\/span><\/span> from the cosureties.\r\n\r\n<\/div>\r\n<\/div>\r\n<div id=\"mayer_1.0-ch28_s04_s02_s03\" class=\"im_section\">\r\n<h2 class=\"im_title im_editable im_block\">Defenses of the Parties<\/h2>\r\nThe principal and the surety may have defenses to paying.\r\n<div id=\"mayer_1.0-ch28_s04_s02_s03_s01\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Defenses of the Principal<\/h3>\r\nThe principal debtor may avail itself of any standard contract defenses as against the creditor, including impossibility, illegality, incapacity, fraud, duress, insolvency, or bankruptcy discharge. However, the surety may contract with the creditor to be liable despite the principal\u2019s defenses, and a surety who has undertaken the suretyship with knowledge of the creditor\u2019s fraud or duress remains obligated, even though the principal debtor will be discharged. When the surety turns to the principal debtor and demands reimbursement, the latter may have defenses against the surety\u2014as noted\u2014for acting in bad faith.\r\n\r\nOne of the main reasons creditors want the promise of a surety is to avoid the risk that the principal debtor will go bankrupt: the debtor\u2019s bankruptcy is a defense to the debtor\u2019s liability, certainly, but that defense cannot be used by the surety. The same is true of the debtor\u2019s incapacity: it is a defense available to the principal debtor but not to the surety.\r\n\r\n<\/div>\r\n<div id=\"mayer_1.0-ch28_s04_s02_s03_s02\" class=\"im_section\">\r\n<h3 class=\"im_title im_editable im_block\">Defenses of the Surety<\/h3>\r\nGenerally, the surety may exercise defenses on a contract that would have been available to the principal debtor (e.g., creditor\u2019s breach; impossibility or illegality of performance; fraud, duress, or misrepresentation by creditor; statute of limitations; refusal of creditor to accept tender or performance from either debtor or surety.) Beyond that, the surety has some defenses of its own. Common defenses raised by sureties include the following:\r\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l01\" class=\"im_itemizedlist im_editable im_block\">\r\n\t<li><em class=\"im_emphasis\">Release of the principal<\/em>. Whenever a creditor releases the principal, the surety is discharged, unless the surety consents to remain liable or the creditor expressly reserves her rights against the surety. The creditor\u2019s release of the surety, though, does not release the principal debtor because the debtor is liable without regard to the surety\u2019s liability.<\/li>\r\n\t<li><em class=\"im_emphasis\">Modification of the contract<\/em>. If the creditor alters the instrument sufficiently to discharge the principal, the surety is discharged as well. Likewise, when the creditor and principal modify their contract, a surety who has not consented to the modification is discharged if the surety\u2019s risk is materially increased (but not if it is decreased). Modifications include extension of the time of payment, release of collateral (this releases the surety to the extent of the impairment), change in principal debtor\u2019s duties, and assignment or delegation of the debtor\u2019s obligations to a third party. The surety may consent to modifications.<\/li>\r\n\t<li><em class=\"im_emphasis\">Creditor\u2019s failure to perfect<\/em>. A creditor who fails to file a financing statement or record a mortgage risks losing the security for the loan and might also inadvertently release a surety, but the failure of the creditor to resort first to collateral is no defense.<\/li>\r\n\t<li><em class=\"im_emphasis\">Statute of frauds<\/em>. Suretyship contracts are among those required to be evidenced by some writing under the statute of frauds, and failure to do so may discharge the surety from liability.<\/li>\r\n\t<li><em class=\"im_emphasis\">Creditor\u2019s failure to inform surety of material facts within creditor\u2019s knowledge affecting debtor\u2019s ability to perform<\/em> (e.g., that debtor has defaulted several times before).<\/li>\r\n\t<li><em class=\"im_emphasis\">General contract defenses<\/em>. The surety may raise common defenses like incapacity (infancy), lack of consideration (unless promissory estoppel can be substituted or unless no separate consideration is necessary because the surety\u2019s and debtor\u2019s obligations arise at the same time), and creditor\u2019s fraud or duress on surety. However, fraud by the principal debtor on the surety to induce the suretyship will not release the surety if the creditor extended credit in good faith; if the creditor knows of the fraud perpetrated by the debtor on the surety, the surety may avoid liability. See Figure 11.6 \"Defenses of Principal Debtor and Surety\".<\/li>\r\n<\/ul>\r\nThe following are defenses of principal debtor <em class=\"im_emphasis\">only:<\/em>\r\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l02\" class=\"im_itemizedlist im_editable im_block\">\r\n\t<li>Death or incapacity of principal debtor<\/li>\r\n\t<li>Bankruptcy of principal debtor<\/li>\r\n\t<li>Principal debtor\u2019s setoffs against creditor<\/li>\r\n<\/ul>\r\nThe following are defenses of <em class=\"im_emphasis\">both<\/em> principal debtor and surety:\r\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l03\" class=\"im_itemizedlist im_editable im_block\">\r\n\t<li>Material breach by creditor<\/li>\r\n\t<li>Lack of mutual assent, failure of consideration<\/li>\r\n\t<li>Creditor\u2019s fraud, duress, or misrepresentation of debtor<\/li>\r\n\t<li>Impossibility or illegality of performance<\/li>\r\n\t<li>Material and fraudulent alteration of the contract<\/li>\r\n\t<li>Statute of limitations<\/li>\r\n<\/ul>\r\nThe following are defenses of surety <em class=\"im_emphasis\">only<\/em>:\r\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l04\" class=\"im_itemizedlist im_editable im_block\">\r\n\t<li>Fraud or duress by creditor on surety\r\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l05\" class=\"im_itemizedlist\">\r\n\t<li>Illegality of suretyship contract<\/li>\r\n\t<li>Surety\u2019s incapacity<\/li>\r\n\t<li>Failure of consideration for surety contract (unless excused)<\/li>\r\n\t<li>Statute of frauds<\/li>\r\n\t<li>Acts of creditor or debtor materially affecting surety\u2019s obligations:\r\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l06\" class=\"im_itemizedlist\">\r\n\t<li>Refusal by creditor to accept tender of performance<\/li>\r\n\t<li>Release of principal debtor without surety\u2019s consent<\/li>\r\n\t<li>Release of surety<\/li>\r\n\t<li>Release, surrender, destruction, or impairment of collateral<\/li>\r\n\t<li>Extension of time on principal debtor\u2019s obligation<\/li>\r\n\t<li>Modification of debtor\u2019s duties, place, amount, or manner of debtor\u2019s obligations<\/li>\r\n<\/ul>\r\n<\/li>\r\n<\/ul>\r\n<\/li>\r\n<\/ul>\r\n<div id=\"mayer_1.0-ch28_s04_s02_s03_s02_n01\" class=\"im_key_takeaways im_editable im_block textbox\">\r\n<h3 class=\"im_title\">Key Takeaway<\/h3>\r\nCreditors often require not only the security of collateral from the debtor but also that the debtor engage a surety. A contract of suretyship is a type of insurance policy, where the surety (insurance company) promises the creditor that if the principal debtor fails to perform, the surety will undertake good-faith performance instead. A difference between insurance and suretyship, though, is that the surety is entitled to reimbursement by the principal debtor if the surety pays out. The surety is also entitled, where appropriate, to exoneration, subrogation, and contribution. The principal debtor and the surety both have some defenses available: some are personal to the debtor, some are joint defenses, and some are personal to the surety.\r\n\r\n<\/div>\r\n<div class=\"bcc-box bcc-info\">\r\n<h3>Exercises<\/h3>\r\n<section id=\"self-check-questions\">\r\n<ol>\r\n\t<li>Why isn\u2019t collateral put up by the debtor sufficient security for the creditor\u2014why is a surety often required?<\/li>\r\n\t<li>How can it be said that sureties do not anticipate financial losses like insurance companies do? What\u2019s the difference, and how does the surety avoid losses?<\/li>\r\n\t<li>Why does the creditor\u2019s failure to perfect a security interest discharge the surety from liability? Why doesn\u2019t failure of the creditor to resort first to perfected collateral discharge the surety?<\/li>\r\n\t<li>What is the difference between a guarantor and a surety?<\/li>\r\n<\/ol>\r\n<\/section><\/div>\r\n<div id=\"mayer_1.0-ch52_s02_s06_n02\" class=\"im_exercises im_editable im_block\"><\/div>\r\n<\/div>","rendered":"<div class=\"bcc-box bcc-highlight\">\n<h3>Learning Objectives<\/h3>\n<p>By the end of this section, you will be able to:<\/p>\n<ul id=\"mayer_1.0-ch52_s02_l01\" class=\"im_orderedlist\">\n<li>Understand what a surety is and why sureties are used in commercial transactions.<\/li>\n<li>Know how suretyships are created.<\/li>\n<li>Recognize the general duty owed by the surety to the creditor, and the surety\u2019s defenses.<\/li>\n<li>Recognize the principal obligor\u2019s duty to the surety, and the surety\u2019s rights against the surety.<\/li>\n<li>Understand the rights among cosureties.<\/li>\n<\/ul>\n<\/div>\n<div id=\"mayer_1.0-ch28_s04_s01\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Definition, Types of Sureties, and Creation of the Suretyship<\/h2>\n<div id=\"mayer_1.0-ch28_s04_s01_s01\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Definition<\/h3>\n<p>Suretyship is the second of the three major types of consensual security arrangements noted at the beginning of this chapter (personal property security, suretyship, real property security)\u2014and a common one. Creditors frequently ask the owners of small, closely held companies to guarantee their loans to the company, and parent corporations also frequently are guarantors of their subsidiaries\u2019 debts. The earliest sureties were friends or relatives of the principal debtor who agreed\u2014for free\u2014to lend their guarantee. Today most sureties in commercial transaction are insurance companies (but insurance is not the same as suretyship).<\/p>\n<p>A <span class=\"im_margin_term\"><span class=\"im_glossterm\">surety<\/span><\/span> is one who promises to pay or perform an obligation owed by the <span class=\"im_margin_term\"><span class=\"im_glossterm\">principal debtor<\/span><\/span>, and, strictly speaking, the surety is primarily liable on the debt: the creditor can demand payment from the surety when the debt is due. The creditor is the person to whom the principal debtor (and the surety, strictly speaking) owes an obligation. Very frequently, the creditor requires first that the debtor put up collateral to secure indebtedness, and\u2014in addition\u2014that the debtor engage a surety to make extra certain the creditor is paid or performance is made. For example, David Debtor wants Bank to loan his corporation, David Debtor, Inc., $100,000. Bank says, \u201cOkay, Mr. Debtor, we\u2019ll loan the corporation money, but we want its computer equipment as security, and we want you personally to guarantee the debt if the corporation can\u2019t pay.\u201d Sometimes, though, the surety and the principal debtor may have no agreement between each other; the surety might have struck a deal with the creditor to act as surety without the consent or knowledge of the principal debtor.<\/p>\n<p>A <span class=\"im_margin_term\"><span class=\"im_glossterm\">guarantor<\/span><\/span> also is one who guarantees an obligation of another, and for practical purposes, therefore, <em class=\"im_emphasis\">guarantor<\/em> is usually synonymous with <em class=\"im_emphasis\">surety<\/em>\u2014the terms are used pretty much interchangeably. But here\u2019s the technical difference: a surety is usually a party to the original contract and signs her (or his, or its) name to the original agreement along with the surety; the consideration for the principal\u2019s contract is the same as the surety\u2019s consideration\u2014she is bound on the contract from the very start, and she is also expected to know of the principal debtor\u2019s default so that the creditor\u2019s failure to inform her of it does not discharge her of any liability. On the other hand, a guarantor usually does not make his agreement with the creditor at the same time the principal debtor does: it\u2019s a separate contract requiring separate consideration, and if the guarantor is not informed of the principal debtor\u2019s default, the guarantor can claim discharge on the obligation to the extent any failure to inform him prejudices him. But, again, as the terms are mostly synonymous, <em class=\"im_emphasis\">surety<\/em> is used here to encompass both.<\/p>\n<div id=\"mayer_1.0-ch28_s04_s01_s01_f01\" class=\"im_figure im_large im_editable im_block\">\n<p><span class=\"im_title-prefix\">Figure 11.6<\/span> Defenses of Principal Debtor and Surety<\/p>\n<p><a href=\"https:\/\/textimgs.s3.amazonaws.com\/buslegalenv\/section_14\/0f088e27f167ebae2a0a9415a0c3f706.jpg\" target=\"_blank\"><img decoding=\"async\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images-archive-read-only\/wp-content\/uploads\/sites\/140\/2014\/09\/20045927\/sm_0f088e27f167ebae2a0a9415a0c3f706.jpg\" alt=\"\" \/><\/a><\/p>\n<\/div>\n<\/div>\n<\/div>\n<p>&nbsp;<\/p>\n<div id=\"mayer_1.0-ch28_s04_s01_s02\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Types of Suretyship<\/h2>\n<p>Where there is an interest, public or private, that requires protection from the possibility of a default, sureties are engaged. For example, a landlord might require that a commercial tenant not only put up a security deposit but also show evidence that it has a surety on line ready to stand for three months\u2019 rent if the tenant defaults. Often, a municipal government will want its road contractor to show it has a surety available in case, for some reason, the contractor cannot complete the project. Many states require general contractors to have bonds, purchased from insurance companies, as a condition of getting a contractor\u2019s license; the insurance company is the surety\u2014it will pay out if the contractor fails to complete work on the client\u2019s house. These are types of a <span class=\"im_margin_term\"><span class=\"im_glossterm\">performance bond<\/span><\/span>. A judge will often require that a criminal defendant put up a bond guaranteeing his appearance in court\u2014that\u2019s a type of suretyship where the bail-bonder is the surety\u2014or that a plaintiff put up a bond indemnifying the defendant for the costs of delays caused by the lawsuit\u2014a <span class=\"im_margin_term\"><span class=\"im_glossterm\">judicial bond<\/span><\/span>. A bank will take out a bond on its employees in case they steal money from the bank\u2014the bank teller, in this case, is the principal debtor (a <span class=\"im_margin_term\"><span class=\"im_glossterm\">fidelity bond<\/span><\/span>). However, as we will see, sureties do not anticipate financial loss like insurance companies do: the surety expects, mostly, to be repaid if it has to perform. The principal debtor goes to an insurance company and buys the bond\u2014the suretyship policy. The cost of the premium depends on the surety company, the type of bond applied for, and the applicant\u2019s financial history. A sound estimate of premium costs is 1 percent to 4 percent, but if a surety company classifies an applicant as high risk, the premium falls between 5 percent and 20 percent of the bond amount. When the purchaser of real estate agrees to assume the seller\u2019s mortgage (promises to pay the mortgage debt), the seller then becomes a surety: unless the mortgagee releases the seller (not likely), the seller has to pay if the buyer defaults.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch28_s04_s01_s03\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Creation of the Suretyship<\/h2>\n<p>Suretyship can arise only through contract. The general principles of contract law apply to suretyship. Thus a person with the general capacity to contract has the power to become a surety. Consideration is required for a suretyship contract: if Debtor asks a friend to act as a surety to induce Creditor to make Debtor a loan, the consideration Debtor gives Creditor also acts as the consideration Friend gives. Where the suretyship arises <em class=\"im_emphasis\">after<\/em> Creditor has already extended credit, new consideration would be required (absent application of the doctrine of promissory estoppel<span id=\"mayer_1.0-fn28_062\" class=\"im_footnote\"><em class=\"im_emphasis\">American Druggists\u2019 Ins. Co. v. Shoppe<\/em>, 448 N.W.2d 103, Minn. App. (1989).<\/span>). You may recall from the chapters on contracts that the promise by one person to pay or perform for the debts or defaults of another must be evidenced by a writing under the statute of frauds (subject to the \u201cmain purpose\u201d exception).<\/p>\n<p>Suretyship contracts are affected to some extent by government regulation. Under a 1985 Federal Trade Commission Credit Practices Rule, creditors are prohibited from misrepresenting a surety\u2019s liability. Creditors must also give the surety a notice that explains the nature of the obligation and the potential liability that can arise if a person cosigns on another\u2019s debt.<span id=\"mayer_1.0-fn28_063\" class=\"im_footnote\">Here is an example of the required notice: Federal Trade Commission, \u201cFacts for Consumers: The Credit Practices Rule,\u201d <a class=\"im_link\" href=\"http:\/\/www.ftc.gov\/bcp\/edu\/pubs\/consumer\/credit\/cre12.shtm\" target=\"_blank\">http:\/\/www.ftc.gov\/bcp\/edu\/pubs\/consumer\/credit\/cre12.shtm<\/a>.<\/span><\/p>\n<\/div>\n<div id=\"mayer_1.0-ch28_s04_s02\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Duties and Rights of the Surety<\/h2>\n<div id=\"mayer_1.0-ch28_s04_s02_s01\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Duties of the Surety<\/h3>\n<p>Upon the principal debtor\u2019s default, the surety is contractually obligated to perform unless the principal herself or someone on her behalf discharges the obligation. When the surety performs, it must do so in good faith. Because the principal debtor\u2019s defenses are generally limited, and because\u2014as will be noted\u2014the surety has the right to be reimbursed by the debtor, debtors not infrequently claim the surety acted in bad faith by doing things like failing to make an adequate investigation (to determine if the debtor really defaulted), overpaying claims, interfering with the contact between the surety and the debtor, and making unreasonable refusals to let the debtor complete the project. The case <em class=\"im_emphasis\">Fidelity and Deposit Co. of Maryland v. Douglas Asphalt Co.,<\/em> in Section 11.5 &#8220;Cases&#8221;, is typical.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch28_s04_s02_s02\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Rights of the Surety<\/h3>\n<p>The surety has four main rights stemming from its obligation to answer for the debt or default of the principal debtor.<\/p>\n<div id=\"mayer_1.0-ch28_s04_s02_s02_s01\" class=\"im_section\">\n<h4 class=\"im_title im_editable im_block\">Exoneration<\/h4>\n<p>If, at the time a surety\u2019s obligation has matured, the principal can satisfy the obligation but refuses to do so, the surety is entitled to <span class=\"im_margin_term\"><span class=\"im_glossterm\">exoneration<\/span><\/span>\u2014a court order requiring the principal to perform. It would be inequitable to force the surety to perform and then to have to seek <span class=\"im_margin_term\"><span class=\"im_glossterm\">reimbursement<\/span><\/span> from the principal if all along the principal is able to perform.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch28_s04_s02_s02_s02\" class=\"im_section\">\n<h4 class=\"im_title im_editable im_block\">Reimbursement<\/h4>\n<p>If the surety must pay the creditor because the principal has defaulted, the principal is obligated to reimburse the surety. The amount required to be reimbursed includes the surety\u2019s reasonable, good-faith outlays, including interest and legal fees.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch28_s04_s02_s02_s03\" class=\"im_section\">\n<h4 class=\"im_title im_editable im_block\">Subrogation<\/h4>\n<p>Suppose the principal\u2019s duty to the creditor is fully satisfied and that the surety has contributed to this satisfaction. Then the surety is entitled to be subrogated to the rights of the creditor against the principal. In other words, the surety stands in the creditor\u2019s shoes and may assert against the principal whatever rights the creditor could have asserted had the duty not been discharged. The right of <span class=\"im_margin_term\"><span class=\"im_glossterm\">subrogation<\/span><\/span> includes the right to take secured interests that the creditor obtained from the principal to cover the duty. Sarah\u2019s Pizzeria owes Martha $5,000, and Martha has taken a security interest in Sarah\u2019s Chevrolet. Eva is surety for the debt. Sarah defaults, and Eva pays Martha the $5,000. Eva is entitled to have the security interest in the car transferred to her.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch28_s04_s02_s02_s04\" class=\"im_section\">\n<h4 class=\"im_title im_editable im_block\">Contribution<\/h4>\n<p>Two or more sureties who are bound to answer for the principal\u2019s default and who should share between them the loss caused by the default are known as <span class=\"im_margin_term\"><span class=\"im_glossterm\">cosureties<\/span><\/span>. A surety who in performing its own obligation to the creditor winds up paying more than its proportionate share is entitled to <span class=\"im_margin_term\"><span class=\"im_glossterm\">contribution<\/span><\/span> from the cosureties.<\/p>\n<\/div>\n<\/div>\n<div id=\"mayer_1.0-ch28_s04_s02_s03\" class=\"im_section\">\n<h2 class=\"im_title im_editable im_block\">Defenses of the Parties<\/h2>\n<p>The principal and the surety may have defenses to paying.<\/p>\n<div id=\"mayer_1.0-ch28_s04_s02_s03_s01\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Defenses of the Principal<\/h3>\n<p>The principal debtor may avail itself of any standard contract defenses as against the creditor, including impossibility, illegality, incapacity, fraud, duress, insolvency, or bankruptcy discharge. However, the surety may contract with the creditor to be liable despite the principal\u2019s defenses, and a surety who has undertaken the suretyship with knowledge of the creditor\u2019s fraud or duress remains obligated, even though the principal debtor will be discharged. When the surety turns to the principal debtor and demands reimbursement, the latter may have defenses against the surety\u2014as noted\u2014for acting in bad faith.<\/p>\n<p>One of the main reasons creditors want the promise of a surety is to avoid the risk that the principal debtor will go bankrupt: the debtor\u2019s bankruptcy is a defense to the debtor\u2019s liability, certainly, but that defense cannot be used by the surety. The same is true of the debtor\u2019s incapacity: it is a defense available to the principal debtor but not to the surety.<\/p>\n<\/div>\n<div id=\"mayer_1.0-ch28_s04_s02_s03_s02\" class=\"im_section\">\n<h3 class=\"im_title im_editable im_block\">Defenses of the Surety<\/h3>\n<p>Generally, the surety may exercise defenses on a contract that would have been available to the principal debtor (e.g., creditor\u2019s breach; impossibility or illegality of performance; fraud, duress, or misrepresentation by creditor; statute of limitations; refusal of creditor to accept tender or performance from either debtor or surety.) Beyond that, the surety has some defenses of its own. Common defenses raised by sureties include the following:<\/p>\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l01\" class=\"im_itemizedlist im_editable im_block\">\n<li><em class=\"im_emphasis\">Release of the principal<\/em>. Whenever a creditor releases the principal, the surety is discharged, unless the surety consents to remain liable or the creditor expressly reserves her rights against the surety. The creditor\u2019s release of the surety, though, does not release the principal debtor because the debtor is liable without regard to the surety\u2019s liability.<\/li>\n<li><em class=\"im_emphasis\">Modification of the contract<\/em>. If the creditor alters the instrument sufficiently to discharge the principal, the surety is discharged as well. Likewise, when the creditor and principal modify their contract, a surety who has not consented to the modification is discharged if the surety\u2019s risk is materially increased (but not if it is decreased). Modifications include extension of the time of payment, release of collateral (this releases the surety to the extent of the impairment), change in principal debtor\u2019s duties, and assignment or delegation of the debtor\u2019s obligations to a third party. The surety may consent to modifications.<\/li>\n<li><em class=\"im_emphasis\">Creditor\u2019s failure to perfect<\/em>. A creditor who fails to file a financing statement or record a mortgage risks losing the security for the loan and might also inadvertently release a surety, but the failure of the creditor to resort first to collateral is no defense.<\/li>\n<li><em class=\"im_emphasis\">Statute of frauds<\/em>. Suretyship contracts are among those required to be evidenced by some writing under the statute of frauds, and failure to do so may discharge the surety from liability.<\/li>\n<li><em class=\"im_emphasis\">Creditor\u2019s failure to inform surety of material facts within creditor\u2019s knowledge affecting debtor\u2019s ability to perform<\/em> (e.g., that debtor has defaulted several times before).<\/li>\n<li><em class=\"im_emphasis\">General contract defenses<\/em>. The surety may raise common defenses like incapacity (infancy), lack of consideration (unless promissory estoppel can be substituted or unless no separate consideration is necessary because the surety\u2019s and debtor\u2019s obligations arise at the same time), and creditor\u2019s fraud or duress on surety. However, fraud by the principal debtor on the surety to induce the suretyship will not release the surety if the creditor extended credit in good faith; if the creditor knows of the fraud perpetrated by the debtor on the surety, the surety may avoid liability. See Figure 11.6 &#8220;Defenses of Principal Debtor and Surety&#8221;.<\/li>\n<\/ul>\n<p>The following are defenses of principal debtor <em class=\"im_emphasis\">only:<\/em><\/p>\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l02\" class=\"im_itemizedlist im_editable im_block\">\n<li>Death or incapacity of principal debtor<\/li>\n<li>Bankruptcy of principal debtor<\/li>\n<li>Principal debtor\u2019s setoffs against creditor<\/li>\n<\/ul>\n<p>The following are defenses of <em class=\"im_emphasis\">both<\/em> principal debtor and surety:<\/p>\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l03\" class=\"im_itemizedlist im_editable im_block\">\n<li>Material breach by creditor<\/li>\n<li>Lack of mutual assent, failure of consideration<\/li>\n<li>Creditor\u2019s fraud, duress, or misrepresentation of debtor<\/li>\n<li>Impossibility or illegality of performance<\/li>\n<li>Material and fraudulent alteration of the contract<\/li>\n<li>Statute of limitations<\/li>\n<\/ul>\n<p>The following are defenses of surety <em class=\"im_emphasis\">only<\/em>:<\/p>\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l04\" class=\"im_itemizedlist im_editable im_block\">\n<li>Fraud or duress by creditor on surety\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l05\" class=\"im_itemizedlist\">\n<li>Illegality of suretyship contract<\/li>\n<li>Surety\u2019s incapacity<\/li>\n<li>Failure of consideration for surety contract (unless excused)<\/li>\n<li>Statute of frauds<\/li>\n<li>Acts of creditor or debtor materially affecting surety\u2019s obligations:\n<ul id=\"mayer_1.0-ch28_s04_s02_s03_s02_l06\" class=\"im_itemizedlist\">\n<li>Refusal by creditor to accept tender of performance<\/li>\n<li>Release of principal debtor without surety\u2019s consent<\/li>\n<li>Release of surety<\/li>\n<li>Release, surrender, destruction, or impairment of collateral<\/li>\n<li>Extension of time on principal debtor\u2019s obligation<\/li>\n<li>Modification of debtor\u2019s duties, place, amount, or manner of debtor\u2019s obligations<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n<div id=\"mayer_1.0-ch28_s04_s02_s03_s02_n01\" class=\"im_key_takeaways im_editable im_block textbox\">\n<h3 class=\"im_title\">Key Takeaway<\/h3>\n<p>Creditors often require not only the security of collateral from the debtor but also that the debtor engage a surety. A contract of suretyship is a type of insurance policy, where the surety (insurance company) promises the creditor that if the principal debtor fails to perform, the surety will undertake good-faith performance instead. A difference between insurance and suretyship, though, is that the surety is entitled to reimbursement by the principal debtor if the surety pays out. The surety is also entitled, where appropriate, to exoneration, subrogation, and contribution. The principal debtor and the surety both have some defenses available: some are personal to the debtor, some are joint defenses, and some are personal to the surety.<\/p>\n<\/div>\n<div class=\"bcc-box bcc-info\">\n<h3>Exercises<\/h3>\n<section id=\"self-check-questions\">\n<ol>\n<li>Why isn\u2019t collateral put up by the debtor sufficient security for the creditor\u2014why is a surety often required?<\/li>\n<li>How can it be said that sureties do not anticipate financial losses like insurance companies do? What\u2019s the difference, and how does the surety avoid losses?<\/li>\n<li>Why does the creditor\u2019s failure to perfect a security interest discharge the surety from liability? Why doesn\u2019t failure of the creditor to resort first to perfected collateral discharge the surety?<\/li>\n<li>What is the difference between a guarantor and a surety?<\/li>\n<\/ol>\n<\/section>\n<\/div>\n<div id=\"mayer_1.0-ch52_s02_s06_n02\" class=\"im_exercises im_editable im_block\"><\/div>\n<\/div>\n<\/div>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-103\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Shared previously<\/div><ul class=\"citation-list\"><li>Business and the Legal Environment. <strong>Authored by<\/strong>: Anonymous. <strong>Provided by<\/strong>: Anonymous. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"http:\/\/2012books.lardbucket.org\/books\/business-and-the-legal-environment\/\">http:\/\/2012books.lardbucket.org\/books\/business-and-the-legal-environment\/<\/a>. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by-nc-sa\/4.0\/\">CC BY-NC-SA: Attribution-NonCommercial-ShareAlike<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":5,"menu_order":76,"template":"","meta":{"_candela_citation":"[{\"type\":\"cc\",\"description\":\"Business and the Legal Environment\",\"author\":\"Anonymous\",\"organization\":\"Anonymous\",\"url\":\"http:\/\/2012books.lardbucket.org\/books\/business-and-the-legal-environment\/\",\"project\":\"\",\"license\":\"cc-by-nc-sa\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-103","chapter","type-chapter","status-publish","hentry"],"part":773,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters\/103","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/users\/5"}],"version-history":[{"count":4,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters\/103\/revisions"}],"predecessor-version":[{"id":1121,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters\/103\/revisions\/1121"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/parts\/773"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapters\/103\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/media?parent=103"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/pressbooks\/v2\/chapter-type?post=103"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/contributor?post=103"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/clinton-buslegalenv\/wp-json\/wp\/v2\/license?post=103"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}