Capital Finance, LLC v. Rosenberg (Maryland U.S.D.C.)

Filed:  January 23, 2019

Opinion by:  Richard D. Bennett

Holding:  The word “and” in a “bad boy” guaranty agreement may require a disjunctive reading of the provision due to the character of the contract when the language is unambiguous and when a conjunctive reading would render the guaranty meaningless, even if a conjunctive reading of the provision is theoretically possible.

Facts:  On July 1, 2015, a lender (the “Lender”) entered into a Credit and Security Agreement and a Note with a group of skilled nursing facilities and long term hospitals (the “Borrower”) controlled by two individuals (the “Guarantors”) who personally guaranteed the financing.  As a condition precedent to the financing, a Guarantor submitted Borrowing Base Certificates that warranted the facilities had paid all payroll taxes.  The Credit Agreement required the Borrower to deposit proceeds into bank accounts by a Deposit Account Control Agreement (the “DACA”).  The Guarantors executed “bad boy” guaranties, “which required them to satisfy all outstanding obligations” upon the Borrower’s commission of fraud or illegal acts. 

The Borrower failed to pay payroll taxes, triggering the guaranties.  The Borrowing Base Certificates falsely represented that Borrower had paid these taxes.  Between December 2016 and January 2017 the terms of the Credit Agreement were further violated when payments were diverted from DACA-controlled accounts to an account that was not controlled by the Lender.  

Section 1(d) of the guaranties provided the following: 

Notwithstanding any provision herein to the contrary, Agent acknowledges that this Guaranty and the Guaranteed Obligations hereby shall only be applicable and enforceable against the Guarantor in the event that: (a) Borrower colludes with other creditors in causing an involuntary bankruptcy or insolvency proceeding involving any of the Credit Parties in an effort to circumvent, avoid or impair the rights of Agent or the Lenders, (b) a voluntary bankruptcy filing by Borrower to the extent that a court of appropriate jurisdiction determines that such filing was made otherwise than in accordance with applicable law, and (c) any act of fraud or other illegal action taken by Borrower or any Credit Party in connection with the Credit Agreement or any other Financing Document.  [emphasis added]

On June 8, 2018, the Lender demanded payment from the Guarantors under the guaranties.  The defendants argued that all three events listed in Section 1(d) of the guaranties must have occurred to trigger liability pursuant to the guaranties. 

Analysis:  “To prevail on a claim for breach of contract under Maryland law, a party must prove the existence of a contractual obligation, a material breach of that contractual obligation, and resulting damages.”  A court does not need to consult extrinsic evidence when a contract is unambiguous.  Maryland law, as provided in Bankers & Shippers Ins. Co. v. Urie, recognizes that the word “and” may require a “disjunctive reading in light of the character of the contract.”  After finding that Section 1(d) of the guaranties is not ambiguous, the court stated that the guaranties would be rendered meaningless if the defendants’ argument held.  “A bad boy guaranty which remains unenforceable until Borrower engages in an implausible triad of egregious conduct, any one of which would seriously inhibit the lender’s access to collateral, does not provide this sort of incentive – it is not a guaranty at all.”  While the defendants’ interpretation of the guaranties is possible – a single entity may undergo voluntary and involuntary bankruptcy proceedings – it is not the reading of a reasonable person. The court found that each of (i) failing to pay payroll taxes and (ii) submitting false Borrowing Base Certificates constituted fraud and provided a base for liability under the guaranties.  

The court also stated that the “No Waiver” section of the Credit Agreement and the “Guaranty Absolute” provision of the guaranties precluded “affirmative defenses of equitable estoppel, waiver, release, and laches.”

The full opinion is available here in PDF.