In Smith v. M&M Pump & Supply, Inc.,1 the Indiana Court of Appeals, Indiana's intermediate appellate court, upheld a trial court's grant of summary judgment that a personal guaranty of a corporate borrower's debt executed by an officer of the borrower was enforceable against the officer.
The court's decision illustrates several fundamental points about guaranties under Indiana law.
In 2011, David Smith was employed as a coal mine superintendent for Lily Group, Inc. Lily executed a credit agreement with M&M Pump & Supply, Inc. Smith signed the agreement on behalf of Lily. The credit agreement was unsecured. In his individual capacity, Smith also signed a section of the credit agreement that provided that he personally guarantied the debt under the credit agreement, as well as all debts arising under any invoices owing from Lily to M&M (in addition to providing credit, M&M also supplied mining equipment to Lily).2
Lily defaulted on its payment obligations to M&M, and M&M filed suit against Lily and Smith in 2012. Lily then entered into an agreed judgment with M&M and subsequently filed for bankruptcy. The trial court granted summary judgment to M&M against Smith in the amount of $63,913.26, which included attorneys' fees, costs and prejudgment interest.
Smith appealed. The appellate court affirmed.
On appeal, Smith made four arguments: (i) that he was not bound by the terms of the guaranty because he did not receive adequate consideration; (ii) that the trial court should not have entered summary judgment until it was determined in Lily's bankruptcy proceedings that Lily would not pay the debt; (iii) that M&M failed to perfect a security interest in the equipment sold to Lily and impaired the value of collateral that could have mitigated the guarantied debt; and (iv) that the trial court erred by holding him liable for attorneys' fees and prejudgment interest. This client alert will address each in turn.
In Indiana, a guaranty is like other contracts in that, to be enforceable against the guarantor as a matter of contract law, the guarantor must have received consideration—something in exchange for the promise to guaranty the underlying obligation. However, if the guaranty is entered into at the same time as the underlying obligation, consideration exists even if the guarantor does not derive any benefit from the underlying contract or the guaranty.3 The court in M&M Pump & Supply found that there was no dispute that Lily (the primary obligor) had received adequate consideration for entering into the credit agreement with M&M, and therefore no additional consideration was necessary for Smith's guaranty to be enforceable under these circumstances.4
We note that, in addition to whether consideration exists in order for a guaranty to be valid under contract law, a separate issue may exist under fraudulent conveyance statutes, which may be relevant whether or not the guarantor is the subject of bankruptcy proceedings. Although the M&M Pump & Supply court did not examine this issue, it can be a much more significant issue than whether the guarantor received consideration for contract law purposes. Under Section 548 of the Bankruptcy Code, a guaranty may be set aside as a fraudulent conveyance if (i) the guarantor was insolvent at the time the guaranty was executed or was rendered insolvent as a result of such guaranty5 and (ii) the guarantor did not receive "reasonably equivalent value" in exchange for the guaranty.6 Note that both elements must exist for a guaranty to be set aside; if one element is not present, the guaranty may not be avoided as a fraudulent conveyance. Thus, if the guarantor were solvent after taking into account the guaranty, whether the guarantor received "reasonably equivalent value" would be irrelevant. On the other hand, if the guarantor were insolvent at the time the guaranty was given, it would be necessary for a court to determine whether the guarantor had received "reasonably equivalent value." The Bankruptcy Code does not define "reasonably equivalent value." A full...