Recent Case Law Update

This is something I haven't done much of, but I think is important. So here goes.

California Antideficiency Statute Does Not Apply to "True" Guarantors

California passed antideficiency statutes during the Depression. They are codified in California Code of Civil Procedure sections 580a, 580b, 580d and 726. The law basically says that if you go into default on your home mortgage, for example, and the bank sells the property in a foreclosure sale for less than what you own on the mortgage, the bank cannot get a judgment against you personally for the difference (or "deficiency").

William and Janyce Hustwitt were guarantors of a loan to their irrevocable Investment Trust, secured by a trust deed for certain real property in Newport Beach, California. The Trust defaulted and the lender, which was actually another trust, foreclosed on the property. The lender sold the property for about $388,000 less than what was owed on the loan, and then sued the Hustwitts for the deficiency under their guaranty agreements. The trial court awarded the deficiency amount, plus interest, to the lender.

The Hustwitts appealed on the grounds that the antideficiency law applies to guarantors, and that in any event they were not "true"guarantors because they were too closely related to the debtor (which was their Investment Trust) as beneficiaries and trustees of the trust.

The appeals court didn't buy it. California law is clear that the antideficiency statute does not apply to guarantors. The antideficiency statute is intended to protect debtors. A guarantor is a separate and independent obligation from that of a debtor. The antideficiency laws do not protect the guarantors.

The appeals court also didn't buy the Hustwitt's argument that they were not "true" guarantors. Sometimes a debtor (or "principal obligor") will take on additional liability as a guarantor of the debt. Courts in California have held that this does not create any additional obligation on the part of the debtor, and that they are therefore not "true" guarantors. Thus, the antideficiency statutes would still apply, and the fact that the debtor is also a guarantor is irrelevant.

Here, the Investment Trust that held the property was an irrevocable trust with a corporate trustee. Although the Hustwitts were the settlors of the trust, they were only secondary, and not primary beneficiaries. The court held that this arrangement removed them from personal liability for the trust's obligations, and also limited their beneficial enjoyment of the property. The court concluded that they were "true" guarantors, and that the antideficiency statute did not apply.

The upshot of this case is that, although irrevocable trusts are a great tool for limiting your liability in and exposure to certain downsides, they are not a "get out of jail free" card. You cannot have it both ways - being protected from the liability of an obligor while taking advantage of certain protections afforded an obligor.

The case is Talbott v. Hustwitt and it was decided in the Fourth Appellate District of California (Orange County). You can read the entire decision here.