A mortgage lender occasionally is willing to limit the amount guaranteed by a third party in connection with a mortgage loan. Usually this is because the loan-to-value ratio at the commencement of the loan is sufficiently strong, or there is enough additional credit support or enhancement (e.g., additional collateral, a letter of credit, a master lease, or a defeasance arrangement), to permit only a limited or conditional guaranty of the underlying indebtedness. The lender may also be willing to condition the guarantor’s liability upon the happening of a future event.There are numerous types of limited and conditional guaranties, including the following: “burn down” or “burn off” guaranties; “top” guaranties; “springing,” “exploding” (or “vanishing”), “creeping,” and “shrinking” guaranties; percentage guaranties; construction-completion guaranties; rental-achievement, lease-up, operating- deficit and “break even” guaranties; debt-service-coverage guaranties; dollar-limit or “maximum principal amount” guaranties; limited-time guaranties; “wrongful (or bad) acts” guaranties; “carry,” “interest and carry,” and “excess interest” guaranties (covering obligations other than repayment of the loan principal); loan-in-balance guaranties; and limited-amount liquidated-damages indemnity agreements. Also, some types of limited guaranties may exempt or exclude certain of the guarantor’s (or guarantors’) assets, or a portion of all of the guarantor’s (or guarantors’) assets, from coverage under the guaranty or, conversely, permit recourse only to a specified pool or portfolio of assets owned by the guarantor(s). Each of these limited and conditional guaranties must be carefully drafted to avoid giving a court the opportunity to construe the limiting or conditional language against the lender and to further limit or even nullify the liability and obligations of the guarantor(s).

 A precise definition should accompany any words or phrases of limitation, and the nature and scope of the limitation should be clearly and comprehensively set forth in the guaranty agreement. The 1996 Restatement of the Law (Third) of Suretyship and Guaranty (“Restatement”) provides definitions of terms commonly used in guaranty and surety agreements, as well as guidelines for interpreting many of the terms and provisions commonly contained in such agreements. The Restatement does not have any specific definition of an “absolute” or an “unconditional” guaranty. This is probably because such language is deemed unnecessary; under § 8 of the Restatement, every guaranty is enforceable against the guarantor immediately upon default of the prime obligor unless the guaranty states otherwise, Many jurisdictions construe an “absolute and unconditional” guaranty as one that is a guaranty of payment and that is effective immediately upon the prime obligor’s default. This is contrasted with a guaranty of collection, which is enforceable against the guarantor only if (1) an execution of judgment against the prime obligor has been returned unsatisfied, or (2) the prime obligor is insolvent, or (3) the prime obligor cannot be served with process, or (4) it is otherwise apparent that payment cannot be obtained from the prime obligor.

Historically, lenders have had a difficult time drafting and enforcing guaranty language that obligated a guarantor to pay, e.g., the “top x%” of the loan amount. Such language, without more, is generally understood to mean that the guarantor is only liable for the difference between the loan balance and an amount set as a percentage of the original loan amount. This type of provision is often used by lenders to provide a “cushion” if the property decreases in value down to the base level as established by the percentage amount of the original loan for which the guarantor is liable. The guarantor generally understands that its liability at any time will be limited to no more than the percentage amount it has agreed to, and that its liability will disappear when the loan balance has been paid down to a certain amount.

 However, this type of limitation on a guarantor’s liability, if not carefully and clearly negotiated and drafted, may be open to a claim of ambiguity with all of the potentially negative consequences that could result from a court’s recharacterization of the language. For example, the lender may contend that the language should be construed so that the guarantor is always liable for an amount equal to the stated percentage of the original loan amount, regardless of the actual amount of the outstanding loan balance. Alternatively, the lender may seek an interpretation of the language (which can also be expected to be hotly contested by the guarantor) that would provide for the guarantor’s liability to decrease on a sliding scale, i.e., the guarantor would remain liable throughout the term of the loan but such liability would decrease pro rata to the extent the principal balance has been paid down by the borrower.

 It also is crucial when utilizing this type of guaranty to clearly define and clarify exactly what type of payments will qualify to reduce the guarantor’s liability. For example, the proceeds from a foreclosure proceeding are generally applied first to the nonrecourse portion of the debt. If this were not the case, the “top” guaranty would be virtually worthless because the amount of foreclosure proceeds available would almost always be more than what would be required to satisfy the top portion of the debt

 The limiting language in the guaranty should also address the extent and amount of reduction of the guarantor’s liability as the result of the application of proceeds received from additional sources, such as prepayment premiums and condemnation and insurance loss proceeds. Furthermore, does the guarantor become responsible for payment of the debt: (1) on the date that the borrower defaults under the note, mortgage, or loan agreement? (2) on the date that notice of such default is delivered to the guarantor? (3) on the date of final disbursement of foreclosure or bankruptcy sale proceeds?, or (4) upon the exhaustion of all other remedies available against the borrower and/or other loan collateral or guarantors?

There are clearly risks to lenders in taking limited guaranties from third parties as additional security for mortgage loans. The above issues should be addressed and answered to the satisfaction of the lender and the borrower, and covered in the provision(s) of the guaranty limiting or conditioning the liability of the guarantor(s).