Surety, Who Pledged A Mortgage To Secure An Ag Loan, Failed To Establish Impairment Of Collateral Defense

Lesson. A surety (a form of guarantor) has a high burden to prove some “unjustified or unreasonable act” by a lender in order to establish the so-called “impairment of collateral” defense.

Case cite. Devlin v. Horizon Bank, 235 N.E.3d 850 (Ind. Ct. App. 2024)

Legal issue. Whether the bank impaired the collateral for its loan to the detriment of the surety.

Vital facts. This is the first of two posts about the Devlin case, which involved a farm operating loan entered into between Bank and borrower (Son). Son obtained an 800K line of credit, secured by Son’s crops, insurance proceeds, government payouts and farming inventory. The loan agreement controlled the flow of cash upon the sale of crops, and the Court’s opinion details the key provisions in the docs. (Review the case for the key language.)

Father, a CPA, agreed to be a surety for Son’s loan and granted Bank a mortgage on 85 acres of Father’s land as additional security for the debt. The mortgage provided, among other things, that Father had “adequate means,” on an ongoing basis, of obtaining financials from Son.

In practice, Son failed to insist on crop payments being made payable jointly to him and Bank (commonly known as joint checks). This enabled Son to take about $363K in sales proceeds and deposit them into his personal checking account. Thus, the funds were not used to pay down Bank’s loan (and to reduce Father’s exposure). Similarly, Son received government funds that he redirected into his checking account at another bank. Ultimately, Son defaulted.

Procedural history. Bank filed suit to enforce its loan. The action included a claim to foreclose the mortgage on Father’s land. After a trial, judgment was entered for Bank in the amount of $1,137,566.74, and the trial court ordered the foreclosure of the mortgage. Father appealed.

Key rules. The opinion in Devlin outlines some of Indiana’s suretyship laws:

• One who mortgages his land to secure the debt of another stands in the position of surety to the debtor.
• A surety may seek to avoid liability in a suit by a creditor by asserting an impairment-of-collateral defense, which provides that “a surety may avoid liability to the extent that a creditor unjustifiably impaired the collateral securing a guaranteed loan.”
• As it relates to Devlin, “impairment of collateral means an injury to the value of the collateral or a deterioration of the interest securing the collateral.”

Holding. The Indiana Court of Appeals affirmed the trial court’s judgment.

Policy/rationale. Father contended that Bank failed to enforce its security interest in the crop proceeds by not taking “steps to insist on receiving jointly payable proceeds.” This, in turn, enabled buyers of the crops to take them free and clear of Bank’s liens, and the loan not being paid down. The Court held that, to prevail on this theory, Father had the burden to establish some “unjustified or unreasonable act by [Bank].”

The Court of Appeals concluded that the record supported the trial court’s rejection of the impairment of collateral defense. Bank “did not act unjustifiably or unreasonably either [it] Bank did not insist that [Son] provide information for potential buyers at the outset of his relationship with Bank or when Bank did not send written notices to potential buyers of its crop lien prior to [Son’s] default.” Because this appeal followed a trial, not a summary judgment, there was a substantial amount of exhibits and testimony, including expert opinions, which formed the basis of the trial court’s decision. It appears the expert testimony on the relationship/loan management issues may have carried the day on what otherwise seemed like a close call.

Related posts.

• Impairment Of Collateral Defense Denied
• IRISH V. WOODS: Which Surety Was Left Holding the $500,000 Bag?

__________
Part of my practice involves representing parties in loan-related disputes, including ag loans. If you need assistance with a similar matter, please call me at 317-639-6151 or email me at john.waller@dinsmore.com. Also, don’t forget that you can follow me on X @JohnDWaller or on LinkedIn, or you can subscribe to posts via RSS or email as noted on my home page.