The 2021 increase in California’s homestead exemption to $ 600,000 is expected to change the legal and economic relationship of guarantors with their lenders and sellers who make loans or sell goods or services on credit. Before examining this significant change in California’s homestead exemption and its effect on warranties, some hindsight is needed on the warranties themselves.
In the Stone Age, when business loans were signed in a conference room with all parties present and exchanging jokes, I watched a borrower’s principal sign a personal guarantee and wondered how it really mattered when the loan amount likely overshadowed everyone’s equity. in the room. After almost everyone had left and the ink was drying on the loan documents (my main job was to keep the documents, especially the promissory note), I put this question to my supervising lawyer. Without hesitation, he explained, “You just don’t understand. First, a surety is a fool with a fountain pen. Never sign. Second, the bank really never wants to enforce that guarantee. If the loan starts to have problems, the bank wants to force the guarantor to say to his spouse, “Honey, we have a problem and we could lose the house”. The risk of this conversation over dinner is what prompts the borrower to act sensibly. This is the real value of most guarantees.
Clearly, my mentor’s cynical perspective oversimplified the risks and rewards of commercial loan and credit guarantees from vendors to businesses. Some creditors sue to collect personal guarantees. Since requiring a guarantee can be an abuse of the parties’ unequal bargaining power when a loan is made and some guarantors do not understand the seriousness of signing a guarantee, California law provides a long list of defenses. and statutory protections for guarantors. Cal. Civ. Code 2787-2855. California courts have rendered a myriad of decisions involving guarantor defenses. See, for example., Bloom vs. Bender, 218 Cal. 2d 793 (1957); Engelman vs. Bookasta, 264 Cal. App. 2d 915 (1968); Wiener vs. Winkle, 273 Cal. App. 2d 774 (1969). But because of the usefulness of guarantees to lenders, sellers, landlords and others, guarantees are considered essential to the availability of credit to businesses and other limited liability entities, California courts generally apply them. Mariner Savings v. Neil, 22 cal. App. 3d 232 (1973). California law even provides the appropriate language for waiving the guarantor’s defenses. Cal. Civ. Code 2856 (d).
Because of the perceived importance of making a “real person” responsible for loans or credits granted to limited liability entities, guarantees are often included in contracts which, on the face of it, are not called a personal guarantee. The language of the guarantor is often included in real estate leases, equipment leases, conditional sales contracts and supplier supply agreements. California law broadly defines a surety or surety as anyone who promises to be answerable for the debt, default, or miscarriages of others. Cal. Civ. Code 2787. Thus, courts and legislatures grapple with conflicting considerations of possible injustice but the economic importance of guarantees. It all comes back to my mentor’s belief that the true value of a guarantor is the specter of that uncomfortable conversation that “we have a problem and could lose the house” which can motivate a reasonable resolution of a loan in the future. an otherwise limited liability borrower.
As of January 1, 2021, that conversation has changed. California has increased the homestead exemption from $ 100,000 for most married couples to a maximum of $ 600,000 in counties with the most expensive real estate. (Cal. Code of Civ. Proc. 704.730) The amendment, which was brought together within days in the 1885 Assembly Bill before the legislature adjourned in August 2020, increased the amount exempt from judgments creditors at least $ 300,000 and up to $ 600,000 in counties where that is the median price of a home. The amount is adjusted annually for inflation as of January 1, 2022. The amount of the exemption is determined in the year in which the exemption is requested.
Exemptions, of course, presuppose that the creditor has obtained a judgment and seeks to enforce it against the residence of the judgment debtor. building owner fees. Thus, the main target of the increased exemption is a non-consensual privilege such as those created by judgments. So, if the guarantor (usually the principal of a company that has signed a guarantee for their company’s construction lease, seller’s supply agreements, or a bank loan) owns a $ 3 million house with a traditional first mortgage. and a second mortgage securing a home equity line of credit totaling $ 2.5 million, his $ 500,000 of accumulated assets are fully protected from judgment creditors with the new $ 600,000 exemption.
Whether increasing the homestead exemption to $ 600,000 is good policy is obviously left to the legislature. Creditors, however, should be aware that getting a company’s principal to secure a building lease, seller’s supply contract, or bank loan does not create the same incentives as before the amendment. of the law in 2021. How should this new reality be approached, if the guarantee was significant for the economy of the extension of credit? Since an exemption does not protect the judgment debtor from consensual privileges, the creditor will have to consider a consensual lien to avoid the effect of the increased exemption. For most creditors, their immediate goal may be a junior residence trust deed. It’s probably bad instinct. Taking out real estate guarantees raises other issues, including deficiency protections and California action. Cal. Code of Civ. Proc. 726 (One action) and 580 (Anti-deficiency). Not only does the creditor then look at the existing trust deeds and property taxes which take precedence over the new trust deed, but the creditor’s rights are limited by the procedural requirements of the single action rule coupled with the limitations of the new trust deed. Anti-deficiency law. Savvy lawyers often advise their clients not to take out a real estate collateral, as tempting and easy as it may seem, due to these practical and legal limitations.
But there is another practical approach. The best option is often to secure the collateral with assets other than real estate. In the past, underwriting and diligence in this regard seemed to be more problematic than warranted, but the increased $ 600,000 exemption for family properties, coupled with the One Action Rule and anti-deficiency limitations, changes the analysis. . The creditor or lender has likely obtained the financial statement of the principal, and there may be separate non-real estate assets that would constitute significant collateral to secure performance of the collateral. This analysis, however, must also recognize other exemptions, such as the exemptions created for pensions and retirement accounts protected by ERISA, as well as dozens of other exemptions. But there can be several types of assets that make sense as non-exempt collateral, like that much-loved Jackson Pollack painting, the 1972 Porsche, or a no-pension brokerage account, that would spark a conversation beginning with, ” I have a problem and we could lose the artwork in the den. Again, the creditor should carefully consider all the exemptions available to the enforcement of judgments, but this is the new reality in 2021, and personal property collateral assessed by the guarantor may be the best approach to consider, despite underwriting and the additional diligence required by pledging the property.
It is true that most creditors and banks do not wish to sue as collateral; they just want to motivate the manager of a business not to rely on the limited liability nature of his business to act unreasonably when trying to resolve a bad loan or credit. The dramatic increase in California’s homestead exemption to $ 600,000 makes this analysis more urgent and legally complex than ever.