Shareholder and guarantor of company bank debt can’t force co-guarantor (and former shareholder) to pay former shareholder’s claimed fair share of the guaranteed debt

This is a case about problems in a transaction where one group of shareholders of Company bought out another group of shareholders of Company, in a case where all the shareholders had previously given their personal guaranty for Company debt owed to Wells Fargo. For simplicity of illustration, the facts are modified so that Company will only have two equal shareholders, Buyer and Seller; and Buyer and Seller gave their personal guaranty for several 2005 and 2006 Wells Fargo loans to Company, totaling $900K; followed by the September 2007 Buyer acquisition of Seller’s Company shares.

In the stock purchase agreement, Buyer agreed to use best efforts to have Company satisfy and repay in full all debt obligations of Company to Wells Fargo.

Company did not make any principal payments to Wells Fargo. As a result, in October 2008, Wells Fargo filed a lawsuit to collect the amount due on two defaulted notes. In April 2009, judgment was entered in favor of the bank on its claims against Company and the guarantors, (Buyer and Seller) in the amount of $909K plus interest.

In June 2009, Wells Fargo entered into a forbearance agreement with Company. As additional collateral to secure the forbearance agreement, Buyer gave Wells Fargo a mortgage lien on a condo Buyer owned in New York. Pursuant to the agreement, Company agreed to make an initial payment of $400,000 at the time of signing and then quarterly payments of $76K thereafter until the debt was discharged.

According to Buyer, Company was unable to make the quarterly payment due in June 2010. Buyer asked his parents for money so Buyer—as opposed to Company—could make the payment. Buyer’s father took money from his retirement account and put it in a joint account held by Buyer and his parents. Buyer then wrote a personal check to Wells Fargo for the June payment. At trial, Buyer testified he borrowed the money from his parents. During cross-examination, Buyer conceded that Buyer did not have a formal loan agreement with his parents, there was no date by which Buyer was expected to pay back the money, and Buyer had not paid any of it back so far—more than five years later. Buyer clarified that, although his parents were unlikely to attempt to compel him to pay back the funds, he felt an obligation to do so.

When the next quarterly payment came due in September 2010, Buyer again believed Company could not afford to make the payment. In a similar situation, Buyer received money from Buyer’s parents to make the payment. Again, there were no written documents memorializing loan terms, there was no date by which the money was to be paid back, no interest accumulating in the meantime, and—as of the time of trial in December 2015— Buyer had not yet returned any money to Buyer’s parents. Buyer testified Buyer felt a moral obligation to pay Buyer’s parents back, but stated Buyer had not yet had an opportunity to do so.

When the December 2010 payment came due, Buyer again asked for and received money from Buyer’s parents. This time, Buyer paid off the entire balance of the loan—approximately $240,000. Buyer testified Buyer received the money from Buyer’s parents for the specific purpose of paying off the loan. Buyer paid the loan off early—rather than waiting to see if Company would have the ability to make future payments, as it was contractually obligated to do—because Buyer wanted to clear Buyer’s New York condo from the debt.

In January 2011, Buyer sued Seller in an Iowa state court to force Seller to bear Seller’s just share of the amounts Buyer paid to Wells Fargo as guarantor of Company’s debt.  The trial court denied Buyer’s claim for what is called “equitable contribution”, noting that payment by Buyer’s parents, even though for Buyer’s benefit, gave Buyer no right force Seller to reimburse Buyer for Seller’s share of the Wells Fargo debt. Additionally, the court found the evidence clearly demonstrated that Buyer’s parents actually made the payments to Wells Fargo and the monies simply passed through Buyer’ bank accounts on their way to Wells Fargo.

Buyer appealed to the Iowa Court of Appeals. This court agreed with the trial court.

The Iowa intermediate appellate court said that generally, one party who satisfies a claim can seek reimbursement through contribution and is used to prevent unjust enrichment. But Buyer was a mere conduit for Buyer’s parent’s money. In other words, although Buyer had signed checks to discharge the obligation, Buyer had not suffered the detriment or harm involved in paying more than Buyer’s share.

Buyer argued that it was its money. It was either a gift to him from his parents or a loan.  The appellate court did not buy either argument.

The court dismissed the loan argument because at the time of trial, it had been more than five years since the money was received, and Buyer had yet to pay back a single cent of the money. Buyer agreed Buyer’s parents were unlikely to take negative action against Buyer if Buyer did not pay back the funds.

The gift argument did not fly because Buyer asked Buyer’s parents for money in order to make payments on the debt, and money was provided to Buyer for the same specific purpose. There is nothing in the record this court said that suggested the parents would have provided the funds otherwise. In other words, Buyer needed approximately $394,000 in order to pay off the debt. Buyer asked Buyer’s parents for that amount in order to pay off the debt, Buyer was given that amount, and Buyer paid it off. Moreover, Buyer’s testimony that Buyer felt compelled or as if Buyer had a moral obligation to return the funds belies Buyer’s claims that the money was gifted to Buyer.

This case is referred to Shcharansky v. Komm, No. 16-1265, Court of Appeals of Iowa, Filed July 6, 2017).

Comment. It looks to me that the substance of the parent’s payments to Buyer were a gift, and thus the sums used to pay off Wells Fargo was Buyer’s money. But that was not the way the Iowa trial or intermediate appellate court saw it.

In 20/20 hindsight, Seller would have asked that Buyer to promise in the stock purchase agreement to waive any right to seek contribution from Seller arising out of the bank note and personal guaranty. Also, Seller would have asked that Buyer indemnify Seller for any loss Seller suffers if Wells Fargo comes after Seller under Seller’s personal guaranty.

By John McCauley: I help people start, grow, buy and sell their businesses.



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Posted in equitable contribution, personal guaranty of company debt by selling shareholder, shareholder buyout of partner, stock purchase agreement

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