You Can’t Judge a Guaranty by Its Title: A ‘Conditional Guaranty’ May Be an Unconditional Guaranty of Payment

When extending credit to financially distressed customers, creditors may request a personal guarantee—frequently from the customer’s principal or owner—as a backstop for full payment of the creditor’s claim against the customer. Best practice is for the creditor to obtain a guaranty of payment (sometimes referred to an unconditional guaranty), where the creditor can seek payment directly from the guarantor without first seeking to collect from the primary obligor. This contrasts with the far less preferable guaranty of collection (sometimes referred to as a conditional guaranty), where the creditor is required to exhaust its remedies against the primary obligor before seeking to collect from the guarantor.

A recent decision from the U.S. District Court for the Southern District of New York (District Court), in KLS Diversified Master Fund, L.P. v. McDevitt (KLS), made clear that the terms of a guaranty, and not its title, control whether the guaranty is an unconditional guaranty of payment or a conditional guaranty of collection. Calling a guaranty an unconditional guaranty or a conditional guaranty has no bearing on whether the creditor has a guaranty of payment; rather, whether a creditor may first seek to collect from a guarantor depends on the language of the guaranty. The old saying “You cannot judge a book by its cover” clearly applies to judging the enforceability of a guaranty by its title and whether and to what extent a creditor may ultimately be able to collect from a guarantor