Lesson. Indiana courts respect language in mortgages and generally will uphold contractual waivers of defenses.
Case cite. Devlin v. Horizon Bank 235 N.E.3d 850 (Ind. Ct. App. 2024)
Legal issue. Whether a surety should be released from liability because the lender did not keep the surety informed of loan modifications or of the principal debtor’s alleged misconduct.
Vital facts. This is the second of two posts regarding the Devlin ag loan dispute. Please click here for the first post, and background. The mortgage that Father (the surety) granted to secure Son’s loan referred to a promissory note for the original amount of $800K “together with all renewals of, extensions of, modifications of, refinancings of, consolidations of, and substitutions for the promissory note….” A couple months after the closing of the loan, Bank and Son modified its terms to change payments from monthly to semi-annually. Then, Son exhausted the entire line of credit, and also misused some of the proceeds to purchase $200K of real property and farm equipment. Upon the original maturity of the loan, Bank and Son agreed to extend the maturity date, and converted the $200K in misused funds into a term loan. Bank did not inform Father of any of this. Bank’s loans matured again, and the two loans went into default.
Procedural history. The ensuing litigation involved, among other claims, Bank’s action to foreclose the mortgage on Father’s land. The trial court awarded Bank a $1,137,566.74 judgment and a decree of foreclosure, and Father appealed.
Key rules. Devlin applies Indiana suretyship law, which includes the below principles:
- “Generally, the nature and extent of a [surety’s] liability depends upon the terms of the contract, and a [surety] cannot be made liable beyond the terms of the [contract]. Nevertheless, the terms of [the contract] should neither be so narrowly interpreted as to frustrate the obvious intent of the parties, nor so loosely interpreted as to relieve the [surety] of a liability fairly within their terms.”
- “When parties cause a material alteration of an underlying obligation without the consent of the surety, the surety is discharged from further liability regardless of whether the alteration is to the surety’s injury or benefit.”
- “A material alteration that effects a discharge of the surety is one that alters the legal identity of the principal’s contract, substantially increases the risk of loss to the surety, or places the surety in a different position.”
Indiana courts have relied on the Restatement (Third) of Suretyship and Guaranty § 47 as it relates to the “material alteration” defense:
If, pursuant to the terms of the contract creating the secondary obligation, the secondary obligor has the power, upon the occurrence of a specified event, to terminate the secondary obligation with respect to subsequent defaults of the principal obligor on the underlying obligation or subsequently incurred duties of the principal obligor, and:
(a) such event occurs;
(b) the obligee knows such event has occurred; and
(c) the obligee has reason to know that the occurrence of such event is unknown to the secondary obligor;the secondary obligor is discharged from the secondary obligation with respect to defaults of the principal obligor that occur, or duties of the principal obligor incurred, thereafter and before the secondary obligor obtains knowledge of the occurrence of the event.
Holding. The Indiana Court of Appeals side with Bank.
Policy/rationale. Father argued that the various loan modifications, as well as Son’s undisclosed misconduct leading to the $200K term loan, discharged Father from liability. The Court disagreed, pointing to the language in the mortgage. The “plain terms … anticipated that the original loan’s terms might be modified and captured those modifications accordingly.” In other words, Father, a sophisticated party, contractually and prospectively waived the “material alternation” defense.
Father also asserted that his suretyship had terminated based on post-closing misconduct by Son (the misuse of funds) that was not disclosed to Father. While there is Indiana case law to support the notion that “a creditor’s failure to notify a surety of a debtor’s misconduct discharges the surety,” such a discharge is not automatic. Citing to the Restatement above, the Court held that, because the mortgage did not reserve Father’s right to terminate the suretyship (the mortgage) for the specific misconduct in question, the right to terminate was not available to Father. The Court reasoned:
[Father] merely seeks to second-guess how [Son] and Bank managed their relationship following the initial issuance of the loan. We think [Father’s] arguments, if adopted, would undermine good-faith dealings between lenders and debtors and would empower sureties to litigate any subsequent action of a debtor as ‘misconduct’ entitling the surety to discharge.
Related posts.
- Indiana Court of Appeals Denies Guarantor’s “Material Alteration” Defense
- Liability of Accommodation Parties When the Original Obligation Is Materially Altered
- Indiana Court Releases Mortgage On Parents’ Farmland Based On Material Alteration Of Kids’ Loan
- “Material Alteration” Defense Rejected In Indiana Guaranty Enforcement Action
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Part of my practice involves representing parties in disputes arising out of loans in default. 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.