2023 New Mexico Statutes › Chapter 55 - Uniform Commercial Code › Article 3 - Negotiable Instruments › Part 6 - DISCHARGE AND PAYMENT › Section 55-3-605 - Discharge of secondary obligors.

(a) If a person entitled to enforce an instrument releases the obligation of a principal obligor in whole or in part and another party to the instrument is a secondary obligor with respect to the obligation of that principal obligor, the following rules apply:
(1) any obligations of the principal obligor to the secondary obligor with respect to any previous payment by the secondary obligor are not affected. Unless the terms of the release preserve the secondary obligor's recourse, the principal obligor is discharged, to the extent of the release, from any other duties to the secondary obligor pursuant to this article;
(2) unless the terms of the release provide that the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor, the secondary obligor is discharged to the same extent as the principal obligor from any unperformed portion of its obligation on the instrument. If the instrument is a check and the obligation of the secondary obligor is based on an indorsement of the check, the secondary obligor is discharged without regard to the language or circumstances of the discharge or other release; and
(3) if the secondary obligor is not discharged pursuant to Paragraph (2) of this subsection, the secondary obligor is discharged to the extent of the value of the consideration for the release and to the extent that the release would otherwise cause the secondary obligor a loss.
(b) If a person entitled to enforce an instrument grants a principal obligor an extension of the time at which one or more payments are due on the instrument and another party to the instrument is a secondary obligor with respect to the obligation of that principal obligor, the following rules apply:
(1) any obligations of the principal obligor to the secondary obligor with respect to any previous payment by the secondary obligor are not affected. Unless the terms of the extension preserve the secondary obligor's recourse, the extension correspondingly extends the time for performance of any other duties owed to the secondary obligor by the principal obligor pursuant to this article;
(2) the secondary obligor is discharged to the extent that the extension would otherwise cause the secondary obligor a loss; and
(3) to the extent that the secondary obligor is not discharged pursuant to Paragraph (2) of this subsection, the secondary obligor either may perform its obligations to a person entitled to enforce the instrument as if the time for payment had not been extended or, unless the terms of the extension provide that the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor as if the time for payment had not been extended, may treat the time for performance of its obligations as having been extended correspondingly.
(c) If a person entitled to enforce an instrument agrees, with or without consideration, to a modification of the obligation of a principal obligor, other than a complete or a partial release or an extension of the due date, and another party to the instrument is a secondary obligor with respect to the obligation of that principal obligor, the following rules apply:
(1) any obligations of the principal obligor to the secondary obligor with respect to any previous payment by the secondary obligor are not affected. The modification correspondingly modifies any other duties owed to the secondary obligor by the principal obligor pursuant to this article;
(2) the secondary obligor is discharged from any unperformed portion of its obligation to the extent that the modification would otherwise cause the secondary obligor a loss; and
(3) to the extent that the secondary obligor is not discharged pursuant to Paragraph (2) of this subsection, the secondary obligor may satisfy its obligation on the instrument as if the modification had not occurred or treat its obligation on the instrument as having been modified correspondingly.
(d) If the obligation of a principal obligor is secured by an interest in collateral, if another party to the instrument is a secondary obligor with respect to that obligation, and if a person entitled to enforce the instrument impairs the value of the interest in collateral, the obligation of the secondary obligor is discharged to the extent of the impairment. The value of an interest in collateral is impaired to the extent the value of the interest is reduced to an amount less than the amount of the recourse of the secondary obligor or the reduction in value of the interest causes an increase in the amount by which the amount of the recourse exceeds the value of the interest. For purposes of this subsection, "impairing the value of an interest in collateral" includes failure to obtain or maintain perfection or recordation of the interest in collateral; release of collateral without substitution of collateral of equal value or equivalent reduction of the underlying obligation; failure to perform a duty to preserve the value of collateral owed, pursuant to Article 9 of the Uniform Commercial Code or other law, to a debtor or other person secondarily liable; and failure to comply with applicable law in disposing of or otherwise enforcing the interest in collateral.
(e) A secondary obligor is not discharged pursuant to Paragraph (3) of Subsection (a) of this section or Subsection (b), (c) or (d) of this section unless the person entitled to enforce the instrument knows that the person is a secondary obligor or has notice pursuant to Subsection (c) of Section 55-3-419 NMSA 1978 that the instrument was signed for accommodation.
(f) A secondary obligor is not discharged pursuant to this section if the secondary obligor consents to the event or conduct that is the basis of the discharge or if the instrument or a separate agreement of the party provides for waiver of discharge pursuant to this section specifically or by general language indicating that parties waive defenses based on suretyship or impairment of collateral. Unless the circumstances indicate otherwise, consent by the principal obligor to an act that would lead to a discharge pursuant to this section constitutes consent to that act by the secondary obligor if the secondary obligor controls the principal obligor or deals with the person entitled to enforce the instrument on behalf of the principal obligor.
(g) A release or extension preserves a secondary obligor's recourse if the terms of the release or extension provide that:
(1) the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor; and
(2) the recourse of the secondary obligor continues as if the release or extension had not been granted.
(h) Except as otherwise provided in Subsection (i) of this section, a secondary obligor asserting discharge pursuant to this section has the burden of persuasion both with respect to the occurrence of the acts alleged to harm the secondary obligor and loss or prejudice caused by those acts.
(i) If the secondary obligor demonstrates prejudice caused by an impairment of its recourse and the circumstances of the case indicate that the amount of loss is not reasonably susceptible of calculation or requires proof of facts that are not ascertainable, it is presumed that the act impairing recourse caused a loss or impairment equal to the liability of the secondary obligor on the instrument. In that event, the burden of persuasion as to any lesser amount of the loss is on the person entitled to enforce the instrument.
History:
1978 Comp., § 55-3-605, enacted by Laws 1992, ch. 114, § 155; 2009, ch. 234, § 11.
OFFICIAL COMMENTS
UCC Official Comments by ALI & the NCCUSL. Reproduced with permission of the PEB for the UCC. All rights reserved.
1. This section contains rules that are applicable when a secondary obligor (as defined in Section 3-103(a)(17)) [55-3-103 NMSA 1978] is a party to an instrument. These rules essentially parallel modern interpretations of the law of suretyship and guaranty that apply when a secondary obligor is not a party to an instrument.
See generally Restatement of the Law, Third, Suretyship and Guaranty
(1996). Of course, the rules in this section do not resolve all possible issues concerning the rights and duties of the parties. In the event that a situation is presented that is not resolved by this section (or the other related sections of this Article), the resolution may be provided by the general law of suretyship because, pursuant to Section 1-103 [55-1-103 NMSA 1978], that law is applicable unless displaced by provisions of this Act.
2. Like the law of suretyship and guaranty, Section 3-605 [55-3-605 NMSA 1978] provides secondary obligors with defenses that are not available to other parties to instruments. The general operation of Section 3-605, and its relationship to the law of suretyship and guaranty, can be illustrated by an example. Bank agrees to lend $10,000 to Borrower, but only if Backer also is liable for repayment of the loan. The parties could consummate that transaction in three different ways. First, if Borrower and Backer incurred those obligations with contracts not governed by this Article (such as a note that is not an instrument for purposes of this Article), the general law of suretyship and guaranty would be applicable. Under modern nomenclature, Bank is the "obligee", Borrower is the "principal obligor", and Backer is the "secondary obligor".
See Restatement of Suretyship and Guaranty
§ 1. Then assume that Bank and Borrower agree to a modification of their rights and obligations after the note is signed. For example, they might agree that Borrower may repay the loan at some date after the due date, or that Borrower may discharge its repayment obligation by paying Bank $3,000 rather than $10,000. Alternatively, suppose that Bank releases collateral that Borrower has given to secure the loan. Under the law of suretyship and guaranty, the secondary obligor may be discharged under certain circumstances if these modifications of the obligations between Bank (the obligee) and Borrower (the principal obligor) are made without the consent of Backer (the secondary obligor). The rights that the secondary obligor has to a discharge of its liability in such cases commonly are referred to as suretyship defenses. The extent of the discharge depends upon the particular circumstances.
See Restatement of Suretyship and Guaranty
§§ 37, 39-44.
A second possibility is that the parties might decide to evidence the loan by a negotiable instrument. In that scenario, Borrower signs a note under which Borrower is obliged to pay $10,000 to the order of Bank on a due date stated in the note. Backer becomes liable for the repayment obligation by signing the note as a co-maker or indorser. In either case the note is signed for accommodation, Backer is an accommodation party, and Borrower is the accommodated party.
See
Section 3-419 [55-3-419 NMSA 1978] (describing the obligations of accommodation parties). For purposes of Section 3-605, Backer is also a "secondary obligor" and Borrower is a "principal obligor", as those terms are defined in Section 3-103. Because Backer is a party to the instrument, its rights to a discharge based on any modification of obligations between Bank and Borrower are governed by Section 3-605 rather than by the general law of suretyship and guaranty. Within Section 3-605, subsection (a) describes the consequences of a release of Borrower, Subsection (b) describes the consequences of an extension of time, and Subsection (c) describes the consequences of other modifications.
The third possibility is that Borrower would use an instrument governed by this Article to evidence its repayment obligation, but Backer's obligation would be created in some way other than by becoming party to that instrument. In that case, Backer's rights are determined by suretyship and guaranty law rather than by this Article.
See
Comment 3 to Section 3-419. A person also can acquire secondary liability without having been a secondary obligor at the time that the principal obligation was created. For example, a transferee of real or personal property that assumes the obligation of the transferor as maker of a note secured by the property becomes by operation of law a principal obligor, with the transferor becoming a secondary obligor.
Restatement of Suretyship and Guaranty
§ 2(e);
Restatement of Mortgages
§ 5.1. Article 3 does not determine the effect of the release of the transferee in that case because the assuming transferee is not a "party" to the instrument as defined in Section 3-103(a)(10). Section 3-605(a) does not apply then because the holder has not discharged the obligation of a "principal obligor", a term defined in Section 3-103(a)(11). Thus, the resolution of that question is governed by the law of suretyship.
See Restatement of Suretyship and Guaranty
§ 39.
3. Section 3-605 is not, however, limited to the conventional situation of the accommodation party discussed in Comment 2. It also applies in four other situations. First, it applies to indorsers of notes who are not accommodation parties. Unless an indorser signs without recourse, the indorser's liability under Section 3-415(a) [55-3-415 NMSA 1978] is functionally similar to that of a guarantor of payment. For example, if Bank in the second hypothetical discussed in Comment 2 indorsed the note and transferred it to Second Bank, Bank is liable to Second Bank in the event of dishonor of the note by Borrower. Section 3-415(a). Because of that secondary liability as indorser, Bank qualifies as a "secondary obligor" under Section 3-103(a)(17) and has the same rights under Section 3-605 as an accommodation party.
Second, a similar analysis applies to the drawer of a draft that is accepted by a party that is not a bank. Under Section 3-414(d) [55-3-414 NMSA 1978], that drawer has liability on the same terms as an indorser under Section 3-415(a). Thus, the drawer in that case is a "secondary obligor" under Section 3-103(a)(17) and has rights under Section 3-605 to that extent.
Third, a similar principle justifies application of Section 3-605 to persons who indorse a check. Assume that Drawer draws a check to the order of Payee. Payee then indorses the check and transfers it to Transferee. If Transferee presents the check and it is dishonored, Transferee may recover from Drawer under Section 3-414 or Payee under Section 3-415. Because of that secondary liability as an indorser, Payee is a secondary obligor under Section 3-103(a)(17). Drawer is a "principal obligor" under Section 3-103(a)(11). As noted in Comment 4, below, however, Section 3-605(a)(3) will discharge indorsers of checks in some cases in which other secondary obligors will not be discharged by this section.
Fourth, this section also deals with the rights of co-makers of instruments, even when those co-makers do not qualify as accommodation parties. The co-makers' rights of contribution under Section 3-116 [55-3-116 NMSA 1978] make each co-maker a secondary obligor to the extent of that right of contribution.
4. Subsection (a) is based on
Restatement of Suretyship and Guaranty
§ 39. It addresses the effects of a release of the principal obligor by the person entitled to enforce the instrument. Paragraph (a)(1) governs the effect of that release on the principal obligor's duties to the secondary obligor; paragraphs (a)(2) and (a)(3) govern the effect of that release on the secondary obligor's duties to the person entitled to enforce the instrument.
With respect to the duties of the principal obligor, the release of course cannot affect obligations of the principal obligor with respect to payments that the secondary obligor already has made. But with respect to future payments by the secondary obligor, paragraph (a)(1) (based on
Restatement of Suretyship and Guaranty
§ 39(a)) provides that the principal obligor is discharged, to the extent of the release, from any other duties to the secondary obligor. That rule is appropriate because otherwise the discharge granted to the principal obligor would be illusory: it would have obtained a release from a person entitled to enforce that instrument, but it would be directly liable for the same sum to the secondary obligor if the secondary obligor later complied with its secondary obligation to pay the instrument. This discharge does not occur, though, if the terms of the release effect a "preservation of recourse" as described in subsection (g).
See
Comment 10, below.
The discharge under paragraph (a)(1) of the principal obligor's duties to the secondary obligor is broad, applying to all duties under this article. This includes not only the principal obligor's liability as a party to an instrument (as a maker, drawer or indorser under Sections 3-412 [55-3-413 NMSA 1978] through 3-415) but also obligations under Sections 3-116 and 3-419.
Paragraph (a)(2) is based closely on
Restatement of Suretyship and Guaranty
§ 39(b). It articulates a default rule that the release of a principal obligor also discharges the secondary obligor, to the extent of the release granted to the principal obligor, from any unperformed portion of its obligation on the instrument. The discharge of the secondary obligor under paragraph (a)(2) is phrased more narrowly than the discharge of the principal obligor is phrased under paragraph (a)(1) because, unlike principal obligors, the only obligations of secondary obligors in Article 3 are "on the instrument" as makers or indorsers.
The parties can opt out of that rule by including a contrary statement in the terms of the release. The provision does not contemplate that any "magic words" are necessary. Thus, discharge of the secondary obligor under paragraph (a)(2) is avoided not only if the terms of the release track the statutory language (e.g., the person entitled to enforce the instrument "retains the right to enforce the instrument" against the secondary obligor), or if the terms of the release effect a preservation of recourse under Subsection (g), but also if the terms of the release include a simple statement that the parties intend to "release the principal obligor but not the secondary obligor" or that the person entitled to enforce the instrument "reserves its rights" against the secondary obligor. At the same time, because paragraph (a)(2) refers to the "terms of the release", extrinsic circumstances cannot be used to establish that the parties intended the secondary obligor to remain obligated. If a release of the principal obligor includes such a provision, the secondary obligor is, nonetheless, discharged to the extent of the consideration that is paid for the release; that consideration is treated as a payment in partial satisfaction of the instrument.
Notwithstanding language in the release that prevents discharge of the secondary obligor under paragraph (a)(2), paragraph (a)(3) discharges the secondary obligor from its obligation to a person entitled to enforce the instrument to the extent that the release otherwise would cause the secondary obligor a loss. The rationale for that provision is that a release of the principal obligor changes the economic risk for which the secondary obligor contracted. This risk may be increased in two ways. First, by releasing the principal obligor, the person entitled to enforce the instrument has eliminated the likelihood of future payments by the principal obligor that would lessen the obligation of the secondary obligor. Second, unless the release effects a preservation of the secondary obligor's recourse, the release eliminates the secondary obligor's claims against the principal obligor with respect to any future payment by the secondary obligor. The discharge provided by this paragraph prevents that increased risk from causing the secondary obligor a loss. Moreover, permitting releases to be negotiated between the principal obligor and the person entitled to enforce the instrument without regard to the consequences to the secondary obligor would create an undue risk of opportunistic behavior by the obligee and principal obligor. That concern is lessened, and the discharge is not provided by paragraph (a)(3), if the secondary obligor has consented to the release or is deemed to have consented to it under subsection (f) (which presumes consent by a secondary obligor to actions taken by a principal obligor if the secondary obligor controls the principal obligor or deals with the person entitled to enforce the instrument on behalf of the principal obligor).
See
Comment 9, below.
Subsection (a) (and
Restatement
§ 39(b), the concepts of which it follows quite closely) is designed to facilitate negotiated workouts between a creditor and a principal obligor, so long as they are not at the expense of a secondary obligor who has not consented to the arrangement (either specifically or by waiving its rights to discharge under this section). Thus, for example, the provision facilitates an arrangement in which the principal obligor pays some portion of a guaranteed obligation, the person entitled to enforce the instrument grants a release to the principal obligor in exchange for that payment, and the person entitled to enforce the instrument pursues the secondary obligor for the remainder of the obligation. Under paragraph (a)(2), the person entitled to enforce the instrument may pursue the secondary obligor despite the release of the principal obligor so long as the terms of the release provide for this result. Under paragraph (a)(3), though, the secondary obligor will be protected against any loss it might suffer by reason of that release (if the secondary obligor has not waived discharge under subsection (f)). It should be noted that the obligee may be able to minimize the risk of such loss (and, thus, of the secondary obligor's discharge) by giving the secondary obligor prompt notice of the release even though such notice is not required.
The foregoing principles are illustrated by the following cases:
Case 1. D borrows $1000 from C. The repayment obligation is evidenced by a note issued by D, payable to the order of C. S is an accommodation indorser of the note. As the due date of the note approaches, it becomes obvious that D cannot pay the full amount of the note and may soon be facing bankruptcy. C, in order to collect as much as possible from D and lessen the need to seek recovery from S, agrees to release D from its obligation under the note in exchange for $100 in cash. The agreement to release D is silent as to the effect of the release on S. Pursuant to Section 3-605(a)(2), the release of D discharges S from its obligations to C on the note.
Case 2. Same facts as Case 1, except that the terms of the release provide that C retains its rights to enforce the instrument against S. D is discharged from its obligations to S pursuant to Section 3-605(a)(1), but S is not discharged from its obligations to C pursuant to Section 3-605(a)(2). However, if S could have recovered from D any sum it paid to C (had D not been discharged from its obligation to S), S has been harmed by the release and is discharged pursuant to Section 3-605(a)(3) to the extent of that harm.
Case 3. Same facts as Case 1, except that the terms of the release provide that C retains its rights to enforce the instrument against S and that S retains its recourse against D.Under subsection (g), the release effects a preservation of recourse. Thus, S is not discharged from its obligations to C pursuant to Section 3-605(a)(2) and D is not discharged from its obligations to S pursuant to Section 3-605(a)(1). Because S's claims against D are preserved, S will not suffer the kind of loss described in Case 2. If no other loss is suffered by S as a result of the release, S is not discharged pursuant to this section.
Case 4. Same facts as Case 3, except that D had made arrangements to work at a second job in order to earn the money to fulfill its obligations on the note. When C released D, however, D canceled the plans for the second job. While S still retains its recourse against D, S may be discharged from its obligation under the instrument to the extent that D's decision to forgo the second job causes S a loss because forgoing the job renders D unable to fulfill its obligations to S under Section 3-419.
Subsection (a) reflects a change from former Section 3-605(b), which provided categorically that the release of a principal obligor by the person entitled to enforce the instrument did not discharge a secondary obligor's obligation on the instrument and assumed that the release also did not discharge the principal obligor's obligations to the secondary obligor under Section 3-419. The rule under subsection (a) is much closer to the policy of the Restatement of Suretyship and Guaranty than was former Section 3-605(b). The change, however, is likely to affect only a narrow category of cases. First, as discussed above, Section 3-605 applies only to transactions in which the payment obligation is represented by a negotiable instrument, and, within that set of transactions, only to those transactions in which the secondary obligation is incurred by indorsement or cosigning, not to transactions that involve a separate document of guaranty. See Comment 2, above. Second, as provided in Subsection (f), secondary obligors cannot obtain a discharge under Subsection (a) in any transaction in which they have consented to the challenged conduct. Thus, Subsection (a) will not apply to any transaction that includes a provision waiving suretyship defenses (a provision that is almost universally included in commercial loan documentation) or to any transaction in which the creditor obtains the consent of the secondary obligor at the time of the release.
The principal way in which Subsection (a) goes beyond the policy of Restatement § 39 is with respect to the liability of indorsers of checks. Specifically, the last sentence of paragraph (a)(2) provides that a release of a principal obligor grants a complete discharge to the indorser of a check, without requiring the indorser to prove harm. In that particular context, it seems likely that continuing responsibility for the indorser often would be so inconsistent with the expectations of the parties as to create a windfall for the creditor and an unfair surprise for the indorser. Thus, the statute implements a simple rule that grants a complete discharge. The creditor, of course, can avoid that rule by contracting with the secondary obligor for a different result at the time that the creditor grants the release to the principal obligor.
5. Subsection (b) is based on
Restatement of Suretyship and Guaranty
§ 40 and relates to extensions of the due date of the instrument. An extension of time to pay a note is often beneficial to the secondary obligor because the additional time may enable the principal obligor to obtain the funds to pay the instrument. In some cases, however, the extension may cause loss to the secondary obligor, particularly if deterioration of the financial condition of the principal obligor reduces the amount that the secondary obligor is able to recover on its right of recourse when default occurs. For example, suppose that the instrument is an installment note and the principal debtor is temporarily short of funds to pay a monthly installment. The payee agrees to extend the due date of the installment for a month or two to allow the debtor to pay when funds are available. Paragraph (b)(2) provides that an extension of time results in a discharge of the secondary obligor, but only to the extent that the secondary obligor proves that the extension caused loss.
See
Subsection (h) (discussing the burden of proof under Section 3-605). Thus, if the extension is for a long period, the secondary obligor might be able to prove that during the period of extension the principal obligor became insolvent, reducing the value of the right of recourse of the secondary obligor. In such a case, paragraph (b)(2) discharges the secondary obligor to the extent of that harm. Although not required to notify the secondary obligor of the extension, the payee can minimize the risk of loss by the secondary obligor by giving the secondary obligor prompt notice of the extension; prompt notice can enhance the likelihood that the secondary obligor's right of recourse can remain valuable, and thus can limit the likelihood that the secondary obligor will suffer a loss because of the extension.
See Restatement of Suretyship and Guaranty
§ 38 comment b.
If the secondary obligor is not discharged under paragraph (b)(2) (either because it would not suffer a loss by reason of the extension or because it has waived its right to discharge pursuant to Subsection (f)), it is important to understand the effect of the extension on the rights and obligations of the secondary obligor. Consider the following cases:
Case 5. A borrows money from Lender and issues a note payable to the order of Lender that is due on April 1, 2002. B signs the note for accommodation at the request of Lender. B signed the note either as co-maker or as an anomalous indorser. In either case Lender subsequently makes an agreement with A extending the due date of A's obligation to pay the note to July 1, 2002. In either case B did not agree to the extension, and the extension did not address Lender's rights against B. Under paragraph (b)(1), A's obligations to B under this article are also extended to July 1, 2002. Under paragraph (b)(3), if B is not discharged, B may treat its obligations to Lender as also extended, or may pay the instrument on the original due date.
Case 6. Same facts as Case 5, except that the extension agreement includes a statement that the Lender retains its right to enforce the note against B on its original terms. Under paragraph (b)(3), B is liable on the original due date, but under paragraph (b)(1), A's obligations to B under Section 3-419 are not due until July 1, 2002.
Case 7. Same facts as Case 5, except that the extension agreement includes a statement that the Lender retains its right to enforce the note against B on its original terms and B retains its recourse against A as though no extension had been granted. Under paragraph (b)(3), B is liable on the original due date. Under paragraph (b)(1), A's obligations to B under Section 3-419 are not extended.
Under Section 3-605(b), the results in Case 5 and Case 7 are identical to the results that follow from the law of suretyship and guaranty.
See Restatement of Suretyship and Guaranty
§ 40. The situation in Case 6 is not specifically addressed in the Restatement, but the resolution in this Section is consistent with the concepts of suretyship and guaranty law as reflected in the
Restatement
. If the secondary obligor is called upon to pay on the due date, it may be difficult to quantify the extent to which the extension has impaired the right of recourse of the secondary obligor at that time. Still, the secondary obligor does have a right to make a claim against the obligee at that time. As a practical matter a suit making such a claim should establish the facts relevant to the extent of the impairment.
See Restatement of Suretyship and Guaranty
§ 37(4).
As a practical matter, an extension of the due date will normally occur only when the principal obligor is unable to pay on the due date. The interest of the secondary obligor normally is to acquiesce in the willingness of the person entitled to enforce the instrument to wait for payment from the principal obligor rather than to pay right away and rely on an action against the principal obligor that may have little or no value. But in unusual cases the secondary obligor may prefer to pay the holder on the original due date so as to avoid continuing accrual of interest. In such cases, the secondary obligor may do so.
See
paragraph (b)(3). If the terms of the extension provide that the person entitled to enforce the instrument retains its right to enforce the instrument against the secondary obligor on the original due date, though, those terms are effective and the secondary obligor may not delay payment until the extended due date. Unless the extension agreement effects a preservation of recourse, however, the secondary obligor may not proceed against the principal obligor under Section 3-419 until the extended due date.
See
paragraph (b)(1). To the extent that delay causes loss to the secondary obligor it is discharged under paragraph (b)(2).
Even in those cases in which a secondary obligor does not have a duty to pay the instrument on the original due date, it always has the right to pay the instrument on that date, and perhaps minimize its loss by doing so. The secondary obligor is not precluded, however, from asserting its rights to discharge under Section 3-605(b)(2) if it does not exercise that option. The critical issue is whether the extension caused the secondary obligor a loss by increasing the difference between its cost of performing its obligation on the instrument and the amount recoverable from the principal obligor under this Article. The decision by the secondary obligor not to exercise its option to pay on the original due date may, under the circumstances, be a factor to be considered in the determination of that issue, especially if the secondary obligor has been given prompt notice of the extension (as discussed above).
6. Subsection (c) is based on
Restatement of Suretyship and Guaranty
§ 41. It is a residual provision, which applies to modifications of the obligation of the principal obligor that are not covered by subsections (a) and (b). Under subsection (c)(1), a modification of the obligation of the principal obligor on the instrument (other than a release covered by subsection (a) or an extension of the due date covered by Subsection (b)), will correspondingly modify the duties of the principal obligor to the secondary obligor. Under subsection (c)(2), such a modification also will result in discharge of the secondary obligor to the extent the modification causes loss to the secondary obligor. To the extent that the secondary obligor is not discharged and the obligation changes the amount of money payable on the instrument, or the timing of such payment, Subsection (c)(3) provides the secondary obligor with a choice: it may satisfy its obligation on the instrument as if the modification had not occurred, or it may treat its obligation to pay the instrument as having been modified in a manner corresponding to the modification of the principal obligor's obligation.
The following cases illustrate the application of Subsection (c):
Case 8. Corporation borrows money from Lender and issues a note payable to Lender. X signs the note as an accommodation party for Corporation. The note refers to a loan agreement under which the note was issued, which states various events of default that allow Lender to accelerate the due date of the note. Among the events of default are breach of covenants not to incur debt beyond specified limits and not to engage in any line of business substantially different from that currently carried on by Corporation. Without consent of X, Lender agrees to modify the covenants to allow Corporation to enter into a new line of business that X considers to be risky, and to incur debt beyond the limits specified in the loan agreement to finance the new venture. This modification discharges X to the extent that the modification otherwise would cause X a loss.
Case 9. Corporation borrows money from Lender and issues a note payable to Lender in the amount of $100,000. X signs the note as an accommodation party for Corporation. The note calls for 60 equal monthly payments of interest and principal. Before the first payment is made, Corporation and Lender agree to modify the note by changing the repayment schedule to require four annual payments of interest only, followed by a fifth payment of interest and the entire $100,000 principal balance. To the extent that the modification does not discharge X, X has the option of fulfilling its obligation on the note in accordance with the original terms or the modified terms.
7. Subsection (d) is based on
Restatement of Suretyship and Guaranty
§ 42 and deals with the discharge of secondary obligors by impairment of collateral. The last sentence of Subsection (d) states four common examples of what is meant by impairment. Because it uses the term "includes", the provision allows a court to find impairment in other cases as well. There is extensive case law on impairment of collateral. The secondary obligor is discharged to the extent that the secondary obligor proves that impairment was caused by a person entitled to enforce the instrument. For example, assume that the payee of a secured note fails to perfect the security interest. The collateral is owned by the principal obligor who subsequently files in bankruptcy. As a result of the failure to perfect, the security interest is not enforceable in bankruptcy. If the payee were to obtain payment from the secondary obligor, the secondary obligor would be subrogated to the payee's security interest in the collateral under Section 3-419 and general principles of suretyship law.
See
Restatement of Suretyship and Guaranty § 28(1)(c). In this situation, though, the value of the security interest is impaired completely because the security interest is unenforceable. Thus, the secondary obligor is discharged from its obligation on the note to the extent of that impairment. If the value of the collateral impaired is as much or more than the amount of the note, and if there will be no recovery on the note as an unsecured claim, there is a complete discharge. Subsection (d) applies whether the collateral is personalty or realty, whenever the obligation in question is in the form of a negotiable instrument.
8. Subsection (e) is based on the former Section 3-605(h). The requirement of knowledge in the first clause is consistent with Section 9-628. The requirement of notice in the second clause is consistent with Section 3-419(c).
9. The importance of the suretyship defenses provided in Section 3-605 is greatly diminished by the fact that the right to discharge can be waived as provided in subsection (f). The waiver can be effectuated by a provision in the instrument or in a separate agreement. It is standard practice to include such a waiver of suretyship defenses in notes prepared by financial institutions or other commercial creditors. Thus, Section 3-605 will result in the discharge of an accommodation party on a note only in the occasional case in which the note does not include such a waiver clause and the person entitled to enforce the note nevertheless takes actions that would give rise to a discharge under this section without obtaining the consent of the secondary obligor.
Because subsection (f) by its terms applies only to a discharge "under this section", subsection (f) does not operate to waive a defense created by other law (such as the law governing enforcement of security interests under Article 9) that cannot be waived under that law.
See, e.g.
, Section 9-602.
The last sentence of subsection (f) creates an inference of consent on the part of the secondary obligor whenever the secondary obligor controls the principal obligor or deals with the creditor on behalf of the principal obligor. That sentence is based on Restatement of Suretyship and Guaranty § 48(2).
10. Subsection (g) explains the criteria for determining whether the terms of a release or extension preserve the secondary obligor's recourse, a concept of importance in the application of subsections (a) and (b). First, the terms of the release or extension must provide that the person entitled to enforce the instrument retains the right to enforce the instrument against the secondary obligor. Second, the terms of the release or extension must provide that the recourse of the secondary obligor against the principal obligor continues as though the release or extension had not been granted. Those requirements are drawn from
Restatement of Suretyship and Guaranty
§ 38.
11. Subsections (h) and (i) articulate rules for the burden of persuasion under Section 3-605. Those rules are based on
Restatement of Suretyship and Guaranty
§ 49.
ANNOTATIONS
Repeals.
— Laws 1992, ch. 114, § 237 repealed former 55-3-605 NMSA 1978, as enacted by Laws 1961, ch. 96, § 3-605, relating to cancellation and renunciation, effective July 1, 1992. Laws 1992, ch. 114, § 155, enacted a new section, effective July 1, 1992. For provisions of former section,
see
the 1991 NMSA 1978 on
NMOneSource.com
. For present comparable provisions,
see
55-3-604 NMSA 1978.
The 2009 amendment,
effective January 1, 2010, deleted the entire former section, which provided for the discharge of indorsers and accommodation parties and added entirely new language.
Common law rule of suretyship superseded.
— The well-established rule of suretyship, that the release of a principal debtor of his obligation on a note discharges the obligation owed to the creditor by an accommodation party, is directly contrary to the rule stated in this section and is, therefore, displaced by the provisions of this section.
Venaglia v. Kropinak
, 1998-NMCA-043, 125 N.M. 25, 956 P.2d 824.
Right of recourse.
— Under Subsection (b), an accommodation party has a right of recourse against an accommodated promisor who has been discharged even if that right is of little or no economic value; it is therefore no defense, in an action by the promisee against the accommodation party, for the accommodation party to claim that it has no right of recourse against the accommodated promisor because the promisor has no assets.
Venaglia v. Kropinak
, 1998-NMCA-043, 125 N.M. 25, 956 P.2d 824.
Material modification of the obligation.
— A material modification of a promissor's obligations, which will discharge an accommodation party under Subsection (d), must relate to the set of duties of the promissor under the note and not to circumstances outside the note, such as a settlement between the promisor and promisee which increases the accommodation party's risk of loss.
Venaglia v. Kropinak
, 1998-NMCA-043, 125 N.M. 25, 956 P.2d 824.