Opinion ID: 1539669
Heading Depth: 1
Heading Rank: 4

Heading: Effect of the Settlement Agreement on Cheah's Liability as a Guarantor

Text: Cheah argues that the settlement agreement between Green Leaves and 617 H Street Associates materially altered the lease without his consent, thereby discharging him from liability on his guaranty of the lease as a matter of law. We disagree. [I]t is well settled that a material or substantial alteration of a guaranteed contract without the guarantor's consent serves to discharge him from liability on his guaranty. [16] As Cheah concedes, courts generally hold that an alteration in the obligation or duty guaranteed will release the guarantor only if it is material and substantial and prejudicial to his or her rights. [17] There was no such alteration here. When Yu executed the settlement agreement in April 2003, Green Leaves was in default on its payment obligations under the lease, having failed to pay some $152,000 in rent (not to mention the unpaid business taxes and repair costs). The default provision in the lease gave the landlord the unconditional right to terminate the lease and the tenant's possession of the premises, and thereafter to sue the tenant for damages caused by its breach. [18] The lease further provided that any efforts by the landlord to mitigate its damages, such as re-letting the premises, would not constitute a waiver of the landlord's right to recover damages from the tenant. [19] Thus, to the extent the settlement agreement merely allowed 617 H Street Associates to terminate the lease and take possession of the premises, it did not alter the terms of the lease; it implemented them. The surrender of possession and termination of the lease pursuant to the settlement agreement therefore did not operate to discharge Cheah from his liability as a guarantor of the tenant's lease obligations. [20] It likewise did not prejudice Cheah or deprive him of any rights; given his failure to take responsibility for the rent arrearage and the repair of the property, Cheah cannot claim that the settlement deprived him of the benefits of his investment. If anything, the settlement eliminated Cheah's open-ended exposure to much greater liability as a guarantor of Green Leaves's on-going obligation to pay rent and future business taxes under a lease that still had years to run. [21] Cheah contends, however, that the settlement extinguished his liability as a guarantor because, in addition to allowing the landlord to terminate the lease and re-take possession upon Green Leaves's failure to cure its default, the agreement released Green Leaves from any residual liability to 617 H Street Associates for back rent and other monetary damages following its recovery of the premises. While the agreement does not release Green Leaves explicitly, it can be so construed. Cheah invokes the general rule that, to avoid unfairness to the principal obligor and its guarantors, where the creditor releases a principal, thereby discharging the principal debt, the guarantor is likewise relieved of liability. [22] However, there is (as, practically speaking, there must be) a way for a creditor to release the principal obligor without losing its right to proceed on its guarantees. Our court has followed the traditional common law rule that a creditor may preserve its rights against the guarantors by the simple expedient of reserving those rights expressly in its release of the principal debtor. [23] As explained in the American Law Institute's most recent Restatement of the law of suretyship and guaranty: Under this so-called reservation of rights doctrine, two consequences followed from the mere act of informing the principal obligor that the obligee was reserving rights against the secondary obligor in conjunction with conduct that would otherwise impair the secondary obligor's recourse. First, by reserving rights against the secondary obligor, the obligee preserved all rights of the secondary obligor as though the conduct had never occurred.... Second, by reserving rights against the secondary obligor, the obligee prevented discharge of the secondary obligor based on the conduct of the obligee because, according to the doctrine, the preservation of the secondary obligor's rights as though the conduct had not occurred resulted in that conduct causing the secondary obligor no harm.[ [24] ] The reservation of rights is deemed to put the principal obligor on notice that it will remain liable to indemnify its guarantors. In the present case, the obligee followed the traditional method of protecting its rights against the guarantors while releasing the principal debtor. In its settlement agreement with Green Leaves, 617 H Street Associates reserved its rights to seek judgement [ sic ] against any officer of Green Leaves Restaurant, Inc. pursuant to the lease agreement. Thus, if we adhere to the traditional rule, the settlement agreement did not extinguish Cheah's obligations as a guarantor. The traditional reservation of rights doctrine has been criticized, however, among other reasons, on the ground that an unsophisticated debtor would be unlikely to realize that a creditor's mere incantation of a `reservation of rights' in a release preserves the debtor's liability to its secondary obligors. [25] Responding to the criticisms, the RESTATEMENT (THIRD) OF SURETYSHIP & GUARANTY departs from the traditional rule and proposes stricter requirements for avoiding the discharge of secondary obligors in a release of the principal debtor. In pertinent part, Section 39 (Release of Underlying Obligation) of the Third Restatement provides as follows: To the extent that the obligee releases the principal obligor from its duties pursuant to the underlying obligation: (b) the secondary obligor is discharged from any unperformed duties pursuant to the secondary obligation unless: (i) the terms of the release effect a preservation of the secondary obligor's recourse (§ 38);[ [26] ] or (ii) the language or circumstances of the release otherwise show the obligee's intent to retain its claim against the secondary obligor; (c) if the secondary obligor is not discharged from its unperformed duties pursuant to the secondary obligation by operation of paragraph (b), the secondary obligor is discharged from those duties to the extent: (i) of the value of the consideration for the release; (ii) that the release of a duty to pay money pursuant to the underlying obligation would otherwise cause the secondary obligor a loss; and (iii) that the release discharges a duty of the principal obligor other than the payment of money;....[ [27] ] Application of these provisions of Section 39 would not result in Cheah's discharge. The settlement agreement between Green Leaves and 617 H Street did not expressly state that the guarantors would retain their rights of recourse against Green Leaves. Hence it did not satisfy the exception from discharge set forth in subparagraph (b)(i). [28] Nonetheless, by stating the landlord's intent to retain its claims against Cheah and the other guarantors, the agreement satisfied subparagraph (b)(ii). Cheah thus was not discharged by operation of paragraph (b). That leaves paragraph (c) to consider. Cheah has not argued that he meets the conditions for discharge set forth in paragraph (c), and we cannot conclude that he does. While subparagraph (c)(i) would credit Cheah with the value of any consideration paid by Green Leaves for the release, the only consideration Green Leaves paid was its surrender of the premises. That surrender, in conjunction with the landlord's consequent ability to re-let the property to another tenant, reduced the landlord's post-termination damages (e.g., loss of future rent for the remaining term of the lease); so far as appears from the record, however, it did not reduce the landlord's pre-termination damages (e.g., the unpaid back rent). [29] The surrender and re-letting therefore did not reduce the guarantors' liability for pre-termination damages. Subparagraph (c)(iii) is likewise inapplicable to the present facts: while Green Leaves presumably was released from both its monetary and non-monetary obligations, Cheah and the other guarantors were adjudged liable to 617 H Street Associates only for the monetary obligations (back rent, business taxes, and attorney's fees). Lastly, subparagraph (c)(ii) would discharge Cheah from liability only to the extent that the release of Green Leaves and the consequent extinguishment of Cheah's recourse against Green Leaves actually caused him a loss. That he has not shown, and it does not appear to be the case. So far as appears, Green Leaves was insolvent following the fire, and it permanently ceased doing business. Even if Green Leaves had not been released from its debt to the landlord, Cheah would have been unable to look to it for reimbursement. The release therefore cost him nothing. [30] (Furthermore, of course, the release of Green Leaves did not impair Cheah's rights of contribution against Yu and Lee.) Thus, whether we follow the traditional reservation of rights doctrine or the approach of the Third Restatement, we conclude that the release of Green Leaves did not discharge Cheah from his obligations as a guarantor of the lease.