Opinion ID: 1250561
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Heading: whether owners are principals or sureties.

Text: South Dakota statutes dealing with suretyship include SDCL 56-2-1 which defines suretyship as a contract by which one who at the request of another and for the purpose of securing to him a benefit becomes responsible for the performance by the latter of some act in favor of a third person or hypothecates property as security therefor. SDCL 56-2-7 states: Whenever property of a surety is hypothecated with the property of the principal, the surety is entitled to have the property of the principal first applied to the discharge of the obligation. SDCL 56-2-2 provides that: One who appears to be a principal whether by terms of a written agreement or otherwise may show that he is in fact a surety except as against persons who have acted on the faith of his apparent character of principal. On its face, Owners argue, and it would seemingly appear, that the mortgage of their reversionary interest in the real estate fits within the definition, rights and liabilities of suretyship as set forth in SDCL ch. 56-2. However, we must look to case authority for an interpretation of the statutory language. Suretyship is a contractual relationship, which results from two persons becoming obligated to the same creditor with one of them bearing the ultimate liability. In other words, if the debt is enforced against the surety, he then is entitled to be indemnified by the one who should have paid the debt before the surety was compelled to do so. However, one who receives and retains the consideration or benefit of a contract cannot occupy the position of surety. 74 Am.Jur.2d Suretyship § 3 (1974). Hence, a person who makes a contract for the purpose of securing to himself a benefit rather than for securing to another a benefit, may be classified as a principal. Heinrich v. Magee, 52 S.D. 371, 217 N.W. 631 (1928). It is immaterial in what form the relation of principal and surety is established, or whether the creditor was or was not contracted with in that relation. The relation is vested by the arrangement and equities between the debtors, and may or may not be known to the creditor.... .... `[Suretyship] is determined by inquiring who received the consideration of the contract, or who, according to the arrangements between the parties, ought to pay the debt.' Heinrich, 52 S.D. at 378, 217 N.W. at 634 (citations omitted); 72 C.J.S. Principal & Surety, §§ 4, 9 (1987). A California court in Matthews v. Hinton, 234 Cal.App.2d 736, 44 Cal.Rptr. 692 (1965), decided a suretyship/principal issue similar to the one currently before us. The Matthews owned an unimproved tract of land which they leased for sixty-five years to a developer. Matthews gave the developers the power to sublet and assign. The agreement also provided that the Matthews would subordinate their title and join in any deed of trust given to secure construction loans for improving the property. The developers' sublessees borrowed $100,000 from a finance corporation and secured the loan with a deed of trust executed by both the Matthews and the sublessees. As in this case, the owner/mortgagors did not sign the promissory note evidencing the debt. The sublessees defaulted on the note and the finance corporation foreclosed. Matthews sued the corporation, alleging that they wrongfully sold the property at a trustee sale. Matthews argued that since they were sureties only, the finance corporation was required to resort to the assets of the principal debtors prior to executing on the owners. In holding the Matthews to be principals, the California court stated: The role in which appellants contracted is depicted on the face of the papers. Appellants were the owners of unimproved land. They leased it to a developer for sixty-five years for ground rentals aggregating $309,000. As lessors they had a direct financial interest in the construction of improvements which would produce income and ground rent.... For the promotion of their personal financial interests appellants agreed with their tenants to subordinate their reversionary estate to any future trust deed securing a construction loan. They fulfilled that agreement by means of a trust deed in which they joined with their tenants as `trustor.' In so doing, they contracted directly with the lender, exposing their reversionary interest to direct liability independently of auxiliary collection attempts against the borrowers.... Having signed the trust deed as principals, they subjected their reversionary interest to primary liability. (Emphasis supplied.) 234 Cal.App.2d at 741, 44 Cal.Rptr. at 696. In this case, the trial court appropriately found that Owners anticipated gaining personal economic benefit from development of the shopping mall upon their property. Owners held an unimproved section of bare land which they leased for ninety-nine years at an annual rental of six percent of all rentals collected by the lessee from tenants' sublessees, but in no event less than $15,000. Eventually, the improvement would have been turned over to Owners or their heirs cost free. Owners were aware of the fact that the lease contained a requirement that they might be required to pledge their fee interest in the property if lessees chose to finance the improvements upon the property and the lender required that Owners join in such mortgage. A fee simple estate would be much more attractive security to a lender. For the improvement of their personal financial situation, Owners agreed with their tenant to subordinate their reversionary estate to any future mortgage in order to secure a construction loan. Matthews is on point and we adopt its reasoning. See also Guaranty Mtg. Co. of Nashville v. Ryan Supply, 363 So.2d 739 (Miss.1978), which followed Matthews. Owners argue that holding them to be principals would render that portion of SDCL 56-2-1, which provides that a suretyship arises when one hypothecates property to secure the debt of another, a nullity. To the contrary, we are not holding that when one hypothecates property to secure the debt of another that he is automatically a principal. We merely hold such a relationship arose under the facts of this case. Under SDCL 56-2-2 Owners could attempt to establish that they were in fact sureties, even though the mortgage was arguably signed as principals. Where the relationship is not apparent on the face of the instrument, the burden is on a person claiming to contract as surety to prove the fact of suretyship. 72 C.J.S. Principal & Surety § 11(b) (1987). Owners did not meet their burden of proof. As the original lease and subsequent agreements of the parties indicate, Owners seemingly signed the mortgage in the capacity of principal, as they had great personal financial benefits to gain in doing so.