Guarantor Partners v. Huff

• Decision Date: 22 January 1992
• Parties: 18 UCC Rep.Serv.2d 798 GUARANTOR PARTNERS, a Tennessee general partnership, Plaintiff/Appellee, v. Billy C. HUFF, Defendant/Appellant.
• Court: Tennessee Court of Appeals

Page 73

830 S.W.2d 73

18 UCC Rep.Serv.2d 798

GUARANTOR PARTNERS, a Tennessee general partnership, Plaintiff/Appellee, v. Billy C. HUFF, Defendant/Appellant.

Court of Appeals of Tennessee,

Middle Section, at Nashville.

Jan. 22, 1992.

Permission to Appeal Denied by

Supreme Court May 4, 1992.

E. Clifton Knowles, Bennett L. Ross, Bass, Berry & Sims, Nashville, for plaintiff/appellee.

Gary D. Copas, Lebanon, for defendant/appellant.

OPINION

KOCH, Judge.

This appeal involves a limited partner's continuing guaranty of a partnership debt. The limited partner declined to honor his guaranty when the partnership defaulted on the note, and the remaining guarantors formed a new partnership, acquired the note and the guaranties from the lender, and then filed suit against the limited partner in the Chancery Court for Davidson County. After the new partnership moved for summary judgment, the limited partner sought to amend his answer and to file a third-party complaint based on fraudulent inducement. The trial court granted the summary judgment and denied the motion to amend. The limited partner has appealed. We have determined that the guaranty is not a negotiable instrument and, therefore, that the new partnership is not entitled to a judgment as a matter of law. Accordingly, we vacate the summary judgment and remand the case for further proceedings.

I.

In August, 1985, Billy C. Huff's accountant, Gale M. Wilson, suggested that he needed a tax shelter. Mr. Wilson also recommended a limited partnership named Willow Creek Group, Ltd. ("Willow Creek"). Willow Creek had been formed by Jere M. Ervin and two partnerships controlled by Mr. Wilson for the purpose of acquiring and operating a 132-unit apartment complex in Little Rock, Arkansas.

On Mr. Wilson's recommendation, Mr. Huff became a limited partner in Willow Creek in November, 1985. Mr. Ervin, the Antioch Investment Company and the Dempsey-Wilson Group ¹ were the general partners, and the other limited partners included Melinda O. Bass, Thomas D. Ferrell, and Michael W. Skelton.

Willow Creek purchased the apartment complex for $3,600,000, financing the sale with a $2,700,000 mortgage and a $887,617 promissory note. On November 21, 1985, Willow Creek borrowed $1,050,000 from Security Federal Savings and Loan Association ("Security Federal"). The note was without recourse against the maker, Willow Creek; therefore, Security Federal demanded and received continuing guaranties from Messrs. Ervin and Wilson, the four limited partners including Mr. Huff, and three other individuals.

Mr. Huff executed his guaranty agreement before the execution of the Willow Creek note. The guaranty was on a form separate from the note. It referred to the note but was not physically attached or incorporated into the note. While the guaranty limited Mr. Huff's exposure to $262,500, it was not restricted to the $1,050,000 note. By its own terms, it applied to all of Willow Creek's "existing and future obligations" to Security Federal. It also provided that Mr. Huff's guaranty was an "independent obligation" and that it should not be construed "as making [Mr. Huff] a 'party' to notes or evidences of indebtedness not in fact signed by [him]."

Willow Creek defaulted on the note when it matured in November, 1988. Security Federal called upon the various guarantors, including Mr. Huff, to honor their guaranties, but Mr. Huff refused to pay, claiming that he had been fraudulently induced to sign the guaranty.

Faced with Mr. Huff's refusal to honor his guaranty, the remaining general and limited Willow Creek partners formed a new partnership named Guarantor Partners. In May, 1989, Guarantor Partners purchased the promissory note and the related guaranties from Security Federal for $923,014. Security Federal actually endorsed the note and delivered it, along with the guaranties, to Guarantor Partners.

Guarantor Partners then demanded that Mr. Huff honor his guaranty and, when he refused, filed suit against him in the Chancery Court for Davidson County in July, 1989. Later, in October, 1989, Security Federal executed an assignment of all its rights under the continuing guaranties to Guarantor Partners.

Mr. Huff's initial defense was that Willow Creek was not a properly formed limited partnership. After Guarantor Partners moved for a summary judgment, Mr. Huff attempted to amend his answer and to file a third-party complaint based on fraudulent inducement. The trial court found that the fraudulent inducement defense could not be asserted against Guarantor Partners, reasoning that Mr. Huff's guaranty was a negotiable instrument and that Security Federal was a holder in due course under Tenn.Code Ann. § 47-3-302 (1979). Accordingly, the trial court denied Mr. Huff's motion to amend his complaint and granted a summary judgment on the guaranty to Guarantor Partners.

II.

The outcome of this appeal hinges on which body of law defines the parties' rights and obligations. The trial court, finding Mr. Huff's guaranty agreement to be a negotiable instrument, determined that Article 3 of the Uniform Commercial Code, Tenn.Code Ann. § 47-3-101, et seq., was controlling. We have determined that the trial court erred as a matter of law and, therefore, that Guarantor Partners was not entitled to a summary judgment.

The courts of this state have never directly addressed the question of whether a separate continuing guaranty is a negotiable instrument. ² However, of the courts that have addressed the question, a vast majority have held that a separate continuing guaranty is not a negotiable instrument for the purposes of the U.C.C. ³ FDIC v. Nobles, 901 F.2d 477, 480 (5th Cir.1990); First City Bank v. Air Capitol Aircraft Sales, Inc., 820 F.2d 1127, 1134 (10th Cir.1987); Ishak v. Elgin Nat'l Bank, 48 Ill.App.3d 614, 6 Ill.Dec. 630, 632, 363 N.E.2d 159, 161 (1977); Gregoire v. Lowndes Bank, 176 W.Va. 296, 342 S.E.2d 264, 266-67 (1986); Crown Life Ins. Co. v. LaBonte, 111 Wis.2d 26, 330 N.W.2d 201, 208 (1983).

The theoretical basis for the majority rule is that a separate continuing guaranty is not an "instrument" as the U.C.C. defines the term. As with other states, Tenn.Code Ann. § 47-3-102(1)(e) provides that the term "means a negotiable instrument." Many types of documents calling for the payment of money are "negotiable." However, they are not "negotiable instruments" subject to the rules in Article 3 unless they contain all the elements required by Tenn.Code Ann. § 47-3-104(1). ⁴

In order to be a negotiable instrument, Tenn.Code Ann. § 47-3-104(1) requires that an instrument

(a) be signed by the maker or drawer, and

(b) contain an unconditional promise or order to pay a sum certain in money and no other promise, order, obligation or power given by the maker or drawer except as authorized by this chapter; and

(c) be payable on demand or at a definite time; and

(d) be payable to order or to bearer.

Guaranties, by their very nature, are conditional promises to pay because guarantors promise to pay only on the condition that the principal debtor fails to pay. FDIC v. Percival, 752 F.Supp. 313, 324 (D.Neb.1990); FDIC v. Galloway, 613 F.Supp. 1392, 1400-01 (D.Kan.1985), rev'd on other grounds, 856 F.2d 112 (10th Cir.1988); Gregoire v. Lowndes Bank, 342 S.E.2d at 267. Likewise, guaranties, even ones containing a limitation on the guarantor's liability, do not involve a sum certain because the amount of the guarantor's liability cannot be determined solely from the instrument itself without reference to an outside source. Branch Banking & Trust Co. v. Creasy, 301 N.C. 44, 269 S.E.2d 117, 122 (1980); Goss v. Trinity Savs. & Loan Ass'n, 813 P.2d 492, 497 (Okla.1991); Dann v. Team Bank, 788 S.W.2d 182, 186 (Tex.Ct.App.1990); Gregoire v. Lowndes Bank, 342 S.E.2d at 267. Finally, a guaranty is not payable at a definite time or on demand since it is payable only when the principal debtor defaults. Continuing guaranties may be payable on numerous occasions. Brooks v. United Kentucky Bank, 659 S.W.2d 213, 215 (Ky.Ct.App.1983); Dann v. Team Bank, 788 S.W.2d at 186; Gregoire v. Lowndes Bank, 342 S.E.2d at 267.

There is one exception to the general rule that a separate continuing guaranty is not a negotiable instrument. This is when the guaranty, although on a separate form, is so firmly affixed to a negotiable instrument that it becomes part of the instrument itself. Shepherd Mall State Bank v. Johnson, 603 P.2d 1115, 1118 (Okla.1979); see also Tenn.Code Ann. § 47-3-202(2). Mere descriptive references in a note to a separate guaranty do not have the same effect. Uniwest Mortgage Co. v. Dadecor Condominiums, Inc., 877 F.2d 431, 434 (5th Cir.1989). However, under this exception, the guaranty itself is not a separate negotiable instrument. It becomes an undistinguishable part of the negotiable instrument to which it is attached. This exception does not apply to this case. Mr. Huff's guaranty was on a separate form and was not affixed or incorporated into Willow Creek's note.

We have found no cases considering whether a continuing guaranty is an "instrument" for the purposes of the shelter rule in Tenn.Code Ann. § 47-3-201(1). ⁵ However, since the shelter rule can only apply to transferees of "instruments"--that is "negotiable instruments"--the majority rule is equally applicable. Thus, we hold that a separate guaranty such as the one Mr. Huff signed is not a negotiable instrument but rather a separate...