Indiana Court Sides with Lender in Dispute with Surety
A recent Indiana Court of Appeals case gave a win to the lender after challenges by a surety who granted additional collateral. The facts in Devlin v. Horizon Bank, 235 N.E.3d 850 (Ind. Ct. App. 2024) seem to reflect a fairly common set of circumstances. Son took out an $800,000 farm operations line of credit loan with Bank, secured by crops. As additional credit support, Dad provided a third-party mortgage on a piece of real estate. Over the term of the loan, Son and Bank agreed to several modifications to the loan including a change in the payment schedule, extension of the maturity date and a conversion to a term note of approximately $200,000 in loan proceeds that had been misused by Son for real estate and equipment purchases. Dad was not informed about any of this. Also, over the course of the loan, Son did not require purchasers of crops to make payment jointly to Son and Bank, contrary to the terms of the loan, and Son did not use these proceeds to pay down the loan.
When the loan went into default, Bank insisted that Son provide a list of the intended purchasers of the crops that served as collateral, and Bank notified these purchasers that funds needed to be made jointly payable to Son and Bank. When the proceeds of the crop sale did not pay off the remaining loan balance, Bank filed suit against Son for the remaining balance due and against Dad for foreclosure of the real estate that served as additional collateral. The trial court entered judgment in favor of the lender and Dad appealed.
Dad raised several arguments in an effort to reverse the foreclosure of his real estate for his son’s debt. First, he claimed that Bank should have notified him or obtained his consent for the various modifications to the loan and should have informed him about the misuse of loan proceeds. He argued that he should not have been held responsible for the debt once it was modified without his consent. Under Indiana law, a surety is only held responsible for the debts that they agreed to guarantee under the written agreement. Dad also pointed to Indiana case law that supported his position that a lender’s failure to disclose borrower misconduct to a guarantor discharged the guarantor from liability.
In making its ruling, the Indiana Court of Appeals found that language in the mortgage that indicated that the real estate served as collateral for the loan and all modifications, extensions and renewals was sufficient for the mortgage to continue to secure the loan through its various changes over the years. The Indiana Court of Appeals further found that a discharge of a surety’s obligations when a lender fails to disclose debtor misconduct is not automatic. The Court found sufficient justification in this case for the lower court’s ruling against Dad.
Second, Dad claimed that the Bank had impaired the value of its collateral by failing to strictly enforce the provisions of the loan terms regarding the sale of crops. Dad argued that, by repeatedly failing to get jointly payable checks and make certain that funds were being applied to the loan, Bank had harmed its own recovery and Dad should not be held responsible for the short fall.
Under Indiana law, if a lender did impair the value of its collateral, then a surety, such as Dad, could point to such actions by a lender as a defense when the lender attempted to collect against the surety. In order to prevail, Dad had to show that Bank acted unreasonably or that Bank’s actions were unjustified. Bank provided evidence to the trial court, including expert testimony, to show that it acted reasonably. In upholding the lower court’s decision, the Indiana Court of Appeals concluded that, even though the loan documents stated that Son was required to provide a list of potential purchasers every year and those purchasers would be required to issue payment jointly to Bank and Son, the fact that Bank failed to strictly enforce those provisions until default, was not unreasonable.
Even though the Bank ended up winning this case, both at the trial court and at the Indiana Court of Appeals, the facts illustrate a prime example of why it is important for a Bank to either enforce its loan covenants, or make a conscious, thought-out decision if it decides not to. The case also reinforces why good communication with all loan parties during the life of a loan can go a long way to cutting off potential defenses of a guarantor or grantor of collateral. Finally, this case once again shows why the language in the loan documents matter. Including language indicating a collateral document secures not just the original debt, but all modifications, extensions and renewals is important when a lender later seeks to enforce a third party security document against a grantor who may not have signed off on every loan modification or extension.