In California, the Code of Civil Procedure sections 580a, 580e, and 726 are anti-deficiency laws that forbid a lender from getting a deficiency judgment from a defaulter after there might have been a nonjudicial real property foreclosure. These statutes do not apply to guarantors. However, before a Sham Guaranty Defense can be applied, it requires proof that the guarantor is the principal obligor. Usually, the principal obligor is entitled to the same non-waivable protection of the anti-deficiency statutes. Thus, a court’s main focus is to study the guarantee’s legitimacy, i.e., to decide if they are shams.

Regarding the above topic, the most frequently cited case is the Torrey Pines Bank v. Hoffman (1991) 231 Cal.App.3d 308 (Hoffman). In the Hoffman case, a husband and wife were the trustors, trustees, and the primary beneficiaries of their revocable living trust. In a bid to get a construction loan, they acted signatory to their revocable trust. The court applied the “instrumentality” test to test whether the trust was “anything other than an instrumentality used by the individuals who guaranteed the debtor’s obligation and whether such instrumentality removed the individuals from their status and obligations as debtors.” (Id. at p. 320.)

In the Hoffman case, the court recognized that the greater the degree of separation between trustors, trustees, and beneficiaries, the more difficult it will be to establish the Sham Guaranty defense. After reviewing the case in Hustwit, the court approved the husband and wife as true guarantors. The trust arrangement exempts them from their status and obligations as debtors. Whereas, in Riddle v. Lushing (1962) 203 Cal.App.2d 831, the partners’ role as debtors in their company is not separated. Hence, the court invoked the protections of anti-deficiency.

You will see from the above point that Sham Guaranty’s defense varies and depends on the court’s decision. To be on the safer side, check in here to find out more.

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