Declaratory Judgment Is Necessary Where Guaranty Does Not Address Certain Uses of Proceeds from a Foreclosure Sale.

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In most commercial lending transactions, it is a common practice for lenders to secure the loan with a mortgage on the business property, which would permit the lender to foreclose on the mortgage securing the property if the borrower were to default on the. For closely held businesses, many lenders also require the business owners to secure the loan with a personal guaranty. A guaranty is an agreement made by a third party to secure the debt of a borrower to a lender in the event that the borrower defaults on the loan.

In a recent decision from the Massachusetts Appeals Court, Phoenix REO, LLC v. Patel, the owner of a New Hampshire hotel, Nayan C. Patel, executed a construction loan agreement on the hotel's behalf for $5.9 million dollars. Patel secured this loan with a mortgage on the hotel and also executed a personal guaranty. Two years later, Patel executed a second loan, and secured it with a second mortgage on the hotel but never personally guaranteed the second loan. Patel eventually defaulted on the first loan, and Phoenix REO, LLC--the holder of both loans--brought an action against Patel to enforce the guaranty on the first loan. REO sought to apply the proceeds from the foreclosure sale to the second loan before satisfying the debt under the first loan. Patel counterclaimed that REO needed a declaratory judgment regarding the parties' rights under the guaranty before REO could use the foreclosure proceeds in that way.

The trial court granted summary judgment in favor of REO; however, the Appeals Court disagreed. The Court noted that while the guaranty granted the lender wide authority to use funds from a foreclosure sale to satisfy the first loan, it was silent as to whether the lender could use the proceeds to satisfy any other loans before the first loan. The judgment regarding the declaratory relief was vacated and remanded for further proceedings.

For more information about Fitch Law Partners LLP's banking law practice, please visit our banking law page.

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