The Conditions of "Unconditional" Guarantees

In an example of how fairness and seeing the whole "story"--not just the current state of the law--can win the day, the Seventh Circuit Court of Appeals recently decided AAR Aircraft & Engine Group, Inc. v. Edwards, 272 F.3d 468 (7th Cir. 2001). In AAR, the Seventh Circuit, predicting Illinois law, decided that a guarantor of a secured debt may not waive the right to a commercially reasonable disposition of collateral upon the debtor's default. Any "absolute, unconditional" guaranty of payment that could be interpreted as a waiver of commercial reasonableness is unenforceable.

The dispute involved AAR's installment sale of an aircraft engine for $1,325,000. Edwards signed a personal guaranty which provided that "the undersigned hereby absolutely and unconditionally guarantees full and prompt payment when due"; "[t]his is an absolute, unconditional, and continuing guaranty of payment..."; and that "[c]reditor shall not be required first to resort for payment of the indebtedness to Debtor or first to enforce, realize upon or exhaust any collateral security for indebtedness, before enforcing this guaranty."

When Kiwi missed a payment, AAR accelerated the debt and sued Edwards for the over $1 million remaining on the contract. AAR then sold the engine for $250,000 at an auction in which AAR was the sole bidder. After the sale, AAR sought a judgment against Edwards for the entire amount remaining on the contract less the $250,000.

Edwards contended that the engine had been sold in a commercially unreasonable manner (aircraft engines in good condition are not typically sold by auction) and that its actual value was about $1 million. The (Illinois version of) Uniform Commercial Code section 9-504(3) provided that a disposition of collateral must be commercially reasonable. AAR argued that the unconditional guaranty waived any requirement of commercial reasonableness.

The district court entered judgment in AAR's favor for the entire amount sought. Thus, AAR had a judgment for $1 million reduced by the $250,000 it paid to itself and the engine worth another $1 million. Edwards sought appellate review but faced an uphill battle. Although the Illinois Supreme Court had never decided the issue, there was case law contrary to Edwards' position, particularly from the Northern District of Illinois. On appeal, the Seventh Circuit, applying Illinois law, reversed. It held that the requirement of a commercially reasonable sale of collateral could not be waived-even in a so-called "unconditional" guaranty.

The Seventh Circuit was persuaded by Edwards' arguments that the Illinois Appellate Court and district court cases relied upon by AAR had not accurately predicted how the Illinois Supreme Court would rule on this issue. The Seventh Circuit surveyed case law throughout the country and carefully examined the pertinent U.C.C. sections. Importantly, it also understood the "story" that Edwards had told. The court held that its decision prevented unjust enrichment to a creditor who had no incentive to act in a commercially reasonable way. It also avoided the "absurd result" of a huge windfall to the creditor.

Alyssa Campbell is a Partner with Williams Montgomery & John Ltd. and supervises the Appellate Practice Section. Her practice concentrates on civil appeals and insurance litigation. She wrote the briefs and delivered the oral argument to the Seventh Circuit Court of Appeals on behalf of the successful appellant/guarantor in the AAR case. Website: http://www.willmont.com

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