Insights

Most commercial lending ventures involve multiple borrowers, which generally include the principal business entity, as well as individual guarantors. Many commercial credit accounts are likewise established using multiple guarantors beyond the business entity to secure personal commitments and assets in the event of default. It is an essential business practice for any creditor to obtain commitments from multiple parties, whether they be financial institutions, large corporations, small-businesses or otherwise. Multiple personal guaranties on commercial accounts are just one of the ways to secure these commitments, and as long as they meet statutory requirements, are generally enforceable in every jurisdiction.  Kentucky is no exception. When a creditor obtains multiple commitments from several parties on a commercial account by way of a valid personal guaranty or similar instrument, they should feel secure about their ability to use the same to impose liability in any subsequent collection proceeding. However, Kentucky’s KRS §412.110 can be an impediment to those efforts and creditors must be aware of its consequences and proceed cautiously when presented with a challenge under the law.

KRS §412.110 has its roots in Kentucky going back as far as the late nineteenth century.  At that time, it was codified under Chapter 104, Sec. 11 of the Kentucky General Statutes and provided that persons jointly liable could require a creditor to sue or execute on a judgment against other co-obligors.   The law essentially reads the same then as it does now and states, “A surety, co-obligor, or cocontractor, or one (1) of several defendants to a judgment may, by notice in writing served in person within the state on the creditor or plaintiff, or, if the plaintiff is a nonresident or absent from the place of his residence for the period of thirty (30) days consecutively, upon his agent or his attorney, require him to sue or issue execution.” Deconstructed, this sentence essentially breaks down into two situations: those involving pre-judgment co-obligors and those involving multiple judgment-debtors. In pre-judgment situations, a guarantor, obligor or the like may demand the creditor sue his co-obligors on the instrument prior to taking action against him. In post-judgment scenarios, a judgment-debtor can request that execution be issued against any of the other judgment-debtors in the case before execution may issue to him.  

To make this request upon a creditor, the guarantor must provide proper notice, sufficiency of which will be discussed below. Assuming proper notice is provided to the creditor or upon its attorney or agent, the creditor is required to take certain affirmative steps. In a pre-judgment scenario, the creditor must in good faith “prosecute the suit with reasonable diligence” against any co-obligor, surety, co-contractor, or guarantor. If the request is made by a judgment-debtor, the plaintiff-creditor must “within ten (10) days after judgment, sue out execution and in good faith prosecute the collection.”

In either situation, if the creditor fails to take such steps to prosecute the claim or execute on the judgment, “the cosurety, co-obligor, co-contractor, or defendant shall be discharged from all liability, except for his proper share according to the then existing condition of the several obligors, contractors, or defendants.” What is the practical implication to the creditor? If a creditor fails to heed a notice sent under this statute, essential terms of a loan agreement, guaranty or other similar instrument could be effectively nullified. While the statute does not discharge liability completely, it certainly extinguishes any joint and several liability that may have existed under the terms of the instrument, which is a key tool for any creditor’s collection efforts against multiple liable parties. Further, it allows for subjective review of what a guarantor’s “fair share” may be and leaves that determination up to a court who could potentially find that the “fair share” is minimal depending on the evidence presented.

While this statute provides debtors with an extraordinary resource to use against enforcement or collection efforts, the good news is that there are limitations on its use and effectiveness. First, there are several key requirements for the notice to be sufficient as a matter of law.   If the notice sent by the debtor is improper, then the requirements of KRS §412.110 do not apply. For example, the notice must be in writing and tendered after the maturity of the note or obligation. Moreover, the written notice must be clear and unambiguous. The burden lies squarely upon the requesting obligor to demonstrate service of the notice upon the creditor, its agent or attorney. Furthermore, the notice must be served upon the creditor before any suit or execution has been made upon the principal obligor. This latter limitation makes sense when considering that the scope and purpose of the statute is to allow relief only if the creditor fails to prosecute the suit and/or enforce the judgment upon proper notice. Thus, ostensibly that purpose is only frustrated where a single party is the lone target of the creditor’s enforcement, and not where the creditor is taking diligent steps to enforce the obligation as to all parties, especially the principal obligor.

Second, under certain circumstances a debtor can waive his rights under KRS §412.110. Waiver is a creditor’s best defense to a co-debtor’s efforts under this statute. The waiver is almost always found in the note or instrument executed at the time the obligation was undertaken. The language of the waiver must be specific, and cannot be general or too expansive. However, where the language of the waiver is unambiguous it will be construed against the obligor. In the early twentieth century, the Court of Appeals gave direction on what language would be sufficiently narrow and specific for an enforceable waiver. In Owensboro Savings Bank & Trust Co.’s Receiver v. Haynes, the Court of Appeals, then the highest court in the Commonwealth, held that an obligor waived his rights under KRS §412.110 when he executed a note that stated he agreed to waive things such as presentment, notice of non-payment, notice of protest, and diligence in bringing the suit. The court held that this language was unambiguous, and concluded that “where a party has contracted away all right to demand diligence in bringing suit, he cannot afterwards give notice under the statue and insist on that diligence which he has expressly waived.”

Today, most of this waiver language is commonly incorporated into lending instruments so much so that it is now considered boilerplate.  Many debtors, or even creditors for that matter, do not recognize the significance of such provisions.   Nonetheless, the case law establishes that these terms, no matter how standard and customary they have become, effectively render KRS §412.110 moot.   Yet, what if the note or similar instrument does not have such language? For example, a services contract between two building contractors, an open account agreement between two businesses, or a simple note between two enterprising businesses or individuals may not include such boilerplate language. Thus, knowing the terms of the agreement for which liability is based upon and ensuring that waiver language is used in those initial documents is vital for any creditor seeking to defend against the provisions of KRS §412.110.

This analysis underscores the necessity of any creditor and its counsel to be mindful of the implications of KRS §412.110. To be clear, this process does not begin at the lawsuit stage, the execution stage, or even at default. Rather, it should begin at the very early stages of negotiation and should be at the forefront of the drafting process to ensure that applicable waiver provisions are included in all lending and account initiating documents. In the event a waiver is not included, the creditor must be on the lookout for any attempt by a debtor to use KRS §412.110 to his or her advantage. Keen awareness of this law by a creditor and its counsel is essential to safeguarding and optimizing collection efforts against multiple parties.

Sources:

1. KRS § 371.06
   
2. Stevens v. Chorn. 8 Ky. Op. 679 (1876);
   
3. Hibler v. Shipp, 78 Ky. 64 (1879).
   
4. Benge's Adm'r v. Garrison, 198 Ky. 447, 248 S.W. 1050 (Ky. 1923);
   
5. Baker v. Whittaker, 177 Ky. 197, 197 S.W. 644 (Ky. 1917);
   
6. Goodloe v. Anderson, 275 Ky. 460, 121 S.W.2d 958 (Ky. 1938) holding that a surety’s oral demand to sue a co-obligor was not proper notice under the statute.
   
7. Benge's Adm'r v. Eversole, supra, citing 32 Cyc (Cyclopedia of Law and Procedure) 104, “Notice must be clear and explicit, and not ambiguous; and the burden is on the surety to show its nature and terms…The notice must amount to a command; it is not sufficient to express a hope, a wish, or a desire; nor will it be a sufficient compliance for the surety to give a hint; to make a request; to urge; to suggest; to advise; or to state that the surety refuses to remain liable, or that he will not pay except under compulsion. The notice must be in effect a demand to sue, and be more than instructions to dun the principal.”
   
8. National Surety Co. v. Arterburn, 110 Ky. 832, 62 S.W. 862, 863 (Ky. 1901).
   
9. Coombs v. Beneficial Finance Company, 549 S.W.2d 327 (Ky. 1977) wherein the court held that a waiver stating “any and all exemptions permitted by law to be waived” was too broad and general to be enforceable.
   
10. Owensboro Savings Bank & Trust Co.’s Receiver v. Haynes ,143 Ky. 534, 136 S.W. 1004 (Ky. 1911)