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Release of Guarantors Under the UCC

February 01, 1996-

A recent decision of the Michigan Court of Appeals in Shurlow v Bonthuis (218 Mich App 142, 1996 WL 446366 Aug 1996) presents a troubling application of Uniform Commercial Code principles to release guarantors when a secured creditor has not properly perfected its security interest in collateral.

In the case, the guarantor of a lessee's obligations under a lease claimed that the landlord's failure to perfect a security interest in the lessee's goods contracted for in the lease impaired the collateral securing performance by the lessee under the lease, and thus released the guarantor. The Court of Appeals affirms grant of summary judgment by the trial court in favor of the guarantor.

As a matter of first impression, the court holds that the contractual "landlord's" lien is not excluded from application of the Uniform Commercial Code under MCL 440.9104(b). This conclusion is buttressed by decisions of other jurisdictions cited in the opinion, and the stated desire by the Court of Appeals to keep Michigan law uniform with other jurisdictions. In its reasoning, the court concluded that the security interest granted under the lease was not a "landlord's lien" as that term is used in MCL 440.9104(b). That term should be interpreted as referring only to liens created by statute rather than by contract.

The court observed that if a secured party fails to file a financing statement when required to perfect a lien, the security interest created will be subordinate to other security interests or types of creditors. After concluding that the landlord's lien in the tenant's personal property created under the lease was "chattel paper", the court applied MCL 440.9207(1) to impose a duty of reasonable care upon the secured party to preserve rights against others claiming priority. Under MCL 440.9207(3), the secured party failing to use such reasonable care is liable for any loss caused by that failure. Because the priority that would have been established by the filing of a financing statement was lost, the guarantor's rights of subrogation to the secured creditor were impaired, and the guarantor was thus discharged.

In its course, the opinion makes some breathtaking conclusions to hold that the contractual lien of a landlord is, in effect, chattel paper (opinion footnote 4, based on MCL 440.9105 comment 4) and that MCL 440.9207, dealing with collateral in possession of a secured party, applies to a security interest given to the secured party in non-possessory collateral.

The latter point is founded on the decision of the Michigan Court of Appeals in National Bank of Detroit v Alford 65 Mich App 634 (1975) which applied MCL 440.9207(1) to create an affirmative duty upon a creditor to preserve the security interest granted or risk discharge of a guarantor or other loss caused by the failure to perfect.

While the cases may be off target in law application, the point is that contractual liens must be perfected by the filing of a financing statement or the creditor risks discharging a guarantor. (Where revised UCC º3-605 is in effect, this discharge will result to the extent of impairment of the value of the collateral the accommodation party would have had recourse to in subrogation.) In addition, the form of guaranty of a lease should not be regarded casually, and all provisions pertaining to waiver of subrogation as well as rights to realize upon security or not at the option of the secured party should be fully and clearly spelled out.

William B. Dunn
(313) 965-8511
email: wdunn@clarkhill.com