Tag: case alert

Guarantors May Have a New Statute of Limitations Defense

In Monroe v. Arizona Acreage LLC, No. 1 CA-CV 18-0476, 2019 WL 2134794 (Ariz. Ct. App. May 16, 2019), the Arizona Court of Appeals implied that under certain circumstances a general continuing guaranty executed outside the state may be governed by a four year statute of limitations under A.R.S. § 12-544(3), even if the underlying obligation is subject to a six year statute of limitations under A.R.S. § 47-3118. In light of this opinion, counsel for guarantors should consider whether their client’s guaranty was (1) executed out of state, (2) a general, rather than a specific, guaranty and/or executed by a non-owner, and (3) whether more than four years has elapsed since its execution. If the answers to these questions are each “yes,” then Monroe suggests that you may have a meritorious statute of limitations defense. 

Presiding Judge Lawrence F. Winthrop delivered the opinion of the Court, in which Judge Maria Elena Cruz and Chief Judge Samuel A. Thumma joined. 

Background

Two different limited liability companies executed separate promissory notes in favor of multiple lenders in order to develop several acres of land in Mohave County. Both notes were secured by deeds of trust on the land, and personally guaranteed by the same developer. The notes, deeds of trust, and personal guaranties were all executed in Nevada. The borrowers stopped making payments on the notes in June 2008, and in June of 2014, the investors filed two class action lawsuits. The Court entered judgments against the borrowers and guarantor, which they appealed.

Analysis

Among other issues, on appeal the borrowers and guarantor argued that the promissory notes and guaranties were subject to a four year statute of limitations under A.R.S. § 12-544(3), and that therefore the investors’ actions—brought nearly six years after the default—were time-barred. A.R.S. § 12-544(3) states (with emphasis added):

There shall be commenced and prosecuted within four years after the cause of action accrues, and not afterward, the following actions:

3. Upon a judgment or decree of a court rendered without the state, or upon an instrument in writing executed without the state. This paragraph does not apply to a judgment for support, as defined in section 25-500, and to associated costs and attorney fees.

The investors countered that the notes and guaranties are actually governed by the UCC’s six year limitation for negotiable instruments, found in A.R.S. § 47-3118(A):

Except as provided in subsection E, an action to enforce the obligation of a party to pay a note payable at a definite time must be commenced within six years after the due date or dates stated in the note or, if a due date is accelerated, within six years after the accelerated due date.

Both parties agreed with the maxim that a specific statute of limitations shall prevail over a competing general statute, but disagreed as to which statute is specific and which is general. The Court ultimately sided with the investors, reasoning that A.R.S. § 47-3118(A) is the more recent statute (enacted almost 70 years after § 12-544), that its application to negotiable instruments is more specific than § 12-544’s application to instruments generally, and that this approach is more consistent with the policy purpose of the UCC to create uniformity in commercial transactions. Accordingly, the Court unambiguously held that A.R.S. § 47-3118(A) governs the notes and deeds of trusts, notwithstanding the fact that they were executed out of state.

Personal guaranties, however, are not negotiable instruments, and therefore required another layer of analysis. The Court first observed that, in Arizona, guaranty agreements are “contracts separate from their related instruments” and are generally not subject to the U.C.C. Monroe, 2019 WL 2134794 at 5. However, the Court went on to create an exception to this rule where the borrower is an entity owned by the guarantor and where the guaranty is a “specific” guaranty that obligates the guarantor “to repay only the debts of the particular promissory notes.” Id. Finding that the given facts presented such a situation, the Court held that the statute of limitations for the guaranties would be governed by the U.C.C. and track the six year limitations period for the underlying notes.

It should be noted that the decision appears to be based on the Court’s view that it would be “illogical” for a personal guaranty to expire earlier than the underlying obligation. Although the merits of this practical approach are readily apparent, the Court did not root this conclusion in statutory authority or precedent. The plain language of neither A.R.S. § 12-544 nor § 47-3118 contemplate any such exception, and the sole case cited by the Court to support its distinction between specific and general guaranties in this context – Consolidated Roofing & Supply Co., Inc. v. Grimm, 140 Ariz. 452, 682 P.2d 457 (App. 1984) – relied on prior provisions of the U.C.C. that have since been repealed. Nonetheless, the Court’s decision results in a clear rule that out-of-state “specific” guaranties that are executed by the borrower’s owner are subject to A.R.S. § 47-3118, not § 12-544.

Ramifications

The implication of this rule is that a guaranty will be subject to the four year limitation of A.R.S. § 12-544 in circumstances where (i) the out-of-state guaranty is not a specific guaranty but merely a general continuing guaranty, or (ii) the guaranty is not executed by the borrower’s owner. Accordingly, this decision potentially has significant ramifications for lenders and guarantors alike, albeit in narrow circumstances where the guaranty is executed outside the state but being enforced in Arizona.

Lenders and their counsel generally assume a six year limitation applies to all contracts, and likely will not think to analyze whether they need to bring suit within four years. It is also relatively common for lenders to rely on a single general continuing guaranty executed at the start of the lending relationship that is designed to apply to any and all current and future indebtedness of the borrower, rather than to have the guarantor execute a fresh guaranty specifically identifying the underlying obligations each time a new loan is made. Therefore, if you are counsel for a guarantor being sued on their personal guaranty, you should determine:

(1) Was the guaranty executed out of state?

(2) Has four years lapsed since the breach?

If the answer to both 1 and 2 are yes, then you should also determine:

(3) Is it a specific guaranty?

(4) Is your client an owner of the borrower?

If either 3 or 4 are no, then you may have a meritorious argument pursuant to A.R.S. § 12-544 and Monroe that the case should be dismissed.

If you are a lender, the Monroe decision simply reinforces the need to follow, or at minimum deliberately consider, certain standard provisions and lending practices for your form guaranties, such as:

  • A provision stating that the guaranty is being executed in Arizona;
  • A provision specifically stating the period in which an action for breach of the guaranty must be brought;
  • Include continuing guaranty language, but also specifically reference the primary obligations you know are being guaranteed; and
  • Have guarantors execute updated guaranties executes a new loan agreement or loan modification that increases the indebtedness. 

About the Author: Michael Rolland is a member of the civil litigation and commercial transactions practice groups with the law firm of Engelman Berger, P.C. Michael has a special interest in the intersection of technology and the law, and writes on tech law issues.

Disclaimer: This blog is not legal advice and is only for general, non-specific informational purposes. It is not intended to cover all the issues related to the topic discussed. If you have a legal matter, the specific facts that apply to you may require legal knowledge not addressed by this blog. If you need legal advice, consult with a lawyer.

Rejection of Trademark License Not Tantamount to Revocation

Have you ever worried about the status of your intellectual property rights if the licensor filed bankruptcy? Outside of bankruptcy, it was settled law that a licensor who breaches cannot revoke its rights under a contract, absent some special contract terms or unique aspect of law. In a bankruptcy, however, revocation was a serious concern in entertainment law and the fashion industry, for example. Days ago, the U.S. Supreme Court clarified your rights and ended any chance of debtors licensing away their intellectual property rights, declaring bankruptcy, and then re-trading them.

In Mission Product Holdings, Inc. v. Tempnology, LLC, nka Old Cold LLC, 2019 WL 2166392, the Supreme Court addressed the issue of whether a debtor-licensor’s rejection of a contract deprives the licensee of its rights to use the trademark. The Supreme Court held that it does not.  Succinctly put, “A rejection breaches a contract but does not rescind it.” Accordingly, those rights conveyed by the contract survive the breach and remain in place.

This case arises in the context of a licensing agreement but should apply equally to all contracts with debtors. Tempnology primarily manufactured workout clothing designed to keep you cool and marketed those products under the brand name “Coolcore.” It used trademarks to distinguish its gear from the competition. Tempnology entered into a contract with Mission Product Holdings which gave Mission an exclusive license to distribute certain Coolcore products in the U.S. It also granted Mission a non-exclusive license to use the Coolcore trademarks. Before the agreement expired, Tempnology filed a voluntary petition under Chapter 11 of Title 11 of the U.S. Code a/k/a the Bankruptcy Code. Tempnology then asked the bankruptcy court to allow it to “reject” the licensing agreement.

The bankruptcy court approved the rejection, thereby relieving the debtor of any obligation to continue to perform and giving counterparty Mission a pre-petition claim for damages. Tempnology wanted more. Tempnology sued for declaratory judgment asking the court to determine that rejection was tantamount to rescission in that it terminated the rights it granted Mission to use Coolcore trademarks. While the bankruptcy court agreed with Tempnology, the Bankruptcy Appellate Panel for the First Circuit disagreed. The First Circuit Court of Appeals rejected the BAP’s analysis and an opinion out of the Seventh Circuit, and reinstated the bankruptcy court’s decision. 

Numerous courts have struggled with the ramifications of a debtor’s rejection of a contract pursuant to Section 365 of the U.S. Bankruptcy Code. Over time, two views emerged.  Some courts concluded that a contract breach should have the same consequences as a breach outside of bankruptcy. Under this scenario, a breach allows the counterparty a suit for damages while leaving intact the rights the counterparty received under the agreement. Other courts have held that a contract breach is more akin to a rescission in a non-bankruptcy environment. In this paradigm, the counterparty still has a suit for damages but the rejection terminates the entire agreement and corresponding contractual rights conferred upon the counterparty. 

As Professor Baird wrote and Justice Kagan quoted for the majority: “A debtor’s property does not shrink by happenstance of bankruptcy, but it does not expand, either.” This principle applies equally to personal property contracts as it does to license agreements. In fact, the hypothetical Justice Kagan weaves throughout the opinion is that of a law firm’s lease of a copier. Thus, we are guaranteed to see various applications of Tempnology as debtors and creditors explore the boundaries of this latest Supreme Court decision.

About the Author: Scott Cohen has practiced commercial bankruptcy, creditors’ rights, and insolvency litigation for 27 years. He is a Board Certified Specialist in Business Bankruptcy Law and a past Bankruptcy Section Chair of the State Bar of Arizona.

Disclaimer: This blog is not legal advice and is only for general, non-specific informational purposes. It is not intended to cover all the issues related to the topic discussed. If you have a legal matter, the specific facts that apply to you may require legal knowledge not addressed by this blog. If you need legal advice, consult with a lawyer.

Case Alert – Ruffino v. Lokosky In The Age Of Email, Service By Publication Is On The Way Out

In Ruffino v. Lokosky, No. 1 CA-CV 17-0353, 2018 WL 3384998 (Ariz. Ct. App. July 12, 2018), the Arizona Court of Appeals held that, under some circumstances, alternative service by email, or even social media, may be a more appropriate means of providing notice of a lawsuit than service by publication.

Judge Paul J. McMurdie delivered the opinion of the Court, in which Presiding Judge Diane M. Johnsen and Judge David D. Weinzweig joined.

Ruffino filed suit against Lokosky for defamation and other related torts for a series of statements by Lokosky on her website. After several failed attempts to serve Lokosky at three addresses identified through skip tracing, Ruffino proceeded with service by publication. Lokosky failed to appear, and the superior court entered a default judgment awarding Ruffino $264,062.50 in damages and injunctive relief. The default judgment was later amended to permit Ruffino to take control of Lokosky’s website, and it was at this point that Lokosky first appeared in the action. Lokosky sought a temporary restraining order and also asked the court to set aside or vacate the default judgment under Arizona Rules of Civil Procedure (“Rule”) 55(c) and 60(b).

After an evidentiary hearing on the issue of service, the superior court made a factual finding that “Ruffino could have communicated with Lokosky about service through several online channels,” which the court later clarified included Lokosky’s email address, phone number, and social media that Ruffino had previously used to communicate with her.  Id. at ¶ 6.

Under Rule 4.1(l)(1), service by publication may be made only if “the serving party, despite reasonably diligent efforts, has been unable to ascertain the person’s current address;” or “the person to be served has intentionally avoided service of process;” and  “service by publication is the best means practicable in the circumstances for providing the person with notice.”

The court held that Ruffino had failed to satisfy the requirement of Rule 4.1(l)(1)(A)(i) that he make “reasonably diligent efforts” to ascertain Lokosky’s current address prior to effecting service by publication, because he did not attempt to contact the defendant via available online channels. Id. at ¶ 14 (“A reasonably diligent effort by Ruffino would have included reaching out to Lokosky via telephone, email, or even social media to verify her correct address.”).

The court further held that, even if the plaintiff had made such reasonably diligent efforts, service by publication would still not be available because under the circumstances it was not the best means practicable to provide notice, as required by Rule 4.1(l)(1)(B). The court stated that “[g]iven our present society, we agree with the superior court that modern methods of communication, especially email, were more likely to give Lokosky notice of a suit than publication in a newspaper distributed in a rural area 70 miles from Lokosky’s Scottsdale home.” Id. at ¶ 16 (emphasis added).

Civil litigators should all sit up and take notice of the court’s opinion in Ruffino. In most civil disputes between parties that already know each other—which includes the vast majority of business disputes—the parties will have already communicated by email, phone number, or social media. Ruffino effectively eliminates the availability of service by publication in these cases. However, Ruffino also sends a strong message to lower courts that service by email, and even social media, should be taken seriously as viable methods of satisfying due process. In theory, our courts have always had the procedural authority under Rule 4.1(k) to approve these methods of service (and Rule 5(c)(2)(D) contemplates service after appearance by electronic means), but there has never been clear precedent from our court of appeals blessing these methods as not only valid, but also superior to service by publication.

Going forward, if the current address of the defendant is not known and cannot be discovered through conventional means, litigators should always ask their clients whether they are able to contact the defendant via email or social media. If so, use those channels to ask the defendant for a current address and, if possible, to send a copy of the service package. Be sure to document your efforts. If the defendant does not cooperatively provide you with a current address, Ruffino provides a strong basis to move for alternative service using the online channel available to you.

This is a sensible and very welcome decision by the court. Despite historical acceptance of service by publication, the idea that publication of a summons in the back pages of some obscure physical newspaper is an effective way to give notice in our modern age borders on absurdity.

About the Author: Michael Rolland is a member of the civil litigation and commercial transactions practice groups with the law firm of Engelman Berger, P.C. Michael has a special interest in the intersection of technology and the law, and writes on tech law issues.

Disclaimer: This blog is not legal advice and is only for general, non-specific informational purposes. It is not intended to cover all the issues related to the topic discussed. If you have a legal matter, the specific facts that apply to you may require legal knowledge not addressed by this blog. If you need legal advice, consult with a lawyer.