THE TRAGIC CASE OF THE DANGLING DEBT

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We live in an age when it is oh-so-easy to incur debt, sometimes without even knowing it.  The moral of this story is that clients need to try to remember the documents they signed before their divorce is over.  And even then, old agreements can linger even after a judicial decree states that all rights are over.

Katherine and Mark Moore were married.  Mark owned a business called J.J. Moore Sales, Inc. in Erie, Pennsylvania.  In 2002, he secured a small business loan from KeyBank for $200,000.  One of the conditions of the loan to the corporation was that both Katherine and Mark had to individually guaranty the loan.  The guaranty would last until the loan was paid in full and the bank/SBA had no duty to seek payment from any other source before calling in the guarantees. Can you tell where this is heading?

Five years later, J.J. Moore, Inc. filed for Chapter 11 protection (a reorganization).  The plan was approved by the Court in 2007.  A year or so after the plan was approved Mark filed a Chapter 7 (liquidation).  He secured a discharge in April 2009.

Ten months before Mark filed for personal bankruptcy, Katherine filed for divorce and equitable distribution.  While that divorce was pending Mark secured his personal bankruptcy discharge (April 2009).  Three years later, in May 2012 the parties reached a settlement agreement.  It contained some language familiar to all of us who practice family law.

“[The Parties] represent and warrant to each other that they have not incurred debts or made any contracts for which the other…may be liable….Each party agrees to indemnify the other from any debts or contracts that may exist or come into existence in violation of this clause.”

A divorce decree adopted these terms.  In 2014 the Small Business Administration began to pursue Katherine for the balance due on the J.J. Moore, Inc. loan.  Katherine sought administrative relief within the SBA claiming statute of limitations defenses, equitable estoppel, and failure to join Mark as an indispensable party.  SBA denied all these defenses and began a garnishment of her wages.  In 2017 she sued her former husband claiming that this was a violation of the indemnification clause.

Mark’s defenses merit careful scrutiny because they prevailed at trial and on appeal.  First, the debt SBA was pursuing was not a debt he contracted but one which the corporation contracted and which he and Katherine guaranteed.  Bear in mind, this was his business in the sense that he owned shares of stock, but it was not technically, his debt.  Second, because Mark and Katherine each guaranteed the debt of J.J. Moore, Inc., the matter of whether the bankruptcies released the debt as to corporation and Mark individually, was immaterial. Katherine had individually guaranteed debt, so the bank/SBA had rights against her without regard to what happened in the corporate or personal bankruptcies.

The gravamen of Katherine’s appeal was that Mark had warranted in the settlement that her husband had agreed to indemnify her for any contract for which she might be liable.  She asserted that this was the clear intent of the parties as expressed in their agreement.

Mark’s response was that while he did own the business this was her individual contract and the debt for which she was held liable was not his debt but J.J. Moore’s.  The guarantee was clear that SBA had no duty to seek payment first from the corporation or its owner.  The note itself was signed by him but his signature indicates he signed as “President” of the corporation and not individually.

The appellate panel decision observes that while both suretyship and guarantees are agreements to assume liabilities for another, the creditor may seek payment from the surety without making claim on the debtor while the guarantor is only liable if the debtor defaults in its obligation. McIntyre Square Assoc. v. Evans, 827 A.2d 446, 452, n.7 (Pa. Super. 2003).  Pennsylvania statute, 8 Pa.C.S. Sec. 1 states that suretyship is presumed unless the instrument specifies the contract to be one of guaranty.

The case does not tell us whether the business was marital or whether it still existed when the divorce was concluded.  What did exist were a Chapter 11 disposition as to J.J. Moore, Inc., and a Chapter 7 discharge of its President from personal liability.  It may well be that the lawyers who concluded the divorce in 2012 never knew that the SBA was still lurking in the marshes with an unpaid debt and a personal guarantee of an individual who had no bankruptcy protection.  If the Chapter 7 discharge of Mark Moore incorporated the guarantee, it’s not clear to this writer whether an indemnification clause in the property settlement agreement could have changed the outcome.  Put differently, can a person discharged from a debt still be held liable on the same debt if he agrees to provide indemnity to a co-obligor in a subsequent transaction?  Suffice to say, contingent debts are out there and can still bite unless addressed in the setting of equitable distribution.

Katherine Moore v. Mark Moore, 974 WDA 2020 (Aug. 27, 2021) non precedential


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