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Question: PT-A: In re Brent Quillen

Instructions, File and Library: In re Brent Quillen 300 KB

Memorandum
To Brent Quillen
From Allan Zackler
RE: InterCon, Inc. bankruptcy

As I understand your situation, you cosigned a loan as a favor to your brother-in-law. You did not benefit personally from the loan nor did you receive any compensation. The loan, or line-of-credit, was from First Franklin, a venture capital firm, to InterCon, Inc. a corporation formed by your brother in law, Mark Phillips. Mark was the CEO of InterCon. The promissory note was signed by Mark as CEO of InterCon, then, separately, Mark signed as an individual on the front of the note. You also signed as an individual on the back of the note. No description accompanied the individual signatures by you and Mark.

The loan was secured by all equipment and inventory of InterCon in 2002. In 2009, InterCon received a second loan from Columbia Bank which was also secured by all equipment and inventory. Columbia seized all the equipment and inventory and sold it for $1,200,000.

InterCon filed for bankruptcy and settled with First Franklin for $1 million of the $3 million loan and First Franklin released Mark. It is now seeking to satisfy the remaining $2 million from you, as cosigner.

You have asked four questions:
1. If you pay First Franklin, do you have the right to be reimbursed by Mark?
The short answer is yes, you probably do. But it depends entirely on whether Mark’s status in signing the loan individually is as a principal (also called the accommodated party) or as a surety (also classed the accommodation party).

Under Melandris, the court announced five factors to determine if a signer to a loan is a surety or a principal. If he is a surety, then you, as a surety, stand in equal footing with Mark. Both of you are equally liable to make good on the default by the principal InterCon. In that case, you would have no right to reimbursement from Mark.

If, on the other hand, Mark was a principal just as InterCon was, you are entitled to reimbursement from Mark for any amount you pay to First Franklin

Here are the five factors:
1. What was Mark’s corporate capacity?
Mark was the CEO of InterCon and owned, with his wife, the largest block of shares, outside of the creditor, First Franklin.
This factor favors treating Mark as a principal because of his ownership interest in the corporation.

2. Did Mark sign on the front of the promissory note?
Mark did sign on the front of the note, consistent with treating him as a principal. However, this alone is not dispositive.

3. Was language used in conjunction with signature to describe the signer’s role?
No, no description was used. This is the same as your own signature, and could be argued that you were both merely sureties.

4. Whether Mark received loan proceeds.
Mark did not receive any loan proceeds directly. He did benefit by being employed by InterCon, taking a salary. However, his salary was minimal, $1500 per month, and he took it only in months when InterCon was running a profit. However, Mark has made a claim in bankruptcy court for compensation for the months when he did not take a salary for $18,000. Mark also received the benefit of a company car that InterCon paid the lease on.  Furthermore, Mark had one-fourth of the shares of the corporation which would have had value if the corporation had been successful.
This factor favors treating Mark as a principal.

5. Intent of parties
While the Melandris court did not have facts to reason about this factor, your testimony about your understanding with Mark can establish that you were cosigning as a favor to Mark and that Mark was trying to start a business. In fact, he was running it as a sole proprietorship when he approached you about cosigning. Mark only incorporated in order to satisfy First Franklin’s condition. First Franklin understood that Mark was the principal. It called for a cosigner in order to protect its interests. So First Franklin’s intention is entirely consistent with your own version of the events. Fortunately, First Franklin’s interests are not threatened by treating Mark as a principal, so it may support your argument.

In summary, the following facts support finding that Mark is a principal:
1. He is the CEO of InterCon
2. He signed on the face of the note
3. No language accompanying his signature delimited his role as a surety.
4. He did benefit through employment and stock due to the loan.
5. You and Mark and Mark and First Franklin all understood that he was the person running InterCon.

Under the Columbia Comm. Code Sec. 3419(e) “An accommodation party who pays the instrument is entitled to reimbursement from the accommodated party and is entitled to enforce the instrument against the accommodated party. “

Therefore, I believe Mark would be found to be a principal (also called an accommodated party) and you would therefore be able to seek reimbursement from Mark for money you pay First Franklin in satisfying the loan.

2. Can Mark recover from you?
The short and clear answer is: No. Mark is an accommodated party and you are an accommodation party. Under Melandris, an accommodated party may not be reimbursed by an accommodation party.

Col. Comm. Code Sec. 3419(e) states: “An accommodation party who pays the instrument is entitled to reimbursement from the accommodated party and is entitled to enforce the instrument against the accommodated party.
However, that section goes on to state: “an accommodated party who pays the instrument has no right of recourse against, and is not entitled to contribution from, an accommodation party.”

Therefore, since Mark will likely be found to be an accommodated party to the loan, along with InterCon, he could not seek reimbursement or contribution from you.

Even if Mark is found to be a surety just as you are, sureties are not entitled to reimbursement from each other. The only right to reimbursement belongs to an accommodation party (surety) from a principal (or accommodated party).

3. Does First Franklin’s loss of its security interest reduce your obligation to pay it, and by how much?
The short answer is, yes, its failure to renew its security interest filing caused it to lose the security, and your obligation is reduced to the value of the security interest it lost.

In Col. Comm. Code Sec. 9515, security interests are valid for only five years and expire if they are not renewed. First Franklin filed its security interest in 2002 and took no further action. So First Franklin’s interest expired in 2007. When Columbia filed its security interest in 2009, there was no valid security interest on file. Because of First Franklin’s failure to follow the statute’s requirements, it impaired its security interest.

Under Col. Comm. Code Sec. 3605, when a secured creditor impairs its security interest, the debtor’s obligation is discharged to the extent of the impairment.
We know from bankruptcy court filings that Columbia received $800,000 for the equipment and $400,000 for the inventory. So the amount that you must pay First Franklin will be reduced by $1,200,000.

4. Does First Franklin’s release of Mark act as release of your obligation to any extent?
The short answer is no it does not. Regardless of whether Mark is a surety or a principal, you are liable to satisfy any remaining balance on the loan beyond what Mark has paid.

The Col. Comm. Code Sec. 3605(b) states: “Discharge of the obligation of a party does not discharge the obligation of an indorser or accommodation party who has a right of recourse against the discharged party.”

In Venaglia the court interpreted this when it said: “3605(b) is not intended to protect an accommodation party from a settlement in which the promisee discharged the accommodated party (in this case, Mark) in return for paying all that he can on the note. The accommodation party should expect to be obligated to pay to the extent that the accommodated party does not have resources to pay.

In plain English, this means that when First Franklin released Mark, it did not release your obligation as a surety, because whatever you pay First Franklin you have the right to get reimbursed from Mark.

However, note that First Franklin is only entitled to one recovery of $3 million (less impaired security interest amount it lost of $1,200,000). Since it got $1 million from Mark, it can only get the $2 million balance from you, less the $1,200,000 security interest lost. This makes your total obligation $800,000, and you can seek reimbursement for this amount from Mark.

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