RESTATEMENT REJECTS STRICT RULE ON DISCHARGE OF GUARANTOR

January 24, 2003

By Steven P. Garmisa
Hoey Farina & Downes 
sgarmisa@felahfd.com


The Restatement (Third) of Suretyship and Guaranty (1996) rejects "the traditional rule" that says "a secondary obligor was completely discharged by a modification of the underlying obligation." Center 48 Limited Partnership v. May Department Stores, 2002 WL 31741469 (N.J. Super., App.Div., Dec 5).

"[T]he traditional rule, that a secondary obligor was completely discharged by a modification of the underlying obligation, was often applied in a mechanical, almost mindless way," the New Jersey Appellate Division explained. Rejecting the traditional approach, "the Restatement chose to adopt the more modern policy of discharging the secondary obligor only to the extent it would otherwise suffer loss as a result of the modification."

Rejecting the traditional rule in a case involving the guaranty of a department store lease, the trial judge ruled a guarantor wasn't discharged from liability based on what turned out to be a harmless change in the lease.

The original lease for a department store provided that the landlord, the predecessors of Center 48 Limited Partnership, had fee-simple ownership of the leased premises. The obligations of the tenant, Caldor Inc., were guaranteed by an affiliated corporation, May Department Stores.

As the result of several transactions, the lease was modified to provide that the landlord only had a long-term ground lease. Theoretically, if Center 48 breached its obligations under the ground lease, Caldor's leasehold interest could have been terminated. But there was no breach of the ground lease, and no disturbance of Caldor's tenancy.
When Caldor went bankrupt, Center 48 sought to hold May Department Stores liable under its guarantee. May argued it was discharged on the guaranty, under the traditional rule, because the change in the nature of the landlord's interest in the property was a material change in the lease.

On appeal, the Appellate Division noted: "Some courts require that if a guarantor is to be released from its agreement, the change in the principal contract must actually injure the interest of the guarantor or must expose the guarantor to an increased or fundamentally different risk. Thus, some courts define a 'material' change in the underlying contract as one which injures the guarantor or increases its risk of injury, while others hold that a material change is one which increases or decreases the guarantor's liability, regardless of injury or benefit; on the other hand, still others hold that any change in the underlying obligation discharges the guarantor, even if not material or prejudicial.

"In the specific context of guarantees of lease agreements," the New Jersey reviewing court explained, American Jurisprudence (Second) "states that a material alteration or departure from the contract of guarantee, without the guarantor's consent, will discharge the guarantor whether or not it is prejudiced, 49 Am.Jur.2d Landlord & Tenant [sec]822 at 671 (2d ed. 1995)."

Concurring in rejection of the traditional rule recited in American Jurisprudence, the Appellate Division concluded that a modification "of the obligation between the principal obligor and the obligee does not discharge the secondary obligor unless 'the modification creates a substituted contract or imposes risks on the secondary obligor fundamentally different from those imposed pursuant to the transaction prior to modification.' " Restatement (Third) of Suretyship and Guaranty section 41(b)(i)(1996).

With the modern rule, summary judgment against the guarantor was affirmed.

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