Commercial loans to closely held business entities, such as an LLC or partnership, typically include guaranties by the entity’s principal. Sometimes, the guarantor demands a “carve-out” to expressly exempt one or more of the guarantor’s assets from the reach of the guaranty.  For example, the guarantor may “carve out” his or her principal residence.  If the guarantor sells a “carved out” asset, can the lender obtain the sale proceeds in the event of a default?

This question was addressed in the recent case of Series AGI West Linn of Apian Group Investors De LLC v. Eves (2013) 217 Cal.App.4th 156.  In that case, a Guarantor executed a personal guaranty to secure a $3.1 million real estate construction loan made to a limited partnership.  The guaranty expressly excluded the Guarantor’s personal residence in Como, Italy on an Asset Exclusion Schedule.  The Guarantor sold the Como residence in 2011, and the proceeds were deposited in accounts segregated from the Guarantor’s other assets, and never commingled with any other funds. The exclusion language in the guaranty did not list those accounts and made no reference to “sale proceeds.”

When the limited partnership subsequently defaulted on its loan, the Lender sued to enforce the guaranty and obtained prejudgment attachment against the Guarantor’s assets, including the sale proceeds.  On appeal, the Court held that the attachment order was proper because the guaranty did not state that the exclusion included the proceeds from the sale of the listed assets. The Court noted that the parties’ use of an Asset Exclusion Schedule demonstrated that care was given to the issue of the assets excluded from the reach of the guaranty, and that if the parties had meant to exclude sale proceeds, they would have used language to that effect.

The good news from the Eves case is that courts will apply the plain language of a guaranty and not attempt to re-write it where there appears to be no basis to do so. The case, however, also provides a warning to commercial lenders and borrowers. “Carve-out” provisions should be tailored carefully to ensure that the parties’ intent is reflected with respect to the exempted assets.  Lenders generally will not wish to include sale proceeds in “carve-out” provisions. When they do agree to do so, care should be taken to limit such a “carve-out.” For example, a lender may wish to retain the right to pursue sale proceeds where they are commingled with other cash or are converted into another asset.