In the recent Illinois case of Phelps Dodge Corporation v. Schumacher Electric Corporation, a court held that a corporation which gave a guaranty 30 years ago was still obligated on the guaranty because the corporation failed to cancel it.
Defendant, Schumacher Electric (“Schumacher Electric”), manufactured battery charging equipment and electrical transformers. A major component of the manufacture of such products is copper wire. In 1968, Schumacher Electric’s principal formed Horning Wire Corp. (“Horning”) to manufacture copper wire for it. Plaintiff, Phelps Dodge Corp. (“Phelps”), sold to Horning the copper rod required for the manufacture of the wire. To induce Phelps to become a trade creditor of Horning, Schumacher Electric executed a guaranty in 1971 wherein it guaranteed the payment of any purchases from Phelps made by Horning.
Thirty years later Horning became insolvent and could not pay Phelps, which it owed $372,000. Phelps demanded that Schumacher Electric pay the amounts due from Horning pursuant to the guaranty. Schumacher Electric refused to comply with the guaranty, arguing it had failed to keep a copy of the guaranty and had forgotten about it. Phelps then filed suit to enforce the guaranty.
Schumacher Electric argued that guaranties with no specific duration expire within a reasonable period of time, and that Phelps had breached its duty to notify Schumacher Electric of developments that increased the risk or amount that it could be liable pursuant to the guaranty.
The court rejected Schumacher Electric’s arguments and entered judgment in favor of Phelps. The court said that a continuing guaranty, without a stated expiration date, like the one at issue in this case, can be revoked at any time by the guarantor upon notice to the obligee; otherwise, a guarantor could be forever obligated on a guaranty. Thus, Schumacher Electric could have revoked the guaranty to limit the duration of its potential liability under the guaranty. Unfortunately for Schumacher Electric, it did not.
The court also rejected Schumacher Electric’s argument that the guaranty should not be enforced because changes in the relationship between Schumacher Electric and Horning between 1971 and 2001, and changes in the ownership of Schumacher Electric, increased its risk. In general, a creditor is not permitted to materially increase the risk of a guaranty without notifying the guarantor.
In this case, there was an ongoing relationship between Phelps and Horning that did not increase Schumacher Electric’s risk. Further, the other issues which Schumacher Electric claimed materially increased its risk were facts that were outside the relationship between Phelps and Horning. The bottom line: Schumacher Electric could have protected itself from increases in the risk by, as an example, canceling its guaranty. Again, unfortunately, Schumacher Electric failed to take any appropriate action.
Companies should have their important contracts reviewed frequently by counsel. Changes in the laws and business conditions, or contractual oversights like the one in this case – Schumacher Electric’s failure to address the expiration of the guaranty – may transform what was a satisfactory arrangement at the outset to a burdensome one at the present. Financial indiscretion may be sidestepped with organization and forethought.