Academic journal article Defense Counsel Journal

Effect on Surety of Obligee's Release of Principal: A Critical Look at the Rules in the Restatement

Academic journal article Defense Counsel Journal

Effect on Surety of Obligee's Release of Principal: A Critical Look at the Rules in the Restatement

Article excerpt

The Restatement (Third) of Suretyship and Guaranty addresses the consequences of the obligee's release of the principal

THE Restatement (Third) of Suretyship and Guaranty, which was adopted by the American Law Institute in 1995 and supersedes the suretyship law provisions of the 1941 Restatement of security, addresses, in Sections 37 through 39, the consequences of the obligee's release of the principal on (1) the rights and duties of the principal and the surety to the obligee and (2) the rights and duties between the principal and the surety.

Three situations are covered:

1. If the obligee releases the principal without more, (a) both the principal and surety are discharged from duties to the obligee, and (b) the principal is discharged from all duties to the surety. Section 39(a) and (b).

2. If the obligee releases the principal but expressly provides in the release for (a) a reservation of the obligee's rights against the surety ("reservation of rights") and (b) a preservation of the surety's rights against the principal ("preservation of recourse"), Section 38, (i) the principal is discharged from its duties to the obligee, (ii) the rights of the obligee against the surety remain unchanged by the release, and (iii) the principal is not discharged from its duties to the surety. Section 39(a) and (b).

3. If the obligee releases the principal under circumstances showing an intent on the part of the obligee to reserve its rights against the surety (Section 39(a)(ii)), (a) the principal is discharged from its duties to the obligee and the surety (Section 39(a)), and (b) the surety is discharged from its duties to the obligee (i) completely, if the underlying obligation is for other than the payment of money (Section 39(c)(iii)), but (ii) only to the extent that the release causes the surety loss, if the underlying obligation is for the payment of money (Section 39(c)(ii)).

The first rule merely recognizes the long-standing principle that a discharge of one debtor of joint debtors or joint and several debtors discharges them all.1

The second rule, later but also long standing, recognizes a reservation of rights doctrine by which a creditor may release a debtor and reserve rights against a guarantor with the consequence that the debtor remains obligated to the guarantor.2 However, the Restatement modifies the reservation of rights doctrine by providing that the debtor is also relieved of its duties to the surety unless there is an express preservation of the surety's recourse against the principal. If there is such a recognition, the principal bargains, in effect, for a release from the obligee but expressly recognizes that the obligee may enforce the underlying obligation against the surety and that the surety may then assert the same claim against the principal. One may wonder why a principal would make a deal that, in effect, closes the front door but leaves the back door wide open.

The third rule, as originally presented, also made a modification in the reservation of rights doctrine and provided simply that a release of the principal with a reservation of rights against the surety discharged the principal from its obligations to the obligee and the surety, but discharged the surety only to the extent of loss.3 The final form came as a result of a compromise because of a contention by surety practitioners that such a release should result in a complete discharge of a surety in all circumstances. A distinction is made based on the nature of the underlying obligation-that is, whether it is to pay money or an obligation other than the payment of money.

It is instructive to an understanding of the Restatement to discuss first the principles that were adopted in the early stages of the drafting process and that prompted the original concept that a release by the obligee of the principal, with a reservation of rights against the surety, should discharge the surety only to the extent of loss, and to point out the shortcomings in those principles. …

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