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Company A is issued a loan that is guaranteed by Company B and is secured by liens on Company C's assets.

Company A defaults on its loan. In what order are the collateral and guarantees used to pay off the creditors who own the loan? For example, is the collateral security from Company C used up completely first and then the guarantees from Company B relied on next, or is it pro-rata somehow between the security and guarantees, or something else entirely? Is there a standard part of an indenture or credit agreement where I can check this, or a convention if not?

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To start with, this is a highly technical issue upon which different jurisdictions may differ, and in which different rules may apply in different circumstances either by agreement or by statute. Also, similar situations are sometimes treated differently in this regard in bankruptcy and out of bankruptcy.

The majority rule is that the lender may choose which remedies - such as collateral and guarantee rights, to enforce, and the lender may choose in which order to enforce them.

For example, most jurisdictions allow a lender to collect from a guarantor even when collateral is available to the lender, in lieu of foreclosing on the collateral.

Sometimes, however, special rules apply.

For example, if the guarantor is a government agency (e.g. the Small Business Administration or the Veteran's Administration), often the lender is required to take all reasonable efforts to collect from the borrower and recover the amount owed from collateral, before the guarantee can be invoked.

Similarly, sometimes the law distinguishes between an accommodation party who receives no consideration in a transaction who signs as a direct debtor, and one who signs in a guarantor capacity. Those jurisdictions may require a good faith effort to collect from direct debtors (often including attempts to foreclose upon collateral) before attempting to collect from guarantors who sign as such.

There are also arrangements, such as credit default swaps or a situation when a consumer provides a credit card payment authorization which a creditor can use in the event of a default (or the large dollar amount equivalent of such an arrangement called a "letter of credit"), in which the line between what constitutes collateral and what constitutes a guarantee can be blurred.

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  • Got it. Do you know which section of an indenture covers the options available for a specific case? – trade_the_basis Apr 26 '18 at 21:47
  • @trade_the_basis There is no fixed place in an indenture instrument to put the relevant language. It is usually buried someplace in the boilerplate, but different lawyers have different styles of drafting and put this language in different places. I'm not entirely consistent on this point even in documents that I draft myself for my clients. – ohwilleke Apr 26 '18 at 21:49
  • Got it. Thank you! Great answer. As a final question, are there any specific phrases I can control+F for to try and find it? – trade_the_basis Apr 26 '18 at 21:55
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    @trade_the_basis I wouldn't trust a control+F search to give you a reliable answer. "Election", "remedies", "cumulative", "rights upon default", and "choice of remedies" would be some phrases to search for, but there are probably half a dozen ways, using different words, that can convey the same meaning. It would be more work to read the whole damn thing, but it shouldn't be longer than 50-70 pages in most cases and you can skim over lots of it by reading topic sentences (e.g. you probably aren't going to find it in a paragraph describing the collateral or discussing prepayment). – ohwilleke Apr 26 '18 at 21:59
  • Thanks, will search for those terms. This one is 300. :( – trade_the_basis Apr 26 '18 at 22:01

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