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NJ Economic Development Authority v. Pavonia Restaurant, Inc.

A-2690-01T5 (N.J. Super. App. Div. 2004) (Unpublished)

CORPORATIONS; GUARANTEES—Even where a debt guaranty document provides for joint and several liability, if it is signed by unequal corporate shareholders, it is proper to look to their shareholder agreement and at their respective percentage shareholdings to determine the liability of one to another for the guaranteed debt.

A restaurant needed to borrow money. Therefore, its shareholders and guarantors entered into a Personal Guaranty Agreement to induce a lender to enter into a loan agreement. The loan agreement provided that if the restaurant defaulted on the loan, the lender could hold each shareholder-guarantor jointly and severally liable for the debt. The restaurant defaulted on its payments. The lender moved for summary judgment and the lower court held each of the shareholder-guarantors jointly and severally liable for the debt, in proportion to their ownership interest.

The majority shareholders claimed that responsibility should have been on a per capita basis as called for in the guaranty agreement. The lower court held that despite what the guaranty agreement said, it would not be fair to hold each shareholder equally liable when some had a much larger interest in the restaurant than others. It pointed out that the parties had invested in the corporation on a percentage basis, and the corporation was in fact broken down on a percentage basis. In its view, because the lender had “an absolute right to proceed against one, five or [all of the shareholders] . . . to collect the judgment,” holding each proportionally responsible would prevent any of them from having to pay the entire judgment.

On appeal, the majority shareholders argued that the guaranty agreement established joint and several liability and that the percentage ownership in the shareholder agreement did not apply to the guaranty. The Appellate Division affirmed the lower court’s holding. Generally, all co-guarantors have a duty to each other to make payment of their just proportion of the debt. Accordingly, a shareholder’s contributive share is the total liability divided by the number of shareholders unless there is an express or implied agreement to the contrary. Where shareholders agree to determine their contributive shares by a different formula, then their agreement controls. However, where no express agreement exists, one can be applied by the circumstances. According to the Court, since a paragraph from the shareholder agreement delineated responsibility for operating costs by proportional interest, then it was appropriate to apply the proportional interests to the guaranty agreement.

The Court also held that the guaranty agreement should not be applied. Rather, it should be applied within the context of the shareholders agreement. To hold each shareholder equally responsible for the debt when they agreed otherwise in the formation of their corporation was held to be inequitable and unfair to the minority shareholders.

One shareholder also brought suit against the corporation for fraud, mismanagement, and breach of fiduciary duty. The Appellate Division agreed with the lower court that the shareholder did not have standing to bring these claims. Suits to redress corporate injuries which secondarily harm all shareholders equally can be brought only by the corporation. Individual shareholders cannot sue for injuries arising from the diminution in value of their shareholdings resulting from wrongs allegedly done to their corporations. Such claims are always derivative. Thus, the shareholder lacked standing to bring this suit.

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