In our last bank alert notice, we were talking about the right of setoff. The operative language of the erroneous setoff provision stated that the “bank would not exercise its right of setoff until all of the bank’s collateral had been liquidated.”
This agreement to “liquidate all collateral” prior to exercising rights is a marshalling agreement. Under no circumstances should the bank agree to such vague proposition with respect to such an important concept. Moreover, what does the word “all” mean? There are often times where the cost of liquidation exceeds the value of the collateral. For sure, the bank did not intend that it would liquidate such collateral and increase its loss. On the other hand, the guarantor who requested the marshalling refused to pay on his guaranty as the bank did not want to liquidate all of the collateral.
In appropriate circumstances, when credit otherwise warrants such an agreement, we do sometimes recognize limited marshalling agreements. Such a limited marshalling agreement in a guaranty for example, could provide as follows:
“LIMITED MARSHALLING RIDER
It is agreed as a condition of this Guaranty Agreement that the Lender shall first proceed to attempt collection of the Obligation from the Borrower’s Collateral prior to making demand upon the Guarantor hereunder, provided however Lender shall not be required so to do, upon the happening of any of the following:
A. Any material diminution of Guarantor’s assets at any time as reasonably determined by Lender;
B. Inability of Lender to proceed, or continue to proceed against any Collateral in expeditious and uninterrupted fashion based upon any order of Court or operation of law, including without limitation, inter- position of the automatic stay pursuant to 11 U.S.C. 362;
C. The determination by Lender, in its sole discretion, of the need to commence any suit(s) or action(s) in any court or with any administrative agency, or by arbitration, in order to recover and thereafter sell any Collateral of Borrower or other property secured or mortgaged to Lender;
D. The determination by Lender, in its sole discretion that the costs of liquidation of the collateral exceeds the value thereof.
E. The absence of any Collateral secured or mortgaged to Lender.
Upon any of the above occurrences, Lender may exercise any and all of its cumulative rights and remedies without further reference to this paragraph.”
As you can see, the bank agrees to liquidate collateral, but then the parties acknowledge that the obligation to liquidate the collateral does not apply in certain important circumstances. In case specific circumstances, additional limited factors can also be incorporated, but generally, the above-stated ones are critical and you should avoid waiving important rights or remedies whether against a deposit account or against a guarantor without carefully drafting them.