In a recent opinion, the Supreme Court of Ohio definitively held that a creditor does not have an affirmative duty to disclose facts that materially increase risk to a surety—and nor does a surety have a duty to disclose to the creditor.
Background
Raymond Schneider and Harold Sosna each owned 50% of the “Keller Group”, which held a variety of companies across the nursing and real estate industries. While Schneider and Sosna each held an equal ownership share in the Keller Group, Sosna wholly owned the company that managed the Keller Group’s portfolio. Sosna, through the management company, engaged Huntington National Bank to arrange loans totaling more than $77 million as part of a plan to refinance after defaulting on a prior loan. Huntington was amenable to a credit agreement encompassing both the management company and the Keller Group, provided that personal guarantees were obtained from both Sosna and Schneider.
The new loans were defaulted on less than a year after the agreement began, and Sosna later pled guilty to bank fraud in connection with kiting checks. Left with no other recourse, Huntington brought a claim to enforce the personal guarantee against Schneider. In response, Schneider argued that he had a surety relationship with Huntington, that Huntington was aware of the financial risk posed by Sosna, and that Huntington breached a duty to disclose by failing to affirmatively make Schneider aware of that risk. The trial court granted summary judgment on behalf of Huntington—finding that the bank had no disclosure obligation—only for the appellate court to reach the opposite conclusion.
The Supreme Court of Ohio granted a discretionary appeal to address whether a lender has a duty to disclose information that increases a surety’s risk.
Court’s Analysis and Decision
In its reversal, the First District Court of Appeals implicitly adopted Section 142(1) of the Restatement (First) of Security, which states that an affirmative duty to disclose arises between a creditor and a surety:
[w]here before the surety has undertaken his obligation the creditor knows facts unknown to the surety that materially increase the risk beyond that which the creditor has reason to believe the surety intends to assume, and the creditor also has reason to believe that these facts are unknown to the surety and has a reasonable opportunity to communicate them to the surety[. In these circumstances], failure of the creditor to notify the surety of such facts is a defense to the surety.
Necessarily, Schneider’s argument hinged on his contention that his relationship with Huntington should be defined as one of surety, not just guarantor. However, the Court first sought to determine whether to adopt the Restatement’s view in the first place—if the Restatement did not hold under Ohio law, then there would be no affirmative duty to disclose, whether in a surety or guarantor relationship.
Ultimately reaching that exact conclusion, the Court relied primarily on longstanding principles of well-established Ohio contract law. Courts have long found that “contracts … fairly made and freely entered into are valid and enforceable,” and “courts are powerless to save a competent person from the effects of his own voluntary agreements” absent fraud or other unlawful circumstances. While the Court did recognize that a relationship of special repose or trust may create some level of fiduciary duty on the part of a creditor, that duty does not extend to banks engaged with a guarantor or surety. And the lack of an affirmative duty to disclose holds in both directions: “there is no duty between the parties to disclose facts that materially increase risk to one another.”
While Schneider claims he was “blindsided” by Sosna’s actions, Huntington’s information about Sosna ultimately had no bearing on the contractual relationship between Schneider and Huntington. Rather, it remained Schneider’s obligation to ascertain facts and inform himself of any risks. The Court held that a surety’s failure—or even inability—to do so “does not shift the burden of responsibility to the bank”.
Key Takeaway
In refusing to adopt Section 142(1) of the Restatement (First) of Security, the Supreme Court of Ohio reinforced that parties to a commercial lending transaction do so at their own risk. Absent a special relationship of trust or confidence, no party to an agreement has an affirmative duty to reveal information that materially increases another party’s financial risk. Lenders, sureties, and guarantors alike are all held to this same standard, and due diligence before putting ink to paper is all the more critical.
