Requirement of Spousal Guaranty May Violate ECOA
When a closely held company applies for financing, the financial institution or business issuing credit ("Creditor") typically requires the owner to guaranty the debt to increase the likelihood the debt will be repaid. If the owner of the closely held company is married, the Creditor often requires the owner’s spouse to also guaranty the debt, regardless of the spouse’s ownership interest. However, requiring the spouse to guaranty the debt when the spouse has no ownership interest may violate the Equal Credit Opportunity Act ("ECOA"). If the Creditor violates the ECOA, the spousal guaranty may be void and the Creditor may be liable for actual and punitive damages.
The ECOA is intended to prevent discrimination against a credit applicant on the basis of, among other things, marital status, and, arguably, prohibits a Creditor from requiring that an applicant’s spouse guaranty the debt or sign a credit instrument as a co-borrower, if the applicant otherwise individually qualifies for the requested credit. The ECOA provides that it is "unlawful for any creditor to discriminate against any applicant with respect to any aspect of a credit transaction . . . on the basis of . . . marital status." The ECOA defines "applicant" as "any person who applies to a creditor directly for an extension, renewal, or continuation of credit . . . ." Though the ECOA does not expressly include guarantors within the definition of "applicant," the Federal Reserve Board, which previously had the power to issue regulations to implement the ECOA before Congress vested that authority in the Consumer Financial Protection Bureau, issued a regulation, known as "Regulation B," that broadly defines "applicant" to include guarantors. Regulation B provides that a "creditor shall not require the signature of an applicant’s spouse or other person, other than a joint applicant, on any credit instrument if the applicant qualifies under the creditor’s standards of creditworthiness for the amount and terms of the credit requested."
Based on Regulation B, several courts have voided spousal guaranties under the ECOA. In many of those cases, the spousal guarantor argued that, because he or she was neither an owner nor involved in the business, he or she could not be classified as a joint applicant and that the Creditor failed to assess whether the owner independently qualified for the extension of credit. A number of courts accepted these arguments and also held that joint ownership of collateral that does not directly benefit from the extension of the credit is not sufficient to turn a non-business owner spouse into a joint applicant.
Though the spouse arguably cannot be required to guaranty the debt, the Creditor may, however, require the spouse to sign a waiver of a spousal interest in certain collateral or a security instrument pledging collateral for the debt when the collateral is at least partially owned by the spouse. The ECOA also allows the Creditor to require a co-borrower or guarantor when the applicant does not qualify for the credit alone, but the Creditor arguably cannot require that the co-borrower or guarantor be the applicant’s spouse. Additionally, if the spouse is a co-owner of the business for which the debt provides a direct benefit, the spouse likely will be considered a joint applicant who then could be required to guaranty the debt.
Creditors should review their internal compliance procedures to ensure that they have designed and implemented a system that complies with this facet of the ECOA. Even though requiring a spousal guaranty from a married business owner may seem appropriate regardless of the spouse’s interest in the business, it may violate the ECOA if the spouse owns no interest in the business, and could expose the Creditor to damages and render the spousal guaranty unenforceable.
Note: On August 5, 2014, the United States Court of Appeals for the Eighth Circuit held that the Federal Reserve Board’s interpretation of "applicant" is not binding and that a person does not, by executing a guaranty, request credit and qualify as an "applicant." Though this is good news for creditors in the Eighth Circuit, this does not completely resolve this issue. The United States Supreme Court may decide to grant a petition for certiorari and weigh in on this issue because the United States Court of Appeals for the Sixth Circuit recently reached a contrary conclusion. Thus, some creditors may want to continue to operate as if the Sixth Circuit’s decision will be adopted by the Supreme Court and continue to take some precautionary measures to ensure compliance with the ECOA, regardless of whether the decision of the Eighth Circuit or Sixth Circuit is adopted.
If you have any questions or wish to discuss compliance with the ECOA, please contact Brian J. Koenig or another member of the Banking, Finance, and Creditors’ Rights Practice Group.
by Brian J. Koenig