Requirement of Spousal Guaranty May Violate ECOA
When a closely held company applies for financing, the financial institution or business issuing credit (“Lender”) typically requires the owner to guaranty the debt to increase the likelihood the debt will be repaid. If the owner is married, the Lender 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 Lender violates the ECOA, the spousal guaranty may be void and the Lender may be liable for damages.
The ECOA is intended to prevent discrimination against a credit “applicant” on the basis of, among other things, marital status. It arguably prohibits a Lender from requiring that the applicant’s spouse guaranty the debt or sign a credit instrument as a co-borrower if the applicant otherwise individually qualifies for the credit without the spousal guaranty. The ECOA does not expressly include guarantors within the definition of “applicant,” but the Federal Reserve Board issued "Regulation B," which broadly defines “applicant” to include guarantors. Regulation B specifically provides that a “[lender] 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 [lender’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 he or she was neither an owner nor involved in the business, was not a joint applicant, and that the Lender failed to first determine whether the owner independently qualified for the credit. Several 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.
Recommendations for Lenders:
- Determine whether the owner individually qualifies for the credit without the spousal guaranty.
- If not, a co-borrower or guarantor is permitted, but the Lender arguably cannot require that the co-borrower or guarantor be the applicant’s spouse.
- If the spouse is a co-owner of the business, the spouse could be required to guaranty the debt.
- If the spouse cannot provide a guaranty, require the spouse to sign a waiver of a spousal interest in jointly-owned property.
- Review internal compliance procedures to ensure a system is designed and implemented that complies with this facet of the ECOA.
Takeaway:
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 Lender to damages and render the spousal guaranty unenforceable.
Note: Lenders should be aware of the jurisdictions controlling their agreements. Several U.S. federal circuit courts are split on whether requiring a spousal guaranty violates the ECOA. The Sixth Circuit has held that the definition of “applicant” could be construed to cover guarantors. However, the Seventh, Eighth, and Eleventh Circuits have all held that guarantors are not “applicants.” The U.S. Supreme Court considered the issue in 2016, but due to a split court, did not arrive at a resolution. Because of the Court’s even split, the law remains unsettled and the Court may be asked to hear the case again. Thus, this issue is worth keeping an eye on.
If you have any questions or wish to discuss compliance with the ECOA, please contact any member of the Banking & Finance Practice Group.
By Brian J. Koenig, edited by Andrew Osborn