The US Supreme Court has agreed to review a decision by the Eight Circuit Court of Appeals in Hawkins v. Community Bank of Raymore, 761 F3d 937 (CA8 2014) where the court found that the Federal Reserve had overstepped its bounds in adopting rules under the Equal Credit Opportunity Act to protect spousal guarantors. The case arose out of a series of loans in 2005 and 2008 made by the Bank—totaling more than $2,000,000—to PHC Development, LLC to fund the development of a residential subdivision. In connection with each loan and each modification, the principals of the LLC and their spouses (who had no interest in the LLC) executed personal guaranties in favor of Community to secure the loans.
In April 2012, Community declared the loans to be in default, accelerated the loans, and demanded payment both from PHC and from the guarantors. The guarantors defended on the basis that Community had required them to execute the guaranties solely because they were married to their respective husbands. They claimed that this requirement constituted discrimination against them on the basis of their marital status, in violation of the ECOA. The Federal Reserve has adopted Regulation B which prohibits a lender from requiring a person’s spouse to join in on any credit documents unless the parties are applying for joint credit. 12 CFR 202(d)(1).
The ECOA makes it “unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction … on the basis of … marital status.” 15 U.S.C. § 1691(a).
The statute defines “applicant” as “any person who applies to a creditor directly for an extension, renewal, or continuation of credit, or applies to a creditor indirectly by use of an existing credit plan for an amount exceeding a previously established credit limit.” 15 U.S.C. § 1691a(b).
The district court concluded that the spouses were not “applicants” within the meaning of the ECOA and thus that Bank had not violated the ECOA by requiring them to execute the guaranties. Accordingly, the district court granted summary judgment in favor of the Bank on the ECOA claim and on the ECOA-based affirmative defense to the Bank’s breach-of-guaranty counterclaims.
The 8th Circuit affirmed the lower court decision and held that the plain language of the ECOA provides that a person is an applicant only if he or she requests credit. In their view, executing a guaranty does not constitute a request for credit.
The decision is in direct opposition to a number of other appellate decisions where courts have found that the Reg B spousal guaranty rule is valid and offers aggrieved spouses a defense against the enforcement of guaranties which had been executed in violation of the rule.
The Bank filed for review by the Supreme Court and the petition was granted in March of this year. There are two issues submitted for review: (1) Whether “primarily and unconditionally liable” spousal guarantors are unambiguously excluded from being Equal Credit Opportunity Act (ECOA) “applicants” because they are not integrally part of “any aspect of a credit transaction”; and (2) whether the Federal Reserve Board has authority under the ECOA to include by regulation spousal guarantors as “applicants” to further the purposes of eliminating discrimination against married women.
The case is fascinating for several reasons. First, we are dealing with a regulation that was first promulgated in 1975 and then amended in 1977 and 1985 to clarify the protection offered guarantors. Over several decades any number of state and federal courts have had the opportunity to review Reg B and the spousal guaranty rule and have never disputed the Federal Reserve’s ability to adopt the protection. Let’s face it, when something has been in effect for 40 years, one assumes that the chances of getting a court to overturn it is pretty small. Second, we have just seen in the AIG case where a federal court held that the Fed went beyond its authority in devising the takeover of AIG during the financial crisis. One wonders if the traditional deference courts have regularly offered the Federal Reserve has begun to weaken. Third, guess who is now responsible for enforcing Reg B? That’s right, the CFPB and they have filed an amicus brief arguing that the Reg B spousal guaranty rule was adopted properly and should be enforced.
I think that Reg B is one of those rules that lenders understand best in the consumer context. If Bill is creditworthy and comes in for a car loan, lenders understand that they can’t simply demand that Bill provide some additional guarantor, much less demand that his spouse co-sign the loan. Things become more complicated is in the business loan context where, as in the Hawkins case, a company is applying for credit. Lenders sometimes take a shorthand approach of “get as many guaranties as we can” as opposed to beginning with a true credit based approach of what is actually necessary to underwrite the loan on a sound basis and what is permissible under the ECOA. As a result, they may find that some of the guaranties may not be enforceable.
Oral arguments in the Hawkins v. Community Bank of Raymore case will be held this October. Until a final decision is reached, the prudent thing for lenders to do would be to assume that the spousal guaranty rule is still applicable and act accordingly. It is not clear at this point what will happen if the Supreme Court strikes down the spousal guaranty rule. It is hard to see the current Congress amending the ECOA to expand protection under the Act. If the rule is upheld, lenders should be back to operating under the same rules that have been in place for the last 30 years.
Take Aways: (1) Lenders should periodically review their internal credit policies to insure that they conform to the current understanding of the ECOA and Reg B. (2) Risk minimization does not stop with adopting a good credit policy, Reg B compliance needs to be communicated to loan officers and credit underwriters. (3) Post closing, there are ways to minimize risk even if a violation has occurred. For example, courts have found that certain ECOA defenses may be waived in the context of a loan forbearance or workout agreement. (4) When in doubt, consult with counsel on the front end in order to minimize legal risk and the likelihood that a guaranty might not be enforceable down the road.
The lawyers at Bryan Cave have experience in advising clients on all aspects of the bank regulations including issues arising under the following federal laws (and state law equivalents, where applicable): Truth in Lending Act, Equal Credit Opportunity Act, Real Estate Settlement Procedures Act, Electronic Fund Transfers Act, Truth in Savings Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, Federal Trade Commission Act Section 5 (unfair or deceptive acts or practices), and Gramm-Leach-Bliley Act Title V (consumer privacy).