Lenders and creditors who grant open credit terms are increasingly finding that the spousal guarantee they obtained at the time of the loan or extension of credit is worthless. Occasionally, creditors are even discovering that the guarantee exposes them to significant damages and lawsuits brought by angry guarantors. The Federal Equal Credit Opportunity Act ("ECOA") in Regulation B describes how spouses may and may not be included in credit transactions.¹

A creditor is "a person who, in the ordinary course of business, regularly participates in the decision of whether or not to extend credit." A credit transaction under the law means "every aspect of an applicant’s dealings with a creditor regarding an application for credit or an existing extension of credit." The ECOA and the regulations which implement the ECOA provide sweeping prohibitions against discrimination by creditors against any applicant with regard to any aspect of a credit transaction. Congress’ purpose in enacting the ECOA was to ensure that financial institutions and businesses engaged in extensions of credit make credit available on a fair and impartial basis without discrimination on the basis of sex or marital status. All forms of consumer and business credit are potentially affected by the ECOA.

Damages

Ignorance of ECOA requirements can be costly. Creditors who violate the ECOA may be held liable to aggrieved guarantors for actual damages suffered, punitive damages of $10,000 (or in a class action, the lesser of $500,000 or one percent of the net worth of the creditor), reasonable attorney’s fees, and any other relief the Court may deem appropriate (such as striking the underlying obligation which was guaranteed). Enforcement actions may be brought by applicants within two years after the occurrence of an equal credit violation. Since the time period for affirmative action claiming damages under the statute is relatively short, the number of these cases reported is minimal. Expect this trend to change as more and more attorneys become aware of the rich pot of potential damages (including ever-popular attorney’s fees) available at the end of the ECOA violation rainbow. Expect also the increased use of the internet as a vehicle for exchange of ideas among these attorneys will hasten the spread of this information.

Statute of Limitations

There is some dispute among courts regarding exactly what the "occurrence" is that begins the two-year statute of limitation. The courts seem unsure whether the occurrence of an ECOA violation takes place when the issue of a spousal guarantee is first raised in discussions between the creditor and its customers or at consummation of the transaction where the prohibited guarantee is actually executed.

Even though damage claims are prohibited when the two-year statute of limitations expires, the aggrieved spouse can still successfully assert an affirmative defense under ECOA in the nature of "recoupment." When a plaintiff brings a claim against a defendant and the defendant has a defense that arises out of the same transaction as the plaintiff’s claim, that is "recoupment". The "recoupment" defense exists as long as the plaintiff’s cause of action exists. Said another way, the aggrieved spouse can always assert the ECOA violation when the lender or creditor brings an action to collect the debt under the spousal guarantee. This is true even though the spouse’s independent cause of action against the lender/creditor can no longer be brought on its own because of the passage of the two-year statute of limitations. A few courts, however, believing that lenders/creditors should be penalized for violations of the ECOA, have allowed the aggrieved spouse to bring the money damage claim when the lender/creditor sued the spouse on the guaranteed obligation, even though it has been more than two years since the guaranty was executed. Another issue arising under the ECOA, which bears close monitoring, is the tendency of a few courts to say an ECOA violation not only cancels the spousal obligation, but also taints the entire obligation with illegality. These courts may rule that the entire underlying instrument will be voided.

What Can A Lender Do?

Each lender/creditor should have creditworthiness guidelines by which they objectively assess an applicant to determine whether to extend credit. These guidelines may set out situations where the creditor may require additional collateral or require additional parties to serve as guarantors or other co-obligors on the loan or credit transaction. A lender or creditor offering secured credit may also require the signature of the applicant’s spouse or any other person necessary under applicable state law to make the property being offered as security available to satisfy the debt in the event of default. An applicant who requests individual credit but relies on the income of another person (including the spouse in a non-community property state) or an applicant who applies for joint credit, may also be required to provide the signature of another person such as the spouse in order to support the extension of credit. For example, if the applicant wishes to pledge real property held in the applicant’s name and the name of a co-owner as collateral for the loan, applicable state law may require that the co-owner of the property sign the mortgage or deed of trust. In this circumstance, the lender/ creditor may require that the co-owner spouse sign the pledge instrument. However, unless applicable state law mandates that the spouse co-sign the Note in order to create the enforceable lien, the lender/creditor may not also require that the non-applicant spouse also sign the underlying Note.

Lender Documentation

Lenders and creditors must work carefully to ensure that their actions comply with ECOA requirements, and perhaps even more importantly, to ensure that compliance is documented. Every effort must be made to ensure that "form" documentation already in existence does not undermine the lender/creditor’s position. For example, loan applications, form commitment letters and credit applications should be reviewed and revised so as to eliminate mandatory requirements for spousal information and guarantees. Lenders and creditors must document the grounds for the spousal’s guarantee and how it was obtained. All written materials related to the loan or credit transaction must consistently support and report the proper behavior of the creditor/lender and the mechanisms through which the spousal guarantee was obtained. Document any of the following that are true.

• the initial application was for joint credit

• the applicant sought to pledge property held jointly by the applicant and the applicant’s spouse

• the applicant offered additional collateral co-owned by the spouse or the spousal guarantee as a way to ensure creditworthiness so that the loan or credit would be extended

• the credit requested could not be granted based on creditworthiness and current underwriting standards without additional collateral or the support of another co-obligor

• in the case of a real property mortgage, the spouse’s signature was necessary to ensure the deed of trust or mortgage could be foreclosed in the event of a default on the primary obligation

One court has enforced a spousal guarantee that was unlawfully required by a lender.² The Indiana Court of Appeals found that a lender is not liable for an unlawfully required spousal guarantee if the lender gets the spouse to sign a subsequent release. If the spouse waives both her right to sue the lender for damages for the violation and her right to assert the violation as a defense to an action against her by the lender to collect on her guarantee, then the lender cannot be liable for an ECOA violation. Since the reference specifically cited the ECOA, use of this release strategy should only be used where the guarantying spouse is already aware of these potential defenses under the ECOA.

In Summary...

Lenders and creditors extending business credit must arm themselves with knowledge of ECOA requirements and ensure they avoid the traps in the ECOA minefield. Having traversed the minefield, they must document their success in such a way to show all the rules were followed.

If you have questions regarding this publication, please contact Judy Thompson at (704) 342-5299 or  jdthompson@poynerspruill.com or Deborah Tyson at (704) 342-5316 or dtyson@poynerspruill.com.

¹  See 11 U.S.C. 1691 et. seq. (1989).
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²  Zollman v. Geneva Leasing Associates, Inc., 780 N.E.2d, 387 (Ind. Ct. App. 2002).
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This electronic publication is published by Poyner & Spruill LLP to provide general information about significant legal developments. Because the facts in each situation vary, the legal precedents noted herein may not be applicable to individual circumstances.