For Better or Worse

0816_forbetter_770

Supreme Court divided in case on spousal guaranties under Regulation B

By Andrew Muller

The judgment is affirmed by an equally divided Court.” With that one sentence, the Supreme Court case of Hawkins v. Community Bank of Raymore came to an end. The first 4-4 decision from the high court since the death of Justice Antonin Scalia leaves unresolved, at least on a national level, whether the Board of Governors of the Federal Reserve acted within its authority when it revised Regulation B and changed the definition of “applicant” under the Equal Credit Opportunity Act (ECOA) to include the spouses of persons who guaranty commercial debt.

After Justice Scalia’s sudden death, the case was resolved as a 4-4 split, leaving the ultimate decision for another day, and for another case. This means, in the Eighth Circuit, guarantors do not have standing to bring Regulation B claims, but in the Sixth Circuit, they do. Other federal circuit courts will now be able to weigh in with their own opinions.

When the court heard oral arguments in this case, the justices confirmed they understood the true issue was not really lending discrimination, but rather agency power. Several of their questions focused on whether Congress’ use of the word “applicant” might be broad enough to include guarantors; whether various dictionary definitions of “applicant” might shed light on the issue; and whether Justice Stephen Breyer could be said to be an “applicant” if he applies on behalf of his grandson for kindergarten.

The touchstone of a discrimination claim under the ECOA is whether the lender denied a loan or made a less favorable loan to an applicant who was otherwise qualified for the loan, because of the applicant’s gender, marital status, race or national origin. As counsel of record representing ICBA and other trade associations, we weighed in, filing a brief in support of Community Bank of Raymore. ICBA demonstrated how the concepts of creditworthiness mean different things when applied to the corporate borrower versus when applied to the owner-guarantors.

In its brief, ICBA stressed that, in the commercial lending context, guarantors of small-business debt differ markedly from the concept of a loan applicant as defined by Congress. Lenders do not evaluate the creditworthiness of a guarantor in the same manner that they might evaluate the creditworthiness of the borrower for purposes of underwriting the loan.

In the amicus brief, ICBA demonstrated that creditworthiness means different things when applied to corporate borrowers and to owner-quarantors.

For most lenders, the creditworthiness in the context of the corporate borrower considers the company’s ability to repay the loan through operations, taking into account the borrower’s revenues, assets and expenses. When evaluating guarantors, the analysis focuses more on what support the guarantor brings to the credit. To be sure, a portion of this review considers the guarantor’s assets, net worth and personal cash flow with an eye toward how the guarantor might contribute to keep the company operating and keep the loan in good standing.

Thus, these differences between how lenders view borrowers versus guarantors in the underwriting process made the ECOA’s provisions unworkable in the guarantor context; guarantors simply are not the same as “applicants” under Congress’ definition in the ECOA.

Furthermore, obtaining guaranties of commercial loans results from sound credit-making decisions and not because of any discriminatory animus. Far from simply being a secondary source of repayment, a personal guaranty may encourage a business owner to stay involved in a struggling enterprise and to commit to keeping the business afloat. The personal guaranty can serve to disincentivize a corporate owner from surrendering the business and walking away from the debt to the bank. In some cases, these efforts to aid a struggling company may depend on the guarantor’s ability to provide financial support to the corporate borrower.

costs for credit. Such a scenario, ICBA argued to the Supreme Court, serves as a stark example of why providing guarantors with protection under ECOA makes little sense to the lending industry.

Unfortunately, because of the 4-4 split in the Hawkins case, community banks outside of the Eighth Circuit Court of Appeals’ jurisdiction do not have definitive resolution on the issue of whether spousal guarantors will be permitted to bring claims under ECOA. Given that uncertainty, it is worth remembering these few best practices when evaluating a loan that may involve spousal guaranties:

  1. Document the process for reviewing and evaluating the financial strength of the borrower(s) and the guarantors, which may involve more than just receiving joint financial statements.
  2. If a joint financial statement does not show sufficient assets owned by the owner-guarantor, document the communication that the owner-guarantor’s assets are not sufficient to support the guaranty.
  3. If the owner offers to provide the spouse’s guaranty as additional credit support, obtain that offer in writing and put it in the loan file.
  4. Include language in your community bank’s spousal guaranties stating that the guaranties were voluntarily provided by the guarantor and not at the request of the bank.
  5. Consider other options for spousal credit support other than an unlimited, unconditional guaranty such as pledges of marital assets or limited guaranties that would place a cap on the spouse’s guaranty
    obligations.

  6. Andrew Muller andrew.muller@stinson.com
    is a partner in the law firm Stinson Leonard Street LLP in Kansas City, Mo., who represented ICBA and other trade associations that filed a joint amicus brief in this case before the U.S. Supreme Court.

comments powered by Disqus
Top