By Trev Peterson
The Supreme Court will hear oral arguments in an appeal of a Reg. B case from the Eighth Circuit on October 5, 2015. The case, Hawkins v. Community Bank of Raymore, 761 F.3d 937 (8th Cir. 2014), involved a Reg. B challenge to spousal guarantees of a bank loan to a limited liability company. The Eighth Circuit held that the spouses/guarantors were not “applicants” as defined in the Equal Credit Opportunity Act (“ECOA”), 15 U.S.C. §1691 et seq.
In rendering its decision the Eighth Circuit also held that the expansive definition of “applicant” which included guarantors adopted by the Federal Reserve Board (the authority to adopt regulations has been changed to the Consumer Financial Protection Bureau) in Reg. B (12 C.F.R. §202.2(e)) exceeded the intent of Congress under its definition of “applicant” in the ECOA. The decision by the Eighth Circuit conflicts with the decision upholding the Fed’s definition in RL BB Acquisition, LLC v. Bridgemill Commons Development Group, LLC, 754 F.3d 380 (6th Cir. 2014).
Reg. B was adopted by the Fed to enforce the provisions of the ECOA. In 1974 Congress adopted the ECOA to eliminate discrimination against women, particularly married women. No longer was a lender legally able to refuse to grant a woman’s credit application solely on the basis of the failure of the woman’s husband to guaranty the debt, or solely on the basis of the marital status of the applicant.
The ECOA’s protection, however, was limited to “applicants” for credit. Congress empowered the Fed to promulgate regulations to enforce the ECOA. Reg. B is intended to promote the availability of credit to all creditworthy applicants without regard to a number of factors including sex and marital status and prohibits creditor practices that discriminate on the basis of any of those factors. 12 C.F.R. § 202.1(b), 12 C.F.R. § 1002.1(b). Among the practices disapproved by Reg. B is a lender’s requirement that the borrower’s spouse guaranty the debt. The regulations permit a lender to require that the debt be guaranteed, but the lender may not require that the guarantor be the applicant’s spouse. “The applicant’s spouse may serve as an additional party, but the creditor shall not require that the spouse be the additional party.” 12 C.F.R. §1002.7(d)(5).
Creditors who violate ECOA or Reg. B may be sued for actual damages, punitive damages and attorneys’ fees. 15 U.S.C. §1691e. However, only “applicants” have the ability to sue for ECOA violations.
To avoid liability under Reg. B our advice to lenders after the adoption of the “spouse-guarantor rule” was that a lender could require that the debt be guaranteed, but could not require that the debt be guaranteed by the applicant’s spouse. A lender could suggest that the spouse is an acceptable guarantor, but could not require that the spouse guaranty the debt without running afoul of Reg. B.
The Sixth and Eighth Circuits were each presented with the question of whether the Fed’s definition of “applicant” which included guarantors exceeded the scope of the Fed’s authority to issue regulations under the ECOA.
RL BB Acquisition, LLC v. Bridgemill Commons Development Group, LLC, 754 F.3d 380 (6th Cir. 2014), involved a wife’s guaranty of a bank loan to her husband’s LLC. The lender and the guarantor disputed how the lender obtained the guarantor’s guaranty. The lender provided a summary of the requirements for the loan which included a requirement that the wife “will be required to co-sign the notes with her future release subject to negotiation.” Id. at 382. The wife conceded that she never spoke with the loan officer, or anyone else at the bank, and that her husband told her that the bank required her signature on the guaranty. The wife said she felt tremendous pressure to sign the guaranty although she admitted that the pressure did not come directly from the lender. The debt was subsequently assigned by the lender to the plaintiff in the case. On cross motions for summary judgment the district court held that the wife/guarantor could not raise the ECOA claim; held that the wife was liable on the guaranty but the amount of the damages was unresolved. After the parties stipulated to the amount due, the district court entered judgment for the lender’s assignee and the guarantor appealed.
After discussing the purpose of the ECOA, the Sixth Circuit noted that the ECOA defined “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 Sixth Circuit determined that “applicant” as defined by Congress §1691a(b) was ambiguous because “applicant” could be read to include third parties—such as guarantors. The decision was based on the court’s view of the broad dictionary definitions of “applies” and “credit” as those words appear in the Congressional definition of “applicant.” Concluding that both “applies” and “credit” were ambiguous, the Sixth Circuit determined that the Fed’s expansion of “applicant” to include guarantors was not beyond the strict construction of the language Congress used in the definition of “applicant” in the ECOA.
Hawkins v. Community Bank of Raymore, 761 F.3d 937 (8th Cir. 2014), involved a loan to a limited liability company. The two owners of the limited liability company personally guaranteed the debt. In addition the bank required that the owners’ spouses guaranty the debt, which was done. When the loan went into default, the bank called the guarantees and the two spouses filed suit in federal court alleging a violation of the ECOA and Reg. B. The federal district court granted the bank’s motion for summary judgment and on appeal the Eighth Circuit affirmed, holding that the spouses/guarantors are not “applicants” as defined in the ECOA. In contrast to the Sixth Circuit, the Eighth Circuit concluded that “The ECOA clearly provides that a person does not qualify as an applicant under the statute solely by virtue of executing a guaranty to secure the debt of another.” To qualify as an applicant, the person must “appl[y] to a creditor directly for… credit, or… indirectly by use of an existing credit plan…”
Quoting 15 U.S.C. §1691a(b),
“A guarantor does not “apply” for an extension of credit. A guaranty is a promise to answer for the debt of another, and provides additional security for the loan.
A guaranty is collateral and secondary to the underlying loan transaction between the lender and the borrower. While a guarantor no doubt desires for a lender to extend credit to a borrower, it does not follow from the execution of a guaranty that a guarantor has requested credit or otherwise been involved in applying for credit. Thus, a guarantor does not request credit and therefore cannot qualify as an applicant under the unambiguous text of the ECOA.”
The Eighth Circuit noted the Sixth Circuit’s opinion in the RL BB Acquisition case but concluded that the text of the ECOA is unambiguous regarding whether a guarantor is an applicant, and the Eighth Circuit determined not to defer to the Fed’s definition of applicant. Because the guarantors did not argue that they qualified as applicants other than as per their status as guarantors of the debt, the Eighth Circuit concluded that the district court properly dismissed their ECOA claims.
The U.S. Supreme Court
The Supreme Court will determine whether the statutory definition of “applicant” is ambiguous. The Sixth Circuit stretched to find ambiguity in the definition and while the Supreme Court is normally reluctant to strike down administrative definitions, where, as here, Congress defined the term and the Fed expanded the definition, it is likely that the Supreme Court will side with the Eighth Circuit and hold that the language is clear and unambiguous and that the Fed’s definition of applicant is overbroad.
The Supreme Court is likely to rule on this case before the end of the year.
So what should lenders do now?
The safest course for lenders is to comply with the Fed’s definition of applicant in Reg. B. By requiring that a borrower find a guarantor, but not requiring that the spouse be the guarantor, the lender does not violate Reg. B. Even after any Supreme Court ruling, lenders may, as a matter of good business practice, wish to allow the borrower and the borrower’s spouse to determine whether the spouse should sign a guaranty of the debt. Nothing in the cases prevents the lender from requiring a spousal signature on security documents—such as a trust deed on the borrower’s and spouse’s homestead—to perfect the lender’s lien position. Lenders may require that all members of an LLC guaranty the debt (the problem in both of the cases was that the guarantors/spouses were not members of the borrower/LLCs).
Care should be taken in drafting commitment letters to be sure that the lender is not “requiring” a spousal guaranty. For example, if the borrower has offered a spousal guaranty, the commitment letter could provide “The bank requires personal guarantees of the Loan. You have offered to provide the guaranties of ________, who are acceptable to the bank.”