Last week the Missouri Court of Appeals issued its opinion in Frontenac Bank v. T.R. Hughes, Inc., et al., which provides some guidance to lenders relating to business loans secured by real estate and spousal guarantees. While the opinion reaffirms recent Missouri Supreme Court opinions on the calculation of the deficiency post foreclosure sale and the so-called “ECOA defense” to spousal guaranties, the opinion once again highlights the old adage “bad facts create bad law.” Lenders can take away two lessons from this opinion. First, lenders should be very careful asserting a non-monetary default under a loan in Missouri or, in the event the lender so elects, lender must understand obtaining summary judgment could be difficult. Second, Missouri lenders need to avoid routinely requiring spousal guaranties of business loans.
In Frontenac Bank, Thomas and Carolyn Hughes, husband and wife, executed personal guaranties in support of promissory notes executed by two development companies, Summit Point, L.C. (“Summit”) and T.R. Hughes, Inc. (“Hughes”) in order to secure financing from Frontenac Bank (“Frontenac”). Frontenac later declared the Notes in default on the basis of a breach of the insecurity clause in the loan documents (i.e., Frontenac’s belief borrower unable to pay loan). After declaring this default, Frontenac undertook foreclosure sales of the real property securing the Notes and then sued Defendants for recovery of the deficiency. Defendants asserted counterclaims (later deemed affirmative defenses) in response. The trial court granted summary judgment in favor of Frontenac against all Defendants, but deferred consideration of Carolyn’s ECOA affirmative defense until after trial. Following trial, the court ruled in favor of Carolyn on her ECOA defense thereby voiding her guaranties. Defendants appealed the trial court’s grant of summary judgment, arguing there were genuine issues of material fact as to whether Frontenac was entitled to a deficiency and the amount thereof; Frontenac appealed the trial court’s finding Carolyn’s guaranties were null and void.
“Good Faith” Belief for Defaults related to Insolvency or Insecurity
While the Frontenac Bank decision reaffirmed the Missouri Supreme Court’s recent decision in First Bank vs. Fischer Frichtel, Inc. holding the foreclosure sale price rather than the “fair market value” of the property at the time of foreclosure was the appropriate credit amount to determine the deficiency balance (for a summary, click here), Frontenac based its default declaration on the subjective criteria of the “insolvency” and “insecurity” clauses in the loan documents. Borrowers only missed payments after the subjective defaults were called and Frontenac refused advance requests on a line of credit established to make payments. Because Frontenac used its discretion in declaring subjective defaults, Frontenac’s “good faith” belief became an issue; one sufficiently challenged by Defendants to create genuine issues of material fact precluding the grant of summary judgment. The court noted “the issues of insolvency and a good faith belief for insecurity are not well-defined for purposes of a summary judgment motion.”
Lenders therefore should beware that even where a lender has a strong basis for declaring defaults due to insolvency or insecurity, the lender may have difficulty obtaining summary judgment given the Frontenac Bank opinion—making the added expense of trial a real possibility.
Spousal Guaranties and the ECOA Defense:
Under the Equal Credit Opportunity Act, creditors are prohibited from discriminating against a credit applicant on the basis of marital status. Regulation B, promulgated under ECOA, goes further and forbids creditors from requiring a spouse’s signature where the borrower or guarantor is independently creditworthy under the lender’s standards.
The facts in Frontenac Bank were less than ideal. Some of the more troubling set of facts revealed that Frontenac’s articulated loan policy required only that the loans satisfy established loan-to-value ratios. In addition, while Carolyn Hughes was listed as the treasurer of the company, facts at trial revealed she had no such role. Further, particularly damaging at trial was a bank employee’s testimony that Frontenac routinely required personal guaranties from wives, because people “ought to be willing to support it with everything [they] had.”
Given the Frontenac Bank opinion, lenders should consider taking certain measures to protect themselves from similar claims going forward including the following:
- Include language in loan underwriting policies and commitment letters specifying that lending decisions are based on numerous factors.
- Lenders should avoid giving the impression that the Lender views the submission of joint financial statements as an offer on the part of the spouse to execute a spousal guaranty.
- Conduct more thorough due diligence to confirm the accuracy of a potential guarantor’s role as an owner, director or officer. Lenders that rely on representations of the potential guarantor in standard form documents without digging deeper do so at their peril.
In light of Frontenac Bank, failure to take adequate precaution risks the possibility that a spousal guarantee may be found invalid in its entirety.
In the meantime, we wait for the outcome of the likely appeal.