The Equal Credit Opportunity Act’s ban against credit discrimination on the basis of race, gender, national origin, and the other prohibited bases listed in the law – including marital status - is not terribly complex. Since its enactment 40 years ago, the ECOA has generated only a small fraction of the lawsuits that the Truth in Lending Act has spawned. Nevertheless, one ECOA rule in particular has continuously been an Achilles’ heel for creditors – the Spouse Guarantor Rule. The Rule is particularly difficult to apply because it attempts to address what would seem to be a logical credit request in the structuring of a loan; that is, the personal guaranty of husband and wife business owners, who often hold jointly-owned assets. A decision last month by the Sixth Circuit Court of Appeals in RL BB Acquisition, LLC v. Bridgemill Commons Development Group, LLC, has now strengthened the Rule by giving it both sword and shield status in the arsenal of a spouse-guarantor defending the enforcement of a guaranty
Bridgemill Commons Development Group, LLC (“BCDG”) was a Georgia real estate development company owned and operated by H. Bernard Dixon. When the Great Recession hit in 2008, Mr. Dixon applied to Bank “A” to refinance a $6.4 million loan BCDG owed to Bank “B”. He provided a personal financial statement to Bank “A” in support of his loan application that described his and his wife’s personal financial condition in 2008. Bank “A” informed Mr. Dixon that it would not approve the refinancing he sought without additional collateral. Mr. Dixon offered to pledge various securities, and Mr. Dixon’s wife, Starr, also offered to pledge certain securities held in her individual name. When this additional collateral still proved inadequate, the loan was approved on the strength of Mr. and Mrs. Dixon’s full personal guaranty. Bank “A” subsequently transferred the loan to Rialto Real Estate Fund, LP, who transferred it to the plaintiff, RL BB Acquisition, LLC. When Bridgemill defaulted upon the maturity of the note on June 5, 2010, the plaintiff filed a collection action in federal district court, including a breach of guaranty against Starr Dixon. In the defendants’ answer, Starr Dixon asserted that her guaranty was unenforceable since it violated ECOA and Regulation B’s prohibition AGAINST requiring a spousal guaranty.
The District Court for the Eastern District of Tennessee held that Starr could not raise violations of ECOA and Regulation B as an affirmative defense in recoupment. It found for the Plaintiff on the issue of liability under the guaranty, and after the parties stipulated to the amount of damages, Starr filed an appeal to the Sixth Circuit Court of Appeals.
However, this underlying question of fact was not before the Court of Appeals. Instead, the issues addressed by the Court concerned whether a guarantor could raise violations of ECOA and Regulation B as an affirmative defense. Specfically, the Court addressed whether the term “applicant” includes a guarantor, and whether a spouse-guarantor can assert the violation of the prohibition against requiring a spousal guaranty under Regulation B – and therefore ECOA – as an affirmative defense.
The first issue is significant because it determines who is entitled to ECOA’s protections and remedies. ECOA states that “applicants” for credit may raise claims for violations of ECOA. ECOA’s definition of “applicant” does not expressly include a “guarantor”; however, Regulation B defines “applicant” to include a guarantor for the purpose of enforcing the spouse-guarantor rule. Relying upon a long line of precedent, including the Supreme Court’s decision in Chevron, U.S.A., Inc. v. Natural Resources Defense Counsel, Inc., the Court gave deference to the Federal Reserve Board’s decision to interpret “applicant” to include a spouse-guarantor. According to the court, the ECOA’s definition of “applicant” is not straightforward and is easily broad enough to capture a guarantor, so that the agency’s interpretation was a reasonable and permissible construction of the statute.
Building on the first issue, the second issue concerns the right of a spouse-guarantor - in exercising her rights under ECOA as an applicant – to assert a violation of ECOA as an affirmative defense of recoupment as a remedy, in addition to the right to bring an independent lawsuit or counterclaim for an ECOA violation. The Sixth Circuit joined the First and Third Circuits in permitting the affirmative defense of recoupment for an ECOA violation. Recoupment allows a defendant to defend a claim by asserting her own claim against the plaintiff growing out of the same transaction, up to the amount of the claim. The Court refuted the Plaintiff’s argument that the affirmative defense was unavailable since it was not expressly permitted by the statute, on the grounds that the statute permits a court to grant “such equitable and declaratory relief as is necessary to enforce” the law.
Additionally, it found that invalidating a guaranty by means of a recoupment defense was not too drastic a remedy, as asserted by the Plaintiff. Regulation B permits spouse-guarantors to sue for actual damages for entering into an invalid guaranty – the Court pointed out that a “recoupment defense simply allows the spouse-guarantor to recover these actual damages in a different procedural posture.”
The Sixth Circuit’s RL BB Acquisition, LLC decision has strengthened the hand of spouse-guarantors in challenging the enforceability of their guaranties. There is some dispute as to how the guaranties of Mr. and Mrs. Dixon became a part of the loan transaction – Bank “A” maintains that Mr. Dixon offered both his and Starr Dixon’s guaranties, and Mr. Dixon’s recollection is that they were both demanded by the Bank. Starr recalled that her husband told her that her guaranty was required by the Bank, and that she felt tremendous pressure to sign it. This lack of clarity underscores the importance of clearly documenting as part of the credit underwriting the sequence of events leading to inclusion of a spousal guaranty as part of the credit terms. Creditors are well-advised to revisit their procedures for negotiating with an applicant where an application requires additional credit support that may include a spousal guaranty. Unambiguous documentation as to how a spousal guaranty was included as part of the loan terms will provide the creditor with strong support for refuting a claim of an ECOA violation.
The Sixth Circuit Court of Appeals has jurisdiction over the district court of covers, Kentucky, Ohio, Tennessee and the Western District of Michigan making this decision the controlling law in those jurisdictions.