No lender wants to discover that a loan guaranty is unenforceable, but increasingly lenders are discovering just that and then some.
The lender also may be exposed to damages for obtaining the guaranty. The Equal Credit Opportunity Act, enacted almost 40 years ago, should be nothing new to lenders; however, the record level of loan defaults has brought renewed attention to it.
The Act prevents discrimination against a credit applicant based on a number of factors, including marital status.
Although the marital status protection in the Act originally was designed to protect unmarried women from discriminatory lending practices, regulations that followed the passage of the Act expanded that scope by prohibiting lenders from requiring the spouse of an independently creditworthy borrower to co-sign or co-guarantee a loan.
In July 2011, Florida’s First District Court of Appeal held that the spouse of an independently creditworthy borrower may assert a violation of the Act as an affirmative defense to void a guaranty obligation. See Chen v. Whitney Nat. Bank, 65 So.3d 1170, 1174 (Fla. 1st DCA 2011).
This decision marks one of the first instances in which a Florida court recognized this position. It is important to note, however, that such a violation does not void the underlying transaction, only the spouse’s guaranty. In Chen, the husband remained obligated to satisfy the loan.
More alarming to lenders is the potential for severe penalties for violations of the Act.
A court may award damages to the aggrieved spouse, including punitive damages of $10,000 per violation plus attorney’s fees. In a class action, liability can reach $500,000. See 12 C.F.R.
§ 202.16(b)(1).
Of course, there are circumstances when a spousal guaranty can be obtained and enforced. The most obvious is when both spouses have an ownership in a borrowing entity.
In addition, if an applicant does not alone meet the lender’s creditworthiness standards, the lender can require a co-signor or guarantor, but it cannot require that the co-signor or guarantor be the applicant’s or affiliated guarantor’s spouse.
Similarly, if a loan is to be secured by a piece of property, a creditor may require the guaranty of the applicant’s spouse if he or she has an interest in the collateral property.
Violations of the Act occur most commonly when a borrowing entity is owned by a person (but not his spouse) alone or with others. Generally, in that case, a lender may not require the spouse’s guaranty. If the lender is unable to make the loan, the prospective borrower can offer their spouse’s guaranty as additional consideration. In that situation, the lender should thoroughly document the sequence of events to evidence that the spouse’s guaranty was not initially requested by the lender.
Lenders must familiarize themselves with the rules governing spousal guaranties. Although the opportunity for liability is narrow, the consequences for a violation are significant, especially in light of recent court activity.
Institutional plans should be implemented and enforced to ensure and document with the Act compliance.
Compliance is not overly costly relative to the substantial exposure of non-compliance.