In the world of commercial finance, it is not unusual to encounter a lender who automatically seeks the guaranty of the applicant’s spouse. If a default subsequently ensues, the lender will pursue the guarantor spouse for payment of the principal obligor’s debt. Typically the paperwork is in order and the lender’s form of guaranty is quite thorough. What possible defense can be raised by the guarantor spouse to avoid liability?
The Equal Credit Opportunity Act (“ECOA”) may present an opportunity. If a spouse of an applicant is required to execute a guaranty simply because the spouse is married to the borrower or another guarantor without further inquiry as to the creditworthiness of the borrower or first guarantor, a defense to enforcement of the guaranty may be available.
The ECOA prohibits a creditor from discriminating against any applicant with respect to a credit transaction “on the basis of race, color, religion, national origin, sex or marital status, or age.” Requiring a borrower or guarantor to obtain a spouse’s guaranty when the borrower or guarantor meets the lender’s borrowing standards if he was not married is discriminatory based on marital status. The lender is treating the borrower differently solely because he is married and damages the borrower by precluding him from establishing credit on his own. The Federal Reserve Board promulgated the following regulation to deal with this: “A creditor shall not require the signature of an applicant’s spouse or other person, other than a joint applicant, on any credit instrument if the applicant qualifies under the creditor’s standards of creditworthiness for the amount and terms of the credit requested.”
The aggrieved guarantor may bring a civil action against the violating lender. However, it is more likely that the issue first presents itself after a default has occurred and the lender is chasing the guarantor spouse. At that time the two year statute of limitations may have run so the guarantor spouse is time-barred from seeking damages. In this situation, the spouse will seek to raise the lender’s violation as an affirmative defense to the creditor’s claim. But the ECOA does not expressly authorize a guarantor spouse to raise the ECOA violation as an affirmative defense and there is a split of authority on whether this remedy is available.
The trend is clearly in favor of allowing the aggrieved guarantor to raise the ECOA violation as an affirmative defense. The courts ruling in favor of the guarantor spouse identify several bases upon which they justify their holdings: (1) it would frustrate the purpose of ECOA and be contrary to public policy to enforce an obligation that violated ECOA, (2) the lender should not benefit from its violation of the law and denying enforceability of the guaranty would deter future violations, and (3) permitting a guarantor to raise the defense after the statute of limitations has run on the ECOA violation best protects victims of credit discrimination because until the lender pursues them under their guaranty they had no knowledge of ECOA’s provisions.
There is nothing new in this blog. The ECOA has been around for decades and the issue discussed herein has frequently been the subject of litigation. However, I thought this would be useful for those guarantors and their counsel who were unaware of the opportunity provided by the ECOA.