Commercial lenders in Missouri should be aware of a recent Missouri Court of Appeals opinion regarding the enforceability of spousal guarantees under Regulation B of the Equal Credit Opportunity Act (the “ECOA”). The case, titled Frontenac Bank v. T.R. Hughes, Inc. et al., specifically holds that where a commercial borrower is independently creditworthy under the lender’s standards for determining creditworthiness, requiring the borrower’s spouse to execute an unlimited personal guarantee constitutes discrimination based on marital status under the ECOA. The case is also significant because it sets forth a relatively thorough analysis and discussion regarding when, and under what circumstances, a commercial lender may require a borrower’s spouse to execute personal guarantees and sheds light on the importance of having and following written guidelines and procedures when determining the creditworthiness of the borrower.
Factual Background
In the underlying case, Frontenac Bank brought suit against St. Louis homebuilder, T.R. Hughes, Inc., a related entity known as Summit Point, L.C., as well as their principal, Thomas R. Hughes and his wife,Carolyn, seeking to recover under several promissory notes, deeds of trust and accompanying guaranty agreements.
The defendants filed several counterclaims and asserted a variety of affirmative defenses—including the defense guaranty, which was an unlimited personal guaranty, was null and void because it violated the ECOA. The basis of this defense was that the borrowers, T.R. Hughes, Inc. and Summit Point, L.C., were both sufficiently creditworthy under Frontenac Bank’s own standards and as such, Frontenac Bank’s requirement that Carolyn guaranty the loans as a condition to their being made was unlawful as discriminating based on marital status under the ECOA. The trial court agreed and held the guarantees invalid and unenforceable.
The Appellate Court’s Opinion and Analysis
The Court of Appeals affirmed, specifically finding that:
a) T.R. Hughes, Inc. and Summit Point, L.C., were both independently creditworthy under Frontenac’s own written standards for creditworthiness;
b)Carolyn was not an officer, director or owner of the businesses whose loans were secured by her guarantees—thereby removing her from the ECOA’s exemption for the personal guarantees of officers, directors or owners of corporate borrowers; and
c) that her guarantees were not voluntarily given, but were in fact required by Frontenac as a precondition to making the loans.
In its analysis, the Court examined Frontenac’s loan procedure, its written policies and the language of Regulation B which expressly provides that a lender:
[s]hall not require the signature of an applicant’s spouse…on any credit instrument if the applicant qualifies under the creditor’s standards of creditworthiness for the amount and terms of credit requested.
In so doing, the Court determined that while Frontenac Bank’s loan officers may have had the ability and authority to consider a wide variety of factors in determining a borrower’s creditworthiness, its only written standard was the loan-to-value ratios contained in its loan policy—which ratios were met by T.R. Hughes, Inc. and Summit Point, L.C. The Court specifically noted that Frontenac’s “written policy speaks only of the ‘loan-to-value’ ratios…and does not include the additional qualifications that Frontenac alleges loan officers were permitted to consider in analyzing a borrower’s creditworthiness.” The Court further noted that Frontenac’s witnesses were “unaware of any credit analysis of [Summit Point, L.C or T.R. Hughes, Inc.] with respect to each loan…” and that “[r]ather than conducting an analysis of Summit and [T.R. Hughes, Inc.’s] creditworthiness, Frontenac deemed the joint financial statements [submitted by Tom and Carolyn] to be an offer by Carolyn to provide her guaranty as well.” This, the Court said, “seemed to be common practice by Frontenac in its treatment of requiring the guarantees by wives on all large loans.”
Based on the above, the Court concluded that because both T.R. Hughes, Inc. and Summit Point, L.C. were independently creditworthy under Frontenac’s own written standards and Frontenac could identify no other business reason or written policy for requesting the guarantees, requiring Carolyn to execute unlimited personal guarantees for each of the loans to T.R. Hughes, Inc. and Summit Point, L.C. constituted a violation of the ECOA. The Court buttressed its point by citingCarolyn’s trial testimony in which she stated that she never offered her guarantees, but only signed what her husband asked her to sign as a condition for his obtaining the loans.
Thus the Court concluded there was sufficient evidence to support the trial court’s finding that “Frontenac did not demand guarantees from Carolyn on the basis of any purported relationship with [Summit Point, L.C or T.R. Hughes, Inc.], but on the basis that Carolyn was Thomas’s wife…”.
Limited Personal Guarantees and Perfecting Security Interests in Jointly Held Collateral
Despite holdingCarolyn’s unlimited personal guarantees null and void, the Court specifically noted that under Regulation B:
[i]f an applicant requests secured credit, a creditor may require the signature of the applicant’s spouse…on any instrument necessary…under applicable state law to make the property being offered as security available to satisfy the debt in the event of default, for example, an instrument to create a valid lien, pass clear title, waive inchoate rights, or assign earnings.
The Court went on to direct that in a “tenants by the entireties” state such as Missouri, a limited guaranty from a debtor’s wife that did not extend beyond her interest in the property securing the loan, “fell within the exception of Regulation B, 12 C.F.R. § 202.7(d)(4).” The Court likewise noted that the ECOA does not prohibit spousal guarantees where the applicant is not “independently creditworthy”. However, because T.R. Hughes, Inc. and Summit Point, L.C. were deemed to be independently creditworthy, and because Frontenac’s unlimited personal guaranty was “more than a financial instrument necessary to make the property being offered as security available to satisfy a debt upon default…”, the Court concluded that Carolyn’s guarantees did not fall within the scope of the exceptions.
Conclusion
In the end, there is no doubt that the Court’s holding in Hughes will cause many commercial lenders to reexamine their policies and procedures regarding how, when and to what extent spousal guarantees are sought in commercial lending transactions. If Sauerwein Simon P.C. can be of any assistance to you in this regard, or you wish to discuss the Court’s decision in more detail, please do not hesitate to contact the attorneys of Sauerwein Simon P.C. at any time. A full copy of the Appellate Court’s Opinion can be found here.
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