Lenders must comply with a constantly changing series of State and Federal laws and regulations.
When loan relationships sour, and lenders seek to collect, borrowers and guarantors may allege the lender has violated some law or regulation.
A common allegation is a lender has violated "Regulation B" by improperly requiring the spouse of a borrower or guarantor to also become obligated for a loan. Fortunately, several recent cases have held that specific language in a workout or forbearance agreement is effective to waive any Regulation B claims. Lenders should not miss the opportunity to insert this pre-approved language in their forbearance or modification agreements.
The Evolution of Regulation B
Regulation B is an implementing regulation of the Equal Credit Opportunity Act ("ECOA"). Congress enacted ECOA in 1974 to combat the problem of lenders refusing to extend individual credit to married women, instead of requiring their husbands to sign on the loan. Regulation B was meant to solve this problem by prohibiting a lender from requiring the joint signature of a spouse if the applying spouse independently qualified for the loan.
While Regulation B was initially designed to prohibit exclusion of women from loan transactions, creative and opportunistic borrowers and guarantors now use Regulation B in reverse, asserting that lenders violate Regulation B by including women in loan transactions. Lenders must be aware that the prospect of a Regulation B claim lurks anytime both spouses are required to become obligated for a debt, whether as co-borrowers or guarantors.
A Common Scenario
John owns an art gallery downtown. John's wife, Susie, is a college professor and does not work at the business. John and Susie own their residence together and have joint bank accounts. When the art gallery needed to update its rental space, John applied for a loan. The lender approved the loan to the art gallery but also required John and Susie to personally guarantee repayment. Neither John nor Susie objected. They understood that personal guarantees were common for small business loans.
Before long, the art gallery fell behind on payments to the bank. The bank twice agreed to give the art gallery more time to catch up on its payments. Ultimately, John was unable to keep the art gallery afloat and he closed the business. After the bank filed suit to enforce John and Susie's guarantees, Susie's attorney responded that the bank has violated Regulation B so that Susie's guarantee is null and void, and the bank is liable for costs and other penalties.
The Requirements of Regulation B and Litigation Issues
A lender can demonstrate that a spousal guarantee was not procured in violation of Regulation B by working through the following steps:
- Determine whether the corporate borrower qualifies for the requested credit based upon its own assets and finances.
- If the corporate borrower does not qualify based upon its own assets and finances, the lender may then request that business owners provide a personal guarantee.
- If the corporate borrower's assets and finances, coupled with the owners' guarantee, still do not meet the lender's ordinary credit approval standards for the requested credit, the lender may inform the owner that an additional guarantor is needed. However, the lender may not require that the owner's spouse be that additional guarantor.
- The lender may accept an owner's spouse as the additional guarantor so long as the spouse volunteers, rather than being required by the lender to guarantee the loan.
This process creates problems for lenders. Lenders are still exposed to litigation because spousal guarantors are free to question whether the lender really considered making the loan without the spousal guarantee, or whether the lender really required the spousal guaranty. As a result, lenders frequently face allegations that they have violated Regulation B, and those allegations create uncertainty and risk.
In the example above, Regulation B would not likely be an issue if John and Susie each owned an interest in the art gallery. Also, if Susie were the sole owner of the art gallery, Regulation B would apply equally to a lender's requirement that John guarantees the business loan along with Susie.
Creating a Record of Initial Compliance with Regulation B
Fortunately, there are steps that lenders can take to ward off potential Regulation B claims. Initially, lenders should ensure that their files are well-documented to show compliance with the steps described above. Good documentation of the lender's separate underwriting of the corporate borrower, then the addition of an owner's guarantee, prior to obtaining a spousal guarantee is the best way to show that Regulation B was not violated in the first place. Further, the lender should have each spouse sign an acknowledgment that the lender informed the owner-spouse that an additional guarantee was needed, that the non-owner spouse was not required to be the additional guarantor, but that the non-owner spouse volunteered to sign a guaranty.
Forbearance or Modification is a Chance to Eliminate Regulation B Claims
Forbearance or loan modification agreements provide important opportunities for lenders to get something in return for lenience in enforcement of lenders' rights. Those agreements should be signed by spousal borrowers or guarantors (as well as all other borrowers and guarantors) and should include specific provisions where guarantors acknowledge the validity of their guarantees and waive and release any potential claims or defenses which they may have against the lender.
Several recent Court decisions in North Carolina have upheld such specific waiver provisions as barring a later attempt by a spousal borrower or guarantor to raise a Regulation B issue against a lender. Thus, lenders can use the opportunity of a forbearance or loan modification, which benefits borrowers and guarantors, as an opportunity to reduce or eliminate future roadblocks to recovery, such as thorny Regulation B claims.
Two of these decisions are particularly useful because they disclose the specific language which the Courts found sufficient to waive any potential Regulation B claims. That language is:
The original obligation of the Borrower(s) as evidenced by the [Note] above described is not extinguished hereby. It is also understood and agreed that except for the modification(s) contained herein said [Note] shall be and remain in full force and effect. Borrower and Debtor(s)/Grantor(s), if any, jointly and severally consent to the terms of this Agreement, waive any objection thereto, affirm any and all obligations to Bank and certify that there are no defenses or offsets against said obligations or the Bank, including without limitation the [Note].
Lenders: Take a hint!
If you enter into a forbearance agreement or loan modification agreement that does not contain the above language, you are missing an important opportunity. If your forbearance and loan modification agreements contain waiver language that differs from the above language, you are inviting a spousal borrower or guarantor to argue why it should not be binding. Take full advantage of the opportunity. Include this pre-approved language in your forbearance and loan modification agreements.
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This article is not intended to give, and should not be relied upon for, legal advice in any particular circumstance or fact situation. No action should be taken in reliance upon the information contained in this article without obtaining the advice of an attorney.