Reg. B is no guaranty: Missouri courts' openly divergent views on the enforceability of coerced spousal guaranties in commercial lending.

• Author: Hurst, Alexander

1. INTRODUCTION

   It is a common narrative: a husband operates a business held by a limited liability entity and applies for a business loan on which the entity is made the primary borrower. Given the risk that the bank could lose the loan amount via discharge in corporate dissolution, the bank requires a personal guaranty from either the husband alone, or the husband and his wife. (1) It is in the second scenario in which there is a potential violation of law. (2)

   A provision commonly known as Regulation B ("Reg. B"), (3) which expands upon the Equal Credit Opportunity Act ("ECOA"), (4) disallows the practice of requiring a husband or wife to co-sign or guaranty an application for credit whenever the primary spouse would independently meet the creditor's standards for creditworthiness. (5) The purpose of Reg. B and the ECOA is to protect married persons from what amounts to discrimination in lending based on marital status. (6) Congress passed the ECOA at a time when lenders often discriminated against married, and even divorced, (7) women based on outdated gender stereotypes. (8)

   While outright gender-related discrimination has probably become a less common factor in lenders' underwriting decisions (likely thanks to a combination of the ECOA and shifting social mores), marital status is still encountered as an element in lenders' determinations of creditworthiness. (9) Banks and other lending institutions tend to be wary of lending to only one spouse, (10) which, depending on state property law, could prevent them from being able to foreclose against the couple's jointly-held assets. (11) Often in these situations, the non-applicant spouse has very few independent assets, whereas the applying spouse may be a wealthy investor who could easily meet the lender's credit standards individually if he or she were not married. (12) Relying on Reg. B's ostensible protection, married individuals can attempt to avoid liability for their spouse's default after having been forced to personally guarantee the obligation. (13) This is true even though the couple is often still married at the time of default because the couple is attempting to limit the number of foreclosable assets and, in the most extreme circumstances, void the underlying obligation for illegality. (14)

   While Reg. B has included guarantors under its blanket of ECOA protection since 1986, (15) it was not until recently that the validity of the Federal Reserve Board's extension of the ECOA to such indirect "applicants" for credit was called into question. (16) In the wake of a U.S. Court of Appeals for the Seventh Circuit decision declaring Reg. B as it applies to guarantors invalid largely based on a textualist argument concerning the definition of the term "applicant," (17) some courts outside the Seventh Circuit have followed Judge Posner's persuasive authority, while others have not. (18) Because state and federal courts have concurrent jurisdiction to interpret the ECOA and Reg. B, the door has been opened for the possibility--and reality--that courts within the same physical realm of personal jurisdiction would reach opposing conclusions on the same issue. (19)

   Nowhere is this more apparent than in the state of Missouri, where the state's two federal district courts have jointly decided to follow the Seventh Circuit's persuasive authority that Reg. B is invalid, (20) whereas Missouri's state courts have continued to follow Reg. B's language and presumed validity. (21) As a result, both potential guarantors for an applicant and the lending institutions from which the guaranteed applicant borrows are faced with a striking amount of uncertainty as to what their rights are vis-a-vis required spousal guaranties. (22) Specifically, potential litigants stand to see the enforceability of a spousal guaranty eligible for the supposed affirmative defense or compulsory counterclaim (23) of Reg. B turn entirely on whether the lawsuit is filed in state or federal court in Missouri. (24)

   This Summary examines how this inconsistency of law came to be, the public policy arguments for and against protecting spouses from being required to sign guaranties, and the potential actions which could be taken to resolve the issue. First, this Summary will examine the legal background of the ECOA and Reg. B as well as the paradigm that developed under the assumption that Reg. B was valid law. The Summary will then turn to the recent diverging cases dealing with the regulation's validity in chronological order, starting with the federal cases that called the law's validity into question, then moving to the Missouri state appellate court case that declined to adhere to this holding, and finally ending with the remaining Missouri federal court cases that have since recognized the disagreement and followed the federal precedent. Lastly, this Summary will analyze whether the bar on spousal guaranties is sound policy and will ultimately address the larger issues that have allowed this quagmire to develop, thereby invoking questions of statutory construction, spousal property law, and the nexus of federal and state courts.

2. LEGAL BACKGROUND

   1. The Terms of the ECOA and Reg. B

      Before delving into the dispute of law at hand, it is important to understand the background underlying both the ECOA (25) and its implementing regulation, Reg. B, (26) as well as the rationales for their enactment. The ECOA, which was enacted by Congress in 1974 and first amended in 1976, prohibits discrimination in lending based on the traditionally protected classes: race, color, religion, national origin, sex, marital status, and age (absent any incapacity to contract). (27) The legislation also makes it illegal to discriminate based on the fact that the applicant is receiving some form of public assistance. (28) One of the main reasons for the ECOA's enactment was to prevent discrimination against married women, (29) a group against which many banks had discriminated under the notion that they "would not be a good credit risk because [they] would be distracted by child care or some other stereotypically female responsibility." (30) Accordingly, many banks had maintained a policy of denying married women credit unless they obtained their husbands' co-signatures. (31)

      To further the goal of preventing discrimination against any of the protected classes, the ECOA authorized the Board of Governors of the Federal Reserve System (the "FRB") (32) to adopt and promulgate regulations in agreement therewith. (33) Accordingly, the FRB adopted Reg. B, which further expanded the ECOA's protections. (34) Reg. B enumerates what lending practices and acts are specifically required, allowed, and prohibited. (35) The main thrust of Reg. B in this context is to generally prohibit a creditor from requiring

      the signature of an applicant's spouse or other person, other than a joint applicant, on any credit instrument if the applicant [individually] qualifies under the creditor's standards of creditworthiness for the amount and terms of the credit requested. A creditor shall not deem the submission of a joint financial statement or other evidence of jointly held assets as an application for joint credit. (36) Essentially, the ECOA and Reg. B operate to prevent a creditor from forcing a spouse to be a joint obligor where the primary spouse is independently creditworthy. Some courts have held that the Reg. B protections must be applied not only during the initial extension of credit but also to reevaluate the need for a guarantor in any subsequent modifications. (37) It is an important distinction that the regulation was not intended to prevent spouses from signing as guarantors generally but rather to prevent a spouse from being required to sign because he or she is the spouse; the latter is the essence of discrimination based on marital status contemplated by the ECOA. (38)

      Note, however, that it is not illegal to require a non-obligated spouse to sign a deed of trust, mortgage, or other instrument necessary to create an enforceable security interest to an item of collateral, or, in the case of an unsecured creditor, a similar instrument that would ensure the creditor could reach the jointly-held property upon default whenever such property materially affects whether the obligated spouse is creditworthy. (39) While the ECOA applies to extensions of credit, it does not encumber a creditor that is acting to create a valid lien, ensure the passage of clear title, or waive inchoate rights to property. (40) Reg. B makes exceptions for secured credit where the proffered collateral is jointly owned and thus would reasonably require the signature of both spouses in order to be foreclosable under state property law. (41) Unsecured creditors in community property states (42) are similarly permitted to obtain a spouse's signature on such instruments subject to some conditions (43) so that creditors might be able to reach the communal property in the event of default. So too are unsecured creditors in non-community property states in order to obtain a valid lien against jointly-held property in certain circumstances. (44) It is important to keep in mind the (at times subtle) distinction between requiring a spousal guaranty--that is to say making the disinterested spouse liable to the same extent as the primary spouse--and requiring that the disinterested spouse grant a lien on a specific piece of jointly-held property. The former is forbidden by Reg. B; the latter is not.

      The FRB did elaborate upon the issue of guarantors in its official staff interpretations before it was supplanted in its tenure of jurisdiction over Reg. B. (45) For example, the FRB staff concluded that "although a creditor may require the personal guaranty of the partners, directors, or officers of a business, and the shareholders of a closely held corporation, it may not require the signature of a guarantor's spouse just as they bar the creditor from...