Terms of Estrangement

A fairly common banking practice requires the signature of both spouses when a loan is made to a closely held family corporation. However, it is not widely known that it may be illegal, in certain circumstances, to compel borrowers and their spouses to both sign. The issue was discussed several years ago by the Supreme Court of Virginia in Louise R. Eure v. Jefferson National Bank, 448 S.E.2d 417 (1994).

On July 17, 1987, Chesapeake Bay Builders, Inc., executed a promissory note for $100,000, payable to the order of Chesapeake Bank and Trust, the predecessor in interest to Jefferson National Bank. On the same date, Charles H. Eure, Jr., who was a principal in Bay Builders, and his wife, Louise R. Eure, executed an "unconditional guaranty" in which they agreed to guarantee payment of "all liabilities" of Bay Builders to Chesapeake Bank. Bay Builders defaulted in payment of the note, and Jefferson National demanded the guarantors pay the balance due. When the demand was not met, Jefferson National sued Bay Builders and the individual guarantors seeking to recover the sum of $72,714.10, plus interest, attorney's fees, and costs. In her responsive pleadings, Louise Eure asserted the defense that she was required to sign the guaranty "solely on the basis of her marital status as the wife of Charles H. Eure, Jr.," that the transaction violated the Equal Credit Opportunity Act (ECOA or the act) and therefore the guaranty was void as applied to her.

The ECOA provides that "it shall be unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction...on the basis of...marital status." In addition, the Federal Reserve Board has prescribed regulations to carry out the purposes of the act. One such regulation provides that "a creditor shall not require the signature of an applicant's spouse..., 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."

In a pretrial hearing, the trial court disallowed Louise Eure's defense and later entered judgment against her for the balance due on the promissory note executed by Bay Builders. On appeal, the Virginia Supreme Court noted that Louise Eure had no interest in Bay Builders, that she was not a joint applicant for credit, and that Chesapeake Bank made no inquiry concerning her credit standing. Further, Jefferson National did not question Charles Eure's creditworthiness; indeed, a financial statement submitted to Chesapeake Bank at the time it extended credit to Bay Builders showed that he earned more than $200,000 per year as president of Norfolk Shipbuilding and Drydock Corp. and had a net worth in excess of $2 million. Nor was it seriously questioned that Louise Eure's signature was required on the guaranty. While Chesapeake Bank's loan officer testified that "there was no banking regulation, rule, or policy which required" her signature, he admitted it was "a fairly common practice" to ask the wife of a stockholder in a closely held corporation, such as Bay Builders, to sign on board a guaranty. Furthermore, one of the "terms and conditions" upon which Chesapeake Bank committed itself to make the $100,000 loan in question was that Louise Eure would be a guarantor, along with her spouse, of the promissory note covering the loan.

However, things were not that simple. The act that Louise Eure was attempting to use as a shield to avoid personal liability had a two-year statute of limitation, and two years had passed since she had guaranteed the note. Jefferson National argued that the act may not be used defensively to avoid liability on a credit instrument and, in any event, the passing of the two years precluded Louise Eure from using the ECOA at all. Jefferson National maintained that the act specifically provides only for the recovery of damages, which may be sought by way of counterclaim. Louise Eure conceded that, had she sought to recover damages for the ECOA violation, rather than to assert it as a defense, her claim would have been barred. But she claimed the two-year statute does not bar defensive use of the violation. The Virginia Supreme Court agreed.

Louise Eure was not seeking invalidation of the debt covered by the promissory note, reasoned the court, but only to have the guaranty she executed declared unenforceable as to her. She was not a primary debtor on the loan made by Chesapeake Bank; she merely guaranteed a loan made to her spouse's corporation, a transaction from which she derived no benefit. Allowing only her to escape liability on an instrument executed solely as a result of an ECOA violation would further the goals of ECOA to deter discrimination in credit transactions. At the same time it reinforced the expectation that primary debtors-debtors who have received the benefits of the loan-remain liable for repayment of the debt.

Finally, the court pointed out that it is a fundamental principle of contract law that contracts executed in violation of law cannot be enforced. The guaranty agreement Louise Eure signed was a contract growing out of an illegal act and contrary to public policy under both ECOA and a similar Virginia statute.

Therefore, to deny Louise Eure the right to use the ECOA violation defensively would be to enforce conduct that is forbidden by the act. Accordingly, Louise Eure's proposal would be in agreement with the will of Congress and would be consistent with the remedies specifically provided by the act. Indeed, to permit such use would give effect to the clear legislative intent to deter discrimination in the particular area of endeavor regulated by ECOA.

Clearly, one lesson that may be learned is that spouses may not be required to guarantee a note simply because lenders desire it. If the spouse whose guaranty is sought is not an applicant and if the borrower's financial statement can support the making of the loan without any guarantors, requiring the spouse to sign may be unenforceable and voidable.

 

Hanon W. Russell, CCIM, JD

Hanon W. Russell, CCIM, JD, is a partner in the firm of Cantor, Floman, Russell, Gross, Kelly, & Amendola, P.C., located in Orange, Connecticut. Russell can be reached by phone at (203) 795-1211 or by e-mail at hwr@chesscafe.com. The discussion of legal issues involved in this column is for informational purposes only. Results may vary depending on state laws and particular facts.