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From Banking and Finance Law Daily, October 6, 2015

Justices probe meaning of ‘applicant’ under ECOA

By Richard A. Roth, J.D.

Did the Equal Credit Opportunity Act give the Federal Reserve Board the authority to adopt a regulatory definition of “applicant” that includes persons who are required to guarantee credit extended to their spouses? Questions posed by the Supreme Court Justices during oral arguments on Hawkins v. Community Bank of Raymore made clear that to Justice Scalia the answer is “no,” but the positions of other Justices were not so clear. The decision could turn on whether a person seeking a benefit for another can be said to apply for that benefit.

The appeal arose from an effort by the bank to enforce guarantees of loans that financed a real estate development project. Two developers borrowed more than $2 million to fund their project, and the credit was guaranteed by their wives. When the development company was unable to make payments, the bank declared a default and demanded payment both from the development company and from the wives as guarantors.

The wives replied by suing the bank, claiming that it had required them to guarantee the loans as a condition of credit. This, they said, constituted discrimination on the basis of marital status in violation of the ECOA and Reg. B—Equal Credit Opportunity (12 CFR Part 202, now 12 CFR Part 1002).

Lower court rejections. The district court judge decided that only credit applicants were protected by the law and the regulation and that guarantors are not applicants. The U.S. Court of Appeals for the Eighth Circuit agreed.

According to the Eighth Circuit, the ECOA defines “applicant” in part as “any person who applies to a creditor directly for an extension, renewal, or continuation of credit.” The Fed adopted a regulatory interpretation that included spouse-guarantors as applicants (12 CFR §202.7, now 12 CFR §1002.7). The question, according to the appellate court, was whether this is an acceptable interpretation.

It was not, the appellate court said. Whether a regulatory agency’s interpretation of a statute should be accepted by the courts is decided under the process created by the Supreme Court in Chevron U.S.A. v. Natural Resources Defense Council, 467 U.S. 837 (1984), the court said. Chevron creates a two-step process, the first step of which is considering whether Congress’s intended meaning is clear. If the law is not unambiguous, no further consideration is needed.

The ECOA text is clear that a credit guarantor is not a credit applicant, the court said. An applicant is a person who requests credit, and a guarantor has made no such request. Obviously the guarantor wants the application to be approved, but that desire is not the same as an application.

“We find it to be unambiguous that assuming a secondary, contingent liability does not amount to a request for credit. A guarantor engages in different conduct, receives different benefits, and exposes herself to different legal consequences than does a credit applicant,” the Eighth Circuit said in reply. Because the ECOA unambiguously says that a credit guarantor is not a credit applicant, Reg. B’s contrary interpretation is entitled to no deference, the court concluded (see Hawkins v. Community Bank of Raymore, discussed in Banking and Finance Law Daily, Aug. 5, 2014).

Guarantors’ arguments. The guarantors’ attorney, John M. Duggan, did not get far into his argument before being interrupted by questions from several of the Justices, with Scalia being the most active. Scalia began by pointing out the inconsistency of treating guarantors as applicants for purposes of demanding spousal signatures but not for any other purpose, and then objected to Duggan’s claim that the wives were required to sign the guarantees. Nobody “put a gun to her head,” Scalia observed.

Duggan based his argument primarily on two points. First, he said, if a spouse guarantees a loan, she would be liable for the debts of a business over which she had no control after a divorce or the death of the primary borrower.

Second, the bank’s loan documents in this case revealed how important the spouses were to the credit transaction, he argued. The documents indicated that the loan had been made based on the value of collateral owned by the wives, not based on the prospects of the real estate development. Also, the guarantees included obligations beyond simply repaying the credit if the husbands’ business defaulted. The spouses clearly were applying for the loan, Duggan asserted.

Scalia was not impressed. Rejecting Duggan’s argument, Scalia drew an analogy to a letter of reference recommending that a person be hired for a job. The letter writer would not be applying for the job, he pointed out. When Scalia later returned to that analogy, Justice Sotomayor observed that an application for credit was a different situation.

Other Justices, including Justice Breyer, attempted an analogy to a parent submitting an application for a child’s private school. In that case, was the parent not the applicant even though the child would be attending, they asked?

Government’s argument. Arguing on behalf of the government, Assistant to the Solicitor General Brian H. Fletcher tried to stick closer to the meaning of “applicant.” He began by noting that the ECOA never used the word “guarantor,” and he claimed that neither that word nor “applicant” have fixed, exclusive meanings among lenders, despite Chief Justice Roberts’s expressed contrary belief. The two terms might have different meanings, Fletcher conceded. However, while “applicant” usually referred to a person seeking a benefit for himself, it did not unambiguously exclude other possibilities.

Breyer wondered why it was necessary for the Fed to adopt a definition of “applicant” at all. Why couldn’t the wives sue based on a claim that the bank’s treatment of the husbands had violated the ECOA? When he was reminded that the ECOA gives a right to sue only to applicants, he told Fletcher that the government might be trying to push the meaning of the word farther than Congress intended. “That’s—that is a problem,” he warned.

Fletcher also was led by questions into a discussion of the proper remedy should a creditor’s insistence on a spouse’s guarantee be a violation. An improperly demanded guarantee should be unenforceable, he said, but that would not necessarily leave the creditor with nothing. If the loan was secured by the guarantor’s property, the creditor still would have an avenue for collection. ECOA does permit a creditor to demand a spouse’s signature if it is needed to create a security interest.

According to Fletcher, the proper remedy would be to put the creditor in the position it would have occupied in the absence of the improper guarantee demand, not to void all of the creditor’s rights or make the loan unenforceable.

Community Bank of Raymore’s argument. The question should be seen as subject to a Chevron analysis, and there was no need to go beyond the first step, according to Stephen R. McAllister, who argued on behalf of the bank. The meaning of “applicant” in the ECOA was not ambiguous, he claimed, and the regulatory agencies simply had no authority to expand its coverage.

McAllister relied heavily on the ECOA’s definition of “credit” as the right to defer payment. A guarantor never had a right to defer payment, he pointed out—if the guarantor ever became obligated to pay, that payment would be due immediately. A guarantor never would be applying for the right to defer payment, so a guarantor never would be an applicant for credit. Neither would a co-signer, he added.

The Eighth Circuit had rightly pointed out that its narrow interpretation of “applicant” was consistent with the intent of the ECOA, McAllister continued. The act was intended to expand credit opportunities for women and minority individuals who had suffered from discrimination. Banning guarantee demands would have no effect on that goal.

McAllister also attempted to convince the Court that the broader interpretation of “applicant” would discourage lending. If lenders feared to demand guarantees they would become reluctant to make unsecured loans, he warned. Only secured credit would be available.

Practical concerns. Questions posed during McAllister’s argument focused the issue on the practical effects of the alternative interpretations. Justice Kagan began the line of inquiry by pointing out a functional inconsistency.

Kagan posed a hypothetical situation of a married person asking a credit card company for a secondary credit card for a spouse. Who would be the applicant, she asked?

McAllister replied that, in his opinion, the spouse who was to receive the secondary card would be the applicant, or at least a joint applicant, even though he had never filled out an application.

Kagan then objected that the bank’s position led to a result that made no sense to her—a lender could not demand that a spouse be a co-applicant for a loan but could demand that a spouse guarantee a loan. “[T]he effect of those two things are exactly the same, which is that it’s a requirement that the spouse essentially become joint and severally liable for the loan.”

Breyer said he could not understand why “applicant” should be restricted to a person who seeks a benefit only for himself. “An applicant means a person who applies for something, so why can’t you apply for the thing, and give the money to this other person?” In reply, McAllister again pointed out to the definition of credit as the right to defer payment.

Justice Sotomayor added that most definitions of “applicant” do not include the requirement that the benefit being sought be conferred on the applicant. Why can’t an applicant be a person who seeks credit to be extended to anyone, she asked?

Corbin on Contracts “clearly thinks that the guarantor is a requestor, is an applicant for credit, and just to a third party, to the principal debtor,” Kagan then pointed out.

Sotomayor also rejected McAllister’s claim that expanding “applicant” to include guarantors would make the requirement that creditors give adverse action notice unworkable. After all, if she were a guarantor of someone’s debt, she would want to know if they became delinquent, she said.

Kagan then returned to the argument, raising the issue of the consideration that makes a guarantee enforceable. The consideration to the guarantor is the extension of credit to the borrower. Why should who is to receive the credit determine who has made the application?

The appeal is No. 14-520.

Supreme Court docket. For details about this and other petitions and cases pending before the Supreme Court, please consult this list of selected banking and finance law cases awaiting action in the 2015 term.

Attorneys: John Matthew Duggan (Duggan Shadwick Doerr & Kurlbaum LLC) for Valerie J. Hawkins and Janice A. Patterson. Stephen R. McAllister (Thompson Ramsdell Qualseth & Warner, P.A.) for Community Bank of Raymore. Brian H. Fletcher, Assistant to the Solicitor General, for amicus curiae United States.

Companies: Community Bank of Raymore

MainStory: TopStory EqualCreditOpportunity Loans SupremeCtNews

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