Can a Creditor Require the Signature of a Spouse as a Co–Grantor?
-By Nan E. Hannah and Tyler Ridout
When an applicant seeks to establish a line of credit with a creditor, but fails to meet the creditor’s requirements for the extension of credit, most creditors will require a personal guaranty for the account before extending credit. A personal guarantor agrees to become personally liable for the unpaid debts owed to the creditor by the applicant. The creditor can pursue any personal property owned by the guarantor in order to satisfy the debt owed by the applicant. Generally, the largest asset owned by most individuals is their home, which, if they are married, is usually co-owned with their spouse as tenants by the entirety. Translation: a creditor of only one spouse can not gain access to the home owned by the couple in order to collect outstanding debts. That raises a question we are frequently asked – Can a creditor require both spouses sign as coguarantors
in order to gain access to their home in the case of default?
According to the Equal Credit Opportunity Act, “a creditor shall not require the signature of an applicant’s spouse or other person, 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.” 12 CFR 202.7 (d). Essentially a creditor can only require that an applicant or guarantor’s spouse sign a personal guarantee if the applicant or guarantor his/her self does not qualify as creditworthy. A creditor can not force an applicant or guarantor’s spouse to sign a personal guarantee without justification simply for the purpose of allowing the creditor to go after property held as tenants by the entirety such as their home in order to repay any possible future debts.
This becomes an issue in several instances. First, when the entity seeking credit is a small corporation or partnership with severely limited assets and/or credit history, justification for seeking guarantors is easy to reach. If a husband and wife are the only officers of the corporate debtor, and if their primary asset is their home, then it may be easy to meet the criteria set out above in evidencing that without both husband and wife’s personal assets, there would not be sufficient credit to meet the creditor’s established criteria. If however, in this same scenario the wife is not listed in any capacity with the business, and if there are two or three officers, members or partners who collectively have sufficient assets to meet the criteria, then it will be tough for a creditor to justify forcing a spouse’s addition.
Second, where the applicant is an individual conducting business as a sole proprietorship, a creditor again may determine that there are not sufficient assets controlled by the applicant and having his or her guarantee gets the creditor nothing. Therefore, the application may be returned requiring a guarantor. However, there is nothing which provides that the creditor can designate who the guarantor must be.
The keys to this issue are establishing clear criteria for extending credit so that the creditor can defend any rejection of credit or requirement of a guarantor, and understanding that while the creditor might make friendly suggestions as to who would make a solid guarantor, ultimately the applicant has the right to decide who they approach for assistance and backing. The creditor can accept or reject any application as long as there is no violation of civil rights or federal credit regulations.
If you have any questions regarding this issue, please contact your attorney for advice.
Introducing Richard A. Prosser —
Vann & Sheridan, LLP is pleased to announce that Richard A. Prosser has joined our firm as an Associate Attorney. Richard is a graduate of the Norman Adrian Wiggins School of Law of Campbell University. Richard also holds a Bachelor of Science in Business Administration, with majors in both Finance and Insurance, from Appalachian State University’s Walker College of Business. During his time in law school, Richard performed a year long externship in the chambers of The Honorable Ann Marie Calabria of the North Carolina Court of Appeals. You may remember Richard from his time here at Vann & Sheridan, LLP as a summer clerk.
Richard’s practice will focus in several areas of civil litigation, including construction law, creditor’s rights and commercial collections. Away from the office, Richard leads an active life. He enjoys running, skiing, basketball, tennis, and attending sporting events of all sorts. He also enjoys the outdoors and tries to spend as much time in the North Carolina Mountains and on the North Carolina Coast as his schedule permits.
Richard grew up in Concord, North Carolina, but has spent the past several years living in the Raleigh area. He is recently engaged to Lauren Williams, a Raleigh native, whom he met during his undergraduate years at Appalachian State. Together, they enjoy attending Appalachian State football games and cheering on their beloved Mountaineers. We look forward to your getting to know Richard and he looks forward to working with the firm and its clients. Richard’s email address is rprosser@vannattorneys.com.
Preferential Transfers in Bankruptcy: How to Minimize the Preference Risk
- By Richard Prosser and Nan Hannah
For suppliers of goods and services, nothing may be more unsettling than discovering that a customer has filed for bankruptcy. To add insult to injury, there is a risk that any recently received payment or settlement might be recaptured by the bankruptcy trustee as a preferential transfer or “preference.”
Fortunately, there are defenses that can be raised against these preference claims. Creditors should be aware that there are contexts in which payment can be extracted from a debtor without fear that the transfer will be avoidable at some future date. Here is a basic overview of the criteria that give rise to preference claims, and also of some common defenses available to creditors in preference actions.
What is a “preference” payment?
Section 547 of the Bankruptcy Code governs preferences. Under this section, a trustee or debtor-in-possession may recover – as “preferences” – any payments or other transfers of assets by a debtor to a creditor within 90 days of the debtor’s bankruptcy filing. There are two main purposes for this policy: to prevent a debtor from favoring any of its general unsecured creditors over the others; and to discourage creditors, upon hearing that the debtor is about to file bankruptcy, from storming the debtor to collect their individual debts.
The elements of a preference claim are: (1) the debtor transferred property to or for the benefit of the creditor (i.e., made a payment); (2) the transfer was made on account of a debtor’s preexisting debt to the creditor; (3) the debtor was insolvent at the time of the transfer; (4) the transfer was made within 90 days of the debtor’s bankruptcy filing; and (5) the creditor obtained a larger sum from the transfer than they would have in a Chapter 7 liquidation had the transfer not occurred. Note that payments to a fully secured creditor fail to meet these criteria.
Common Preference Defenses
The Bankruptcy Code provides a series of defenses that creditors can assert to evade preference treatment. These defenses are primarily aimed at encouraging creditors to continue doing business with financially troubled companies. Those defenses most frequently asserted are: (1) contemporaneous exchange for new value, (2) ordinary course of business, and (3) small transfers. If a creditor is to routinely evade preferences, a working knowledge of these defenses is imperative.
1. The Contemporaneous Exchange for New Value Defense
The contemporaneous exchange defense is found in Section 547(c)(1) of the Bankruptcy Code. It excuses any payment or other transfer that the debtor and creditor intend as a contemporaneous exchange for new value, and that is, in fact, a substantially contemporaneous exchange. In other words, if a creditor provides new goods and/or services and receives payment at substantially the same time, the payment will not receive preference treatment.
An example of such a contemporaneous exchange would be payments received on a C.O.D. basis. In districts other than the Eastern District of North Carolina, a lien waiver exchanged for payment will generally insulate you from a preference claim. In the Eastern District, unless a lien is filed and/or served, a waiver will not protect you.
2. The Ordinary Course of Business Defense
Under Section 547(c)(2) of the Code, payments received in the ordinary course of business on debts incurred in the ordinary course of business are excepted from preference treatment. Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, the ordinary course defense required proof that: (1) the payment was made in the ordinary course of business of the debtor and the supplier; and (2) that the transfer was made according to ordinary business terms. The revised Code replaces the conjunctive “and” with the disjunctive “or,” effectively creating two independent defenses. In other words, a creditor may utilize the ordinary course defense in either of the following contexts: (1) where payment is received in its ordinary course of business with the debtor, or (2) where payment is received according to the ordinary course of business in that industry.
For the first test, the court’s basic inquiry involves a subjective evaluation of the debtor/creditor relationship. This generally takes the form of a consideration of the length of time the parties have had a business relationship, and whether the amount or form of payment at issue differed from past business practices between the parties. The key is the ability to demonstrate that the payment activities of the creditor and the debtor in the 90-day period look the same as those in the year or two years before that period.
For the second test, a more objective inquiry is utilized. The supplier must establish that the terms by which it extended credit to the debtor were “ordinary” within industry standards. This does not mean that all invoices are required to be paid within the invoice terms. The creditor needs to show that payments made by this debtor are similar in time with payments routinely made in the particular industry involved, or at least in a manner and form consistent with the payment practice being challenged. An expert witness is often required to prove this defense.
3. The Small Transfer Defense
The small transfer defense is another product of the 2005 Act. This exception bars preference claims in the case of primarily non-consumer debt for payments of up to $5,000. Creditors should keep this ceiling amount in mind when structuring payment from debtors. As a matter of strategy, creditors may prefer cumulative payments during any 90-day period of $4,999 to payments not appreciably greater than that amount.
Conclusion
Often, bankruptcy trustees will file preference claims against all creditors who have received payment from the debtor in the 90-days immediately preceding a bankruptcy filing. The strategy is to file the claims upfront, and then sort out the merits later in the process. A basic understanding of preferences can help creditors avoid making a reflexive, yet unnecessary, refund payment. Nonetheless, as demonstrated by the cursory outline above, these matters can be complex and are best addressed with the assistance of a lawyer specializing in bankruptcy law.
Signs That A Customer May Be Approaching Bankruptcy
- By James Vann
It can be shocking, crushing, and, worse, financially devastating to have a valued customer declare bankruptcy. However, the ambitious credit manager and business owner should strive to be prepared for the bankruptcy of a customer. Careful planning can mitigate or even negate the economic impact of a customer’s bankruptcy. Yet to fully prepare for the worst, it is necessary to have an idea of what might be coming. That is why it is important to recognize potential signs of a customer’s pending financial ruin.
Most credit managers and business owners are aware of obvious signals, such as increasingly slow pay, rampant changes in staff, and the death of a founder or key leader. However, there are many subtle things that should tip off the business manager/owner that something might be wrong. Here are some signs to watch for:
• Breakdown of relationships: a decrease in the level of professionalism and courtesy displayed by your customer may be a sign of problems. Broken promises and unreturned phone calls are examples of this behavior; on a larger scale, even an outdated corporate website could be such a sign.
• Industry trends: if companies similarly situated to a customer of yours are struggling or failing, you should keep a close eye on your customer. Although outward signs of trouble may not be evident, declining trends within the industry are a cause for concern, and a prompt to dig deeper.
• Lagging inventory levels: a slowdown in inventory could be evidence of cash-flow issues or other financial or structural distress. If possible, have your sales staff or drivers try to monitor fluctuations in inventory levels.
• Loss of a major account: obviously, it is bad news to learn that your customer has lost a key customer of its own. It would be wise to monitor how your customer reacts to this setback. Try to determine if your customer has a plan to overcome such hurdles.
• Financing issues: another sign of trouble is if banks or other creditors stop lending to your customer. Of course, depending on the circumstances, you may or may not want to follow their lead. Nonetheless, be aware of it.
• Pending major legal action: monitor closely any civil or criminal matters in which your customer is involved, as such events may greatly affect business.
• Regulatory action: be aware of the actions of those parties with the power to control your customer’s business.
• Media reports: be sure to investigate any reports of distress within your customer’s organization.
It takes simple measures and diligence to monitor these signs. To begin, cultivate strong relationships both with the customer and within your own company. We exchange information most openly and honestly with those we know and trust. Moreover, take the time and effort to participate in industry trade groups, which are likely to offer a collective level of knowledge greater than your own. Finally, follow the news, including that coming from journalist sources, and that coming directly from your customer.
Most importantly, please remember that if a customer does file for bankruptcy, there are ways to collect the account. Likewise, if you are faced with a preference claim from the bankruptcy estate, you may very well have defenses to the preference claim of which you need to utilize.
Hot Legal Topics Seminars: A Review
We at Vann & Sheridan would like to thank those who joined us in Raleigh or Charlotte for the recent “Hot Legal Topics” seminar and receptions. For those unable to attend, we hope that you will be able to join us in the coming years as we hope to make these an annual event.
This year, we covered topics including Securing Collections in a Challenging Economy; E-Discovery Issues and how they can impact our clients; Red Flag Warnings and other Identity Theft Legislation; Corporate Formalities; and Common Issues in Lien Law.
Attendance was good at both seminars and also at the receptions. Everyone enjoyed the music provided by wonderful deejays at the receptions. Those attending the Charlotte reception thoroughly enjoyed the adventure of watching race cars circle the track.
We would love to get your feedback on the locations, topics and overall quality of the events. We are also looking for topics of interest to our clients, so if you have suggestions for either future newsletter articles or for the next “Hot Topics” seminar, please let us know.
Identify Theft and FTC Red Flag
- By James R. Vann
North Carolina law provides that a business which operates in North Carolina and collects personally identifiable information (social security number, drivers license number, date of birth, etc.) on individuals (including employees and customers), the business is required to maintain an Identify Theft Policy. The Federal Trade Commission now requires businesses to identify “red flags” which are areas for possible identify theft and to adopt a written policy to protect personally identifiable information maintained by the business.
If your business has not adopted a written policy, we will be glad to assist you in preparing a policy for your business.
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