N.C. Supreme Court Issues Significant Ruling On Commercial Forbearance Agreements and Spousal Guaranties

Facts

The foreclosure was granted, but appealed.  The appeal stayed while the parties litigated the separate lawsuit against the borrower and the guarantors.  Along the way, summary judgment was entered against the borrower (a single asset entity), one of the guarantors filed personal bankruptcy, and the other two guarantors settled with the debt buyer.  Thus, the lawsuit proceeded against the last guarantor, alone, whom we will call the "Spouse Guarantor".  That Spouse Guarantor is the wife of the bankrupt guarantor, and she claimed no leadership, operational or employment role in the borrowing entity.

At trial, the Spouse Guarantor asserted an affirmative defense that her guaranty was obtained in violation of the ECOA.  At its core, the ECOA affirmative defense stated: (1) Spouse Guarantor did not offer to serve nor was she offered by the borrower to serve as a personal guarantor to the loan, (2) Spouse Guarantor was required by Regions Bank to guaranty the loan simply because she was the spouse of an officer of the borrowing entity, and (3) Spouse Guarantor was required to serve as personal guarantor despite that Regions Bank did not first determine the creditworthiness of Spouse Guarantor's husband, a valid guarantor (i.e., Regions Bank did not first determine the financial strength of husband's guaranty before requiring wife's guaranty).

The trial court found that the guaranty violated the ECOA and denied recovery on Spouse Guarantor's personal guaranty.

The N.C. Court of Appeals affirmed the trial court.  Most notably, in a case of first impression, the Court held that the ECOA may be asserted as an affirmative defense in the context of a spousal guaranty as opposed to a claim for relief or for recoupment, an issue over which courts are split.  

The Court of Appeals:  "A number of other state and federal courts have addressed this question [as to how to treat the ECOA] and have typically resolved it in one of three ways....  The first approach requires that a debtor can only assert an ECOA violation as a claim or counterclaim for damages, a position supported by Plaintiff in its brief....  The second approach allows a debtor to assert an ECOA violation as an affirmative defense in the nature of a 'recoupment.'....   The third approach allows a debtor to assert an ECOA violation as an affirmative defense based on the defense of illegality....  We believe that the third approach above is the most consistent with the law of this State and, therefore, we hold that a guarantor-spouse may assert an ECOA violation as an affirmative defense in an action brought by a lender."  

The significance of this decision for lenders in North Carolina could not have been overstated: in most instances, the limitations period for such ECOA claims had long run, as it did in this case, but the limitations period does not affect the ECOA as an affirmative defense.   In other words, if the ECOA is a valid affirmative defense in North Carolina, as it was determined to be by the Court of Appeals, there is no limitations period applicable to invalidate the ECOA defense.

In the wake of this Court of Appeals decision, a number of commercial guaranties governed by North Carolina law were, overnight, rendered toothless.
 

The North Carolina Supreme Court reversed the Court of Appeals in RL REGI North Carolina, LLC v. Lighthouse Cove, LLC, No. 427PA13 (August 20, 2014).  However, the Supreme Court did not address the Court of Appeals' analysis of the ECOA and how it is to be treated in North Carolina.  Rather, the Supreme Court focused on the forbearance agreement.  

The Supreme Court determined that the trial court improperly allowed the Spouse Guarantor to assert a defense that she waived under the forbearance agreement, thus depriving RL REGI of the benefit of its contractual bargain.  The Spouse Guarantor had previously argued (and ultimately unsuccessfully, to the Supreme Court) that the forbearance agreement lacked consideration as to Spouse Guarantor because the guaranty on which the forbearance was based -- the "only" consideration as to Spouse Guarantor, according to her -- was invalid.

Specifically, the Supreme Court held that parties are free to waive various rights, including those arising under statutes. Although the guarantor did not specifically waive the ECOA defense in the forbearance agreement, the Court found the “comprehensive language contained in the agreement” and “overall expansive language of the waiver” to be sufficient to include any potential claim or defense. Ultimately, the Court stated that “a waiver of potential defenses to the guaranty, including a potential defense for a violation of the ECOA, was a part of defendant’s decision to accept the benefits of the forbearance agreement."

The Supreme Court's decision in RL REGI is as important for what it says as it is for what it abrogates.  The Supreme Court's decision says that a well drafted forbearance agreement is a very good insurance agreement for a lender, it hits the "reset button" and it can cure potential ills with existing loan documents.  The Supreme Court's decision abrogates the Court of Appeals holding as to the ECOA:  "It is unnecessary, however, for us to determine in this case whether a violation of the ECOA occurred and, if so, whether such a violation creates an affirmative defense to the recovery of the indebtedness."

The RL REGI decision sends a clear signal that waivers and releases contained in forbearance agreements, modifications, and other loan documents will be enforced by North Carolina courts.  Lenders should be diligent in properly and fiercely documenting forbearance agreements, modifications, extensions and other restructuring documents to include adequate waiver and release language both to protect from affirmative liability and to limit defenses to foreclosure and collection.

The RL REGI decision is also a reminder to lenders to strategically evaluate the use of forbearance agreements and other modification opportunities as means to obtain lender protections and reduce risk throughout the life of a loan, including protecting the loan's value on the secondary market.

 

"You told me the forbearance agreement lacked consideration because of that ECOA-thingy!  And why does your mother hate me?"