Business Credit and the Spousal Guaranty

A personal guaranty is commonly required by credit professionals to reduce credit risk when selling to a corporate debtor. The guaranty is normally signed by a principal of the company that is purchasing the goods or services offered by the seller. It acts as an inducement to the seller to sell on credit terms to the corporate debtor.

Some credit professionals perceive a personal guaranty to have questionable collectability. However, if a debtor company is unable to pay all of its vendors, the personal guarantor will most likely advocate the corporation to pay those debts that are personally guaranteed before paying other debts.

As a credit executive certain steps need to be taken to ensure the guaranty is valid to avoid legal attacks by the guarantor. As credit professionals are well aware, a guarantor will always attempt to find ways to challenge the validity of the guaranty.

Unfortunately, the ECOA (Equal Credit Opportunity Act) is helping them. ECOA was enacted by Congress in 1989, and the Federal Reserve Board issued Regulation B to implement ECOA in 1990. ECOA is a federal statute that prohibits credit grantors from discriminating in the granting of credit based on a prohibited basis, including race, color, religion, national origin, gender, marital status or age.

The effects of ECOA on personal guarantees are so important that I am including the following copy of the regulation below.

Guidance on Regulation B Spousal Signature Requirements

This guidance provides information on the rules governing spousal signatures as they relate to extensions of credit, including business credit.1 (For reference, see the attached chart depicting the regulatory requirements concerning spousal signatures.)

I. ECOA and Regulation B.

The Equal Credit Opportunity Act, 15 U.S.C. § 1691 et seq., prohibits creditors from discriminating against credit applicants on the basis of race, color, religion, national origin, sex, marital status, age (provided the applicant has the capacity to contract), or because an applicant receives income from a public assistance program or has in good faith exercised any right under the Consumer Credit Protection Act. The Federal Reserve Board’s Regulation B at 12 C.F.R. Part 202 implements ECOA, and the staff’s official interpretations are incorporated in Part 202, Supp. I.

II. General Rule.

Under Regulation B, § 202.7(d)(1), generally a creditor may not require the signature of an applicant’s spouse or any other person (other than a joint applicant) on any credit instrument if the applicant qualifies for the amount and terms of the credit requested under the creditor’s standards of creditworthiness.2 This rule applies to all open-end and closed-end, secured and unsecured extensions of consumer credit and business credit.3

If an applicant does not meet the creditor’s standards of creditworthiness, then the creditor may condition approval of the credit application upon the applicant either (1) furnishing the signature of another person (cosigner, guarantor or similar person), but the creditor may not require that person to be the applicant’s spouse,4 or (2) securing the credit extension with sufficient collateral (or in the case of an application for secured credit, additional collateral) to satisfy the creditor’s standards.5 Therefore, if a creditor routinely requires spousal guarantees, for example, without first ascertaining whether an applicant is creditworthy, then the conditioning of the loan on the spousal guarantee violates § 202.7(d)(1).

As you can see the ECOA has created problems for companies who wish to quickly open credit accounts and obtain deliveries. Before spousal signatures can be required, the customer must submit individual financial statements; the creditor must review those financial statements and determine that the individual assets are insufficient.

This can take time and many customers do not like supplying individual financial statements. In most cases, individual assets will be insufficient, because most assets are owned jointly by married couples. The safest course for suppliers will be to require and evaluate individual financial statements and then either decline credit or require additional guarantors if individual assets are insufficient.

If this is not practical, you may want to consider providing customers a choice of submitting complete financial statements of individual assets to apply for individual credit or provide the signature of other guarantors such as other officers, shareholders, spouses or other family members. I am not aware of this being tested in court; however this option would seem to comply with the spirit and letter of the ECOA.

The owners of most small closely held corporations will probably decide to provide guarantees of owners and spouses, but it is the customer that has decided to make a joint application. Spousal signatures can be volunteered by the customer but cannot be required by the creditor. The customer is always free to make an application for individual credit, supported by financial statements.

There are exceptions. If a married applicant requests unsecured credit and resides in a community property state, or if the property upon which the applicant is relying is located in such a state, a creditor may require the signature of the spouse on any instrument necessary, or reasonably believed by the creditor to be necessary, under applicable state law to make the community property available to satisfy the debt in the event of default if:

(a) applicable state law denies the applicant power to manage or control sufficient community property to qualify for the amount of credit requested under the creditor’s standards of creditworthiness; and

(b) the applicant does not have sufficient separate property to qualify for the amount of credit requested without regard to community property.

Personal Guaranty Forms should also waive rights under the ECOA and acknowledge that individual guarantors have decided not to apply for individual credit. It is also important to keep a complete written record of notices sent.

Please contact our office if you need additional information on Personal Guaranty forms and/or the required ECOA notice.

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BPO and KPO – What are they?

Business process outsourcing (BPO) is the process of hiring another company to handle business activities for you.

Outsourcing has been around as long as work specialization has existed. In recent history, companies began using outsourcing to carry out narrow functions, such as payroll and billing. Those processes could be done more efficiently and therefore more cost-effectively, by other companies with specialized tools and facilities and specially trained personnel. It is now common for companies to outsource financial and administration processes, human resources functions, customer service activities, payroll, accounting and credit functions.

Knowledge process outsourcing (KPO) is an offshoot of BPO. KPO includes those activities that require a greater skill level, knowledge, education and expertise. BPO and KPO deals often involve multi-year contracts that can run into hundreds of millions of dollars. BPO and KPO contract durations need to strike a balance. They must be long enough to make a difference, and short enough to allow a measure of flexibility to the relationship. BPO and KPO contracts normally last from three to five years. Some companies still enter into 10 year deals but a better approach would be a shorter contract so that periodic reviews can be made.

BPO and KPO promises cost savings, the use of shared resources and greater efficiencies. However, only by using an appropriate set of metrics will you ensure that your organization fully realizes the benefits of outsourcing.

Many AR outsourcing services are available. They include order management, credit risk and analysis, billing, invoice collection, cash application, exception management, and bad debt collection. Some of the benefits of AR outsourcing include reduced AR costs, improved performance, speed of cash recovery, and conversion of fixed costs to variable cost.

Outsourcing, in the earlier days was used by larger companies which farmed out many low-end business processes. Since then, outsourcing has become more of a norm than an option. In addition to the cost savings, outsourcing is seen as a strategic move that can allow businesses to gain a competitive advantage. Outsourcing has opened up opportunities for companies to utilize skill sets and expertise that they normally would not be able to access without large investments.

Finding skilled resources is one of the biggest challenges faced by companies today, not to mention the investment required to train employees and the attendant infrastructure required, which can rapidly drain funds. Outsourcing frees companies from these hassles by providing access to skilled resources at lower costs, with the additional benefit of not having the burden of managing them directly.

Outsourcing not only brings cost advantages but it can also improve the efficiency of business operations. If your business goals are properly aligned with the deliverables in outsourcing, productivity and efficiency are bound to increase. Outsourcing providers with the right expertise and experience can actually help streamline business processes and contribute to the bottom-line.

Cost cutting is not the only reason to outsource, although it is certainly a major factor. Outsourcing converts fixed costs into variable costs, releases capital for investment elsewhere in your business, and allows you to avoid large expenditures in the early stages of your business. Outsourcing can also make your company more attractive to investors, since you are able to pump more capital directly into revenue producing activities.

If you have any questions or would like additional information please do not hesitate to contact our office.

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