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Thursday, August 14, 2008

Guarantees - Should the Spouse Sign?

As part of its Business Law practice, the attorney's at Gross & Romanick frequently receive questions about whether or not a spouse can--or should--serve as Guarantor in a business debt. As part of their client education initiative, they've prepared the following article.

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Often, a guaranty of a debt or lease may mean the difference to the creditor between getting paid and taking a loss. The first to get paid when a business is failing are the creditors who can pursue the operators of the business. Guarantors, who are not operators of the business, have a unique incentive to pressure the business to pay.

Spouses may be particularly attractive as co-guarantors because an individual guarantor's principal asset is often a residence or some other asset owned as "tenants-by-the-entirety," which cannot be seized unless both spouses are judgment debtors. (See The Edward Gross Report, Spring 1992.) However, several recent cases indicate that enforcing guarantees against spouses may violate the Equal Credit Opportunity Act, 15 U.S.C §1691, when the guarantees were required solely on the basis of marital status. NationsBank v. Sarelson, (Fairfax Circuit Court, 1992); CMF Virginia Land, L.P. v. Edward L. Brinson, et.al., (U.S. District Court, Eastern District of Virginia, 1992). These cases indicate that creditors may have difficulty enforcing guarantees against spouses who are not parties to the contract when the applying spouse would independently qualify for credit under the creditor's standards.

In order to protect yourself, be sure to document your reasons for requiring a spouse to sign as a guarantor. Make sure that you can prove a legitimate business purpose behind your requirement, such as showing that the spouse was an owner, officer, or other active participant in the business at the time the contract was made, or, alternatively, that the spouse in the business would have been ineligible for credit without the spouse's co-guaranty. Since circumstances will often have changed, accurate documentation of your reasons at the time guaranty is executed is critical to the successful enforcement of the guaranty at any later date.

Beware! These same rules will apply to consumer debts, for which the Equal Credit Opportunity Act was originally intended.

For more information or to seek legal counsel, contact the attorneys at Gross & Romanick today.