On August 20, 2014, the North Carolina Supreme Court issued an opinion giving great weight to properly-drafted forbearance agreements in a commercial loan and guaranty context. RL REGI N.C., LLC v. Lighthouse Cove, LLC, No. 427PA13 (N.C. Aug. 20, 2014) reverses the Court of Appeals decision from 2013, which focused on a defense pursuant to the federal law Equal Credit Opportunity Act ("ECOA").

The Supreme Court's decision in RL REGI is a significant victory for lenders in North Carolina not only for what it says (highlighting the immeasurable value of well drafted loan documents) but also for what it abrogates (the lower court's holding that the ECOA is valid defense to a spousal guaranty in a commercial loan context).

We begin this piece by noting that one of the editors of this blog was involved in this matter at the trial stage on the lender side.  Though that involvement was ultimately only on the behalf of original lender Regions Bank, which was not involved at the trial stage or the appellate stage.  

Facts

Regions Bank provided over $4 million in financing for the acquisition and development of real property near Wilmington, North Carolina. The loan was secured by the real property, and the loan was backed by personal guaranties of the borrowers’ individual business partners and their spouses.  The wives were not officers of, employees for or otherwise involved in the borrowing entity though nonetheless executed personal guaranties. 

As the economy took a poor turn -- we all remember those days -- the borrower and the guarantors defaulted on the loan.  After default, and before foreclosure on the real property, the borrowing entity and the individual guarantors -- two couples, husbands and wives --  entered into a single, omnibus forbearance agreement. The forbearance provided that the lender would forego exercising its remedies under the loan documents (note and the personal guaranties) for a defined time period in exchange for certain agreements from borrowers and guarantors.  The forbearance agreement acknowledged the validity and enforceability of the loan documents and the agreement included a “Waiver of Claims” section, whereby the borrowers and guarantors specifically waived and released any claims that the lender failed to act in good faith or conduct itself in a reasonable manner and generally released the lender from “any and all claims, defenses and causes of action” that occurred prior to the date of the forbearance agreement.  After the execution of the forbearance agreement, the loan was purchased from Regions Bank by a different entity, debt holder RL REGI North Carolina, LLC.

The borrower and the guarantors defaulted on the forbearance agreement, and debt holder RL REGI foreclosed on the property and filed a lawsuit against the borrower and guarantors. 

The Lawsuit and the "Equal Credit Opportunity Act" Defense

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 North Carolina Court of Appeals

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 decision, a number of commercial guaranties governed by North Carolina law were, overnight, rendered toothless. 

The North Carolina Supreme Court

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."

What's It All About, Alfie?

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!"