«JOURNAL OF LAW, ECONOMICS & POLICY VOLUME 10 SPRING 2014 NUMBER 2 EDITORIAL BOARD 2013-2014 Steve Dunn Editor-in-Chief Crystal Yi Meagan Dziura Sarah ...»
Part I of this Comment provides the key background law necessary to address the issue of guarantor liability under the SCRA. This background begins in Part I.A with the statute itself, and then moves on to Part I.B, which focuses on § 527 to demonstrate the section’s lack of clarity regarding its limits on guarantor liability. Part I.C then discusses three recent district court cases addressing guarantor liability under the SCRA to further demonstrate that no court has yet directly addressed the specific question of guarantor liability under § 527.
Part II.A of this Comment analyzes the text of § 527, relevant SCRA case law, and the law of guaranty to argue that a court addressing the issue 4 Barack Obama, U.S. President, Remarks at the Commemoration Ceremony of the 50th Anniversary of the Vietnam War, (May 28, 2012), available at http://www.whitehouse.gov/the-pressoffice/2012/05/28/remarks-president-commemoration-ceremony-50th-anniversary-vietnam-war.
5 Facts on Veterans and Entrepreneurship, SMALL BUSINESS ADMINISTRATION, http://www.sba.gov/about-offices-content/1/2985/resources/ 160491 (last visited Oct. 10, 2002). While the hardware store in this example was owned by both a veteran and an active duty servicemember, the SCRA applies only to active duty servicemembers.
6 50 U.S.C. App. §§ 501-97b (2012).
7 Id. § 596.
8 Id. § 521.
9 Id. § 527; see Newton v. Bank of McKenney, No. 3:11cv493-JAG, 2012 WL 1752407 at *8
of guarantor liability should find that a servicemember can be liable as a guarantor for debt that accrues at a rate greater than 6%. Finally, Part II.B of this Comment argues that the result of the technical legal analysis in Part II.A is sound policy because it is consistent with the legislative intent of the SCRA and actually serves to protect the servicemember’s economic interests.
A. The Servicemembers Civil Relief Act The purpose of the SCRA is “to provide for, strengthen, and expedite the national defense through protection extended... to servicemembers of the United States to enable such persons to devote their entire energy to the defense needs of the Nation.”11 To achieve this purpose, the SCRA provides a number of procedural protections and substantive benefits to servicemember borrowers, as well as other protections and benefits not directly related to borrowing activities.12 A servicemember under the SCRA is a “member of the uniformed services,” which includes the Army, Navy, Air Force, Marine Corps, Coast Guard, and the commissioned corps of the National Oceanic and Atmospheric Administration and the Public Health Service.13 Military service under the SCRA is defined as active duty and any period when a servicemember is lawfully absent from active duty.14 Military service for a member of the National Guard is defined as “a call to active service authorized by the President or Secretary of Defense for a period of more than 30 consecutive days.”15 The SCRA provides servicemembers in military service several key protections and benefits that have particular relevance to guarantors. First, a servicemember is entitled to a stay of proceedings in a civil action if her military service materially impacts her ability to appear at the proceedU.S.C. App. § 502 (2012).
12 See generally THE JUDGE ADVOCATE GENERAL’S LEGAL CTR. & SCH., THE JUDGE ADVOCATE GENERAL’S SCHOOL GUIDE TO THE SERVICEMEMBERS CIVIL RELIEF ACT (2007) [hereinafter JAG
GUIDE]; JOHN S. ODOM, JR. A JUDGE’S BENCHBOOK FOR THE SERVICEMEMBERS CIVIL RELIEF ACT(2011). Protections and benefits related to borrowing activity that are not directly relevant to this Comment include: protection from mortgage foreclosure, 50 U.S.C. App. § 533 (2012); protection from foreclosure on installment loans for purchase of real or personal property, id. § 532; and protection from an adverse credit report made as a result of a servicemember exercising her rights under the SCRA, id.
§ 518. Protections and benefits not directly related to borrowing activity include protections and benefits related to: insurance coverage and premiums, id. §§ 536, 541–47, 593–94; tolling of statute of limitations, id. § 526; taxation, id. §§ 570-571; and voting rights, id. § 595.
13 50 U.S.C. App. § 511(1) (2012); see also 10 U.S.C. § 101(a)(5) (2012).
14 50 U.S.C. App. § 511(2) (2012).
15 Id. § 511(2)(A)(ii).
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ings.16 If, however, a servicemember fails to appear in a civil action and a default judgment is entered against her, the servicemember may reopen the default judgment if her ability to defend the action was materially impacted by her military service.17 Even if a servicemember’s ability to appear or defend an action is not materially impacted by her military service, a lender may not seek the servicemember’s nonbusiness assets in order to satisfy an obligation of the servicemember’s business.18 If a court grants a servicemember relief in the form of a stay of proceedings or vacation of a default judgment, the court may grant the same relief to any party secondarily liable (including a guarantor) on the same civil obligation.19 Finally, a servicemember is entitled to have the interest rate on any obligation that existed prior to her military service reduced to 6%.20 The Supreme Court requires courts to “liberally construe [the SCRA] to protect those who have been obliged to drop their own affairs to take up the burdens of the nation.”21 While the SCRA was enacted in 2003, the current statute traces its origin directly back to the Soldiers’ and Sailors’ Civil Relief Act of 1940 (SSCRA) and indirectly back to civil relief statutes dating to the Civil War.22 The SCRA retains and builds upon the key concepts of the earlier legislation, and therefore the case law developed from this earlier legislation is still relevant in analysis of the current statute.23 B. Section 527 Does Not Address Guarantor Liability This comment examines the applicability of § 527 of the SCRA to a guarantor of corporate debt that accrues at an interest rate greater than 6%, and therefore a detailed examination of the text of § 527 is appropriate.
The key provision of § 527 provides:,
An obligation or liability bearing interest at a rate in excess of 6% per year that is incurred by a servicemember, or the servicemember and the servicemember’s spouse jointly, before the servicemember enters military service shall not bear interest at a rate in excess of 6% (A) during the period of military service and one year thereafter, in the case of an obligation or
liability consisting of a mortgage, trust deed, or other security in the nature of a mortgage; or (B) during the period of military service, in the case of any other obligation or liability.24 Any interest in excess of 6% is forgiven, not merely postponed.25 Creditors are required to reduce any required payment amount by the amount of interest that is forgiven and cannot increase the amount of principal due to maintain the same required payment amount that existed before any interest was forgiven.26 To take advantage of § 527, the servicemember must provide written notice and a copy of her military orders to the creditor within 180 days of the end of the servicemember’s military service.27 Once a creditor is notified, the creditor must forgive all interest in excess of 6% that has accrued since the date the servicemember was called to military service.28 A creditor may be exempt from the requirements of § 527 if it can demonstrate that the servicemember’s ability to pay interest in excess of 6% is not materially impacted by the servicemember’s military service.29 The 6% interest rate cap applies to all types of liabilities, including student loans.30 The text of § 527 does not differentiate between liability of a guarantor and a borrower; the 6% interest rate benefit simply applies to any “liability... incurred by a servicemember.”31 While the text of § 527 does not directly address the question of whether a guarantor can be liable for interest that accrues at a rate greater than 6%, parsing the text provides a two-requirement framework that, depending on how courts construe each requirement, can provide different rules for guarantor liability.32 The first requirement of § 527 is that the servicemember incur a liability or obligation prior to entering military service.33 The second requirement of § 527 is that a liability must accrue interest at a rate greater than 6% per year.34 Exactly when and how a court determines each of these two requirements to have been satisfied will determine which of three potential rules for guarantor liability that court will adopt.35 24 50 U.S.C. App. § 527(a)(1) (2012).
25 Id. § 527(a)(2). But cf. id. § 513 (allowing a court to extend relief in the form of a stay, postponement, or suspension to a guarantor).
26 50 U.S.C. App. § 527(a)(3) (2012).
27 Id. § 527(b)(1).
28 Id. § 527(b)(2).
29 Id. § 527(c); In re Watson, 292 B.R. 441, 444 (Bankr. S.D. Ga. 2003) (“The lender bears the burden of showing that the serviceman has the ability to pay at the original interest rate.”).
30 20 U.S.C. § 1078(d) (2012).
31 50 U.S.C. App. § 527(a)(1) (2012).
32 See infra Part II.A.
33 50 U.S.C. App. § 527(a)(1) (2012); see also Shield v. Hall, 207 S.W.2d 997, 1000 (Tex. Civ.
App. 1948) (refusing to extend the SSCRA’s interest rate benefit to a mortgage that was incurred while the servicemember was in military service).
34 50 U.S.C. App. § 527(a)(1) (2012).
35 See infra Part II.A.
A court could determine that the first requirement is satisfied either when the guaranty is executed or when the loan’s borrower defaults; if a court makes the latter determination and the borrower defaults after the guarantor enters military service, then the benefit of § 527 would not be available.36 A court making the alternative determination—that a guarantor incurs liability when the guaranty is executed—could similarly make a determination that the second requirement—that the liability accrues interest in excess of 6%—is satisfied either when the guaranty is executed or when the loan’s borrower defaults.37 The benefit of § 527 would be available to the guarantor under either determination of when the second requirement is satisfied; however, a determination that the liability accrues interest in excess of 6% only after the borrower has defaulted would result in guarantor liability for interest in excess of 6% that accrued after the servicemember entered military service, but before the borrower defaulted.38 This analysis of how a court could determine when and how each of the two requirements of § 527 is satisfied illustrates what this comment will refer to as the “two-requirement framework.” A. Recent Case Law Does Not Directly Address Guarantor Liability Under § 527 No federal court at any level has directly addressed guarantor liability under § 527 of the SCRA.39 Three district court cases since 2001 have addressed the applicability of the SCRA to corporations; however, in each case, the corporation had a servicemember owner who had personally guaranteed the corporation’s debt.40 While these cases do not explicitly apply the two-requirement framework, both Cathey v. First Republic Bank and Newton v. Bank of McKenney imply the first requirement by acknowledging the need to identify a liability incurred by a servicemember. In both these cases, it is clear that a corporation incurred a liability for a business loan;
the court, however, focuses on whether a servicemember incurred a liability as required by § 527.41 The third case, Linscott v. Vector Aerospace, fails to apply the text of § 527 in reaching the conclusion that the benefits of the 36 See infra Part II.A.3.
37 See infra Part II.A.1–2.
38 See infra Part II.A.2.
39 See Newton v. Bank of McKenney, No. 3:11cv493-JAG, 2012 WL 1752407, at *7–8 (E.D. Va.
May 16, 2012) (reviewing the available case law and acknowledging the unanswered question, “[C]an the servicemember be liable as a guarantor for corporate debt that accrues at a rate greater than 6%?”).
40 Cathey v. First Republic Bank, No. 00-2001-M, 2001 WL 36260354 (W.D. La. July 6, 2001);
Linscott v. Vector Aerospace, No. CV05-682-HU, 2006 WL 1310511 (D. Or. May 12, 2006); Newton, 2012 WL 1752407.
41 Cathey, 2001 WL 36260354, at *4; Newton, 2012 WL 1752407, at *7–8; see supra Parts I.C.1,
SCRA extend to the servicemember’s corporation.42 While these cases did not require the courts to decide the issue of guarantor liability, 43 their analysis and facts are useful to demonstrate how the issue can be addressed through applying the two-requirement framework; this application is the focus of Part II.A of this Comment.
1. Cathey v. First Republic Bank
In Cathey v. First Republic Bank, Stewart and Donna Cathey, together with their corporation, were comakers44 of two construction loans intended to fund the construction of a gas station and convenience store.45 Both loans provided that the borrower on the loans included both the corporation and the Catheys in their individual capacities.46 In addition to signing the loan documents as borrowers, the Catheys executed personal guarantee agreements and pledged their home as collateral for the loans.47 After the loans and guarantees had been executed, Mr. Cathey, a member of the United States Army Reserve, was called into active duty in Bosnia and sought to have the interest rate on the loans reduced to 6% as provided by the SSCRA.48 In holding that the defendant was required to reduce the interest rate on the loan to 6%, the District Court for the Western District of Louisiana was careful to state that Mr. Cathey was entitled to the SSCRA benefits as a borrower on the loan and not as an owner of the corporation: “This is not a case where loans were executed by a corporation which happened to be owned in part by a serviceman. Rather, this case involves loans incurred by a serviceman.”49 The court did not base its holding on Mr. Cathey’s status as a guarantor, but rather states simply that the guaranty was a “redundant requirement.”50 42 Linscott, 2006 WL 1310511, at *4; see infra Part I.C.2.