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«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 ...»

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43 Cathey, 2001 WL 36260354, at *4; Linscott, 2006 WL 1310511, at *4; Newton, 2012 WL 1752407, at *7–8; see infra Parts I.C.1–3.

44 Comakers include cosigners and any party who participates jointly in the borrowing of money.

BLACK’S LAW DICTIONARY 302 (7th ed. 1999).

45 Cathey v. First Republic Bank, No. 00-2001-M, 2001 WL 36260354, at *1 (W.D. La. July 6, 2001).

46 Cathey, 2001 WL 36260354, at *2–3.

47 Id.

48 Id. at *1. Cathey was decided in 2001 under the SSCRA of 1940, the legislation that preceded the 2003 enactment of the SCRA. The substance of § 526 of the SSCRA of 1940 for purposes of this Comment is identical to the substance of § 527 of the SCRA of 2003.

49 Id. at *4–5.

50 Id. at *4.

–  –  –

While the Cathey court was careful to state the exact basis of the servicemember’s ability to invoke the SSCRA’s interest rate cap provision, the District Court of Oregon in Linscott v. Vector Aerospace extended the benefit to a corporation by misreading the Cathey holding.51 In Linscott, a helicopter repair company obtained a judgment against Jeffrey Linscott’s corporation in a Canadian court based on the corporation’s failure to pay for repairs that the helicopter repair company made to the corporation’s helicopter engine.52 Mr. Linscott, an Air Force Reserve Major, had been on active duty for seven months between the dates when the defendant first invoiced Mr. Linscott’s corporation for the repairs and when the judgment was entered.53 The Canadian court ordered Mr. Linscott’s corporation to pay $106,074.90, representing the amount owed plus interest that had accrued at 18% per year.54 Mr. Linscott was not a party to the action in Canadian court, but had personally financed the original purchase of the corporation’s helicopter and had previously made assurances to the helicopter repair company that he would pay what his corporation owed if the repair company would return the helicopter engine to his corporation.55 Before the defendant could register the judgment in the United States, Mr. Linscott and his corporation brought an action for violations of the SCRA.56 The court, “persuaded by the reasoning of the court in Cathey,” held that the protections of the SCRA extend to the servicemember’s corporation, and granted a preliminary injunction preventing the defendant from registering the Canadian judgment because the 18% interest rate used to calculate the judgment amount violated § 527 of the SCRA.57 The court interpreted Cathey as holding that “the protections extended to the servicemember by the Act extend to the servicemember’s corporation, especially when, as in Cathey and as in this case, the corporation’s obligations were personally guaranteed by the servicemember and the corporation ‘depend[ed] on its owners’ presence for profitability.’”58 This statement suggests that, despite the lack of any guaranty agreement between Linscott and the defendant, the court considered Linscott a guarantor of his corporation’s 51 Linscott v. Vector Aerospace, No. CV05-682-HU, 2006 WL 1310511, at *4 (D. Or. May 12, 2006).

52 Id. at *2.

53 Id. at *2.

54 Id.

55 Id. at *1–2.

56 Id. at *1.

57 Linscott v. Vector Aerospace, No. CV05-682-HU, 2006 WL 1310511, at *4 (D. Or. May 12, 2006).

58 Id. (quoting Cathey v. First Republic Bank, No. 00-2001-M, 2001 WL 36260354, at *5 (W.D.

La. July 6, 2001) (alteration in original)).

2014] BETTING THE FARM 423 debt.59 However, regardless of whether the court considered Linscott an actual guarantor or not, the court is clear that it based its holding on the theory that the benefits of § 527 of the SCRA extend to the servicemember’s corporation, not on a theory that the benefits of § 527 extend to a guarantor of the corporation’s debt.60 Not only is it unclear whether the court considered Linscott a guarantor, the court is unclear when and how Linscott incurred a liability as required by the text of § 527.61 Although the court did not directly address the issue, by expanding the boundaries of the applicability of the SCRA beyond Cathey, it certainly suggested that it would extend the benefits of § 527 to a guarantor as well.

3. Newton v. Bank of McKenney

In Newton v. Bank of McKenney, the District Court for the Eastern District of Virginia agreed with this characterization of Cathey and Linscott while, in dicta, suggesting a resolution to the issue of guarantor liability for debt that accrues at a rate greater than 6%.62 In Newton, two corporations formed by Burl and Sharon Newton each executed a note that provided financing for a new hardware store.63 While the Newtons executed personal guarantees for the notes, they were not parties to the notes in their individual capacities.64 Ms. Newton was called into active duty in the Navy, and less than two years later the defendant foreclosed upon the corporations’ assets in order to satisfy the unpaid debt on the notes.65 In denying the Newtons’ claims under § 533 of the SCRA,66 the court rejected the Linscott court’s incorrect interpretation of Cathey and refused to extend the benefits 59 Id. at *4 (“[I]n this case... the corporation’s obligations were personally guaranteed by the servicemember....”).

60 Id. (“[T]he protections extended to the servicemember by the Act extend to the servicemember’s family corporation....”); see also Fifth Third Bank v. Schoessler’s Supply Room, L.L.C., 940 N.E.2d 608, 613 (Ohio Ct. App. 2010) (“In both the Cathey and Linscott decisions, the courts found that the protections afforded by the SCRA were applicable to the servicemembers' companies.”).





61 In fact, the court fails to cite § 527 in its analysis. Also, the court incorrectly refers to the SCRA’s interest rate limitation provisions as arising out of § 526, Linscott, 2006 WL 1310511, at *3–4, whereas the 6% interest rate limitation had been enacted as § 527 of the SCRA on December 19, 2003.

Servicemembers Civil Relief Act, Pub. L. No. 108-189, § 206-07, 117 Stat. 2862, 2844 (2003) (codified as amended at 50 U.S.C. App. §§ 526–27 (2006)); cf. Newton v. Bank of McKenney, No. 3:11cv493JAG, 2012 WL 1752407, at *7 (E.D. Va. May 16, 2012) (noting that Linscott failed to acknowledge the language of § 596, 117 Stat. at 2865, also enacted in December 2003).

62 Newton, 2012 WL 1752407, at *7–8.

63 Id. at *3.

64 Id. at *3, *7.

65 Id. at *3–4.

66 50 U.S.C. App. § 533 (2006) prohibits a lender from foreclosing upon any real property of a servicemember that is secured by a mortgage or similar instrument.

–  –  –

of the SCRA to a corporation.67 In reaching this holding the court relied on the text of the SCRA and bedrock corporation law, which both recognize distinct rights of the servicemember and any corporate entity that she may own.68 In addition to foreclosing on the corporation’s assets, the defendant continued to assess interest at a rate in excess of 6% on one of the notes after Ms. Newton had requested an interest rate reduction in accordance with § 527.69 This action by the defendant was supported by the Small Business Administration, who stated that the benefits of § 527 do not extend to the corporation of a servicemember.70 In the end, the defendant credited all interest charged in excess of 6% back to the balance due on the note, rendering the Newtons’ § 527 claim moot.71 Nonetheless, the court took the opportunity to distinguish the Newtons’ liability as guarantors from the Catheys’ liability as borrowers.72 In dicta, the court stated that the defendant had no obligation to lower the interest rate on the note because “[t]he guarantor on a note has a different liability than the maker—liability that only comes into existence when the maker defaults. As such, the Newtons incurred liability only when the corporation defaulted.”73 The court immediately thereafter states that it has not addressed the related question of whether the guarantor, having incurred liability due to the corporation’s default, can be liable for debt that had accrued interest at a rate of greater than 6%.74 This comment will now argue that the court had in fact answered the very question it purportedly left unanswered.

II. ANALYSIS

The text of the SCRA and the case law applying it leave open “a question the answer to which turns on a fine distinction”—can a servicemember guarantor be liable for interest greater than 6% under § 527?75 The text of the SCRA and the case law do, however, provide a framework for analyzNewton, 2012 WL 1752407, at *7.

68 Id. at *5–6.

69 Id. at *3.

70 See id.; see also H.R. REP. NO. 108-81, at 53 (2003) (“The interest rate is not reduced to six percent... if the debt was incurred by the small legal entity... owned and operated by the individual who is called to active military service, and who is an essential employee of the business.”) (quoting a letter from Hector Barreto, Administrator, Small Business Administration). The Small Business Administration was a co-guarantor of the Newtons’ corporation’s debt. Newton, 2012 WL 1752407, at *3.

71 Id. at *8.

72 Id. at *7–8.

73 Id. at *8.

74 Id.

75 Id.

2014] BETTING THE FARM 425 ing the issue through three potential rules. Part II.A of this Comment presents and analyzes these three rules in more detail, and argues that courts adopt the third rule because it aligns with the court’s analysis in Newton and the principles of guaranty law. This third rule would hold that a servicemember guarantor incurs a liability that bears interest in excess of 6% when the corporation defaults and the guarantor becomes primarily liable for the debt. Practically, this results in a servicemember guarantor being unable to claim the benefit of § 527 for corporate debt whenever the corporation defaults after the servicemember has entered active military service. Part II.B of this Comment argues that this result, although arguably harsh, is sound policy because it aligns with the legislative intent of the SCRA and serves the long-run economic interest of servicemembers.

A. Courts Should Find that a Guarantor Can Be Liable for Interest Greater than 6% Under § 527 None of the three recent district court opinions to address § 527 directly analyze the question using the two-requirement framework provided by the text of § 527. The court in Newton v. Bank of McKenney, however, references the requirement that a servicemember incur a liability; this is the first requirement of this analytic framework. However, when discussing the liability incurred by a guarantor, the court in Newton does not address the unique nature of the guaranty relationship, where two separate liabilities are created. The second requirement, which entails the identification of a liability that bears interest in excess of 6%, provides a tool to analyze the applicability of § 527 to this unique relationship.

A guaranty relationship consists of two separate obligations. The first is the obligation of the borrower to the lender to adhere to the terms of the loan, and the second is the obligation of the guarantor to the lender to fulfill the first obligation if the borrower fails to adhere to terms of the loan.76 When a guarantor agrees to fulfill the obligation of the borrower, he has incurred the second obligation. When the borrower defaults, the guarantor incurs the second obligation—he assumes the borrower’s unconditional financial obligation to pay the loan.77 It is at this point that the guarantor’s liability is “fixed.”78 While the benefit of § 527 applies to an obligation or liability incurred by a servicemember, the text of § 527 does not specify how to treat a guarantor who incurs these two unique obligations at different times. However, analyzing § 527 using the two-requirement framework can address this ambiguity.

76 38 AM. JUR. 2D Guaranty §§ 1, 4 (2010).

77 Id. at § 15.

78 Id. Fixing a liability is synonymous with establishing a liability. See BLACK’S LAW DICTIONARY, supra note 44, at 626, 712.

–  –  –

The first requirement of the framework requires a court to identify the point in time when a servicemember incurs a liability. The second prong requires a court to identify the point in time when a liability bears interest in excess of 6% per year. Conceptually, these could occur at the same point in time—either when the guaranty is executed or when the borrower defaults—or the liability could begin bearing interest in excess of 6% after the liability is incurred.79 The following parts of this comment will examine the analytic implications of these three potential rules.

1. Rule 1: Guarantor Incurs Liability Bearing Interest in Excess of 6% When Guaranty is Executed Under this rule, a servicemember guarantor incurs a liability that bears interest in excess of 6% when the guaranty is executed, regardless of when the borrower defaults. Conceptually, the servicemember has incurred an obligation by promising to fulfill the borrower’s obligation if the borrower defaults—this conditional obligation bears interest in excess of 6% because the underlying loan bears interest at a rate in excess of 6%.

For example, under the facts of Newton, a court determining whether Ms. Newton was entitled to the 6% interest rate benefit of § 527 would, under the first requirement, find that Ms. Newton had incurred a liability on July 6, 1998, when she executed the guaranty agreement.80 Under the second requirement, a court would find that the guaranty obligation bore interest at a rate in excess of 6% because the underlying obligation, the loan agreement between the Newtons’ corporation and the Bank of McKenney, had an interest rate of 10.25%.81 Therefore, the court would find that Ms. Newton is entitled to benefits of § 527 with respect to this obligation because the obligation, which bore interest in excess of 6%, had been incurred before she entered military service on June 13, 2005.82 Because the obligation would accrue interest in excess of 6% at all times during Ms. Newton’s military service, the 6% interest rate limitation would apply to any interest accrued both before and after the corporation’s default.



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