«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 ...»
104 See, e.g., Terms and Conditions of BankAmericard, BANK OF AMERICA, https://www.bankofamerica.com/credit-cards/credit-cards-terms-andconditions.go?cid=2088696&po=R9 (last visited November 12, 2012) (“If you accept or use an account, 2014] BETTING THE FARM 431 promotion where the interest rate on the purchase is 0% for some period of time.105 If, after the promotion ends, the servicemember is called into active military service, absent the benefit of § 527 of the SCRA, the interest rate on that purchase may increase to some amount in excess of 6%.106 In this case, § 527 will apply and, while the servicemember is in active military service, limit the interest rate that can be assessed to 6%.107 In this scenario, similar to the guarantor scenario, § 527 applies because the servicemember incurred a liability before entering military service even though the liability did not begin bearing interest in excess of 6% until some later date. A similar scenario can occur when a liability accrues interest at a variable rate tied to some index rate.108 The key analytic point of these examples is that the second requirement of the two-requirement framework—that a liability bear interest in excess of 6%—need not be satisfied before the servicemember enters military service; only the first requirement—that a liability be incurred—must occur prior to military service.
However, this rule for guarantor liability is difficult to reconcile with the text of § 527 of the SCRA. While the SCRA is to be construed liberally to accomplish its purpose, “liberal interpretation does not allow the Court to rewrite the Act.”109 The 6% interest rate cap applies to “[a]n obligation or liability bearing interest at a rate in excess of 6% per year that is incurred by a servicemember... before the servicemember enters military service.”110 While this section can be liberally interpreted as applying to a liability that begins bearing interest in excess of 6% after the servicemember enters military service, no reasonable interpretation of this section would allow the two requirements to be satisfied by separate, legalyou do so subject to the terms of this application, the ‘Details of Rate, Fee and Other Cost Information’ and the Credit Card Agreement, as it may be amended; you also agree to pay all charges incurred under such terms.”).
105 See, e.g., id. (“0% Introductory APR for the first 15 Statement Closing Dates following the opening of your account.”).
106 See, e.g., id. (“After [the promotion ends], your APR will be 10.99% to 20.99%, based on your creditworthiness when you open your account.”).
107 See, e.g., Rodriguez v. Am. Express, no. CV F 03-5949 AWI LJO, 2006 WL 908613, at *8, *10 (E.D. Cal. Apr. 7, 2006) (describing that defendants Citibank and American Express complied with the requirements of § 527 by reducing the interest rate on plaintiff’s credit card accounts to 6% or lower without any discussion of what the interest rate on the accounts was at the time the plaintiff incurred liability).
108 A variable interest rate is an interest rate “that varies at preset intervals in relation to the current market rate (usu. the prime rate).” BLACK’S LAW DICTIONARY, supra note 44, at 888. For example, an interest rate tied to the Bank Prime Loan rate would have increased from 4% on June 29, 2004, to 8.25% on June 29, 2006. H.15 Release–Selected Interest Rates–Historical Data, BD. OF GOVERNORS OF THE FED. RESERVE SYS., http://www.federalreserve.gov/releases/h15/data.htm (last visited Nov. 17, 2012) (under “Bank Prime Loan,” click “Daily”).
109 Newton v. Bank of McKenney, No. 3:11cv493-JAG, 2012 WL 1752407, at *6 (E.D. Va. May 16, 2012).
110 50 U.S.C. App. § 527(a)(1) (2006).
68432 JOURNAL OF LAW, ECONOMICS & POLICY [VOL. 10:2
ly distinct obligations. Specifically, under this rule the first requirement would be satisfied by the guaranty obligation, which is incurred when it is executed. The second requirement would be satisfied once the guarantor incurs the separate, primary obligation to pay the loan according to its terms, which occurs only when the borrower defaults. The language of § 527 cannot be interpreted as allowing each of the two requirements to be satisfied by separate obligations; it applies to “[an] obligation or liability,” not a set of related but distinct obligations or liabilities.111 In contrast, the obligation in the credit card example is a single obligation that accrues interest at a different rate as time passes; there are no separate obligations as there are in the guarantor scenario.
Therefore, while a rule recognizing that a liability may be incurred before it begins to bear interest in excess of 6% has some practical appeal and can be technically justified through analogy to other liabilities, this rule is not reconcilable with the text of the SCRA and should therefore be rejected by the courts.
3. Rule 3: Guarantor Incurs Liability Bearing Interest in Excess of 6% When Borrower Defaults Under this rule, the liability to which § 527 is to be applied is incurred by the guarantor when the borrower defaults, and the liability begins to bear interest at 6% at the same point in time. Conceptually, the occurrence of the borrower’s default condition in the guaranty agreement creates a distinct, new obligation of the guarantor to fulfill the borrower’s obligations under the original loan agreement. Upon this occurrence, an obligation is incurred by the servicemember, satisfying the first requirement of § 527. If this obligation bears interest at a rate greater than 6%, then the second requirement of § 527 is satisfied. While a liability bearing interest in excess of 6% has been incurred upon the corporation’s default, the 6% interest rate cap will not apply if default occurs after the servicemember guarantor enters active military service.
Applying this rule to the facts in Newton demonstrates this implication. There, Ms. Newton executed an agreement guaranteeing a loan to her corporation on July 6, 1998,112 entered military service on June 13, 2005,113 and then became obligated to fulfill the terms of the loan on May 24, 2007, when her corporation defaulted.114 A court that adopts this rule would find that the servicemember guarantor incurred a liability that bears interest in excess of 6% on May 24, 2007. Since this liability was incurred after 111 Id. § 527 (2006).
112 Def.’s Mem. in Supp. of Summ. J. Ex. I, Newton, 2012 WL 1752407 (No. 3:11cv493-JAG).
113 Newton, 2012 WL 1752407, at *3.
114 Id. at *3 n.4.
2014] BETTING THE FARM 433 Ms. Newton entered military service, Ms. Newton would not be entitled to the 6% interest rate limitation of § 527.
This result is consistent with the language used in dicta in Newton.
There, the court described the guarantor’s liability as secondary to the borrower’s liability, with the guarantor’s liability becoming primary when the corporate borrower defaulted.115 Using precisely the same language of “incurred liability” as is used in § 527, the court clearly intended this statement to be analyzed in the context of the text of § 527. The implication of this statement is plainly that because Ms. Newton had already entered active military service, the benefit of § 527 could not apply to this liability because, as the court specifically states, the liability had been incurred after Ms. Newton entered military service. Although the court concludes its dicta by stating that this key question of whether a guarantor can be liable for debt that accrues at a rate greater than 6% has not been answered, the court’s unambiguous statement about when liability is incurred by a guarantor leaves little doubt that the court, if given the opportunity, would hold that the guarantor could be held liable for debt that accrues at a rate greater than 6%.116 This result is also consistent with the law of guaranty that holds that the guarantor’s liability after the borrower’s default is distinct from the liability before default. Prior to the borrower’s default, the guarantor is secondarily liable and the borrower primarily liable; after the borrower’s default, the guarantor becomes primarily liable.117 More specifically, after the borrower’s default, the guarantor is no longer purely a guarantor; she becomes the debtor on the loan.118 Put differently, the liability of the guarantor becomes “fixed on default of the debtor.”119 Regardless of the precise meaning of “fixed” in this context, it is clear that the guarantor has incurred a distinct liability upon the debtor’s default. The debtor’s liability has transferred to the guarantor; like a recently purchased used car, this liability is not new—but is new to the guarantor.
Courts should adopt this rule because it is most consistent with the Newton court’s interpretation of § 527 and the principles of guarantor liability. However, as the timeline in Newton demonstrates, this rule leads to a potentially harsh result: not only would a servicemember guarantor be held liable for interest in excess of 6% that accrued on the corporate debt before the corporation’s default, but also the servicemember would be unable to 115 Id. at *7–8; see also 38 AM. JUR. 2D Guaranty §§ 10, 15 (2010).
116 Newton, 2012 WL 1752407, at *8.
117 38 AM. JUR. 2D Guaranty § 2 (“A guaranty creates a secondary obligation under which the guarantor promises to be responsible for the debt of another.”); id. § 15 (“[T]he guarantor becomes primarily liable when the principal obligation has matured and is not performed.”).
118 Pollas v. Hardware Wholesalers, Inc., 663 N.E.2d 1188, 1190 (Ind. Ct. App. 1996) (“When the person or entity primarily liable for the debt defaults, the guarantor becomes the debtor.”).
119 State Bank of Burleigh Cnty. v. Porter, 167 N.W.2d 527, 532 (N.D. 1969) (citing 38 AM. JUR.
claim the 6% interest rate cap for interest that accrues on the debt after the corporation’s default. While this result may be harsh, Part II.B of this Comment will demonstrate that this result is consistent with legislative intent and actually promotes servicemembers’ long-run financial interests, even if they are liable for interest in excess of 6%.
B. Permitting Guarantor Liability for Interest Greater than 6% Under § 527 is Sound Policy The rule proposed in Part II.A of this Comment would potentially saddle an active duty servicemember with liability for interest that has accrued at a rate in excess of 6%. Although this increases the financial liability of a person who is serving her country, after balancing all the relevant interests and consequences, the result is actually sound policy. First, this result is consistent with Congress’s intent in passing the SCRA because it properly balances the interests of all the parties involved in the corporate loan transaction. Second, this result will provide servicemember small-business owners increased access to credit. Finally, this result will prevent the corporation’s management from intentionally defaulting on their obligations in order to take advantage of the benefits of § 527.
1. There Was No Legislative Intent to Extend § 527 to Guarantors
Congress’s purpose in passing the SCRA, provided in § 502, is “to provide for, strengthen, and expedite the national defense through protection extended by this Act to servicemembers of the United States to enable such persons to devote their entire energy to the defense needs of the Nation.”120 By this plain statement, it would seem that Congress intended the SCRA to provide servicemembers with every possible tool to enable them to ignore any potential distractions or pressures from their personal lives.
Congress recognized and balanced the needs of the national defense, servicemembers and their families, and, critically for the analysis in Part II.B.2 of this Comment, “the needs of those who have dealt with and depend upon Servicemembers for fulfillment of their obligations.”121 When assessing whether an interpretation of the SCRA is consistent with the legislative intent, the analysis is not as simple as determining whether the rule reduces the burden on the servicemember from her obligations at home.
120 50 U.S.C. App. § 502(1) (2006).
121 H.R. REP. NO. 108-81, at 51 (2003) (quoting H.R. 5111, the Servicemembers’ Civil Relief Act and H.R. 4017, the Solders’ and Sailors’ Civil Relief Equity Act, Hearings Before the H. Subcomm. on Benefits of the H. Comm. on Veterans’ Affairs, 107th Cong. 3–4 (2002) (statement of Craig Duehring, Acting Assistant Secretary of Defense, Reserve Affairs)).
2014] BETTING THE FARM 435 For example, a rule that is beneficial for servicemembers, and therefore serves the national defense by making recruitment easier, is not necessarily consistent with the legislative intent without balancing the national defense interest against the impact on any counterparty to a servicemember’s obligation.122 In passing § 527, Congress recognized that one of the many potential impacts on servicemembers’ personal lives is a decrease in income: “[This bill] springs from the inability of men who are in service to properly manage their normal business affairs while away. It likewise arises from the differences in pay which a soldier receives and what the same man normally earns in civil life.”123 Having recognized this potential impact, Congress sought through § 527 to provide some relief for high interest payments, which during World War II were as high as 3.5% per month.124 Congress’s intent for § 527 was not to eliminate required payments altogether, or to prevent new required payments; rather, the point of § 527 was to reduce existing required payments.125 Applying this background to the question of whether a guarantor can be held liable for interest in excess of 6% under § 527, it is evident that either of the rules that would allow the guarantor to limit her interest rate to 6% would be in conflict with the legislative intent. First of all, prior to the default of the corporation the servicemember has no payment liability whatsoever, so reducing the interest rate to 6% cannot possibly support Congress’s intent; the servicemember’s payments remain at zero.126 While the servicemember’s corporation may receive some payment relief in this situation, the servicemember herself would not.127 Also, providing the interest 122 But see Statement of Interest of the United States at 8, Cathey v. First Republic Bank, 2001 WL 36260354 (W.D. La. July 6, 2001).