«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 ...»
123 H.R. REP. NO. 108-81, at 33 (2003) (quoting 88 CONG. REC. H5368 (1942) (statement of Rep.
124 See Amy J. McDonough et al., Crisis of the Soldiers’ and Sailors’ Civil Relief Act: A Call for the Ghost of Major (Professor) John Wigmore, 43 MERCER L. REV. 667, 680 (1992) (quoting 88 CONG.
REC. H5368 (1942) (statement of Rep. Overton Brooks)); James P. Pottorff, Contemporary Applications of the Soldiers’ and Sailors’ Civil Relief Act, 132 MIL. L. REV. 115, 130 (1991).
125 H.R. REP. NO. 108-81, at 39 (2003) (“To resolve lingering questions about congressional intent, [§ 527] would clearly provide that interest above the 6 percent rate is to be forgiven, and that the amount of the monthly payment is to be reduced.”); see also JAG GUIDE, supra note 12, at 106 (“The point is to have the servicemember’s payment reduced else there is little benefit.”).
126 See, e.g., Newton v. Bank of McKenney, No. 3:11cv493-JAG, 2012 WL 1752407, at *3 (E.D.
Va. May 16, 2012) (describing the servicemember’s corporation’s payment history prior to default and that the bank only began requesting payment from the servicemember herself after the corporation’s default).
127 See, e.g., Pl.’s Mem. in Supp. of Summ. J. at 8, Newton, 2012 WL 1752407 (No. 3:11cv493JAG). The plaintiff’s corporation would have been liable for $23,676 less interest prior to the corporation’s default if the 6% interest rate cap had applied to the corporation; this could have reduced the required payments the corporation was required to make, but could not reduce the servicemember’s
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rate benefit to the corporation in this way would not support Congress’s intent because it would not reduce the servicemember’s interest rate payment burden; it would only reduce the corporation’s burden. Congress’s intent in granting the 6% interest rate cap to servicemembers acknowledges that their incomes may be reduced; a rule that would allow the corporation to claim the 6% interest rate benefit would, in effect, result in increased income because the corporation would pass along the interest savings to its servicemember owners in the form of salary or dividends.128 Second, after the corporation’s default the servicemember guarantor’s payment liability would jump from zero to some amount higher than zero— specifically, whatever payment liability the corporation had prior to default.129 In this situation, limiting the interest rate on this obligation to 6% might reduce the payment required to some extent, but this slight relief would be minor relative to the overall increase in required payment that remains. For example, Ms. Newton’s required payment jumped from $0 to over $300,000 because the lender had the right to call the entire balance due upon the borrower’s default; there, the interest in excess of 6% that was forgiven by the bank was $23,576.130 Congress’s intent with § 527 was to provide some relief for existing required payments, not to reduce the required payment on a newly incurred obligation by a mere 8%.
2. Permitting Interest Greater than 6% Increases Servicemember Small Business Owners’ Access to Credit If a court were to adopt a rule that allows a guarantor to claim the 6% interest rate benefit of § 527, that court may provide some marginal payment relief to the servicemember, but this impact could be overwhelmed by the resulting difficulty servicemember business owners will endure attempting to find affordable credit for their businesses. Insofar as § 527 is simply a limitation on the interest rate that lenders can legally charge a servicemember borrower, § 527 is essentially a type of usury law—“a law prohibiting moneylenders from charging illegally high interest rates.”131 Such laws may benefit some borrowers in uncompetitive or imperfect marpayments because the servicemember was already making no payments because she was not liable for payments prior to the corporation’s default.
128 18B AM JUR. 2D Corporations § 998 (2010) (corporation may distribute profits to its owners in the form of dividends); id. § 1661 (closely-held corporation may pay its managers a reasonable salary).
129 See, e.g., RESTATEMENT (THIRD) OF SURETYSHIP & GUARANTY § 1 (1996) (providing that a surety or guarantor “has a duty to effect, in whole or in part, the performance of the subject of the underlying obligation...” if the borrower does not perform his obligations).
130 See Newton, 2012 WL 1752407, at *4; Pl.’s Mem. in Supp. of Summ. J. at 8, Newton, 2012 WL 1752407 (No. 3:11cv493-JAG).
131 BLACK’S LAW DICTIONARY, supra note 44, at 1685.
2014] BETTING THE FARM 437 kets.132 However, basic economic theory demonstrates that a cap on possible interest rates will reduce the supply of money that is available for borrowing and therefore reduce the amount of credit that is available to the small businesses owned by servicemembers.133 Because lenders will be less eager to lend to servicemember small-business owners (SSB Owners) due to the potential that the interest rate will be reduced to 6% under the SCRA in the future, lenders may choose not to lend to the servicemember-owned small businesses at all or may choose to charge a higher interest rate when the servicemember is not in active military service.134 In either scenario, the servicemember is potentially better off without the benefit of § 527 because his business may otherwise have access to more or cheaper credit.
In order for a reduction in credit available to SSB Owners to occur, lenders would have to adjust their lending policies for SSB Owners to account for the impact of the SCRA. While this amounts to discrimination against servicemembers in lending decisions, there are no significant obstacles to such discrimination. The Equal Credit Opportunity Act does not outlaw discrimination in lending on the basis of a borrower being a servicemember.135 A policy of unfavorable treatment for SSB Owners in lending decisions would likely be accompanied by significant public relations and political backlash against the lender, but behavior consistent with such a policy is not unprecedented. Despite the potential public relations and political toll, lenders have in the past targeted servicemembers for payday loans that accrue interest at rates well over 300%.136 Applying the SCRA’s 6% interest rate cap to corporate debt that is guaranteed by a servicemember is not necessarily bad policy simply because lenders would, as allowed by law, discriminate against SSB Owners and reduce the amount of credit available to them. For example, propoSee generally Paul G. Hayeck, An Economic Analysis of Justifications for Usury Laws, 15 ANN.
REV. BANKING L. 253, 253 (1996) (describing the justifications for usury laws as “(1) markets are noncompetitive; (2) important social utility and distributional effects will otherwise be lost; (3) low interest rates encourage economic growth through increased borrowing; and (4) credit markets are characterized by imperfect information”).
133 See Eric A. Posner, Contract Law in the Welfare State: A Defense of the Unconscionability Doctrine, Usury Laws, and Related Limitations on the Freedom to Contract, 24 J. LEGAL STUD. 283, 301 (1995) (explaining that usury laws, which usually set an interest rate ceiling, tend to have the effect of reducing the availability of credit to the poor).
134 See, e.g., Rudolph C. Blitz & Millard F. Long, The Economics of Usury Regulation, 73 J. POL.
ECON. 608, 613 (1965) (“While the oft-stated purpose of usury legislation is to help that class of debtors which includes the landless peasants, poor urbanites, and very small businessmen, maximum rates are likely to affect them adversely by excluding them from the market.”).
135 15 U.S.C. § 1691 (2006).
136 Steven M. Graves & Christopher L. Peterson, Predatory Lending and the Military: the Law and Geography of “Payday” Loans in Military Towns, 66 OHIO ST. L.J. 653, 661 (2005). Congress responded to this practice by outlawing lending to servicemembers at interest rates in excess of 36%. 10 U.S.C. § 987. This prohibition only applies to consumer lending, and not commercial lending to small businesses. Id.
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nents of traditional usury laws have argued that they are sound policy because the protection they offer low income and uninformed borrowers outweighs the marginal reduction in credit available to these borrowers.137 However, the same cost–benefit analysis would not apply in the context of lending to SSB Owners at rates in excess of 6%. In this context, the usury law (the SCRA) does not provide protection to vulnerable borrowers, but rather protects all servicemember borrowers from some of the distraction of concerns at home.138 The benefit of this protection is likely small and may not outweigh the cost of reduced credit available to SSB Owners.139
3. Permitting Interest Greater than 6% Reduces the Borrower’s Incentive to Strategically Default A rule that limits servicemember liability as a guarantor for debt that accrues at a rate greater than 6% could create an incentive for corporate borrowers to take advantage of the benefits of § 527 through strategic default, a tactic unavailable to ordinary corporate borrowers.140 Under such a rule, a corporate borrower obligated on a note guaranteed by a servicemember on active duty that is currently accruing interest at a rate in excess of 6% could strategically default on the note in order to shift liability for the note to the servicemember, who by law could not be liable for interest in excess of 6%.141 Such behavior by corporate management could lead to a number of undesirable outcomes. First, the servicemember guarantor would become responsible for payments on the loan at the exact time when the SCRA intends to reduce the servicemember’s payment obligations.142 Second, the servicemember guarantor may willingly take on the shifted liability for the loan despite her military service because she is both the manager and guarSee generally Hayeck, supra note 132, at 253.
138 See 50 U.S.C. App. § 502 (stating that the purpose of the SCRA is to enable servicemembers to “devote their entire energy to the defense needs of the Nation...”); H.R. REP. NO. 108-81, at 51 (2003) (“[This bill] springs from the inability of men who are in service to properly manage their normal business affairs while away.”) (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)).
139 See supra Part II.B.1.
140 Newton v. Bank of McKenney, No. 3:11cv493-JAG, 2012 WL 1752407, at *5–7 (E.D. Va.
May 16, 2012).
141 A strategic default occurs when “borrowers who have the ability to repay... find it in their
antor of the business she owns.143 Under this scenario, the guarantor could make required payments, reduced by the amount of forgiven interest, using proceeds paid to her by the business. The business could funnel these proceeds to the servicemember either as dividends or salary.144 Alternatively, the servicemember as guarantor could seek reimbursement from her business for the amount she has paid on the loan, an amount that has been reduced by the amount of interest forgiven under § 527.145 While this scenario results in the servicemember having a net payment burden no greater than she would have if the strategic default had not occurred, this result is still undesirable because it indirectly allows the business to take advantage of § 527. This is a result that the text of the statute does not contemplate and that has been rejected by Cathey and Newton.146 Third, if a guarantor were entitled to the benefit of § 527 and could require the lender to reduce the interest rate on the corporation’s loan to 6%, corporations would have an incentive to seek out a servicemember guarantor for every loan.147 There are several reasons why corporate management may not choose to strategically default, however. First, any default under the loan document may allow the lender to accelerate the payment due.148 As in Newton, a servicemember guarantor is often unable to pay the entire amount due, in which case the lender may seek to foreclose on the servicemember’s family farm in order to satisfy the debt.149 Second, while the corporation may benefit from a reduced interest rate on the particular loan guaranteed by the servicemember, the strategic default would likely damage the corporation’s credit rating, increasing the interest rate the corporation would be expected to pay on any future loans.150 Even if the corporation chooses to strategically default to capture the benefit of § 527, the corporation may encounter additional legal challenges 143 See, e.g., Cathey v. First Republic Bank, No. 00-2001-M, 2001 WL 36260354, at *4 (W.D. La.
July 6, 2001) (“It is the plaintiffs whose labor and expertise was required to operate the corporation profitably so that its obligations could be met.”); Linscott v. Vector Aerospace, No. CV05-682-HU, 2006 WL 1310511, at *1 (D. Or. May 12, 2006) (“Plaintiff Jeffrey Linscott owns and operates JLA....”); Def.’s Mem. in Supp. of Summ. J. Ex. Y, Newton, 2012 WL 1752407 (No. 3:11cv493JAG) (joint owner of hardware store also served as the business’s vice president).
144 18B AM. JUR. 2D Corporations § 998 (2010) (corporation may distribute profits to its owners in the form of dividends); id. § 1661 (closely-held corporation may pay its managers a reasonable salary).
145 RESTATEMENT (THIRD) OF SURETYSHIP & GUARANTY § 22 (1996).
146 Cathey, 2001 WL 36260354, at *4, *5; Newton v. Bank of McKenney, No. 3:11cv493-JAG, 2012 WL 1752407, at *5-7 (E.D. Va. May 16, 2012).
147 Reply of Defs. to the Mot. for Partial Summ. J. of Pls. at 7, Cathey, 2001 WL 36260354 (No.
00-2001-M) (“Surely this is not what Congress intended.”).
148 Def.’s Mem. in Supp. of Summ. J. Ex. F, Newton, 2012 WL 1752407 (E.D. Va. May 16, 2012) (No. 3:11cv493-JAG).
149 Newton, 2012 WL 1752407, at *4.