Guaranties, Garnishments and Overdraft Fees: Case Law Continues to Emerge
By: LEAH C. JANUS & BEAU J. HURTIG
Although the banking industry is primarily focused on emerging statutes and regulations and navigating the current climate, bankers should note that case law involving bank operations continues to emerge. The following is a summary of some recent decisions.
Garnishment – Debtor v. Creditor (Minnesota Supreme Court)
Factual background – The creditor served a garnishment summons on the Bank (the garnishee) and the debtor. The Bank retained funds from two accounts jointly held by the debtor and debtor’s spouse. Because the debtor did not claim any exemptions and the debtor’s spouse did not intervene, the Bank released the funds to the creditor after the 14-day waiting period. The debtor and debtor’s spouse sued the creditor claiming that some of the funds in the joint accounts belonged to the spouse and, therefore, were not properly subject to the garnishment.
Legal arguments asserted – The debtor argued that the creditor should have the burden of proving that some of the funds in the account belong to the debtor because the non-debtor’s funds should not be subject to garnishment in the first place. The debtor further argued that the Bank should presume that all parties to the joint account have an equal interest in the funds.
Holding – The Court held that under the garnishment statute, the garnishee Bank may initially presume that all of the funds in an account held jointly by the debtor and another individual are owned by the debtor. An account holder may rebut this presumption. However, it is the account holder’s burden to prove that some of the funds in a joint account do not belong to the debtor. There is no provision in the statute that requires creditors or debtors to prove net contributions before the garnishee must retain the funds. Rather, “a garnishee’s obligation to retain funds is immediate.”
Banks are often placed in a difficult situation when they receive a garnishment because they must hold a customer’s funds so these funds may be transferred to a third party creditor. A garnishment of joint accounts is even more difficult because it is possible that not all funds in the garnished account belong to the debtor. Bankers may take some comfort in this holding because it permits banks to freeze all garnished funds immediately, even those held in a joint account. Therefore, banks would be wise to ensure that their garnishment procedures require an immediate hold on all accounts held by the debtor and to follow such procedures consistently.
Equal Credit Opportunity Act – Bank v. Guarantors (Supreme Court of Iowa)
Factual background – The Bank loaned funds to the company. To secure payment, the Bank obtained a mortgage and obtained guaranties from the two principals of the company and the two spouses of the principals. The company defaulted on the debt. The Bank filed suit on the guaranties.
Legal arguments asserted – Spouses asserted defenses and counterclaims under the Equal Credit Opportunity Act (ECOA), claiming that the Bank obtained their guaranties solely because they were married to the principals and not because other parties obligated to the Bank were not sufficiently creditworthy to satisfy the company’s obligations. Therefore, the spouses claimed that the Bank unlawfully discriminated against them based on their marital status, rendering the guaranties void and unenforceable.
Holding – The Court held that the guaranties were unenforceable. The spouses could assert the ECOA as a defense to the enforcement of the guaranties, even though they were only guarantors and not the original applicants for the credit. In addition, they could defeat the enforcement of the guaranties by asserting the defense despite the fact that the statute of limitation had run on their ability to assert a violation of the ECOA as an affirmative claim. The Court further held that the spouses presented evidence that parties to the loan transaction other than the spouses were qualified under any reasonable standard of creditworthiness for the amount and terms of credit requested. Finally, the spouses presented evidence that it was the Bank’s policy to require the signature of spouses of the principal shareholders of a corporation on the loan documents. Thus, the spouses had asserted facts to support their ECOA defense, and the guaranties were unenforceable.
Regulators may be skeptical of guaranties when examining loan portfolios. This holding further illustrates the potential unreliability of guaranties in the collection process. Although it remains prudent for banks to obtain personal guaranties from the principals of a borrower, banks should rely primarily upon adequate collateralization to help ensure a highly rated portfolio and repayment.
Unenforceability due to fraud or mistake – Bank v. Guarantor (North Dakota Supreme Court)
Factual background – The Bank had a long-term relationship with the company and the company’s principal, including several short-term loans secured by a security interest in the company’s assets. The Bank and the company then consolidated the short-term notes, and the Bank granted the company a line of credit. The Bank sought additional security for the debt in the form of a co-signer. The principal’s father signed a commercial guaranty for “all obligations” of the company. The company defaulted on the debt, and the Bank sued the co-signer.
Legal arguments asserted – The co-signer claimed that he signed the commercial guaranty without reading it carefully and, based on his conversations with the banker, was under the impression that he was guarantying $20,000 of debt, rather than over $150,000 of debt. Therefore, the co-signer defended the suit on the grounds that he was induced to sign the guaranty because of fraud or mistake.
Holding – The Court held that the Bank was not entitled to judgment on the guaranty without a trial. While the Court noted that “a party cannot claim ignorance because of a failure to read a guaranty,” it held that the evidence of conversations between the Bank and the co-signor prior to the execution of the guaranty could be considered. Because the co-signer alleged that the Bank told him that if he signed the guaranty, he was helping the company buy “one load of lumber for $20,000,” he asserted sufficient facts to raise an issue “about fraud or mistake and his inducement for signing the guaranty.”
When asking for third-party guaranties, banks should clearly explain to the guarantor the terms of the guaranty and total liability under the guaranty, and note such discussions in the file. Further, banks should examine their guaranties to ensure they clearly state the total liability and should consider having the guarantor initial each page. Proper documentation could be very helpful in the event a guarantor later claims ignorance.
Reasonableness of overdraft charges – Bank v. Account Holder (North Dakota Supreme Court)
Factual background – Account holder opened a checking account at the Bank. Account holder incurred over $11,000 in overdraft charges. In connection with the account, account holder signed an account agreement that provided, in part: “If an item is presented [to Bank] without sufficient funds in your account to pay it, we may, at our discretion, pay the item (creating an overdraft) .... The amount of the overdraft ... fees are disclosed elsewhere.” After the account was opened, the Bank instituted a new schedule for overdraft fees. The Bank mailed a “Fees and Service Charges” brochure to customers explaining the new schedule. The brochure indicated that the Bank would charge two different overdraft fees. First, the Bank would charge clients a fee on “each day that an overdraft balance remains on your account ....” The amount of the daily overdraft fee escalated with the amount of the overdraft balance. When a client’s account was overdrawn by more than $10,000, the Bank charged the account $100 per day. The Bank charged the daily overdraft fee whether or not the client utilized the overdrawn account on that day. Second, the Bank would charge $10 “for each statement cycle that the account balance is below zero ....” The Bank sued account holder to collect on outstanding overdrafts and the overdraft fees. Because account holder had periods of time when the account was overdrawn by more than $10,000, there were times when account holder was charged $100 per day in overdraft fees.
Legal arguments asserted – Account holder argued that the overdraft fees charged by the Bank were unconscionably high when compared to the size of the overdraft balance, and therefore she should not have to pay the fees. Account holder also argued that the account agreement was unfair, and therefore should not be enforced.
Holding – The Court held that the overdraft fees charged by the Bank were not unconscionable, and therefore the account holder was required to pay the fees. The Court held that the account agreement was valid and that it provided notice to account holder that overdraft fees would be charged if the account was overdrawn. Account holder was on notice that she would be charged the overdraft fees because she received the fee schedule brochure and the Bank mailed her the schedule and notices each time the Bank honored a check that created an overdraft. Finally, the Court held that account holder did not present any evidence to support a finding of unconscionability, such as evidence about the total amount of fees her account was charged or comparative data from other banks.
This holding is favorable to banks with respect to upholding customer contracts and permitting overdraft fees. The holding emphasizes the importance of having clear overdraft policies and the communication of those policies to account holders. The prudent practice is to ensure overdraft fees are reasonable and consistent with applicable statutes and to manage customer relationships to avoid high overdraft balances. Finally, bankers should be aware that states other than North Dakota may take a different view if presented with the same facts.