Post September 11: Equal Credit Opportunity Act

ECOA Still Prohibits Discriminating Against Applicant Requesting Credit

The terrorist acts of Sept. 11 have unified the country and patriotism has been brought to the forefront. Recent federal legislation, such as the Patriot Act, focuses on ways to combat terrorism, especially from the Middle East. The press has reported racial profiling, for example, where pilots are denying certain passengers to fly. May a credit professional refuse to extend credit to an applicant, say, a sole proprietor originally from the Middle East? The Equal Credit Opportunity Act (ECOA) says no. ECOA is a federal statute that prohibits credit grantors from discriminating in the granting of credit based on prohibited basis, and requires creditors to comply with certain notifications, and retain records. How does ECOA impact a credit professional's commercial credit decision making and notifications, especially post-Sept. 11?

A. What Is ECOA?

ECOA was enacted by Congress in 1989, and the Federal Reserve Board issued Regulation B to implement ECOA in 1990. ECOA is a federal statute that prohibits credit grantors from discriminating in the granting of credit based on a prohibited basis, including race, color, religion, national origin, gender, marital status or age (collectively referred to under the regulations governing ECOA as the "Prohibited Basis"). As ECOA is a federal statute, it applies to all states. ECOA is intended to promote the availability of credit without regard to characteristics that have nothing to do with creditworthiness. Creditors are required to notify applicants of action taken on their applications, and to retain records of credit applications.

ECOA's prohibitions against discrimination are aimed primarily at the evaluation of a credit application by a credit grantor. The general rule is that a credit grantor can consider any information it obtains in evaluating whether to extend credit so long as the information is not used to discriminate against an applicant on a prohibited basis.

1. Only Applies When "Credit" Is Considered To Be Extended

ECOA only applies when "credit" is considered to be extended. "Credit" is defined as "the right granted a creditor to a debtor to defer payment of debt or to incur debts and defer its payment or to purchase property or services and defer payment therefore." Thus, a vendor extending business credit on, for example, 30 day terms, can be reasonably read as extension of "credit" under ECOA.

The regulations promulgated the Board of Governors of the Federal Reserve System are expansive. Under the regulations, ECOA applies to "credit transactions" which are defined as "every aspect of an applicant's dealings with a creditor regarding an application for credit or existing extension of credit (including . information requirements; investigation procedures; standards of creditworthiness; terms of credit; furnishing of credit information; revocation, alteration, or termination of credit; and collection procedures").

C. Notice Of Credit Decision And Statement Of Reasons: The 30/60/30 Day Rules

ECOA requires credit grantors provide written notification to applicants.

1. Notice of Adverse Action Within 30 Days

Under ECOA, a credit grantor must provide notice to the applicant of action taken with the request for credit within 30 days after a completed application received by the credit grantor. The possible actions under ECOA are (a) an adverse decision ("Adverse Action"), (b) a counteroffer, or (c) granting the credit requested.

Adverse Action is defined as:

a. Refusal to grant credit in substantially the amount or terms requested - unless the credit grantor makes a counteroffer (for different credit terms) and the applicant accepts the counteroffer;

b. Termination of an account or an unfavorable change in terms; or

c. Refusal to increase the amount of credit available.

If Adverse Action is taken, notice must be provided by the credit grantor to the applicant that the party has the right to request reasons for the Adverse Action in writing within 60 days of such action. See Attachment A. Notification may be done verbally if the application was verbally made, otherwise it must be done in writing. ECOA provides that the notice of Adverse Action must contain language advising of ECOA similar to that in Attachment A.

2. Credit Applicant's Request For Statement Of Reasons Within 60 Days

The applicant has 60 days from receipt of the credit grantor's Adverse Action letter to request an explanation of adverse ruling.

3. Credit Grantor's Statement Of Reasons Within 30 Days

If an applicant requests an explanation of Adverse Action within 60 days, the credit grantor is to provide a statement of reasons within 30 days. The credit executive is not required to provide specific reasons for the Adverse Action, but instead may provide language such as, "adverse credit history"; "lack of business experience"; "lack of working capital"; or "too much secured debt." One form of letter addressing the statement of reasons letter is provided as Attachment C.

C. Obtaining A Spouse's Guarantee

ECOA does not permit a credit grantor to require a spouse to sign a personal guaranty if that spouse is not directly involved with the applicant. A personal guarantee can be required only when an applicant does not meet the creditor grantor's scoring model for credit. If the business owner's spouse is not involved in the business and does not hold a position with the corporation, a personal guarantee that includes the spouse may be discriminatory.

D. Retention Of Records

ECOA requires credit grantors to retain records for applicants denied credit. The records a credit grantor retains are the credit application, the credit grantor's notification of action, the statement of specific reasons for the adverse action and the applicant's written statement alleging violation of ECOA.

The period of time that the records must be retained depends on the amount of the gross revenues of the applicant. For credit applicants with gross revenues of $1 million or less, the credit professional must keep records for 12 months after notification. For credit applicants with gross revenues in excess of $1 million, the credit professional must keep records for at least 60 days after notification. However, if an applicant requests that the records be retained, the creditor must retain the records for 12 months.

Retention of records is required beyond 12 months if the credit grantor has notice that it is under investigation, is subject to an enforcement proceeding, or is served with notice of an action filed. Then records must be kept until the later of the 12 months or the final disposition of the matter, unless an earlier time is allowed by court order.

The statute of limitations to commence an action against the credit grantor is two years after applying for credit.

E. ECOA In The Internet Age

The Internet is revolutionizing how the credit professional handles credit transactions. Credit professionals are using the Internet for a myriad of credit and financial functions, from credit research and scoring, to automatic invoicing customers through their Web site, to automatic payment posting. Credit departments are loading their web pages with credit applications and guarantees for the customer to retrieve. The electronic credit department has arrived.

The Electronic Signatures in Global and National Commerce Act (The E-Sign Act) makes e-signatures as legally binding as ink-and-paper signatures. The E-Sign Act also eliminates legal barriers to storing documents and sending notices electronically. A credit professional may now engage in e-credit transactions across state lines and the credit sale contract is valid in all states.

Neither the E-Sign Act nor the ECOA should bar a credit professional from electronically notifying an applicant of Adverse Action or storing credit information electronically, and otherwise be in full compliance with the FCRA. However, the ESign Act requires that the consumer decides whether to use an e-signature or handwritten signature, and the vendor must conduct test e-mailings before sending out subsequent e-mail notifications.

1. E-Notification Of Adverse Action And Statement Of Reasons

ECOA requires a credit grantor give notification of Adverse Action. The ESign Act may allow a credit grantor to give electronic notification of Adverse Action and statement of reasons.

2. Storing Credit Applications Electronically

The E-Sign Act authorizes storing documents electronically. This means that a credit professional may store electronically the credit files of declined applicants.

F. Avoiding The ECOA Lawsuit: Steps To Comply

A paper trail demonstrating to disgruntled applicants (or their counsel) or FTC audits that a credit grantor complies with ECOA can be useful in keeping lawsuits at bay. To comply with ECOA, there are several steps a credit grantor may consider adopting. These steps assist the credit grantor in creating a paper trail evidencing compliance with ECOA.

1. Company Policy: consider adopting a stated policy that there shall be no discrimination on a prohibited basis with the extension of credit.

2. Written Manual: consider including in your company's policy manual a statement the company complies with ECOA.

3. Training The Troops: Train credit and sales personnel about ECOA. ECOA may also apply to the credit grantor's sales' brokers and agents if the company cloaks them with authority to request credit information from the applicant.

4. Credit Application: The credit application should provide for statement of the vendor's compliance with ECOA. See Attachment A. The credit application should not include any language or seek information that may lead an applicant to believe that the information sought would be used to discriminate. See Attachment A.

5. Personal Guarantee: ECOA does not permit a credit grantor to require a spouse to sign a personal guaranty if that spouse is not directly involved with the applicant.

6. Notification To Applicant: Comply with the 30/60/30 written notification.

7. Record Keeping: Store credit records. Digital records may be recognized.

G. Types Of Evidence Proving Credit Discrimination

What type of evidence may prove a violation of ECOA?

1. Overt Discrimination: When a credit grantor blatantly discriminates on a prohibited basis. Expressions of a discriminatory preference may constitute a violation of ECOA even if the credit grantor does not act on the preference. The example post Sept. 11 where a credit professional refuses to sell a sole proprietor of Middle Eastern origin because of his origin.

2. Disparate Treatment: When a credit grantor treats applicants differently based on a prohibited basis. May be overt or subtle and does not require evidence that differences in treatment were caused by prejudice or conscious intention to discriminate.

3. Disparate Impact: When a credit grantor applies a policy or practice uniformly to all applicants, but the policy or practice has a disproportionate effect on groups protected under ECOA. No violation of ECOA if the disparity created by the policy or practice is justified by business necessity and there is no less discriminatory alternative.

I. Enforcement Of ECOA

Enforcement of ECOA may be through private lawsuit or through administrative enforcement. A creditor failing to comply with ECOA may be subject to civil liability for actual and punitive damages in either individual or class action lawsuits. Punitive damages are capped at $10,000 in individual lawsuits; and capped at the lesser of $500,000 or 1% of the creditor's net worth in class action lawsuits. Winning plaintiffs may also recover from the defendant reasonable attorneys' fees and costs. The Federal Trade Commission regulates ECOA.

J. Post Sept. 11, The Credit Professional Cannot Discriminate With Credit Decision

Post Sept. 11 has caused us to consider those around us in different a light, given the continued threat of domestic terrorism. The country has come together on a united and patriotic way. On the commercial credit front, post Sept. 11 neither the U. S. Congress nor the FTC have changed ECOA's prohibition of denying credit based on national origin or race, for example, where a sole proprietor from the Middle East requests commercial credit.

Reprinted by permission from Trade Vendor Quarterly Blakeley & Blakeley LLP Spring 02