Credit Today Legal Case Study: The ‘Business Exception’ to the Fair Credit Reporting Act


This article originally appeared in Credit Today, the leading publication for the credit professional.
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By Ann Morales Olazábal

Landers Lighting Co. is a large manufacturer and retailer of lighting products. In addition to its retail business, Landers does fairly sizable sales to local contractors, some of whom are on open credit terms. One of its longstanding business customers is Del Amo Electric, Inc. (DAE), a contractor in the business of installing and servicing lighting and other electrical fixtures. Frank Del Amo is DEA’s president, and he and his wife are the company’s sole shareholders.

DEA’s account with Landers has gotten in arrears recently, and the parties have informally discussed the possibility of Mr. and Mrs. Del Amo personally guarantying a note representing the $26,000 outstanding balance owed by DEA. Consequently, Landers’s credit manager is considering pulling a consumer credit report on the Del Amos “to ascertain their personal creditworthiness. Landers routinely obtains such credit reports on its retail customers by way of a contractual agreement with one of the three largest nationally recognized consumer credit information providers.

Under these circumstances, and given the business-oriented purpose of the credit report, may Landers legally obtain Mr. and Mrs. Del Amo’s consumer credit report?

Make your decision and read below for the answer!




The ‘Business Exception’ to the Fair Credit Reporting Act

By Ann Morales Olazábal

No. The Fair Credit Reporting Act is a consumer protection statute that requires credit reporting agencies to “adopt reasonable procedures for meeting the needs of commerce for consumer credit, personnel, insurance, and other information in a manner which is fair and equitable to the consumer, with regard to the confidentiality, accuracy, relevancy, and proper utilization of such information.” 15 U.S.C. Section 1681(b).

Most of the provisions of the FCRA regulate the behavior of credit reporting agencies. But, because consumer credit reporting agencies cannot prohibit illegal use of consumer credit information if credit report users are not bound by law to obtain consumer credit reports only for permissible purposes, the FCRA also extends to the conduct of parties who request credit information.
Generally speaking, credit reports can legally be requested by those considering (1) the extension or collection of consumer credit accounts, (2) employment of a consumer, (3) underwriting of insurance for a consumer, (4) a consumer’s entitlement to government benefits, or (5) any another “legitimate business need” in connection with a consumer business transaction.

This latter purpose for obtaining credit reports has long been referred to as the “business exception” to the FCRA. Six years ago, the FCRA was substantially amended as part of the Consumer Credit Reporting Reform Act of 1996. Since then, the precise language of the “business exception” provision of the FCRA has read as follows: . . . any consumer reporting agency may furnish a consumer report under the following circumstances . . . (3) To a person which it has reason to believe . . . (F) otherwise has a legitimate business need for the information — (i) in connection with a business transaction that is initiated by the consumer.

Exception in Question

While courts had previously held that businesses extending trade credit may have had a legitimate need for consumer credit information on sole shareholders, the 1996 amendment to the statute’s language threw the continuing validity of the FCRA business exception, as we once knew it, into question.

Subsequent Federal Trade Commission Staff Opinion letters interpreting the FCRA make it clear that where a credit application is made by a business entity, the statute does not provide a permissible purpose for a creditor to obtain a consumer report on a guarantor or co-signer for–or a principal, owner, or officer of–the commercial credit applicant. Thus, no consumer credit report should be obtained in circumstances similar to this case without the individual subject’s consent.

Both the entities and individuals who are involved in obtaining and using consumer credit information in circumstances other than those specifically outlined in and permitted by the FCRA can be held liable in private lawsuits brought by the subject(s) of the credit report. Therefore, both Landers and its credit manager, individually, could be sued and held legally liable for any resulting damage award, if a consumer credit report is obtained on the Del Amos, in connection with their offer to guaranty their business’s outstanding debt.

The best practice is always to obtain the consumer’s written consent before requesting a consumer report from a credit reporting agency. Another alternative may be to investigate the Del Amos’ business history and status by way of a commercial credit information agency, which would not be subject to the strictures of the FCRA.

Ann M. Olazábal, MBA, JD, formerly Credit Today’s Legal Editor, is Vice Dean, Undergraduate Business Education, Chair and Professor, Business Law at the University of Miami School of Business Administration.

Thanks to Credit Today’s library of Legal Case Studies


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Legal Issues in Credit

A company’s credit department is often one mired in legal issues and while many of them relate to reducing legal exposure and getting money when a customer goes delinquent, many others are problems that could penalize the debtor due to inadvertent unfair practices. Laws like the Fair Credit Reporting Act (FCRA), multiple antitrust statutes and the Equal Credit Opportunity Act (ECOA) are all geared toward preventing discriminatory, anticompetitive and unsafe privacy practices and credit professionals up and down the corporate ladder need to be
aware of them to prevent legal woes.

In a recent CMA-sponsored webinar entitled “Legal Issues in Credit: An Update,” Wanda Borges, Esq.  of Borges & Associates, LLC led listeners through these potential problems and offered advice on how best to avoid these issues. “It is a way of being fair in the extension of credit,” said Borges of the ECOA, adding that many companies
who think they’re exempt from ECOA requirements are not in many instances. “Those of you with large companies may think to yourself ‘you never have to deal with this because you’re dealing with Fortune 500 companies, etc.’ Well, yes and no. Anytime you make a credit decision that is ‘no,’ you need to stop and think if ECOA applies to you.”

The ECOA deals with discrimination in terms of credit and the issue of when a vendor needs to notify a customer when denying them credit or when reducing their current level of credit, referred to in the law as “adverse actions.” Borges went through what constitutes an adverse action and noted the times when the law’s stipulations do not apply. “The ECOA means an individual,” said Borges. “That’s also your personal guarantor. So perhaps you’re dealing with a large company and ask for a personal guarantee. Then you need to think of the ECOA.”

“Creditor [as defined by the ECOA] is anyone in your company that makes the credit decision. It’s not just the director of credit, it’s not just the CFO; it can be a credit analyst and they need to be sure to know the ECOA and abide by its rules and regulations,” she added.

Borges also discussed how to comply with the ECOA without having to keep a list to check over and over again, and went on to address compliance with the FCRA, the Uniform Commercial Code (UCC) and several antitrust statutes.


Credit Applications and Related Legal Issues

After a number of years in the industry, it might be easy for a credit professional to overlook the credit application as something that’s more a part of the landscape than anything else. However, if an account goes bad, a haphazard credit application could make the collection process a lot more difficult. “Credit executives seem to have an attitude of ‘I’ve been around for a long time, I know everything there is to know about credit applications,’”
said Wanda Borges, Esq. of Borges & Associates, LLP in a recent CMA webinar.

Borges noted that while this may be the case, she’s noticed seasoned credit professionals in other presentations obviously being reminded, enlightened and refreshed about some easily overlooked and commonly forgotten credit application strategies. “I hope today for all of you on the line I will either refresh you as to some things you forgot about or teach you some things you never thought about with credit applications,” she added.

Borges delivered on this wish in her teleconference, entitled “Credit Applications and Related Legal Issues,” by offering attendees a quick and effective guide to all the ways a company should protect itself from customer
default and legal exposure using its credit application.

One of the first considerations to make when constructing a credit application is what information needs to be collected. “My primary rule of credit is ‘know thy customer,’” said Borges, who offered a thorough list of what
details should be collected up front to put the creditor in a more advantageous position. Specifically, Borges discussed the importance of getting corporation details, ownership details and to include stipulations about references.

Ownership details, Borges noted, can be of great use should a collection effort be necessary. “You want that information so you can go find them,” she said, adding that every application should require home addresses and ownership interest information for each owner of the business entity. For references, Borges suggested that credit grantors require at least three trade references and also stipulate that they can get references from the customer’s bank. “The trade credit reference is actually going to be the best of their trade credit references,” she said. “You are not limited to the references they give you.”

Borges’ presentation also offered participants text to include in a credit application to protect a creditor from exposure to laws like the Fair Credit Reporting Act, the Equal Credit Opportunity Act and the Fair and Accurate Credit Transactions Act’s disposal rule. She also offered tips on how to clearly organize the application to make sure the customer understands it and can’t reasonably plead ignorance in a court case.