You learn that your new open account corporate customer has gone out of business. Newspapers report that your corporate customer had orchestrated a bust-out and the president of the company has fled. Most frustrating, you learn too late that the president who orchestrated the bust-out has a personal history of defrauding creditors; and that the president's personal credit history reveals several judgments and a personal bankruptcy. Could you have headed off this problem earlier by obtaining a personal, or consumer, credit report on the president in connection with credit application?

In analyzing whether to extend trade credit to a closely held corporation, a credit executive may wish to review the president's or shareholder's personal credit history. Often the payment history of such a corporation is a reflection of the payment history of the officer or shareholder. Likewise, to reduce risk of nonpayment, a credit executive may seek a personal guaranty from a corporation's shareholder or officer, or limited liability corporation's member, before extending commercial credit. In connection with this guaranty, a credit executive may wish to review the guarantor's personal credit history.

Would obtaining such individual credit reports run afoul of federal laws? The Fair Credit Reporting Act (FCRA) affects how a credit executive may gather information to make these credit decisions. FCRA regulates the use of individual credit reports and credit information. Generally, the collection of business, trade, and commercial credit reports are not covered by FCRA. But does FCRA require a credit executive extending trade credit to a sole proprietorship, partnership or closely held corporation to obtain written authorization to obtain an individual's personal credit history, such as the credit history of a corporation's president or shareholder? Does FCRA require written authorization to pull a consumer credit report for an individual guarantying a corporate credit obligation? Before answering these questions, some background of FCRA is considered.  

1. FCRA's General Purpose

The FCRA statute concerns only the use of personal consumer credit reports used to evaluate credit in a business transaction. FCRA ensures that credit reporting agencies, and the users of such reports, will respect a consumer's right to privacy by authorizing pulling credit reports only in certain approved circumstances. FCRA's general purpose: to require that consumer reporting agencies 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 in accordance with the requirements of this [Act]. See 15 U.S.C. § 1681b.

2. What is a Credit Report?

A credit report may be any written or oral communication bearing on a consumer's credit standing, credit capacity, character, general reputation, personal characteristics, or mode of living. The report must be either used or expected to be used, or it must have been collected in whole or in part, for a "permissible purpose."

3. Written Authorization is Required Except for a Legitimate Business Purpose

FCRA as a general rule requires a trade credit grantor to obtain written authorization, i.e., permission, from an individual to run a consumer credit report. There is an exception to the statute, however, where authorization is not required. A consumer credit report may be obtained without authorization from the consumer if there is a legitimate "business purpose" in connection with a transaction initiated by the consumer.

A "business transaction" under FCRA refers to an exchange of goods or service for money. The general language of this subsection is extremely broad and seems to suggest that any "business need" would be sufficient to allow a credit executive to pull a consumer credit report without authorization from the individual, such as a corporation's president. On the other hand, the courts have limited the scope of the phrases "business need" and "business transaction," holding that "business transactions" include only those types of transactions described in other parts of the statute. Most courts have limited "business transactions" to those involving (a) the extension of credit, or (b) the collection of debt. 

For example, in Wrigley v. Dun & Bradstreet, Inc., subscribers of Dun & Bradstreet sought credit information regarding Wrigley Construction Company in connection with Wrigley's application for the extension of trade credit. Dun & Bradstreet provided information about the company and also personal information regarding the criminal convictions and bankruptcy of the owner of Wrigley. Consent from the owner was never obtained. In a lawsuit by the owner against Dun & Bradstreet, the court held that FCRA does not extend coverage to a consumer's "business transactions." The court ruled in favor of the credit reporting agency, finding no violation of FCRA and, thus, no liability.

Regarding debt collection efforts, one appellate court held it generally proper to obtain a consumer report in connection with debt-collection litigation. The court reasoned that the "lawsuit involves the collection of a debt, [therefore] the attorney is likely to procure the consumer report for a purpose analogous to those enumerated in § 1681b." Duncan v. Handmaker, 149 F.3d 424 (6th Cir. 1998). As the goal or purpose of a lawsuit moves outside debt collection, it is less likely, although not impossible, that an attorney will obtain the report for a purpose that is within FCRA. 

4. Notification if Credit is Declined Based Upon the Credit Report

FCRA requires that a credit grantor provide notice to the consumer if the credit grantor is denying credit, or otherwise taking adverse action with respect to the credit application, based upon the information obtained in the credit report. Thus, a credit grantor will provide notice to the company of the denial of credit; the credit grantor must also provide notice to the president, shareholder, or guarantor with respect to whom the credit report was obtained.

The notice can be oral, in writing, or electronic. The credit grantor is required to provide the name, address, and telephone number of the consumer reporting agency. In addition, the credit grantor must state that the consumer reporting agency did not make the adverse credit decision and such agency is unable to provide the consumer with the specific reasons why the adverse credit decision was taken. Finally, the credit grantor must notify the consumer of the consumer's right to obtain a free copy of the consumer report and "an indication" of the 60-day period that the consumer has to obtain such free copy. Notice must also be provided of the consumer's right to dispute with the consumer reporting agency the accuracy or completeness of any information in the consumer report. 

5. Penalties for Violating FCRA

In the consumer context, the private enforcement provisions of FCRA permit a consumer to bring civil suit for willful noncompliance with the FCRA, with no ceiling on the amount of punitive damages. The consumer may sue for negligent noncompliance, for actual damages sustained. The consumer may also seek to recover the consumer's reasonable attorneys' fees, as determined by the court. The reported judicial decisions applying FCRA penalty provisions to business transactions are scant. However, there is no exception in the statute and, thus, no basis to believe that the penalty provisions of FCRA would not apply to business transactions. In addition, criminal penalties may also be assessed including fines and imprisonment against any person who knowingly and willfully obtains a consumer report under false pretenses.

6. Trade Creditors Should Comply with FCRA as a Precautionary Measure

Don't be the test-lawsuit. As noted, FCRA as a general rule requires a trade credit grantor to obtain written authorization from an individual to run a consumer credit report. However, where an individual intends to guaranty the credit of a company, FCRA appears to provide an exception which allows the trade credit grantor to run a consumer credit report on the guarantor without authorization if there is a "business purpose" for running such report.

However, there is little case law interpreting the "business purpose" exception of FCRA. In light of this, we recommend trade credit grantors obtain written permission to run a consumer credit report of the individual guarantor and the insider of a company so as to protect the trade credit grantor from becoming a test-lawsuit. A credit executive should obtain written permission by including the following type of authorization language in the business credit application and personal guaranty form.

a. FCRA Authorization Contained in Trade Credit Application

A credit executive extending trade credit should include the following language in his or her trade credit application to authorize obtaining consumer credit reports on the corporation's individual insiders or LLC's individual members. Please see exhibit A.

Exhibit A

The undersigned consents to [insert: name of your business] obtaining a consumer credit report on [insert name of the sole proprietor/president/officer of closely held company] for the purpose of evaluating the creditworthiness of [insert name of the sole proprietor/president/officer of closely held company], in connection with this application.

Signed by____________________________
[type here name of sole proprietor/president/officer of closely held company]

FCRA Authorization Contained in Personal Guaranty A credit executive requiring a personal guaranty for extensions of trade credit should include language in his or her personal guaranty form to authorize obtaining a consumer credit report from the guarantor. Please see exhibit B.

Exhibit B

The undersigned consents to [insert: name of your business] obtaining a consumer credit report on [insert name of the guarantor] for the purpose of evaluating the creditworthiness of [insert name of the guarantor], in connection with an application for business credit.

Signed By:___________________________
[type name of guarantor here]

This language could be included as a separate form, or addendum to accompany the application or personal guaranty for trade credit.