Skip to Main Content
Close Search Box

Ask The Attorney: Considerations for Reducing or Revoking Credit

By Bruce S. Nathan and Scott Cargilll – Lowenstein Sandler
June 2022


Q:  Is there a legal protocol or process a supplier has to go through to reduce or take away open terms from a customer?

While there is no specific legal approval process required before reducing or revoking a customer’s credit terms, any credit decision is subject to challenge by a customer in court.  It is therefore very important to contemporaneously document the specific reasons for any adverse credit decision.  Basing adverse credit decision upon a “feeling” or a “hunch” potentially invites costly litigation and customer claims that the creditor violated the Equal Credit Opportunity Act (the “ECOA”), as implemented by “Regulation B”, which is overseen by the Bureau of Consumer Financial Protection and prohibits adverse credit decisions based upon impermissible factors, including, race, color, national origin, sex, marital status, religion, gender, or age (“Discriminatory Criteria”).

Regulation B requires, among other things, that a creditor notify a customer of an adverse credit action (such as a refusal to extend credit).  However, an adverse credit action does not include a creditor’s refusal to extend credit based upon a customer’s prior default.

For customers with revenues of over $1 million in the preceding fiscal year, or for transactions involving the extension of trade credit, a creditor must notify its customer, either orally or in writing, within a “reasonable time” of taking adverse action on an existing account.  If within 60 days of such notification, the customer requests in writing the creditor provide its reasons for the adverse credit decision, the creditor must:

  • Provide the specific reason(s) why the adverse action was taken and state the principal reason(s) for the credit decision. It is insufficient to state only that the action was based on the creditor’s internal standards or policies, or that the customer failed to achieve a qualifying score on the creditor’s credit scoring system; and
  • Provide a copy of an “ECOA Notice”, which must contain specific language required by Regulation B explaining that the ECOA prohibits a creditor from making credit decisions based upon, among other things, the Discriminatory Criteria, and it must list the names of the federal agencies charged with administering compliance with the ECOA.

In addition to Regulation B, a creditor, subject to a contract for sale of goods that includes an agreement to extend credit to its customer, has remedies governed by Article 2 of the Uniform Commercial Code (“UCC”), including UCC §§ 2-609, 2-702(1) and 2-703.  Pursuant to §§ 2-702(1) and 2-703, if a creditor has not yet delivered goods to its customer and discovers that the customer is insolvent and/or is in breach of its contract, the creditor may refuse to deliver the goods unless the customer pays for such goods before or upon delivery.

Similarly, § 2-609 provides that a creditor with “reasonable grounds for insecurity” about a customer’s ability to perform a contract, such as concern about the customer’s ability to pay for the goods, may demand that the customer provide assurance that the customer will timely perform under the contract.  A creditor exercising its rights under § 2-609 could switch to cash-in-advance payment terms to provide assurances that the customer will timely perform under the contract.

A creditor considering an adverse credit action, or exercising its UCC remedies, should act based upon permissible, articulated, and objective criteria.  Equally important, the creditor should maintain documentation of such decisions in the event that the customer later raises a legal challenge.  Finally, a creditor considering an adverse credit decision and/or exercising UCC remedies should consult with in-house counsel as any wrong move could give rise to materially increased litigation risk.

For any questions, please feel free to reach out to Lowenstein’s Scott Cargill ([email protected]) or Bruce Nathan ([email protected]).