Removing Unfair Lending Terms for SMEs

Topline

  • Following regulatory and judicial scrutiny of business borrowing terms, lenders are being warned to be more transparent and to remove unfair contract terms.
  • The Australian Securities and Investments Commission (ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au) is Australia’s integrated corporate, markets, financial services and consumer credit regulator.
  • ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au has recently approved changes to the Australian Banking Association’s Code of Conduct that provides that lending contracts for small business borrowers should not contain a range of potentially unfair and one-sided terms.
  • Following an ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au review into the non-bank lender, Prospa, fintechs have been asked to assess their standard form small business loan contracts to address terms considered to be unfair under the unfair contract terms provisions of the ASIC Act and Unfair Contract Terms (UCT) law.

Royal Commission into Banking

In response to mounting community anger over repeated scandals exposed by the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (aka ‘royal commission’), the Australian Banking Association (ABA) has rewritten their Banking Code of Practice to include promises of more straightforward contracts with fewer conditions.

The changes to the existing ABA code followed a demand from ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au for a complete rewriting of the current rules drawn up by the banks. ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au had made the demand on the banks in 2015 – before royal commission commenced – however the banks only finalised the new code in July this year.

Changes to the Banking Code of Practice

The changes ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au required to small business loan contracts by the big four banks were:

  • ensuring that the contract does not contain ‘entire agreement clauses’ which prevent a small business borrower from relying on statements by bank officers (for example, about how bank discretions will be exercised);
  • limiting the operation of broad indemnification clauses;
  • addressing concerns about event of default clauses, including ‘material adverse change’ events of default and specific events of non-monetary default (for example, misrepresentations by the borrower);
  • limiting the circumstances in which financial indicator covenants will be used in small business loans and when a breach of a covenant will be considered an event of default; and
  • limiting the bank’s ability to unilaterally vary contracts to specific circumstances with appropriate advance notice.

The Australian Small Business and Family Enterprise Ombudsman, Kate Carnell, welcomed the approval saying: “The new Code is in line with our Small Business Loans Inquiry, where we recommended the Code be revised, that it be approved by ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au and include a dedicated section on small business written in plain language.

ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au guidance to SME lenders

In March, ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au published the Unfair contract terms and small business loans report which outlines changes to small business loan contracts made by the big four banks to comply with the UCT law. ASCI’s report also provided guidance to the broader small business lending industry.

At the same time as it released its Unfair contract terms report, ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au announced that it would also examine other lenders’ small business loan contracts to ensure they do not contain terms that raise concerns under the UCT law.

Following their review of the lending contracts of bank and non-bank small business lenders, last week ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au wrote to Fintech Australia to ask its members to comprehensively review their small business loan contracts to ensure compliance with the unfair contract terms law.

ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au also asked FinTech Australia’s members to consider the change made by Prospa, which provides unsecured loans to small businesses, and to assess whether their own loan contracts need to be amended to ensure compliance with UCT law.

Prospa unexpectedly pulled the plug on its highly anticipated $146 million IPO in June 15 minutes before it was scheduled to go ahead, citing issues raised by the ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au about unfair loan terms.

Changes to Prospa’s loan contract

Prospa agreed to make the following changes to its standard form small business loan contract:

  • amended the early repayment clause so that borrowers can now      prepay their loan early without requiring Prospa’s consent, and removed Prospa’s absolute discretion whether to provide a discount for prepayment – Prospa will now apply a published Early Prepayment Policy so borrowers  can determine the discounts they they can expect to receive if they do pay back their loan early; 
  • amended the ‘unilateral variation’ clause to significantly limit Prospa’s ability to unilaterally vary contracts to specific instances. Prospa has also extended the notice period to 60 days where Prospa intends to vary fees; 
  • amended clauses defining events of default to add remediation periods and materiality thresholds and to permit changes to control of the Borrower with the lender’s consent (not to be unreasonably withheld); 
  • removed a broad ‘cross-default’ clause which allowed Prospa to call a default under the loan contract due to any default under another finance document related to the loan (for example, guarantee or security document); 
  • restricted the borrower’s indemnity to ensure that:

–    the borrower is required to indemnify only Prospa, its employees and agents (and not third parties that are not parties to the contract such as receivers or contractors); and

–    the borrower is not required to indemnify Prospa for losses or costs incurred due to the fraud, negligence or wilful misconduct of Prospa, its employees, officers, agents, contractors or receivers appointed by Prospa; 

  • removed an ‘entire agreement’ clause which absolved Prospa from contractual responsibility for conduct, statements or representations made to borrowers about the loan contract; 
  • limited the class of people who can provide guarantees under the loan contract to:

–    people who are actively involved in the management of a borrower’s business;

–    if the borrower is a company, people who are directors or shareholders of the borrower; and

–    if a shareholder of the borrower company is a company, directors or shareholders of that company. 

  • inserted a 5-business-days’ notice provision to guarantors about:

–    borrowers who are 30 calendar days behind their agreed repayment schedule; and

–    the commencement of legal proceedings against a borrower or the appointment of a receiver. 

  • limited the guarantor’s liability so that the guarantor is not liable for any increase in the amount of the loan principal and interest agreed at the start of the loan(but the guarantor is liable for fees and reasonable enforcement costs). 
  • inserted a provision to obtain consent of the guarantor:

–    where there is a discharge or release of any security held by Prospa given by the borrower or a guarantor; and

–    where there are multiple guarantors, before releasing a guarantor. 

  • limited the actions of lender-appointed attorneys where there is an event of default under the loan contract so that an appointed attorney cannot act in a way that prefers the interests of the attorney over the interests of the borrower or guarantor.

ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au’s eternal vigilance

In light of their reviews into banking and non-bank lenders and the misconduct exposed by the royal commission, ASICAustralian Securities and Investments Commission (ASIC) is Australia’s corporate, markets and financial services regulator. asic.gov.au has said that their surveillance of small business loan contracts will be ongoing and that they will consider regulatory action where appropriate.

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