Lending To Individuals

Introduction

When lending to an individual borrower, or seeking to obtain a personal guarantee or security from an individual, a lender will need to consider a number of matters, and should take advice from suitably experienced lawyers.

This briefing paper sets out some of the relevant legislation, issues and other factors that a lender should consider in financing transactions involving individuals. This paper is aimed at lenders operating in the private wealth sphere and, as such, it does not consider the full scope of regulations and other factors to be taken into account by lenders offering retail banking services to individual customers.

UK Consumer Credit Regime

Transfer from OFT to FCA

The UK consumer credit regime underwent important overhaul on 1 April 2014 when the regulation of consumer credit activities was transferred from the Office of Fair Trading to the Financial Conduct Authority ("FCA"). The regulatory framework now consists of:

the Financial Services and Markets Act 2000 ("FSMA") FSMA's secondary legislation, most importantly the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 ("RAO") the FCA Handbook, including the Consumer Credit sourcebook ("CONC") the retained provisions of the Consumer Credit Act 1974 ("CCA") and its retained secondary legislation. When is this relevant?

The FCA consumer credit regime will apply to "regulated credit agreements" between a "lender" and a "borrower". This means that it applies to credit arrangements of any value entered into by a lender with:

Individuals; Sole traders; Partnerships of two or three partners (unless all partners are bodies corporate); or Other unincorporated bodies, such as clubs (again, unless they consist entirely of bodies corporate), in each case wherever they are resident if dealing with a UK lender and an English law governed credit agreement.

The definition of what constitutes a "credit agreement" for the purposes of the FCA consumer credit regime is a broad one and it extends to cover loan agreements, overdrafts, certain hire purchase agreements, conditional sale agreements, pawn agreements, credit card agreements and other agreements where goods or services are supplied, but payment for which is deferred or credit provided.

It should be noted that it is irrelevant, for these purposes, whether or not interest is charged in relation to any of these arrangements; the FCA consumer credit regime may equally apply to, for example, an interest-free loan.

It should also be noted that whilst the position prior to 6 April 2007 (and applicable to agreements made prior to this date) was that credit agreements of a value in excess of £25,000 fell outside the definition of "regulated agreement" under the Applicable CCA, this financial limit was removed by the Consumer Credit Act 2006 and there is currently no exclusion for agreements above a certain value (save for those to which the "business purposes" exemption outlined below would apply).

When a lender has established that the relevant credit arrangement is itself one that meets the above criteria, and so falls within the scope of the FCA consumer credit regime, the next question to ask is whether the arrangement amounts to a "regulated credit agreement", or whether an exemption applies.

What exemptions could apply?

When considering whether one of the exemptions applies to a consumer credit agreement (which would take the agreement outside the scope of the FCA consumer credit regime), care must be taken to consider the precise terms of the relevant exemption.

The exemptions that are most likely to be relevant are the following:

"High Net Worth Individual" exemption

This exemption may apply if the borrower or hirer is a natural person with an income (net of National Insurance contributions and income tax) of not less than £150,000 and/or net assets (excluding items such as the value of their primary residence and pensions contributions) of not less than £500,000 in the "previous financial year" (i.e. the financial year ending on 31 March).

From 1 February 2011, it is an additional requirement that the credit must either exceed £60,260 (if it is not secured on land) or be secured on land in order for this exemption to apply.

It should be noted that, in order to be able to rely on this exemption, it must be invoked by the borrower and not by the lender and that the exact requirements of the RAO and CONC must be complied with. A declaration of high net worth in the prescribed form must be included in the credit agreement and a statement of high net worth in the prescribed form must be obtained in respect of the borrower during the period of one year preceding the entry into the credit agreement. If there is more than one individual borrower under a credit agreement, each of them must qualify in order for the exemption to apply.

"Business purposes" exemption for agreements above £25,000

A credit agreement which exceeds £25,000 will not be a regulated agreement if it is entered into by a borrower or hirer wholly or predominantly for the purposes of a business carried on, or to be carried on, by him. If the borrower or hirer makes a declaration to that effect in the form prescribed by CONC in the credit agreement itself, it will be presumed that this is the case.

"Acting in the course of business" means in the course of a business regularly carried on by the borrower or hirer. If the lender or hirer (or anyone acting on his behalf) knows, or has reasonable cause to suspect that the agreement is not, in fact, being entered into wholly or predominantly for business purposes, it cannot rely on this exemption.

Exemption for FCA-regulated mortgages

"Regulated Mortgage Contracts" (as described in the "Regulated Mortgages" section below) which constitute a regulated activity under FSMA will be exempt from the FCA consumer credit regime on the basis that they fall within the FCA's separate regime set out in Mortgages and Home Finance Conduct of Business sourcebook ("MCOB"). It should be noted, however, that loans secured by a second charge (or any charge other than the first legal charge) over such property will still be regulated by the FCA consumer credit regime unless one of the other exemptions applies.

Exemption for certain agreements secured on land

In addition to the exemption for FCA-regulated mortgages, certain other types of credit agreements secured on land will be exempt from the FCA consumer credit regime. These can only be relied upon by deposit-takers (i.e. banks or building societies) and certain other bodies (such as local authorities) listed in CONC.

The exemptions are for (i) credit agreements secured by a land mortgage where the credit is used to purchase land, a dwelling or business premises (of limited application in light of the FCA's regulated mortgages regime); (ii) credit used for land or home improvement where the lender holds a mortgage over the land or property being improved; (iii) credit used to refinance debt which falls within one of the two of the above mentioned categories; and (iv) the "buy-to-let" exemption, which applies to secured loans used to purchase property or land, less than 40% of which is to be used as or in connection with a dwelling by the borrower or the borrower's family.

Small number of payments exemption

This exemption will apply if, under a borrower-lender-supplier agreement (i.e. an agreement where the credit is to be used to finance the supply of particular goods and services on the basis of pre-existing arrangements, e.g. credit card purchases) for fixed sum credit, the credit is repayable by the debtor in four or fewer payments over a period of less than 12 months and the credit is either free of any interest or other charges or is secured on land.

Low cost of credit exemption

There is also an exemption for certain low interest rate agreements offered to a limited class of individuals, but the technicalities which have to be met before this exemption can be relied on mean that the scope for the application of this exemption is very limited.

What if none of the exemptions apply?

If the credit agreement in question meets the criteria for regulation under the FCA consumer credit regime and none of the exemptions apply, the lender must comply with the procedures of such regime whether it is a licensed consumer credit business or not.

This means that the lender must have the relevant authorisation (see below) comply with the pre-contractual requirements of the FCA consumer credit regime, the form, content and format of agreements prescribed by the FCA consumer credit regime, the post-contractual information provision requirements and the procedures prescribed by the FCA consumer credit regime for steps to be taken in the event that things go wrong, and upon enforcement.

Failure to comply with the requirements of the FCA consumer credit regime when entering into a credit agreement would render the agreement unenforceable without a court order.

It should be noted that there is a "light touch" regime that would apply to certain types of agreements which are technically covered by and regulated by the FCA consumer credit regime, but to which only certain of the provisions of and formalities required by the FCA consumer credit regime would apply. These include non-commercial agreements, overdrafts and small value agreements.

Who needs FSMA authorisation?

A lender carrying on a consumer credit regulated activity must obtain authorisation under FSMA.

The FCA consumer credit regime also regulates a number of activities connected with credit agreements, such as credit brokerage, advertising and promoting credit...