UK Court Characterizes Loan Agreements As Debentures - Implications Under The Financial Services And Markets Act 2000

The recent UK Court of Appeal decision in Fons Hf v Corporal Ltd and Pillar Securitisation - which found that a loan agreement even if undrawn, is an instrument which evidences or acknowledges debt and consequently a debenture - has created significant legal uncertainty as to whether certain UK loan transactions may be regulated under the Financial Services and Markets Act 2000 (FSMA).

Pursuant to the FSMA, debentures are "specified investments" subject to the financial regulation regime arising from sections 19 and 21 of that statute. Breach of this regime is a criminal offence and renders any relevant agreement unenforceable by the party in breach.

The established understanding prior to Fons was that, while loan agreements may create a contractual framework under which loans are advanced, they did not themselves constitute a debenture or other investment creating or acknowledging indebtedness and accordingly were outside the scope of the FSMA (other than in respect of certain consumer credit and mortgage contracts).

It should be noted that Fons was not concerned with the FSMA or the regulatory regime established by it and therefore did not consider whether loan agreements constitute debentures specifically for purposes of the FSMA.

Fons will be of primary concern to UK based banks and lenders, who will need to consider whether they and their borrowers are required to be in compliance with the regulatory regime under the FSMA. Overseas lenders (such as Canadian banks), may also want to seek advice from UK counsel in connection with loan agreements entered into by UK borrowers.

Fons

Fons concerned the interpretation of a security agreement and whether security granted over "debentures" included the security provider's rights as a lender under certain loan agreements.

The Court of Appeal found that a loan agreement, even if undrawn, created an acknowledgement of debt and was thus a "debenture". While, the Court of Appeal did not consider the FSMA regulatory framework's treatment of debentures, the ruling nevertheless gives rise to the concern that loan agreements may fall within that framework.

While exemptions from the regulatory framework in the FSMA exist, they do not cover all circumstances relevant to borrowers and lenders under loan agreements. The City of London Law Society (which represents City lawyers, including some of the largest international law firms in the world) has accordingly written to HM Treasury asking for urgent...

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