Small and medium-sized enterprises (SME) account for the vast majority of businesses operating in Australia and yet obtaining business finance from the country's top bank lenders can be a challenging and time-consuming exercise for them. Unsurprisingly, there seems to be a growing preference amongst businesses in recent years towards non-traditional lending options due to less stringent requirements, giving rise to an increase in private lenders operating in the space.
Private loans to corporate entities are generally subject to fewer regulations, which makes the application and approval process quicker and easier.
The National Credit Code
The National Credit Code (NCC) together with the National Consumer Credit Protection Act 2009 (Cth) (Act) is a national framework for the regulation of credit agreements with effect from 1 July 2010, where:
- the lender is in the business of providing credit;
- a charge is made for providing credit;
- the borrower is a natural person or strata corporation; and
- the credit is provided (wholly or predominantly) for personal or household purposes (including for purchases, renovations, refinancing).
The NCC is administered and regulated by the Australian Securities and Investments Commission and its primary purpose is to protect consumers' rights and interests in connection with loans and credit agreements to which the NCC applies.
It is prudent for lenders to determine whether the NCC applies to a loan.
What is an unregulated loan?
Put simply, an unregulated loan is commonly referred to as a loan that is not regulated by the NCC. For example, where:
- a lender is a private lender;
- the borrower is a corporate entity; and
- the loan is wholly or predominantly for business purposes,
those credit agreements fall outside the scope of the NCC.
In this somewhat unchartered lending space, lenders still need to comply with the appropriate lending obligations and must ensure their rights are adequately protected, including their rights to recover moneys due to them.
Security
It is important that lenders carry out the necessary due diligence and risk assessments in relation to potential borrowers, and consider the key information such as the purpose of the loan and the extent of the security required. In addition, it is essential that the transaction is governed by suitable loan and security documentation setting out the loan terms, articulating the rights and obligations of the parties, and mitigating the risks to the lender.
A secured loan poses far less risk to a lender than an unsecured loan. Security can be given in various forms, such as a charge over assets or a personal guarantee and indemnity. A personal guarantee securing the performance of the borrower's obligations under a loan agreement is common in commercial lending transactions where the borrower is a corporate entity.Where real property is given as security, a lender's interest in the property should ideally be protected under a registered first mortgage, which confers extensive rights and powers on the lender as mortgagee. While second mortgages and caveats have become increasingly common, it is important for lenders to carefully consider the priority of the security and the competing interests of other lenders.
A general security over the assets of borrowers and/or guarantors can further mitigate the risks of lenders. Such security usually extends to all personal and real property of the borrower, including future acquired assets.
Penalty Interest
Lenders should be mindful of charging a default rate of interest in the case that a borrower defaults under a loan. If the interest provisions are not properly drafted or if the rate is set too high, it could place the lender at risk of seeking to impose a penalty on the borrower which could have adverse implications.
The importance of engaging experienced legal practitioners
It is the lender's responsibility to ensure that their rights as a lender are adequately protected under their loan documents. Conversely, it is equally important that borrowers and guarantors obtain independent legal advice regarding the loan documents. From the lender's perspective, such advice is important to avoid borrowers and guarantors asserting that they were not advised prior to signing the loan documents.
It is imperative that a lender's rights to enforce or perfect any securities are protected and feasible, at any time during the term of the loan. Otherwise, attempting to recover outstanding money from a borrower in default may lead to further financial loss for the lender. Engaging an experienced legal practitioner to provide timely advice and prepare your legal documentation is key in mitigating risk and ensuring long-term success for private lenders.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.