This article is not about those banks that invest more monies in government securities than in loans to their customers; that's a discussion for another day. The question today is whether a bank, having signed a loan agreement, has an obligation to disburse the full amount regardless.
Is a bank ever obliged to lend you its proverbial umbrella when it rains? Is the banker obliged to also lend a borrower additional support, a raincoat and gumboots, when the borrower is in a flood of debt? Should the bank give the additional protective gear and perhaps a boat as well to navigate the seasonal floods?
Let's hear it from the courts
The two arguments came to a classic header in Uganda Development Bank v Ringa Enterprises. The borrower strenuously argued that the lender, as a national development bank, had a duty to provide a long-term development loan facility to finance critical investments in sectors such as hospitality to create jobs in the West Nile sub-region where the borrower's project was located.
The bank, on the other hand, insisted that it was entitled to take back its proverbial umbrella. The court appreciated that the borrowers' arguments made economic sense but did not have legal support. The court recognised the clash between the economic and legal considerations and that the borrower was, in essence, telling the bank not to kill the goose that lays the golden egg. If the bank was courageous enough, it could lend more money, and the golden goose would make everyone happy. The court, however, declined to make a new bargain for the parties.
In Nakasero Market Sitting Vendors v Centenary Bank, the plaintiff sought specific performance of the bank's promise to lend, in the alternative, a recovery of all the costs and payment of damages in the exact amount of the loan. The bank developed cold feet after learning of governance and other issues of the prospective borrower and declined to lend. The court held that the bank, upon a consideration of prudence, had the right to terminate the facility agreement. It also held that such contracts were not enforceable by specific performance as a borrower could always borrow the money elsewhere and claim any difference in interest rates. The court declined the award of damages in the loan amount as a disguised attempt at specific performance. The court, however, awarded the borrower a reimbursement of its legal expenses with interest from the date of judgment.
In Progressive Group of Schools v Absa Bank, the court found that failure to disburse the sums promised in a facility letter amounts to a breach of contract.
In Kwagala v Standard Charted Bank, a staff loan was withheld because of an ongoing departmental restructuring that was likely to affect the first plaintiff's job. The first plaintiff was indeed terminated following the restructuring. He sued for breach of the loan agreement and won! The court was quite sympathetic that the borrower had fulfilled various conditions for the loan at great expense. The plaintiffs had sold their car and borrowed from family to make the required downpayment on a property.
The court found that the facility letter and mortgage deed were binding contracts under the Contracts Act and that the Constitution enjoined the court to give adequate relief to victims of wrongs. The court held on basic principles of offer and acceptance that the Bank could not purport to recall the loan offer after it had been accepted. The court did not see why the restructuring would affect the loan, especially given that there were two borrowers and that the asset being acquired was income-generating.
Then, in Choudry v Bank of Baroda, the bank was ordered to pay the balance on an approved loan sum with interest, even though the borrower had long repaid the partly disbursed loan. The judge found that the bank had breached its contract to lend the full amount. It is not clear whether this amount is now disbursed as a new loan to the customer and therefore recoverable by the bank with interest or not. This is important as the damages for failure to lend a certain sum cannot be that sum itself, but rather whatever loss would have resulted.
The courts seem to be starting to run with the idea that once there is a loan agreement, it creates a binding obligation on the bank to lend.
What about material adverse change?
A well-drafted facility letter would have a material adverse change (MAC) or a material adverse effect (MAE) clause, entitling the lender to terminate an agreement to lend if the borrower's circumstances change. The facility letter also retains the lender's discretion to lend in any event. Say the borrower's factory burns down, or he loses the contract sought to be financed, it cannot be that the lender is then still bound by the agreement to lend.
In Citibank Uganda v Uganda Fish Packers, we see an example of a lender's reliance on a MAC clause to demand repayment of its facilities upon the demise of the borrower's managing director.
Prudence and lender discretion
It is the depositors' funds that banks put at risk when lending to their customers. The bank is required to exercise prudence in its lending decisions, and it must therefore always retain discretion on whether to lend or not, and by the same token, whether to recall its loan or not. It is important that the banks push back on any suggestions that they are compelled to lend or that they can be punished for lending when the borrower's circumstances change.
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