Drafting loan documents to deal with the new Banking Code of Practice is a major challenge. This report explains why.
The challenge is not only for ADIs subscribing to BCOP but also for other lenders because FOS and CIO (the predecessors of AFCA) both stated that BCOP is likely to be seen as good practice which should be applied to non-subscribers. We expect AFCA to continue this line of thinking.
We have previously alerted you to the problems with the substantial benefit provisions and the ‘sleeper issue’ about borrowers of convenience – see attachment.
Another major issue is that BCOP 80 and 85 limit the permissible non-monetary defaults for business lending. This challenge is complicated by the need to remove any unfair contract terms from existing contracts (remembering that not only will unfair contract terms be void, but there has been discussion about imposing penalties for including unfair terms in contracts). A loan will be subject to BCOP’s small business provisions if the loan is wholly or predominantly for a trading or commercial purpose, and the borrower is a small business. Many borrowers will meet the definition of ‘small businesses’ particularly once the existing definition (an annual turnover of less than AU$10 million, fewer than 100 full-time equivalent employees, and less than AU$3 million total debt including undrawn amounts of its own and related entities) is changed in accordance with the recommendation (to be adopted by the Government) to mean a business with less than 100 full-time equivalent employees, where the loan applied for is less than AU$5 million.
In the past most loan and security documents have provided that default occurs if there is breach of any term of the agreement. This provision is probably unfair because it facilitates enforcement proceedings based on minor breaches. Deletion of the ‘any breach’ clause means:
breaches to trigger loan repayment or default action must be listed as a default event;
these breaches must be material in nature in order to be fair;
the types of permitted breaches is limited by BCOP 80 for small business loans – and perhaps by extension for loans to individuals.
Many lenders use their standard home loan documents or property lending documents to make loans to small businesses. There are important events concerning secured assets in these documents since business facilities are often secured, however because of BCOP 80 they may not be permitted as default events. These include:
material adverse change (not limited to financial change) – BCOP 84;
material reduction in value of security, including loss or damage to security;
where the business stops trading;
where construction is halted or works are defective
There’s some hope in BCOP 85 which provides that ‘financial indicator covenants or special covenants tailored to the particular nature of [the] loan’ can be included in loans for:
‘property development’ (this won’t include ‘private’ construction);
‘specialised lending transaction[s]’ (BCOP 85 sets out some examples).
BCOP 2 and 3 provides that the terms of BCOP need not be set out in loan and security documents. Despite those provisions, BCOP 3 and 73 require terms and conditions to be provided. It is hard to see how something as substantial as enforcement rights can be omitted from the T&Cs (especially from a contract law perspective).
The changes to address these issues need to be made not only to loan T&Cs but also security documents including mortgage common provisions. We have spent the last two months reviewing various formulations to achieve a commercially fair and legally compliant solution and can now provide solutions which address both BCOP and unfair contract terms.