The Current Regulatory Landscape
It is a surprise to many people that, when financial firms undertake commercial lending, that activity is largely unregulated. In most cases when an entrepreneur or established business goes to an otherwise regulated high street bank for a commercial loan of more than £25,000, that customer will have no regulatory protection or access to compensation should things go wrong. This regulatory void leaves businesses of all sizes vulnerable to bank misconduct, and there is an obvious need to have systems in place to prevent this.
With no requirement for transparency, good faith or a duty of care, problems are sealed into commercial banking relationship from the outset. Often businesses are not given the information they require to make informed decisions and have no option but to agree to obtuse and one-sided contractual terms involving onerous covenants to access the funding they require. The principle of caveat emptor–buyer beware – that applies to commercial finance contracts is inappropriate where there is such asymmetry of information. The business has no power to negotiate the fine print of the terms; this is certainly not a contract of equals. The Impact Assessment produced by the Government for the Small Business Commissioner as part of the Enterprise Bill 2016 articulates many of the problems that can arise in a relationship between parties of unequal size. It states: ‘The Government is concerned that for small firms, negotiating a contract with a larger business can be challenging… Government has been told that small businesses often feel intimidated and accept such terms (rather than walking away from a proposed contract or refusing to agree to a change) and there is concern that larger firms sometimes use their market power to impose unfavourable terms.’ In this case the Government was looking at the relationship between a small and a large business, but the same principles apply and problems are amplified for a business and its dealings with a finance provider as the disparity in size between the two is even greater.
Contracts Working Group
In March 2017, the Lending Standards Board established the ‘Standards of Lending Practice for Business Customers’, which are applicable to all commercial lending to businesses with a turnover of up to £6.5m. The new standards cover principles for lending, product information and product sales – including declined applications, product execution, credit monitoring, financial difficulty, vulnerability, portfolio management, and governance and oversight.
Crucially, the new standards highlight the importance of ensuring that SME customers are fully aware of what they are purchasing, by providing key product facts – including covenants and break clauses – in a similar way to the summary terms and conditions sheets now used for regulated mortgages.
The Contracts Working Group has therefore been established to provide the opportunity for business representatives and banks to tackle the issues identified in the provision of contracts between banks and their business customers and to promote a more equal relationship between lenders and borrowers.
So far we have secured participation from Barclays, Clydesdale, HSBC, Lloyds, RBS, Santander, TSB and Triodos. We also hope to secure the participation of other organisations in the future.
The promotion of a more equal relationship between borrowers and lenders will be achieved by reviewing standard lending contracts provided by the banks to ensure that the contracts adhere to the Standards of Lending Practice and to consider if the contract terms are ‘transparent’. For the Working Group, transparency implies that contracts are legible, expressed in reasonably plain language, readily available to any party affected by the terms and presented clearly with the implications being known to the borrower in the event of difficulties.
The Working Group has a number of objectives in undertaking this work. It seeks to make recommendations on the steps that can be taken to improve the comprehension of contracts where necessary. It also wishes to identify the clauses that could give rise to disputes and to identify the clauses or obligations that cause a significant imbalance in the parties’ rights and obligations arising under the contract. These are terms that are not reasonably necessary to protect the legitimate interests of the party that would benefit from its inclusion and terms that could cause financial or other detriment to a business if it were applied or relied on. We also hope to determine whether any additional improvements to the LSB Standards should be made.
The Founding Director of Momentous Change Ltd, Michelle Thomson, will Chair the Steering Committee, which also has representatives from UK Finance, The APPG on Fair Business Banking, Lending Standards Board, Chartered Banker Institute, Federation of Small Businesses, Chartered Institute of Arbitrators and SME Alliance to ensure that all interested parties are represented on this piece of work as it moves forward. The Group will also have support from independent legal experts, to be appointed in the near future.
The Contracts Working Group is funded by one-off contributions from the participating organisations. This funding will enable the APPG to provide the administrative support required for the duration of the project. The participating organisations that have provided funding for the project are: Barclays, Clydesdale, HSBC, Lloyds, RBS, Santander, TSB and Triodos.