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Many alternative lenders in the UK seek to stay outside the regulatory perimeter when lending to individuals by ensuring that their loans fall within exempt categories of credit agreement. One exemption commonly used by bridging and other lenders is for "investment property loans" ("IPLs"), as set out in article 61A(6) of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 ("RAO"), which provides a carve-out from the regulated mortgage contracts ("RMCs") regime.
In Kumar and others v LSC Finance Ltd, the Court of Appeal recently considered whether certain loan agreements secured on residential property were RMCs or IPLs. The lender in this case was not authorised by the Financial Conduct Authority ("FCA") to enter into RMCs and so if the loan agreements were found to be RMCs, they would have been unenforceable against the borrower. The lender and its directors could also face criminal sanctions.
Whilst the Court ultimately found that the loan agreements were IPLs, it ruled that the declaration contained in the lender's standard form loan documentation was not effective to raise the statutory presumption under the RMC regime that the loans had been entered into for business purposes. Lenders relying on the exemption for IPLs should therefore review their own documentation to see whether it requires amendment. The case also touches on several other points that will be of interest to alternative lenders and illustrates how disgruntled borrowers can seek to challenge the enforceability of loan agreements.
Background
In Kumar, the lender made loans to three individuals that were secured over property intended to be used as or in connection with a dwelling. The lender did not have permission from the FCA to enter into RMCs as lender. The intention from the lender's perspective was that the loans would be IPLs. The borrowers defaulted on the loans and sought to challenge the enforceability of the loans on the grounds that they were not IPLs, but rather were RMCs that the lender did not have permission to enter into.
One of the key conditions to qualify as an IPL is that the loan agreement must be entered into by the borrower wholly or predominantly for the purposes of a business carried on, or intended to be carried on, by the borrower. The RAO provides a statutory presumption that this condition is satisfied if the loan agreement contains an appropriate declaration from the borrower, although this presumption can be rebutted if the lender has cause, or reasonably should have had cause, to suspect that the loan is not actually for business purposes.
Declarations not effective to raise statutory presumption under RMC regime
The loan agreements in Kumar each contained a "business purposes" declaration by the borrower. However, the wording of the declaration complied with the requirements of the "business purposes" exemption from the consumer credit regime set out in article 60C of the RAO. The business purpose exemption under Article 60C is relevant in deciding whether an agreement is a regulated credit agreement. The wording of the business purpose exemption is similar to the IPL exemption relating to RMCs, but the requirements for the declarations relating to the two exemptions differ.
The Court held that these declarations met the criteria for the article 60C exemption for business purposes, but did not meet the requirements applicable to the IPL exemption. The declarations did not make it clear to the borrower that the statutory protections afforded to RMCs would be lost. They only referred to the regulated credit and consumer hire regimes, and a reasonable observer would not have inferred that this included RMCs. They were therefore not effective to raise the statutory presumption under the RMC regime.
This illustrates that a single declaration will not suffice for both the IPL exemption and the consumer credit "business purposes" exemption. Furthermore, the latter imposes strict form and content requirements on the declaration, which means that modifying it to refer to RMCs would then breach those requirements. Two separate declarations should be included where both exemptions need to be relied upon.
Effect of declaration
An interesting point from Kumar is that, because the declaration was not effective to raise the statutory presumption in the context of IPLs, the Court held that the statement in the declaration that the loans were for business purposes could not operate as an estoppel by representation or convention that would prevent the borrower from adducing evidence that the statement was untrue. This is on the basis that it would be wrong in principle to treat the declaration as having the same effect as one which did raise the statutory presumption.
Evidential considerations
A declaration is not mandatory for a loan to be an IPL, and a declaration which does not raise the statutory presumption does not automatically mean that the loans are not IPLs. However, in Kumar the fact that the declarations were not effective to raise the statutory presumption meant that the onus was on the lender to positively demonstrate to the Court that the loans had been made for business purposes. In contrast, if the declarations were effective to raise the statutory presumption, the borrower would have the burden to demonstrate that the lender knew, or had reasonable cause to know, that the loan was not for business purposes.
This will involve a fact-sensitive enquiry into the borrower's purpose for entering the loan, and whether it is wholly or predominantly for business purposes. The Court will be concerned with ascertaining the loan's true purpose (from the borrower's perspective), irrespective of the lender's state of knowledge about it.
In Kumar, the borrowers adduced oral evidence in the High Court that they had repeatedly told the lender that the loans were not for business purposes. The lender relied on various pieces of evidence to the contrary, including recollections of conversations with the borrowers, statements in pre-contractual documents, and representations in the loan documentation itself. The Court also took into account testimony from the senior management of the lender that they knew that the lender was not authorised to engage in regulated lending (and that lending to individuals to buy or develop a dwelling for personal use would be regulated) and would not knowingly have approved a regulated loan. The Court also considered whether the senior management's explanation of why the loan had been made to individuals rather than to a company was credible.
The Court ultimately found the borrowers' evidence to not be credible and preferred the lender's evidence. However, the fact-sensitive nature of this enquiry, and the fact that the Court will look at all the surrounding circumstances, demonstrates the importance for the lenders of keeping detailed records of meetings and conversations with borrowers and to ensure that all documentation is consistent with the loans being for business purposes. The enquiry does not end with the terms of the loan agreement, and the terms by themselves are not conclusive evidence. This means that lenders need to be prepared to justify their conclusions that the loans are for business purposes in the event of challenge by the borrower.
Separately, it is worth keeping in mind that an effective declaration only provides a presumption in relation to the "business purposes" element of the IPL definition. Lenders must still positively demonstrate that the other elements are satisfied, including that the borrower does not intend to use more than 40% of the mortgaged land as a dwelling for themselves or related persons. Again, lenders should be keeping proper records to document these aspects and including appropriate terms in the loan agreement to restrict the use of the land.
Changes in circumstances
Finally, the Court helpfully stated that the factual enquiries as to whether a loan satisfies the IPL conditions relate to the time at which the loan agreement is made. If the borrower's intended use of the land or the purpose for the loan later changes, this will be immaterial. The regulatory characterisation of the loan is therefore fixed at the time it is made. This will be of some comfort to lenders concerned about the potential for borrowers to breach representations or covenants in the loan documentation regarding the use of the funds or the mortgaged land.
If you would like to discuss the implications of this article, please get in touch with your usual Fieldfisher contact or a member of the Financial Markets & Products team.