ASIC has released a report Unfair contract terms and small business loans (REP 565) setting out the details of the changes made by the four major banks to remove unfair terms from their small business loan contracts of up to $1 million.
The report also provides guidance to other bank and non-bank lenders about compliance with the unfair contract terms laws as they relate to small business.
ASIC says it will next conduct a review of small business loan contracts from other lenders, including bank and non-bank lenders to ensure that their small business contracts do not contain unfair terms.
The report follows the announcement in August 2017 that the four banks had committed to improving terms of their small business loans following work with ASIC and the Australian Small Business and Family Enterprise Ombudsman to make it more likely that all small business loans entered into or renewed from 12 November 2016 will comply with the unfair contract terms law.
For small business loan contracts of up to $1 million, the banks have:
• ensured that the contract does not contain ‘entire agreement clauses’ which prevent statements by bank officers (e.g. about how bank discretions will be exercised) from forming part of the contract;
• limited the operation of broad indemnification clauses;
• addressed concerns about event of default clauses, including ‘material adverse change’ events of default and specific events of non-monetary default (e.g. misrepresentations by the borrower);
• limited the circumstances in which financial indicator covenants will be used in small business loans and when breach of a covenant will be considered an event of default; and
• limited their ability to unilaterally vary contracts to specific circumstances with appropriate advance notice.
However the changes have not been made consistently or in the way ASIC would prefer.
In ASIC’s view, a risk remains that the wording of these events is still broad enough for an event to be used to trigger a disproportionate enforcement action by the lender. For example, ASIC says it would be unfair to a small business borrower if a minor and inconsequential misrepresentation by the borrower (e.g. an incorrect place of birth) led to a default under the loan contract, even though ‘misrepresentation’ is a specific event of default.
ASIC considers that lenders should:
(a) provide a reasonable period for a borrower to remediate a breach of a specific event (if it is remediable); and
(b) adopt a materiality threshold so that a breach of a specific event must create a material risk to the lender of a monetary default or of the lender being unable to enforce its rights against any secured property.
ASIC has also observed that some banks include a term in their general business loan contracts that any breach of any other agreement with the bank (e.g. a guarantee or security agreement to support the loan contract or a separate financing agreement) will constitute a breach of that contract (a ‘cross-default’ clause). ASIC expects that cross-default clauses should not operate in a way that is inconsistent with the commitments made by the banks limiting the permissible non-monetary events of default in the loan contract.
Financial indicator covenants
ASIC reports that:
(a) the banks have removed financial indicator covenants for property investment loans;
(b) two banks will apply a materiality threshold to the use of these covenants so that a breach of a covenant must present a material credit risk to the bank before it can treat the breach as an event of default;
(c) one bank has limited the use of financial indicator covenants to four types of products (i.e. property development, SMSF loans, margin lending and foreign currency loans); and
(d) one bank will treat a breach of covenant in cash flow lending as a review event (and not a default event), entitling the bank to take other action but not an enforcement action.
Notice of unilateral variation
In relation to advance notice periods when banks vary loan contracts unilaterally:
(a) One bank will now provide 90 calendar days’ notice if a variation only applies to the particular small business borrower’s contract and if the change is materially adverse to the borrower.
(b) One bank will now provide 90 calendar days’ notice for all changes unless the change is not adverse to any borrower affected by the change.
(c) Two banks will now provide 30 calendar days’ notice or such longer period as may be required under the Code of Banking Practice.
ASIC notes that as the unfair contract terms law is not prescriptive, in general the longer the notice period, the smaller the risk that the unilateral variation clause will be found to be unfair by a court.
ASIC will monitor the individual banks’ use of the changed clauses to determine if they are in fact applied or relied on in an unfair manner.