Lending to friends: don’t assume that you’re secure
Don’t take this the wrong way: if you’re lending to your friend, it may not be the end of the world if you’re not repaid.
Don’t take this the wrong way: if you’re lending to your friend, it may not be the end of the world if you’re not repaid. But if you take repayment seriously enough to ask for security for the loan, you should at least ensure that it works.
The recent credit squeeze has forced many of us to look beyond traditional bank lending as a source of finance. This has presented opportunities for the cash-rich to lend to the cash-strapped, typically at interest rates greater than they’d earn on bank deposit.
The borrower may need the money for his business, or he may have a personal reason, such as buying a new car.
Where the borrower is an individual or a general partnership, many lenders are now alive to the pitfalls posed by the consumer credit legislation (CCA) and may choose to lend only if the loan is unregulated. A common exemption for CCA purposes applies to a business loan of more than £25,000. Where lending to a friend for non-business purposes, it may be possible (although not without risk) to rely on the one-off nature of the loan to minimise the demands of the legislation.
After congratulating yourself for spotting, and avoiding, the CCA problem, it would then be a shame to fall foul of the ancient Bills of Sale legislation. Like the CCA, this applies to loans to individuals and partnerships; in fact, unlike the CCA, the Bills of Sale legislation will apply to larger partnerships of four or more individuals.
What is a Bill of Sale?
A Bill of Sale is a document prescribed in the Bills of Sale Acts of 1878 and 1882. For present purposes, we are considering one of two types: the security Bill of Sale. This is a form of mortgage over tangible, movable property, such as a car, where such mortgage is granted by an individual (rather than a company or LLP).
Bills of Sale are commonly used as security for relatively small, one-off loans. However, whilst the concept is relatively straightforward, the archaic legislation provides for a number of pitfalls and has been described by the Law Commission as being seriously out of date.
To comply with legislation, lenders must adhere to complex documentation requirements, in respect of document format, execution formalities and registration. Sanctions for non-compliance are severe as the lender loses its right to the secured asset as well as its right to repayment of the debt. And registration is not the end of the story: if they are to remain valid, Bills must be registered at the High Court every five years.
In recent years, Bills of Sale legislation has been most commonly relied upon in relation to logbook loans, which are a form of consumer credit secured against a vehicle. For many individuals whose house is mortgaged to the hilt, their car is their most valuable asset. By a Bill of Sale, legal ownership is transferred from the borrower to the lender as security for a debt. The borrower may continue to use the vehicle, provided they continue with loan repayments.
Currently, the law poses problems for all parties:
- Borrowers, who often misunderstand what they are signing and do not appreciate that they no longer own the secured vehicle whilst the loan remains outstanding. Borrowers enjoy only limited safeguards against repossession of their vehicles, as the lender does not need a Court order, even where the borrower has missed just one payment.
- Lenders, who currently face a convoluted and costly process to ensure that their security is enforceable
- Third parties who attempt to purchase the vehicle from the borrower, who may have no knowledge of the lender’s interest. They will not become the legal owner and risk having the vehicle seized by the lender.
The changes proposed
Whilst the current legislation is laced with complexities and potential hardship for all involved, the Law Commission’s consultation may lead to better protection for all parties. The Commission’s proposals focus on a modification of current legislation; to outlaw Bills of Sale would ignore the fact that, for some, personal property still represents an important source of finance.
There follow the key proposals for what the Commission has dubbed the “goods mortgage”:
- A simplified mortgage should bear a clear warning to borrowers that they may lose their asset. Repossession of the asset will be a last resort and, where a third of the loan amount has been repaid, will require a Court order.
- For logbook loans (for vehicles), there will be no need to register the mortgage at the High Court. Instead, a new vehicles registry should be established. For other assets, High Court registration should continue, but with a simplified process.
- Unless the mortgage is properly registered, third parties who purchase the asset in good faith should become the owner of the asset.
The Law Commission is due to publish its final report in summer 2016, and it can be assumed that any legislative change will not be forthcoming for several months after that. Until then, lenders must think carefully before lending against tangible, moveable assets, even if satisfied that the loan will escape CCA legislation. If no alternative security is available, does the loan still make commercial sense in view of the costs and complexity of complying with the Bills of Sale Acts?
If you would like to know more about the reform of the Bills of Sale legislation, please contact Isabelle Inskip, a solicitor in the corporate department, on 0151 242 9466 or email firstname.lastname@example.org, or alternatively contact Trish Grinyer, a partner in the corporate department, on 0151 243 9527 or email email@example.com.