Are you Lending Money? STOP and Read this Article First!

There are a few steps lenders must consider before parting with their money.  These are as follows:

1. Preparation of the Loan Documentation

The loan agreement is vital. Without this, the lender would have no proof that the monies were lent, under what conditions the money would be repayable, or what interest and other terms were applicable. Relying on the good faith or honesty of the borrower is a big mistake, primarily because there may be factors which are out of the borrower’s control, resulting in them being unable to repay the loan.

The loan document should specify the amount lent and the repayment provisions. It should deal with interest and other charges payable, as well as outlining to the borrower what constitutes a breach of the loan agreement and the lender’s rights if a breach occurs. Finally, it should also include dispute resolutions provisions, determine who should pay the costs of the process, and contain provisions dealing with the lender’s rights to exercise any security or guarantees held.

2.         Taking Security

Loans may be made on a secured or unsecured basis. If the loan is unsecured and the borrower defaults and becomes insolvent, the lender will rank alongside all the other creditors of the borrower, and may lose some or all of their money.  If, however, the lender has taken security for the loan, then they may be protected on the borrower’s insolvency to the value of the assets secured, and may be able to be repaid in full and ahead of other creditors. 

Securities over assets should be documented, as most securities are rendered invalid or unenforceable if not in writing. There are also registration considerations, as some securities will be void if not registered or otherwise perfected. The security documentation should detail all the assets covered by the security, the powers to exercise the security and the powers of any person appointed over the assets.  Securities can be anything from taking a fixed or floating charge over a company’s assets, a legal charge registered against the borrower’s property, to claiming a lien over the borrower’s assets. 

3.         Obtaining Guarantees

A guarantee obtained from a third party can act as insurance for the lender in that if the borrower becomes bankrupt, they have another avenue to pursue to recover their monies. If no guarantee is in place, they would be in the same position as other creditors in insolvency proceedings. 

A guarantee must be in writing to be enforceable, and careful consideration should be given to its wording to ensure its effectiveness if the borrower defaults.

4.         Thinking Beyond the Loan

Depending on the circumstances, there are other ways in which a lender or creditor may protect themselves, enabling them to recover their monies outside any insolvency proceedings issued against the borrower. 

This can be done by, for example, retaining the title to goods (in the case of a creditor who has supplied goods to a debtor prior to their insolvency) or by forming a purpose trust for which monies have been lent to a borrower. In the latter case, the borrower would be holding the monies on trust for the lender if it is not used for the purpose for which it has been assigned. 

These, amongst other mechanisms, can enable creditors to put themselves ahead of others in insolvency proceedings.

The above measures are helpful in preventing you from facing the prospect of entering litigation to recover your borrower default. For further advice on any bad debt issues, contact specialist litigation solicitor Asil Albayaty (aa@silvermansherliker.co.uk) or Senior Litigation Partner John Abbott (jca@silvermansherliker.co.uk) on +44 (0)20 7749 2700.