The Australian Securities and Investments Commission (ASIC) is teaming up with the Small Business Ombudsman to ensure banks remove unfair contract terms from their small business loans agreements, claiming many are not meeting the requirements under new laws which came into effect last year.
Small Business Ombudsman Kate Carnell has gone head to head with the big banks in recent weeks, after handing down recommendations from her 2016 inquiry into small business lending practices.
Carnell has previously told SmartCompany there’s is no good reason for the banks not to adopt her recommendations to make loan terms clearer and eliminate non-monetary default clauses from contracts.
However, the big four banks have not been so enthusiastic in their response to every one of the recommendations, having now each stated their positions through submissions to the House of Representatives Standing Committee on Economics this month.
As regulators and business groups continue to push for more straightforward lending practices, what issues are in play? Here are three things you need to know.
What does unfair contracts legislation have to do with small business loans?
In November 2016 a new suite of unfair contract laws came into effect to protect small businesses from contracts that give one party more power over the terms and termination of the contract than the other.
ASIC is responsible for enforcing this legislation in relation to financial products and services, and can apply to have a court determine whether a specific contract is considered unfair.
In a statement released this week, ASIC and the Australian Small Business Family Enterprise Ombudsman (ASBFEO) Kate Carnell said that having reviewed a number of small business loan contracts from eight lenders, and found overall, the banks are failing to meet their obligations.
The main concerns are that the banks had contract clauses that allowed the lender to unilaterally vary the loan terms. ASIC and Carnell also found the banks had terms that absolved the lender from responsibility for representations made to the borrower outside of the contract, and terms that gave too broad a range of circumstances in which a loan could default.
ASIC deputy chair Peter Kell said in the statement that where ASIC identifies an unfair contract term, it will look to work with the parties to remove it. “If the lender refuses to do so, we will consider all regulatory options, including taking the matter to court as ultimately a court can decide whether or not a term is unfair,” said Kell.
SmartCompany contacted Westpac, Commonwealth Bank, ANZ and National Australia Bank for a response to the announcement from ASIC and Carnell. Only the National Australia Bank responded prior to publication.
“Our loan contract terms are fully compliant with Unfair Contract Terms (UTC) legislation,” said Leigh O’Neill, NAB executive general manager of Business Direct and Small Business.
“While the legislation is mandatory for qualifying ‘small business contracts’ entered into or renewed from 12 November 2016, NAB has applied the changes retrospectively to all existing business lending customers that have standard form contracts.”
How does this fit into the small business lending inquiry?
Carnell has previously told SmartCompany her top concern in conducting the small business lending inquiry is the big banks issuing loan terms that are overall unfair to small business, because they change the goal posts for businesses mid way through the loan repayment process.
As part of her report, she recommended the banks be prevented from defaulting on a loan where a small business has acted lawfully, and that a clear summary of loan default triggers is outlined at the beginning of the loan.
The big four banks have now responded to each of these recommendations in submissions to the House of Representatives economics committee, with general support given to a number of recommendations.
Each bank has outlined its support in broad terms for recommendations that improve the clarity and commitment to industry codes and goals. One recommendation, around a revised Code of Banking Practice that is written in plain English and has a dedicated section for small business, has broad support from each bank.
But while many of the general principles of the recommendations have been supported by the banks, the specifics, especially around default loan terms, have been met with less enthusiastic support.
What is the major concern from the banks on loan recommendations?
The Ombudsman’s recommendation that the banks be unable to default loans of under $5 million for any reason if a small business has complied with loan payments has been met with a higher level of concern from the major lenders.
The change is designed to prevent instances where a bank can use the value of security assets to vary the loan terms, or use other clauses that may cause a business to default even if they are meeting their repayments.
On this point, the NAB responded that non-monetary covenants act as “early warnings signs” for financial distress, and are useful for early intervention when working with customers who face financial challenges.
The Commonwealth Bank has said it supports elements of this change, but warns the suggested $5 million threshold, rather than the current $1 million definition for a small business loan, would be inappropriate because it would then cover loans to bigger businesses for which these clauses are more appropriate.
ANZ has outlined plans to remove “catch-all” material adverse change clauses, but says it plans to introduce three new, clearer subcategories of defaults.
Westpac said it supports the spirit of making it clearer to businesses when they would default, but says it would need to retain clauses that would allow the bank to default a loan based on specific events, like the death of a company director, bankruptcy or fraud.