New act gives some protection to borrowers

By Nigel Stranaghan

Friday 28th May 2004

Lending to small businesses will soon be significantly de-regulated but is this a good thing?

On April 1, 2005, the Hire Purchase Act 1971 (which applies to business and consumer hire purchase agreements) and the Credit Contracts Act 1981 (which applies to business and consumer loans and other credit contracts) will be repealed by the Credit Contracts and Consumer Finance Act 2003.

Repeal of the Hire Purchase Act is welcome, since it adds little to the protections given by the Credit Contracts Act and it is difficult to justify its application to large transactions with business borrowers.

However, it is arguable that the Credit Contracts Act serves a useful function for small-business borrowers by protecting them from oppressive contract terms and conduct by lenders and by requiring disclosures that make it easier to compare the cost of loans. (In this context a small-business borrower is a business borrowing less than $250,000).

The argument for a distinction between consumer and business lending is that consumers need to be protected but businesses can look after themselves.

It is consistent with the approach taken in New Zealand in the Consumer Guarantees Act and the Credit (Repossession) Act. (On the other hand, the Fair Trading Act applies to business and consumer transactions). It is also consistent with the approach to credit regulation taken in Australia under its Consumer Credit Code.

However, New Zealand has a large number of small businesses and it is certainly arguable that they are not in any better position to look after themselves than consumers.

Does it make sense that a relatively unsophisticated individual borrowing $200,000 to buy a house will be protected by the new act but will not be protected if he or she borrows the same amount for business purposes? There is even an argument that the $250,000 cut-off point in the Credit Contracts Act is too low, as it does not reflect more than 20 years of inflation. If the cut-off had been inflation-adjusted, businesses borrowing up to about $850,000 would have the benefit of the act's disclosure regime.

These issues were considered by the select committee that considered the new act and to some extent the need to protect business borrowers has been recognised. In particular, although disclosure requirements and rules relating to interest and fees in the new act will not apply to business borrowing, its oppression provisions will apply to both business and consumer borrowing.

So what protections will small businesses be missing out on? The lender's obligations to make disclosure when loans are made or varied are carried forward with some changes. The main new protections for consumers will be:

a broader obligation on lenders to make periodic continuing disclosure in the case of all consumer credit contracts, not just in revolving credit contracts;

greater regulation of the way interest is charged. For example, there is a prohibition on the charging of interest in advance;

greater regulation of when payments by the borrower must be recognised by the lender. Early payments cannot be held in suspense until the date they were due to be paid unless this is specifically contracted for;

limitation on charging of fees. Fees must generally only be used for recovery of actual third-party costs and reasonable actual internal costs, rather than being used as a source of additional revenue for the lender;

a statutory right for consumer borrowers to make full repayment of their loan at any time. The lender may recover a charge on a full prepayment but it must not exceed a reasonable estimate of the actual loss suffered. The Rule of 78, customarily used to calculate early settlement charges for hire purchase contracts, is effectively banned;

consumers will also have a right to make partial early repayments, unless this right has been specifically excluded by the lender;

easier enforcement by consumer borrowers of their rights through a statutory damages regime and by giving the Commerce Commission an enforcement role similar to that under the Fair Trading Act; and

a consumer borrower who suffers hardships such as illness, injury, loss of employment or the end of a relationship may apply to the lender to change the terms of a contract if he or she has not failed to make a loan payment or exceeded a credit limit, and if the hardship was not reasonably foreseeable at the time the contract was made.

Nigel Stranaghan is a banking partner with the transtasman commercial law firm Phillips Fox

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