General
A loan offer will generally be framed in such a way as to become a binding contract on acceptance by the borrower. Common law contract rules apply to the loan agreement. When signed, the bank becomes obliged to lend subject to satisfaction of the various preconditions or conditions precedents (cps) within the period stated or implied. If there is an event of the default, the bank’s commitment to lend will generally terminate.
The contents of the particular loan agreement (and the mortgage documents) is what mainly governs the rights and obligations of the bank and the borrower in any particular case. There will always be so called special conditions which are unique to each case, in addition to the general conditions.
Regulation and Format
The form and content of loan offers and loan agreements used in England and Wales are broadly similar to those found in Ireland. In the case of commercial loans in England, the loan agreement may contain terms which are more usually found in the mortgage / charge document in Ireland.
The loan agreement and the mortgage deed will set out the legal rights and obligations of the lender and borrower. Convenience and practical considerations usually lead to a separate loan agreement and mortgage deed. Difficulties may arise by reason of inconsistencies between the mortgage deed and loan agreement.
Many lenders use a relatively standard form of loan agreement. Particular conditions specifically relevant to the circumstances are usually inserted by way of special conditions.
The complexity and content of the loan agreement will depend on the circumstances. In some cases, the loan agreement may have been negotiated to an extent. In most standard transactions, the borrower is likely to have been offered the lender’s form of loan agreement for the loan product concerned.
There is no direct equivalent of the Housing Loan provisions in the Irish Consumer Credit Act in UK buy to let and commercial property lending. Regulation does apply to loans to owner occupiers. Buy to let loans are unregulated in England and Wales, provided the buy to let loan is secured on an investment property.
Loans by an Irish-based bank to an Irish based borrower, but secured in on UK property, which are not solicited in the United Kingdom are generally outside the scope of UK regulation, by reason the lack of connection with the UK. They may however be subject to Irish regulation in the same way as a loan secured in Irish property.
Unfair Contracts Regulations
Loan agreements with consumers are subject to the Unfair Contract terms legislation, which derives from European Union law. The legislation is almost identical under Irish and English law. A “consumer” means an individual who is acting outside of his normal trade or business. A buy to let case may or may not fall within the regulations, depending on the circumstances.
Where the regulation apply, an “unfair” clause is not enforceable against a consumer. The regulations may require that a clause is interpreted in such a way so as to limit its application to a fair and reasonable interpretation. The regulations also require that the agreement be in plain and intelligible language.
The regulations apply, broadly speaking, to standard form contracts. A clause in a contract is unfair if it has not been individually negotiated and if contrary to good faith, it causes a significant imbalance in the parties’ respective rights and obligations to the detriment of the consumer. Unfairness does not apply to pricing and other commercial conditions.
The regulations contain a list of types of clauses that are potentially unfair. The FSA publish a statement of good under the regulations for financial consumer contracts. This is not binding but is useful guidance on what may or may not all be invalidated by the regulations.
Contents
A loan agreement will generally contain clauses covering the following matters;
- purpose of the loan
- drawdown preconditions
- warranties and representations
- ongoing covenants and obligations
- events allowing termination of the loan
- Security over borrowers assets
- Fees and charges
- governing law
- provisions on assignment
- notices
Purpose of Loan
When loan monies are advanced, they become the absolute property of the borrower. Generally, the lender has no direct right to a fund of monies representing the loan proceeds or to any assets purchased with them. The lender has a general right to be repaid (i.e. the debt). This is a contractual (i.e. a personal) right to enforce the debt against the borrower personally.
There is a limited exception to this rule where a loan is advanced for a particular purpose. This is a so called “Quistclose” trust. The courts have in some cases taken the view, that where monies are advanced for a very specific purpose, the lender may have an interest in the proceeds of the loan monies, even after they are advanced to the borrower.
This is a matter of debate and would require court proceedings to assert. It should not be relied on as a general proposition, but the principle may prove to be of use in some circumstances. Where the principle apples, the lender may be able to “trace” entitlement to another asset which has been purchased with the loan monies.
Repayment
The period of the loan, the capital repayments requirements and the interest rate basis will be key commercial terms. The loan agreement will set out specifically or by implication, the provisions for interest and repayment of capital. There may be a schedule of payments of interest and capital in regular periodic payments.
Repayment may be on a specific date or in accordance with a schedule of payments. Early prepayment can lead to broken funding costs. The bank may require an indemnity in respect of loss incurred.
In commercial loans, repayment may be at a distinct point in time by way of a single repayment. In construction and development loans repayment may be contemplated from a particular source, at a particular time or over a period of time.
The facility may be rolled over from time to time. In many cases, repayment is on demand. This gives the lender considerable flexibility to demand repayment and terminate the facility.
Interest
The loan agreement will specify the applicable interest-rate. The bank may set a base rate with reference to its overall average cost of funds. It may set a floating rate based on a basis rate plus a margin. This basis rate may be the bank’s marginal cost of funds on the interbank market.
The interest rate may be set by reference to some internal or external benchmark. In commercial loans, interest is more likely to be set by reference to the bank’s cost of funds on the inter-bank market or some equivalent benchmark.
The rate of interest for Sterling loans will often be LIBOR plus certain costs plus margin. The costs usually refer to mandatory costs arising from the costs of regulatory requirements and deposits. The margin will be set as a commercial term, depending on the borrower’s status and risk.
The London interbank offered rate (LIBOR) is a common basis for charging interest. It is usually set at 11 a.m. on each business day. LIBOR may be ascertained by reference to certain reference banks. A common basis is to use a screen rate, which is generally an average rate compiled by the British Bankers Association A number of prime banks’ costs of funds are calculated, discarding the highest and lowest bands and averaging the remainder.
There may be provision for a higher default interest rate, if the borrower fails to pay the sums due. Provided that the default interest can be justified as reasonable compensation for having to deal with the default the clause should be upheld in non-consumer loans.
Generally, there is no statutory restriction on the rate of interest that may be charged if the borrower is not a consumer. Clauses allowing for variation of interest agreement are lawful under English and Irish law subject to provisions of the Consumer Credit legislation.
Withholding Tax on Interest
Under some circumstances, there is an obligation on an individual or company paying interest to withhold tax. This risk can apply in particular, to cross border payments. There is usually a clause in the loan agreement dealing with this risk which requires the payment to be “grossed up” (increased) so that the bank receives the required interest after tax is withheld. The purpose is to protect the bank from withholding tax, but the clause can substantially increase the cost to the borrower.
Where the loan is made by an Irish based bank to an Irish based borrower, secured on UK property, the position will be the same as with any other Irish loan. Irish tax law only will apply. There are exceptions available to banks which mean that interest can usually be paid without Irish tax deduction.
Companies are generally required to withhold tax on interest payments under both UK and Irish tax law. There are some important exceptions which were generally available to Irish banks. Interest paid to a recipient within the scope of UK corporation tax is exempt. There is also an exception if interest is paid to a company resident in a country with a double taxation agreement with the UK (such as Ireland).
Security
The loan agreement will stipulate the security required. This will include one or more properties in the case of a property investment loan. Buildings insurance should be procured. The interest of the lender should be notified to the insurer. It is possible to take security over the benefit of the insurance policy itself. Security over a life policy, a deposit or other assets may required.
It is desirable to specify that the secured property is security for all sums due on all accounts between the borrower and lender. This means that the security will be available to cover shortfall on other loan accounts.
In the case of development, construction or commercial loans, the required security may be more extensive than a mortgage or charge over property. In many cases, additional security over other assets such as insurance policies, bank accounts, contracts, and rents receivable may be required.
It is possible to give security over a wider class of assets than just property and buildings, even in the case of security by individuals. A company may give security over its circulating trade assets by way of a floating charge which it continues to use in the course of its trade until enforcement.
Fees and Costs
Fees may be provided for by the loan agreement. There may be a front end fee in consideration of the initial set up of the loan. There will be a commitment fee in relation to the commitment to make money available and to cover costs. The Consumer Credit Act may be relevant.
A loan agreement will usually also require the borrower to pay incidental costs in connection with the set up and running of the loan. This may include registration legal registration, fees etc. There is no stamp duty at present on mortgages or loans in England.
Governing law
The governing law of the contract will specify which country’s law is to apply. The loan agreement may be governed by the law of the country with which is has closest connection. In the case of a loan agreement in Ireland between an Irish bank and an Irish based borrower, the appropriate law to govern the loan agreements may be Irish law.
The mortgage and all property aspects must be governed by English law if the security is situated in England and Wales. This is because any matter concerning ownership or rights in land must always be governed by and enforced in the place where the land is situate.
