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An unaffordable loan for a small business

Richard runs a small building business. In early March 2023, he secured a contract to complete repairs for a large organisation on an ongoing basis. He thought it would generate an income of about $200,000 over several months. He needed to quickly take on some new staff, purchase another work vehicle and some more gear, and needed some immediate cashflow of $50,000.

Richard applied online for a business loan and then communicated with the lender over the phone. The lender asked him questions about the loan’s purpose and about his financial situation. The only documents the lender required him to provide were statements for his business’s bank account. A few days later the lender approved the loan. The term was 12 months, and in total Richard would pay about $67,000 including fees and interest, making his weekly repayments $1,300.

Initially Richard made the weekly payments but, by the middle of April 2023, he stopped paying. He was able to make some payments a few months later, but stopped again. The loan went into serious arrears and, by November, the lender had placed caveats over two of his properties, including his family home. Richard reached out to a financial mentor, who complained to the lender that Richard was never able to afford the loan. The mentor asked to see copies of the lender’s affordability assessment, but when communication between the mentor and the lender broke down, the mentor brought the complaint to FSCL.

Dispute

In Richard and his mentor’s view, the lender had not conducted a suitable assessment of whether he could afford to pay the loan. The lender considered they had reasonably assessed affordability. They wanted to explore reaching an arrangement with Richard to reduce his weekly payment amount. The lender also froze his account meaning no further default fees could be added. However, with the parties being unable to resolve the issue about whether the loan was affordable, we started our investigation.

Review

From the outset, we told the parties that this was a business loan, meaning the responsible lending provisions of the Credit Contracts and Consumer Finance Act 2003 (CCCFA), and the Responsible Lending Code, did not apply. However, although the lender did not need to meet the more strict affordability assessment requirements under the CCCFA, the lender still needed to do some assessment to be satisfied Richard was going to be able to make the relatively high repayments of $1,300 per week.

The lender’s affordability assessment information only consisted of information Richard had told the lender (not verified by any documentation) about what his/the business’s financial situation was, and about the income he expected to receive from the new contract. He had also provided the business’s bank statements for the 3 months before he took out the loan. The lender did not ask to see the business’s annual financial statements, or any information about the contract Richard had secured for the ongoing work, showing what he was likely to earn.

We reviewed the business’s bank statements. These showed a regular pattern of Richard receiving large payments of several thousand dollars for completed building jobs. But within only 2 or 3 days the balance had reduced to a few hundred dollars. Mostly Richard appeared to be paying staff wages, and buying building supplies, depleting all the funds. It was not clear how Richard was going to be able to afford the repayments of $1,300 per week, and we could see why he was unable to make repayments so soon after taking out the loan. We thought the lender should have obtained some more detailed information before approving the loan; at the very least the business financials, and a copy of the new contract Richard had secured.

When we spoke to Richard, he said he knew before signing the loan contract that he wouldn’t be able to afford the $1,300 repayments. However, he really needed the cash and the lender could get it to him quickly, so he signed the contract. Richard wanted to pay back the loan but felt a reduction of at least 20% of the loan balance, which was still about $67,000, would be fair. We spoke to the lender, and they offered to reduce the balance to $50,000 and for Richard to pay this at $480 per week over 2 years.

The lender’s offer was essentially for Richard to pay back the principal amount borrowed. The offer didn’t take into account the approximate $10,000 Richard had managed to make in payments. If this was a consumer credit loan, we would have said that all fees and interest would be written off, and so Richard would have had to pay back only $40,000. However, because this was a business loan, and Richard was aware before he took out the loan that he could not afford the repayments, we suggested that Richard counteroffer to reduce the balance to $45,000, giving him the benefit of half of the payments he’d made. The lender agreed to this. The lender also agreed to accept payments of $385 per week, which meant Richard would pay the loan off in about 2.5 years.

Resolution

The parties agreed that Richard’s loan balance would be reduced to $45,000 and frozen at that amount, with him making weekly payments of $385. Once the loan was paid, the lender would remove the caveats.

Insights for consumers and participants

FSCL will treat a business loan differently from a consumer loan. When you take out a business loan you do not have the same protections or remedies as might be the case if it was a consumer loan. It carries more risk because a lender may have the power to place a caveat, require security over assets including the family home, or take personal guarantees.

This case also highlights to lenders that although the stricter affordability assessment requirements that apply to consumer loans do not apply to business loans, the lender still needs to assess whether the borrower will be able to repay the loan.