If ever there was a contract which should be put into writing it is a contract to lend money. Nothing provides a more fruitful source of disagreement (except perhaps religion!)
The circumstances of our transactions vary widely. The agreements supplied by Net Lawman are more likely to be used by a lender than by a borrower, so we will refer primarily to the lender’s position in this article.
We are not concerned with formal lending and borrowing such as a normal house mortgage or even a corporate bond. Looking at less formal transactions, you might wish to lend to:
Your child, to buy a house;
A friend to engage in a new business;
A friend to get him out of trouble or avoid disaster;
A business colleague in a business you jointly operate;
A virtual stranger, for a good return on your money.
The agreement you choose and how tough you make it depends on:
How far you trust the borrower to repay;
What confidence you have in the ability of the borrower to repay;
How you assess the chances of change for the worse in the affairs of the Borrower;
How important it is to you to be repaid in specific terms - or at all;
How important it is to you to obtain the best rate of interest.
Even if you are lending only to your child, it is important to record the amount and terms of the loan. If you fail to do so, you can be sure that, between you, you will fail to consider some important element, upon which later you will find you have different views - and that is before you even begin to consider the terms where you have different recollections.
At the other end of the scale, you have cash doing nothing very much for two years and a neighbor whose son or daughter is setting up in business and could do with £20,000 for a short time. They offer you a good rate of interest, so you agree to lend. This is an arms length transaction, so you need to set down every possible consideration, so that you have confidence that you really are “agreed”.
Whether your loan is close to home or at arm’s length, the main terms to consider are:
How much is required and will this be enough to satisfy the Borrower’s full requirement?
At what rate of interest and upon what other terms are you prepared to lend?
What info do you want up front, to satisfy yourself or your accountant that the proposition is viable?
What security or third party guarantee can be provided and how tight do you want to make it?
What information do you require from time to time to stay satisfied that the Borrower is solvent and that you will be first in line when the time for repayment arrives?
What will happen, in detail, if the borrower is unable to repay?
The question of security is worth deeper consideration. The three most common forms of security, in order of preference, are:
Traceable securities or intellectual property which can be sold;
A promise by a third party to pay or make good if the debtor fails - that is a personal guarantee;
Goods given in security - usually plant or machinery which is not likely to be moved.
Of course, most borrowers are not in a position to offer you the perfect security. If they were, they would probably be borrowing from a bank and not from you or your company. The main criteria to take into account in choosing security (if you have a choice) are:
Value;
Liquidity;
Value to the borrower.
Value
Obviously, security does not “secure” your cash loan unless the value you would receive on selling it is at least equal to the amount lent, plus accumulated interest and expenses.
Of course, you could imitate the position taken by a bank and ask for a “fixed and floating” charge. You would not take such a charge from an individual because it amounts to a personal guarantee, which is far easier to document and subsequently claim. But if the borrower is a company then an “F&F” gives you all the security you can obtain. What it amounts to is a charge on all the assets of the borrower, whether they are fixed assets such as cars or plant or office furniture, or floating assets which change constantly such as stock for sale of materials for manufacture.
We do not recommend a floating charge for use by individuals or small company lenders because there may be difficulties in proving ownership and right to sell. Stay with specific assets which are easy to sell. If you must have floating assets, choose goods which are identifiable and which do not turn over too often, such as beef cows, rather than nuts and bolts.
Liquidity
This means not merely ease of the selling deal, but all things in connection with the sale. Most lenders fail to assess the difficulties in liquidation certain types of security. Ask yourself how you would go about selling a potato cleaning and sorting plant and how long it would take to make the sale. Compare that with a share transfer form (and certificate) for the sale of 100,000 shares in HSBC plc. There is a tendency for a borrower to offer as security the goods he intends to buy with the loan. This may seem neat, but it is not logical. If the borrower has better security, go for it.
Value to the borrower
It is best to take security which is also of great value to the borrower. You may be able to sell security assets for only a small sum, but if they are worth far more to the borrower, then his effort to repay the loan will be correspondingly greater.
Those are the questions which are relevant to the Net Lawman template agreements. We provide you with options and alternatives on all the crucial matters, but what you decide “goes” is entirely for you.
Other Issues Lending to a close relative - Your money is at risk any time you fail to provide a proper agreement with appropriate safeguards. If you do not wish to tie down the borrower (for any reason) then you increase your risk. It is not our business to provide an agreement which fails to protect you. So if you want a document for this situation, we suggest you buy one our template documents then remove whatever provisions are distasteful to you.
Real property (buildings and land) as security - Real property is not as liquid as many financial assets, but certainly better than fixed plant. Such a security is of course usually called a mortgage or charge. You need a solicitor to prepare and register a mortgage (preservation of the monopoly) so we do not sell template documents for this purpose.
Before country wide land registration, real property could be taken as security by physical possession of the title deeds, without which the borrower could not deal with the property in any way, and which could form the basis of an application to court for the lender to sell the property. Today, that does not work. To take a land certificate as informal security is a non starter, for technical reasons we shall not here explain.
What about promissory notes? - Historically, a promissory note was useful as a means of recording money debts between people who trusted each other to pay. Cheques now perform that function more efficiently. The main problem with promissory notes today is that it is far easier than it was 200 years ago for the debtor to persuade a court that he has a good reason not to honor the note. In other words, the note may not tell the full and up-to-date story of the financial relationship.
If you would like help in drafting your agreement, particulars of our drafting service are here.
If by chance you find some error of law or fact in any Net Lawman information page, do please tell us. We should also welcome your suggestions for new subjects for information pages. These notes:
Do not provide a complete or authoritative statement of the law;
Do not constitute legal advice by Net Lawman;
Do not create a contractual relationship;
Do not form part of any other advice, whether paid or free.
