Loans made by a company to its shareholders, and shareholder loans made to companies are common. In particular, and often in B-BBEE transaction, we see companies offering vendor finance to prospective shareholders by way of the provision of loan funding, with interest. The borrowing shareholder in such an example is often an individual, and a minority shareholder without a controlling interest in the company. Our clients are often surprised to learn that this arrangement falls within the ambit of the National Credit Act. As a result, the company, as lender, will not be able to enforce its rights under the loan agreement, unless it is a registered credit provider (which it will not be, unless it is in the business of money lending). Our clients will say to us, “But this is a once-off shareholder loan. Surely there is no need for us to register as a credit provider?”. Unfortunately, the National Credit Act is broad enough in its application that it very likely could apply in such a situation.
Application of National Credit Act
The National Credit Act applies to every credit agreement between parties dealing at arm’s length and made within, or having an effect within, South Africa, subject to certain exceptions. For example, if the borrower is a juristic person (e.g. a company) with an asset value or annual turnover which is, at the time the agreement is made, equal to or more than R1,000,000, then the credit agreement will not be subject to the National Credit Act. Large credit agreements (more than R250,000) are also not subject to the National Credit Act if the borrower is a juristic person (even with no, or very little, asset value or turnover).
A loan made to a borrower that is not a juristic person will not fall within any of these exceptions.
But surely, regardless of the size of the loan or whether the borrower is a juristic person, loans to shareholders and shareholder loans are not subject to the National Credit Act for the simple reason that they are not made between parties dealing at arm’s length?
Shareholder Loans Exception
Many of our clients assume that the National Credit Act doesn’t apply at all to shareholder loans, or loans to shareholders. However, the National Credit Act states that this is only the case where the relevant shareholder has a controlling interest in the company. A controlling interest is not defined in the National Credit Act, but it was confirmed in a High Court judgement that “there appears little purpose in limiting the term to a majority shareholding … It is clear that a person can influence the affairs of another person by means other than holding a majority shareholding in the latter.” Whether a shareholder has a controlling interest in a company must be assessed on a case by case basis. However, what is clear is that if a company lends money to a minority shareholder (with no controlling interest) or vice versa, that transaction will not automatically be seen as arm’s length.
We caution our company clients to make sure that if they lend money to one of their minority shareholders, that the arrangement must genuinely not be arm’s length, for reasons other than the fact that there is shareholder relationship between them. The key here is that the arrangement must be one in which each party is not independent of the other and consequently does not necessarily strive to obtain the utmost possible advantage out of the transaction. In the relevant loan agreement, we would state that this is the case and reference why it is the case, for example, with reference to the interest rate or repayment terms being more favourable than what the borrower would otherwise obtain from a third party financier. Substance over form is important here, however. It doesn’t matter what a contract says, if, in fact, the loan terms demonstrate that the transaction is arm’s length and akin to any ordinary commercial lending arrangement.
Consequences of Non-Compliance
The National Credit Act requires that a person must apply to be registered as a credit provider if the total principal debt owed to that credit provider under all outstanding credit agreements exceeds the prescribed threshold – which has been nil since 11 May 2016. If the lender, or credit provider, is not registered as such, the loan agreement is seen to be invalid. The lender will not be able to enforce its rights for repayment of the loan.
A loan agreement which is subject to the National Credit Act will be invalid if the lender is not a registered credit provider. It does not matter whether the loan is a once-off arrangement, or whether it is made between a company and a shareholder. A shareholder loan (bearing interest) does not automatically fall outside the ambit of the National Credit Act. We caution our clients who are considering lending money to a shareholder or to a prospective shareholder to consider the National Credit Act carefully. The loan arrangement must not be arm’s length in nature. The parties must be able to show that the loan was made due to the shareholding relationship between the parties and the terms must reflect that the lender is not striving to obtain the utmost possible advantage out of the transaction.
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Reckless Credit is any credit granted to a consumer in terms of a credit agreement where the credit provider (e.g., a bank, or a retail store), at the time the credit agreement is to be concluded, has not conducted a proper assessment.
What is the credit assessment?
When a consumer applies to credit, the credit provider must conduct a proper assessment of the consumer. As part of this assessment, the credit provider must take reasonable steps to evaluate the prospective consumer’s (i) understanding and appreciation of the proposed credit agreement (the risks, and costs to be incurred, as well as the consumer’s rights, under the credit agreement) and (ii) the prospective consumer’s ability to meet his or her obligations timeously (e.g., the ability to pay instalments in full and on time).
The credit provider is also obliged to assess the debt repayment history (credit rating) of the consumer under other credit agreements, the consumer’s existing financial means, income and expenditure and the prospects of success of any commercial purpose, if this is the reason for application for credit.
The prospective consumer, during the assessment, must fully and truthfully answer any requests for information made by the credit provider.
When is a credit agreement reckless?
A credit agreement may be reckless if:
If the credit assessment is not done at all
Where a credit assessment is conducted, but it is apparent to the credit provider that the consumer does not fully understand and appreciate the implications, costs, risks and obligations of entering the credit agreement
Where, even if the assessment were properly conducted, and even if the consumer did fully understand and appreciate the implications of the credit agreement, by entering into the credit agreement, the consumer would become over-indebted.
When can a credit provider defend an allegation that a credit agreement is reckless?
If the credit provider shows that a consumer did not fully and truthfully answer any requests for information made by the credit provider when doing its assessment, and that such failure had a material impact on the credit provider’s ability to make a proper assessment, then this is a complete defense to an allegation of reckless credit. This means that a court would not set aside or suspend a credit agreement and the consumer will be bound by it.
What happens if the credit is reckless?
The consequences are drastic. The credit agreement may be set aside, which means that the credit provider cannot claim payment of any amounts due by the consumer, nor for the return of any goods bought on credit. The credit agreement may be suspended, which means the consumer’s obligations to perform (e.g. to make payment), and the credit provider’s right to enforce its rights (e.g. to enforce payment) are suspended for a time, where after they revive. During suspension, no interest or charges may be levied by the credit provider.
https://www.brevitylaw.co.za/wp-content/uploads/2021/02/NCA.jpeg389500Office Adminhttps://www.brevitylaw.co.za/wp-content/uploads/2017/08/brevity-logo-1-300x138.pngOffice Admin2021-02-24 08:11:552021-02-24 08:11:59WHAT DOES THE NATIONAL CREDIT ACT SAY ABOUT RECKLESS LENDING?
The National Credit Act, 2005 (“National Credit Act“) has widely been criticized as being one of the most confusing pieces of legislation in our law. In fact, in Absa Technology Finance Solutions (Pty) Ltd v Michael’s Bid A House CC and Another 2013 (3) SA 426 (SCA), in referring to the decision made by the court of first instance, Lewis JA stated “the [H]igh [C]ourt … held that the particular lease was not a lease. This may sound like a fragment of Alice in Wonderland. If that is so, it is because the [National Credit] Act itself could have been written by Lewis Carroll, so peculiar are some of its provisions“. So what is it about the way the National Credit Act deals with leases that is so peculiar?
What is a lease?
Most would agree that a lease can accurately be described as an agreement in terms of which one person (the lessor) gives another person (the lessee) temporary possession of property in exchange for the payment of rent. The word “temporary” assumes that the property must be returned by the lessee to the lessor at the end of the agreement.
The National Credit Act’s definition of a lease
The National Credit Act also defines a lease as an agreement in terms of which “temporary possession” of movable property is given to a lessee. However, the definition then goes on to specify that at the end of the agreement, ownership of the property in question passes to the lessee (rather than requiring possession to be returned by the lessee to the lessor).
This definition is clearly problematic. Not only does it run counter to the essential elements of a lease, but the reference to “temporary possession”, followed by the requirement for ownership of the property to pass to the lessee at the end of the lease, is illogical.
While the National Credit Act is commendable in its aim to protect consumers by promoting fair and responsible lending practices, it can be an intimidating piece of legislation, rife with obscurity. If you are in the business of leasing moveable property, be sure to investigate whether the National Credit Act applies to you.
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