When it comes to the issue of regulation, most people automatically think of FSA regulation, but what about Consumer Credit Act (CCA) regulation? Clive Whitfield-Jones, Partner at Jeffrey Green Russell Solicitors, offers us an insight into corporate lending transactions…

Sham transactions in corporate lending

Where individuals guarantee a loan to a company, and provide security for that guarantee by way of a first or second charge over their dwelling, neither the loan nor the guarantee are regulated  by the regulated mortgage contract regime or the CCA. This is because the lender agrees to provide credit to the company, not to the individuals, and corporate lending is outside such regulation.

If, in reality, the loan is to individuals but is dressed up as a loan to a company, there may be a sham transaction and a court or regulator may well find the agreement to be regulated.

Mr Smith applies for a loan for personal purposes secured by a second charge over his dwelling. No CCA exemption is available. Mr Smith is a director and main shareholder in a successful local manufacturing company. Mr Smith is told that the loan cannot be made to him personally, however the lender will make the loan to the company, with a guarantee from Mr Smith backed by a second charge over his dwelling. Mr Smith can then draw the money out of the company. Alternatively, Mr Smith can buy a new SPV from company incorporation agents and the SPV can take the loan.

In these circumstances there is a significant risk that the arrangements amount to a sham and that a court or regulator would look through the pretence and regard the true agreement as being made between the lender and Mr Smith. There is also a danger that the lender cannot recover the loan from the company at all. A director has a duty to act in the best interests of the company. This loan is for the benefit of the director, not the company. The lender appears to have notice of the fact that the director is breaching this duty by causing the company to enter into the loan for his personal benefit.

The lender might face a successful challenge under the unfair relationship provisions of sections 140A and 140B of the CCA on the basis that the lender had failed to treat the agreement as a regulated agreement and has not provided Mr Smith with the prescribed information and explanations.

The risks are higher where a loan is made to a company established with the sole objective of enabling the lender to make the loan. Lenders should always be alert to the risk that sham corporate lending transactions are being proposed; particularly where it is claimed a newly incorporated company is embarking on a new business.

Mr Smith is also taking risks beyond the scope of this article, particularly if his company becomes insolvent, including director’s breach of duty, a fraud on minority shareholders, taxation on funds extracted and in some cases disqualification.

Mr Jones is a shareholder in a newly incorporated company, which intends to acquire a buy-to-let property. Mr Jones applies for a loan to enable him to fund the company’s activities, secured by a second charge over his dwelling. The business purpose exemption is not available, because, as we saw last week, the loan will not be made for the purposes of a business carried on or intended to be carried on by Mr Jones. Indeed, there are doubts whether the company is carrying on a business at all as the purchase of one buy-to-let property may not amount to a business. Mr Jones is told that the loan cannot be made to him personally, but the lender will make the loan to the company, with a guarantee from Mr Jones backed by a second charge over his dwelling. What is your verdict?

I don’t see a sham transaction on these facts. The funds are needed for the company’s activities, not Mr Jones’ personal use and so may legitimately be borrowed by the company. But the company may not be carrying on a business. A corporate loan need not necessarily be taken out for the purposes of a business carried on by the company, provided that it is taken out in good faith in order to further the interests of the company and in accordance with all requisite corporate authorisation procedures.

Tip: The company should always complete its own application form where there is a change of borrower in this way.

Next week: Cinderella and the high net worth exemption.