Crunch time for local authority credit

Are you loaning money to employees or other individuals? Are you sure that you are compliant? Are the agreements enforceable? Are you risking committing a criminal offence? Adam Finch and Fran Mussellwhite look at issues that local authorities should consider if they are providing any form of credit to anyone.

We are increasingly seeing examples of local authorities offering forms of flexible credit agreements, especially to employees. While many entities are required to obtain a consumer credit licence from the Office of Fair Trading (OFT) in order to be able to offer loans of this type, local authorities are exempt from this requirement. However, they are still required to comply with all other provisions of the Consumer Credit Act 1974 (the CCA). There is a real risk that credit agreements will be deemed unenforceable without a court order if the agreements fail to adhere to the stringent and complex provisions in the CCA.

We are also seeing examples of local authorities requiring the debtor under these credit agreements to take out payment protection insurance (PPI) policies to cover the repayment of the loan in the event of the borrower being unable to repay the loan as a result of, for example, sickness or unemployment. In some cases, we have seen local authorities “self insuring” the loans by underwriting the insurance policies themselves rather than using a third party insurer. There is a risk that in doing so without authorisation by the Financial Services Authority, you will be committing a criminal offence.

Consumer credit agreements

A consumer credit agreement is an agreement between a creditor and an individual by which the creditor provides credit to the individual. Credit means a cash loan or any other form of financial accommodation where the debtor is allowed time to pay.

Is it regulated?

The starting point is that where credit is made available to an individual, the  agreement is likely to amount to a consumer credit agreement and will therefore be regulated by the CCA. There are exemptions from regulation under the CCA, however these are very limited in number and scope.

An example of an exemption from regulation under the CCA would be where the loan is for an amount of £25,000 or more and where the facility is entered into wholly or predominantly for the purposes of a business carried on by the borrower. To fall under this exemption, the loan agreement must include a declaration in the prescribed statutory form.

A more likely exemption is where the local authority makes a loan available to a particular class of individuals, for example employees, and not to the public generally. However, such loans must adhere to a number of rules, including those relating to charges and interest.

Compliance with the CCA

Despite the fact that local authorities are not required to obtain a licence from the OFT, they must comply with all other provisions of the CCA. The CCA contains stringent requirements as to, for example, the means of execution of a regulated consumer credit agreement. Failure to comply with these requirements will render the agreement unenforceable save upon an order of the court. We have increasingly seen examples of local authorities falling at this hurdle, causing additional cost to be incurred to have the agreements enforced.

What happens if the agreement is unfair?

Under the Consumer Credit Act 2006, if a court considers that an agreement between the creditor and the debtor gives rise to “unfairness” which is detrimental to the debtor, the court has a number of options available to it. These include:

• refusing to enforce an agreement;
• requiring the return of monies paid; or
• altering the terms of an agreement in such manner as the court sees fit.

Unfortunately, there is little guidance from the courts on what they would treat as unfair. The obvious culprits are excessive interest rates and default charges. As such, local authorities must take special care to ensure that the terms of any agreement are risk assessed to reduce the likelihood of an agreement being considered unfair.

Payment Protection Insurance

By funding PPI policies for debtors, the local authority may be deemed to be arranging and underwriting contracts of insurance. These activities are regulated activities by the Financial Services Authority under the Financial Services and Markets Act 2000 (FSMA). In order to carry out a regulated activity in the United Kingdom, the provider of that regulated activity would need to be authorised under FSMA (unless any exemption was available).

Where local authorities have funded PPI policies to individuals, there are significant regulatory risks if it were determined that the local authority had undertaken a regulated activity for the purposes of FSMA without being an authorised person. The local authority will in this case be in breach of the “general prohibition” as set out in FSMA, and will have committed an offence. In addition, any insurance policies between the local authority and the individuals will be unenforceable.

It may be possible for a local authority providing PPI to argue that it is not undertaking such activity by way of business and therefore, that it is not undertaking a regulated activity under FSMA. Whether this is the case or not will vary significantly depending on the facts and circumstances and we would generally recommend that a local authority outsource the underwriting, effecting and administration of insurance policies to authorised, regulated third party insurers.

New requirements from 1 February 2011

Finally, to add an additional layer of complexity, the Consumer Credit Directive came into force on 1 February 2011. The effects of the Directive are wide ranging on those consumer agreements that are not exempted. The main points include:

• a duty on the lender to provide an adequate explanation about the credit on offer;
• a duty on the lender to check the credit worthiness of the borrower prior to lending;
• a right of the borrower to cancel the agreement within 14 days without giving a
• reason; a right for the borrower to make partial early repayments;
• a change in how the APR is calculated; and
• a duty on credit intermediaries to disclose their status to the borrower in advertising and other materials and details of any fees charged.

What should I do?

If you are providing any form of credit, you should immediately review all credit and loan agreement schemes in place. Carefully check that you are compliant with the CCA legislation and that you are not carrying out any regulated activities unless authorised by the FSA.

This article also appears in our local authority newsletter Authority View Spring 11.