In Fons Hf v. Corporal Ltd & Anor (Fons), the Court of Appeal held, in the context of a specific agreement, that "debentures" included loan agreements, on the basis that a loan agreement "creates or acknowledges a debt". Although the Court of Appeal did not consider the regulatory impact of this conclusion, the decision nevertheless creates the unlikely possibility that loan agreements could be "specified investments" under Article 77 of the FSMA (Regulated Activities) Order 2001 (as amended) (the RAO). Rosali Pretorius explains why this is causing such concern to those involved in UK loan market activity.
Why is this potentially a problem?
Article 77 RAO states that, subject to various exclusions not relevant for these purposes, "specified investments" for the purposes of FSMA include "any …. instrument creating or acknowledging indebtedness".
Any person who enters into an agreement which is a specified investment, makes arrangements for others to do so, advises on it, or performs other activities relating to it by way of business in the UK may conduct regulated activities under FSMA. If an unauthorised person does so without an appropriate exemption or exclusion (among other consequences):
(a) that person commits a criminal offence; and
(b) agreements entered into in the course of carrying on an unauthorised regulated activity are unenforceable against the other person.
Arguments against the view that loan agreements fall within Article 77
Our view is that loan agreements do not generally "create or acknowledge a debt", and this has always been the prevailing view in the market. Most loan agreements provide a contractual framework under which a borrower can borrow money, but do not themselves evidence any debt.
Other factors suggest it is illogical that loan agreements should fall within Article 77, and that they were not intended to do so. Loans are the simplest and commonest way of creating a debt. It seems inconceivable that Article 77 would not have referred to loan agreements expressly if they were intended to fall within its scope.
If loan agreements did fall within Article 77, who would be at risk?
UK-based bank lenders are already likely to have regulatory permission to deal in investments. Many non-bank lenders and borrowers will not be authorised, and could be treated as "dealing as principal" (a regulated activity). In practice, both would be likely to benefit from exclusions, at least outside the secondary market.
In our view, those most likely to be at risk would be:
- non-bank lenders buying commitments in the secondary market;
- unregulated intermediaries arranging or advising on loans; and
- those with discretion to manage assets including loans, in each case where acting in the UK. Firms with business models that include these activities may want to consider Fons more carefully.
All parties should note that, if a communication amounts to an incitement or inducement to engage in loan activity, it could be a "financial promotion". If so, it must be issued or approved by an FSMA authorised person in compliance with FCA rules unless exemptions apply.
What could happen next?
Parties to loan agreements should not panic. The City of London Law Society has written to HM Treasury copying other regulators, asking them to clarify their policy intentions urgently (by confirming that loans are not within Article 77).
The Court of Appeal's decision in Fons may be appealed to the Supreme Court. If that were to happen, and the Supreme Court overturned the Court of Appeal's decision, much of the uncertainty created by the Court of Appeal's decision would be likely to disappear. However, irrespective of any future appeals in Fons, the case itself cannot be a binding precedent for interpreting the RAO as it did not consider the RAO or previous FSA guidance on its interpretation.
It seems unlikely the Fons decision will immediately lead participants in the loan market to stop trading or rush to become authorised under FSMA because of their commercial lending activities. However, there will remain some uncertainty in this area until regulators have addressed this development.
Law stated as at 30 July 2014.