Throughout the Covid-19 pandemic lenders, borrowers and regulators have been paying close attention to lenders’ responsibilities towards defaulting borrowers, particularly in relation to enforcing security.
The Prudential Regulation Authority still advises a patient and cooperative approach towards borrowers in financial difficulty, however enforcement action is not always avoidable, and we have previously set out key points to consider in our recent notes on enforcing security against real estate and first steps to enforcing security.
In some situations, it may be more appropriate for lenders to renegotiate the terms of financial agreements with their borrowers rather than enforce any security. The recent case of Morley (t/a Morley Estates) v Royal Bank of Scotland Plc highlights three key issues to consider in such negotiations:
- has the borrower obtained legal advice;
- do lenders need to act with reasonable care and skill; and
- do lenders need to act in good faith?
1. Has the borrower obtained legal advice?
In the Morley case, the borrower was in default and entered into renegotiated arrangements with the lender. The borrower later argued that they only entered into a renegotiated arrangement because they were intimidated and under duress from the lender, i.e. they had no choice but to agree to the lender’s requests as the alternative was to remain in default and face enforcement action. However, this was rejected by the courts and one of the key observations was that the agreement reached between the borrower and the lender was “a result of robust (and even aggressive) negotiation between commercial parties, each of which had legal advice”.
As such, lenders should ensure that borrowers seek proper and independent legal advice, particularly where the borrower is less experienced. This will help rebut any suggestion that a renegotiated agreement is the result of intimidation or economic duress.
Similarly, borrowers should take care that the legal advice they receive is thorough and not just “rubber-stamping” the proposals, particularly where the borrower intends to take an active role in the negotiation. A court is unlikely to intervene where a borrower later regrets the agreement reached, even more so if there is a significant passage of time before the complaint is raised.
2. Do lenders need to act with reasonable care and skill?
In the Morley case, the borrower also argued that the lender had breached a duty to exercise reasonable care and skill, which is implied into all agreements with service providers.
Again, the court rejected this argument for several reasons and importantly noted that, in the context of lending arrangements, the only services provided by a lender are to make the loan(s) available for drawing. Once the loan(s) have been drawn down there are no further services to be provided by the lender and no implied requirements to act with reasonable care and skill. Helpfully, the court added that even if such a duty could be implied (which in these circumstances it could not):
- it was acceptable for the lender to have other motives for the renegotiated arrangements and their sole motive did not have to be the recovery of the debt; and
- any duty of skill and care would not require the lender to advise the borrower on “how to resist its attempts to get more money out of him”.
Whilst in the specific circumstances of the Morley case the court rejected any implied duties described above, lenders should nevertheless consider carefully their responsibilities to the borrower when proceeding with enforcement actions to ensure that they act appropriately.
3. Do lenders need to act in good faith?
In the Morley case the borrower further argued that there was an implied duty of good faith under the loan agreement for the lender not to act vexatiously or contrary to its legitimate commercial interests to recover the debt. Helpfully for lenders, the court found that the bank’s actions were all “rationally connected to its commercial interests” so there was no breach of duty to act in good faith, even if such a duty did apply. Whilst a duty of good faith was not explicitly ruled out, it seems that having clear commercial justifications for any enforcement or renegotiation actions would be sufficient to satisfy such a duty. Lenders should bear this in mind in their interactions with borrowers and document these clearly.
The decision in Morley should provide some reassurance for lenders. The court upheld the lender’s exercise of its contractual rights and discretions and was hesitant to impose implied duties beyond the duties already owed as a mortgagee. This must be right if the market is encouraging lenders to find solutions to defaulting loans that do not include taking enforcement action. However, lenders should be careful to ensure that they continue to act appropriately and to not take advantage of borrowers in financial difficulty, especially in light of the overarching theme of lenience requested by the regulators during the pandemic. The three points set out in this note are a good starting point for lenders when approaching negotiations with borrowers in default.