The Bank of Mum and Dad: does it need to be FCA regulated?
With property prices making it increasingly difficult for younger adults to buy their own homes, many families are turning to the Bank of Mum and Dad to help finance a first home purchase. Recent changes to the mortgage affordability criteria applied by established lenders also means that it can be ever more difficult for those working freelance, who are self-employed or in the gig economy to obtain finance from traditional lenders. As a result, we are seeing an increasing number of enquiries from our clients who are widening the remit of the Bank of Mum and Dad to the Bank of Friends and Family. However, there are some tricky regulatory issues that anyone considering making these types of loans should be aware of.
The starting point under the relevant legislation is that all lending activity is regulated, but may be exempt or excluded from regulation if the circumstances of the lending fit certain criteria. The main exemption that will apply to loans between friends and family members is that lending that is not carried on "by way of business" is not regulated. Although this might appear to be straightforward, the question of whether the lender is making loans "by way of business" will depend heavily on the facts. A one-off loan to a daughter with little or no interest payable will almost certainly not be considered to be carried on "by way of business". But anyone who finds that they are regularly making loans or who lends to friends and those outside their immediate family should consider carefully whether the picture taken as a whole would put them into the category that would require them to be regulated by the FCA.
A recent case highlights some of the potential pitfalls of lending to friends and relations and the risks of straying, however, unintentionally, into the world of regulated activity and the role of the Financial Conduct Authority (FCA) in protecting consumer borrowers. In that case, the lender was friendly with the borrowers. Lending was not his only or even main business activity. Nevertheless, the Court ruled that he could not enforce the loan he had made to the borrowers because the circumstances under which the loan was made suggested that, on balance, the lender was lending "by way of business".
Relevant factors will include:
- The frequency with which the lender is making loans;
- The terms of the loan, such as the rate of interest and whether the lending is secured by a mortgage or other type of charge on the borrower's property;
- The relationship between the borrower and the lender and how they came to meet;
- The respective experience of the borrower and the lender – for example, if the lender is experienced in commercial matters and the borrower is, relatively speaking, unsophisticated in matters of finance; and
- The amount of money loaned.
The penalties are severe – not only was the lender unable to enforce his security and recover the sums loaned from the borrower (who was, by now, bankrupt), there is also the possibility of criminal prosecution. Whilst the relationship between the lender and the borrower might be excellent at the time the loan is made, there is always the risk of a falling out or a dramatic change to the borrower's financial circumstances later down the line at which point enforcement of the loan may be more problematic.
Although the legislation specifies that the regulatory regime applies to loans made to individuals, it is wide enough to catch trustees, small partnerships and unincorporated associations. Therefore, it's important to consider carefully all of the factors surrounding the loan to establish whether the regulatory regime will kick in.
Michelmores' lawyers regularly assist clients with loans which might be caught by the requirement for regulation. We can advise you on the risks associated with these types of loans and ensure that the terms of the loans are clearly documented for the benefit of both parties. As one judge said "..the closeness of the parties' relationship made it easier, as it so often does, for expectations to become blurred…".
Anna Thompson is a Senior Associate in the Banking team at Michelmores. She regularly advises clients on all aspect of banking and finance, including loans between friends and family members, as well as advising larger corporate borrowers and lenders on lending and security structures.
Andrew White is a Senior Associate in the Tax, Trusts and Succession team at Michelmores. He specialises in advising individuals and families on a range of estate planning issues, including the mitigation of taxes, succession to family assets and the creation of trusts to manage and protect family wealth. Andrew works closely with Anna and the Banking team in relation to loan arrangements involving individuals and trustees in particular.
Anna and Andrew are members of Michelmores' Private Wealth sector group, which brings lawyers from different disciplines together to provide comprehensive advice and guidance on their personal and financial affairs.