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Dealing with customers in financial difficulty: small business

» Introduction

» Our jurisdiction

» Power to vary credit contracts

» Disputes received from small businesses

» Discussion

» Assisting a small business in its financial difficulty

» Conciliation

» Where financial difficulty cannot be overcome

» Appointment of a receiver

» Guarantors

» Case studies

» Summary

 

Introduction

Bulletins 46, 53 and 60 discussed the Ombudsman’s approach to financial services providers’ (FSPs’) obligations under the Code of Banking Practice (CBP) and the Uniform Consumer Credit Code (UCCC) when dealing with customers in financial difficulty.

We have recently received an increasing number of disputes from small businesses complaining about their FSP’s response to their requests for assistance when they are in financial difficulty. Whereas an individual’s financial difficulty may be caused by unemployment, illness or over commitment, a small business’ financial difficulty may be caused by other events including bad debts, loss of clients, competition or unexpected changes in market conditions.

The CBP places an obligation on its subscribers to try to help individual and small business customers overcome their financial difficulty. The purpose of this article is to give financial services providers some guidance on our expectations in relation to assisting small businesses in financial difficulty which will, given the nature of a commercial enterprise, differ from those which apply to an individual in terms of the information that is assessed.

Clause 25.2 of the CBP states:

“With your agreement, we will try to help you overcome your financial difficulties with any credit facility you have with us. We could, for example, work with you to develop a repayment plan. If, at the time, the hardship provisions of the Uniform Consumer Credit Code could apply to your circumstances, we will inform you about them.”

The Mutual Banking Code of Practice (MBCP) provides for similar obligations to be placed on credit unions and mutual

 

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building societies in respect to financial difficulty and responsible lending.

Clause 24.1 of the MBCP states:

“We will work with you in a constructive way if you experience genuine difficulties meeting your financial commitments. With your agreement and commitment, we will try to assist you to overcome those difficulties. We will do this whether or not you have a right to seek hardship variation or change under consumer credit laws.”

Clause 24.2 of the MBCP provides additional detail regarding a credit union or mutual building society’s procedures in considering a customer’s financial difficulty.

We think that the obligations under clause 24.1 of the MBCP mirror those of the CBP in respect to financial difficulty. Credit unions and mutual building societies should therefore consider the approach of our office in respect to financial difficulty disputes as outlined below and in previous publications in addition to the procedural obligations outlined in clause 24.2 of the MBCP.

Non-code subscribers

We consider that non-code subscribers also have obligations to small businesses in financial difficulty as a result of their own internal hardship policies and good industry practice.

As previously expressed, we also consider that the provisions of the CBP, and similarly the more recently created MBCP, reflect good industry practice. A prudent FSP would conduct itself in the manner contemplated by those codes whether or not it is a subscriber.

 
Our jurisdiction

There is often confusion as to whether we have jurisdiction in relation to small business financial difficulty disputes where the facility limit exceeds the applicable monetary limit.

In summary, we have the power to consider a dispute to the extent that any claim for financial loss does not exceed our applicable monetary limit.

In assessing whether we have jurisdiction to consider a claim about financial difficulty lodged by a small business, we will consider the amount of the loss that is claimed. The account balance or facility limit is not relevant when assessing jurisdiction. It is the amount of loss suffered that is significant. This potential loss usually encompasses the “moneys worth” of any variation sought, any default margin levied on the contractual interest being charged, enforcement expenses and costs of any Receiver or controller appointed over the secured assets.

  • For disputes lodged before 1 January 2010, the Banking & Finance Terms of Reference apply and we are unable to consider a dispute where the claim exceeds $280,000.
  • For disputes lodged after 1 January 2010, our current Terms of Reference apply. Under our new Terms of Reference we are able to consider a claim for loss of up to $500,000, however, the maximum compensation

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which we can award is capped at $280,000 including a maximum award for non-financial loss (for an individual or partnership) or consequential (indirect) loss of $3,000 per claim.

For example, if a small business held a commercial overdraft facility of $800,000 and requested assistance because it was in financial difficulty, we would consider a dispute lodged after 1 January 2010 despite the commercial overdraft facility exceeding the monetary limit provided the claim for loss was less than $500,000 (subject to the maximum award of $280,000).

We also receive disputes in relation to requests for assistance to meet a demand made under a personal guarantee which was given by directors of a small business. If the director is experiencing financial difficulty in meeting their repayment obligations under the guarantee, the dispute will be within our jurisdiction irrespective of the limit of the guarantee.

However, if the guarantor is disputing their liability for amounts less than $500,000 demanded under a guarantee, then we can only award compensation up to $280,000. If the guarantor is seeking to set aside a guarantee in full, then the guaranteed debt must be less than $280,000.

 

 
Power to vary credit contracts

Pursuant to clause 9.1(f) of the current Terms of Reference, we have a new power to vary credit contracts regulated by the UCCC or the National Consumer Code (NCC) from 1 July 2010. This power does not at this time extend to variation of business facilities. Accordingly, the approach set out in our

 

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previous bulletins, which in summary requires that financial services providers can show they have given genuine consideration to requests for assistance, continues to apply to requests for assistance made by small businesses.

 
Disputes received from small businesses

Definition of a small business

The definition of a small business is consistent across the CBP, the MBCP and our Terms of Reference. A small business is defined as a business having:

a) less than 100 employees if the business is or includes the manufacturing of goods, or
b) in any other case, less than 20 employees.

Nature of disputes

Disputes often concern the cancellation of business facilities on a request for assistance, demand by a financial services

 

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provider for immediate repayment of a credit facility in full, or unreasonable timeframes for refinance. Small businesses have also disputed the appointment of an investigative accountant, application of increased risk margins and higher interest rates on a request for assistance.

Where a financial services provider takes such action without first giving genuine consideration to a request for assistance, then this conduct could have the effect of seriously prejudicing the small business’ ability to operate as a going concern or the opportunity to refinance.

 

Discussion

Central to an FSP meeting its obligations under clause 25.2 of the CBP, clause 24.1 of the MBCP, and industry practice, is the concept of genuine consideration. We have previously stated that FSPs should:

  • give genuine consideration to a repayment proposal or hardship variation application and any reasonable alternatives that will help the customer overcome their financial difficulties
  • give reasons for any rejection of the proposal, preferably in writing
  • ensure that those reasons reflect legitimate considerations and are referable to the particular customer’s circumstances
  • not start or conclude enforcement action before a decision is made and communicated, and
  • respect the customer’s appointment of an advisor and, if one is appointed, not deal directly with the customer.

Acting consistently and ethically, in our view, requires that FSPs:

  • have clear and reasonable internal processes for assessing hardship variation or enforcement postponement requests and other repayment proposals
  • be able to demonstrate that their staff have followed those processes
  • record and keep any promises made, for example, about suspending enforcement action, and record and keep to any agreement reached. If that includes that the arrangement be reviewed at a certain date, FSPs should not seek to review the arrangement earlier if the customer is keeping to it. Any review should be based on a genuine consideration of the customer’s position at that time
  • ensure that any collection related correspondence is consistent with what has been promised or agreed, and
  • confirm in writing any agreement reached and ensure that collection agents and/or later assignees

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have a copy.

Type of information required to assess an application for assistance

The principles set out above apply equally to the assessment of a request for assistance from a small business as they do to the assessment of an individual’s request. However, in assessing an application from a small business for assistance in its financial difficulty, the nature of the information required to assess the application would include information, if not already held, to allow it to consider the viability of the business as a going concern. Information that an FSP may require to assess an application for assistance from a small business may include:

  1. a revised business plan
  2. cash flow statements and projections, profit and loss and balance sheet information
  3. inventory management records (open/closing stock levels)
  4. gross profit projections
  5. aged debtor and creditor listings
  6. documentation relevant to the small business’ statutory obligations including payroll, taxation, superannuation, GST and workcover records.

Responding to information requests

We have previously stated that we expect Applicants to work with their FSP and respond promptly to reasonable requests for assistance. Failure of a customer to respond to a request for information was dealt with in Bulletin 53. We stated in that bulletin that if adequate information is held about the Applicant’s current financial position then the next step is for the FSP to make an assessment as to any proposal it can make to achieve repayment of the debt on reasonable terms.

If a small business does not provide information on request, it is open for the FSP to make its assessment on the basis of information that it already holds and to state expressly any applicable provisos or assumptions made. The onus would then be on the small business to show that incorrect information has been used or that an assumption is incorrect.

 

 

Assisting a small business in its financial difficulty

Whether an FSP is able to assist a small business in financial difficulty will depend on the individual circumstances facing the business. Many options may be available to an FSP, including assistance such as:

  • temporary increase in overdraft limit facility
  • an extension of trade finance terms
  • deferment of scheduled principal repayments
  • the appointment of an investigative accountant to better understand the small business, taking into account the contractual entitlement of the financial services provider to do so. We would expect that there has been appropriate consideration and communication with the small business in respect to the purpose and cost of the appointment, particularly where the FSP proposes to pass on the costs to the small business 
  • consolidation of debts, and/or
  • restructure of finance facilities and terms to reflect changes in cash flow.

We would however expect a lender to be mindful of its responsible lending obligations under clause 25.1 of the CBP (clause 6 of the MBCP) if the provision of further credit is being considered as a means to enable its customer to overcome financial difficulty. Small businesses should note that we are unable to compel a lender to make further advances or extend an overdraft limit.

Whether an FSP is able to provide ongoing assistance will be substantially influenced by the ability of the small business to demonstrate its ongoing viability. If the small business is unable to demonstrate ongoing viability based on reasonably tested information, then we would not expect an FSP to accept further risk. In such circumstances, the assistance required may be to provide a reasonable time to refinance (and by reasonable we mean erring on giving more time than less) or work with the business to achieve an orderly winding

 

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up of the business.

We expect that an FSP should be able to demonstrate that it has genuinely considered whether providing assistance by way of varying an existing contract will allow the small business to continue to operate as a going concern in the long term. As with individuals, the aim of any assistance should be to assist the small business overcome short term financial difficulties. Provided that genuine consideration has been given to the request for assistance, it is a commercial decision for an FSP as to whether it agrees to vary any existing contracts. We have no power to review such a decision (the current Terms of Reference only enable us to review an FSP’s commercial decision about varying a customer’s contract where the contract is regulated by the UCCC or the NCC). Further, we accept that assistance may not necessarily be appropriate if a company cannot demonstrate its long term viability.

Applying increased risk margins

We consider that the application of an appropriate interest rate is a commercial decision for the FSP. However, it may not be appropriate to apply a default interest margin when the small business is already experiencing financial difficulty and is in a dialogue, or has made an arrangement, with the FSP about how to overcome those difficulties.

Other assistance options

In demonstrating genuine consideration, it may be appropriate for the small business to be referred to government agencies and/or small business councils for advice or availability of grants or venture capital assistance. Such services may include:

  • the Federal Government’s AusIndustry
  • state based small business councils and advisory services, or
  • the Council of Small Business Organisation of Australia (COSBOA).

 

Conciliation

A telephone conciliation conference may take place to seek to reach a resolution of the dispute. We will take into account whether the Applicant has provided information to show that

 

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the small business is viable and whether a timeframe for the sale of the assets is an appropriate resolution.

 

Where financial difficulty cannot be overcome

We accept that FSPs may refer the relationship to an asset realisation area where the FPS’s focus changes to loss mitigation. Where a small business can no longer operate as an ongoing concern, the business may be liquidated either by its owners, creditors or other appointed controllers.

We would expect that prior to taking such steps the FSP

 

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should undertake a process of genuine consideration of the small business’ financial difficulty. In our investigation we will seek supporting documentation from the FSP in respect to the steps that it took to give genuine consideration to the small business’ financial difficulty prior to the referral to the asset realisation area or the appointment of an external controller.

 

Appointment of a receiver

If a receiver is appointed on behalf of the company, we can only consider the validity of the appointment of the receiver by the FSP. We will consider whether the appointment of the receiver was in accordance with the terms and conditions of the security documentation.

That is, a receiver is appointed to act on behalf of the company and is the company’s agent, rather than the FSP’s agent. Accordingly, we cannot review any action by a validly appointed receiver.

The receiver is not obliged to suspend enforcement action while we are considering the dispute and we cannot intervene in any action by the receiver, such as sale of the company assets.

However, we do have the ability to consider a dispute in relation to an FSP’s response to its customer’s request for assistance in financial difficulty. Any such dispute can only be made to us with the consent of the receiver (as the company’s representative) and may require the receiver to take such steps as attend a telephone conciliation conference.

This is because in order to conduct or assist in any negotiation between the customer and the FSP we must deal

 

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with the party authorised to negotiate on behalf of the business. Upon the appointment of a receiver, the directors or owners of the company are no longer capable of binding the company to any agreement reached between it and the bank.

Additionally, it is important to note that any award made in favour of the Applicant or the company, involving a cash payment by the bank would be paid to the receiver for distribution to its appointer (usually the FSP).

It should be noted that clause 13.1(b) of our current Terms of Reference allows us to consider an FSP’s request to exercise its enforcement rights to the extent necessary to preserve the assets which are the subject of a dispute. In our next Circular, we will provide further guidance on our approach to an FSP’s request under clause 13.1.

Liquidation

Where a small business goes into voluntary liquidation or is placed into liquidation as a result of a court order, we recognise that the Liquidator controls the affairs of the company and stands in the shoes of the directors. On this basis, the Liquidator must lodge the dispute.

If the company is controlled by an Administrator the authority must be signed by the Administrator.

 

 

Guarantors

We regularly consider disputes which have been raised by guarantors who have provided personal guarantees to a small business.

Where an FSP makes a claim under a guarantee, the guarantors are generally entitled to raise any claim the company may have unless the terms of the guarantee expressly do not allow it to do so and where it would be unfair to allow the FSP to recover any amount outstanding without taking into account any claim the company may have. In such circumstances, the dispute would usually be brought by the company and the guarantors. However, if the company is in liquidation, we do not require the Liquidator’s consent to the dispute being lodged with our office, as the guarantors

 

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are entitled at law to raise any claim which the company may have without involving the insolvent company.

The obligations of an FSP under clause 25.2 of the CBP and clause 24.1 of the MBCP apply to the guarantors of a small business, including the obligation to give genuine consideration to the guarantor’s financial difficulty. The options available to the FSP to assist in meeting its obligation may include time to pay or instalment arrangements. If a realistic repayment arrangement cannot be agreed, consideration may be given to allow a reasonable time for sale of assets by the guarantors or negotiation of a timeframe for the guarantors to seek the opportunity to refinance the business debts into their name.

 

Case studies

Cash flow difficulties

The Applicants owned a small business specialising in finance broking. It received its income on a fluctuating basis, as it was dependent upon the settlement of its client’s financial arrangements.

The small business experienced financial difficulty as a result of a downturn in finance settlements due to the global financial crisis. This impacted on the small business’ ability to meet the repayment conditions on a short term cash flow facility and its repayment obligations on other facilities. The small business was seeking assistance from the FSP in the form of the provision of a different facility, with the aim of spreading its repayment obligations over a longer term to offset the fluctuation of commission sales.

After a period of negotiation, an agreement was reached between the small business and the FSP prior to a telephone conciliation conference. Pursuant to the agreement, the short term cash flow facility was converted into a regularised principal and interest facility to be repaid over an extended term. In addition, the FSP gave concessions in relation to previous charges which had been incurred by the small business.

Appointment of Investigative Accountant

The Applicants owned a retail store which had previously experienced a period of growth, financed by the small

 

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business through debt. Over time the small business became concerned that it would be unable to service its trade facility, and elected to sell assets which acted as underlying security to the FSP’s facilities.

The repayment in full of these facilities following the sale of assets put in jeopardy the long term viability of the business as it was at risk of being unable to meet its short term obligations. In accordance with the lending agreement, the FSP appointed an Investigative Accountant for the purpose of further understanding the small business and what options were available. The small business was concerned about the cost of this review.

We conducted a telephone conciliation conference to determine whether a resolution could be reached between the parties before we conducted a detailed investigation into whether the FSP had met its obligations. An agreement was reached. A progressive reduction of facilities over time was put in place to enable the business to continue trading. In addition, arrangements were put in place to enable the injection of further funds to the business by a third party. The conclusions reached by the Investigative Accountant in his report formed the basis of the agreement. By obtaining the report, the parties were able to obtain a clearer view about the longer term direction and viability of the business. The FSP agreed to refund half the costs of the Investigative Accountant as a gesture of goodwill.

 

Summary
  • The principles we previously set out in Bulletins 46, 53 and 60 concerning the requirement to give genuine consideration to a customer’s financial circumstances apply equally to the assessment of a request for assistance from a small business as they do to the assessment of an individual’s request. The application of these principles has not changed under the current Terms of Reference. These principals equally apply to credit unions and mutual building societies through their MBCP.
  • Our new power to vary credit contracts does not apply to business loans.
  • The information gathered by an FSP to give genuine consideration to a small business’ financial difficulty

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will differ from that required from an individual and may be more extensive.
  • The options available to an FSP to assist a small business are numerous and will vary depending on the specific circumstances of the small business. Whether an extension or increase in a facility is granted ultimately remains a commercial decision that we cannot review.
  • If an FSP is not able to provide ongoing support to the small business to enable it to continue as a going concern, the parties should then consider whether, and in what time frame, asset sales or refinance are appropriate.