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Uncancelled Lines of Credit

We have recently considered a number of disputes brought by customers about their financial services provider’s (FSP) failure to close a credit facility.

 

Common scenario

Issues arise where:

  • as part of a restructuring of accounts or transfer of facilities from one FSP to another, a credit facility or limit is not closed
  • the customer has knowingly, or inadvertently, drawn down on the former credit facility, and
  • the customer has then become unable to service their accounts as well as the monies drawn down on the amount which was to be cancelled. 

 

Customer’s complaint

In the above scenarios, the customer says:

  • the FSP’s act or omission in allowing the customer access to the former credit facility constituted maladministration in lending by the FSP, and
  • the FSP has failed to deal with them appropriately in their subsequent financial difficulty. 

 

There is a common misconception by the customer that the appropriate remedy should be that they are not required to repay the amount which had accrued on the former credit facility.

 

FOS approach to these scenarios

FOS’s approach to these disputes includes that:

  • the failure by the FSP to close off the former facility may amount to a breach of its implied contractual duty to exercise reasonable care and skill in performing its part of the contract
  • the monies accessed by the customer from the former credit facility amount to payments made by mistake to the customer by the FSP because the funds were accessed as a consequence of the FSP’s failure to close the line of credit, rather than by any conscious decision by the FSP to renew the customer’s former credit facility
  • in accordance with the law in relation to mistaken payments, the customer would be required to repay the monies drawn as a result of the FSP’s mistake unless they could show that, in good faith, they had changed their position to their detriment
  • as a matter of fairness, the FSP should not be entitled to interest on the mistaken payments if the customer can repay the mistaken payment within a reasonable time frame, and
  • the principles relating to maladministration should not apply because  the FSP:
    • did not intend that the customer should have access to the former credit facility, and
    • has not exercised its commercial judgment, or applied its credit assessment methods to form an opinion about the customer’s ability to repay the drawings.

 

Mistaken payments

The law in relation to mistaken payments is clear, as between:

  • the person who mistakenly makes the payment- the FSP and
  • the person who receives it - the customer who has drawn against a line of credit which was intended to be cancelled. 

 

The person who receives the payment (the customer) is obliged to return the funds withdrawn unless:

  • in good faith,
  • they have changed their position to their detriment (as this is interpreted by case law). 

 

Good faith

The requirement of good faith means that a customer who knows that there has been a mistake must return the funds, whether or not they have spent the money, and regardless of how the funds have been spent.

 

An applicant may establish they acted in good faith if they can show there was no reason to suspect that an error had been made.  For example, the payment may correspond with a genuine payment expected by the customer. 

 

An applicant who knows they have refinanced an old loan, but continues to draw down on the former credit facility may have some difficulty in establishing that they acted in good faith.

 

Change of position
But, even where good faith is established, the customer must have changed their position to their detriment or they would be liable to repay those funds. 

 

It is also a legal principle that there is no detriment if the money received by mistake is used to:

  • pay for everyday expenses, or
  • reduce a pre existing debt.

 

Using the funds to pay bills or on general living expenses is not sufficient to amount to a change of position.


Interest on mistaken payments
The courts have held that a person who is entitled to recover a mistaken payment is also entitled to recover simple interest on that amount from the time a demand for repayment is made. 

 

They have also recognised the right of FSPs to charge compound interest in certain circumstances, mainly arising when the recipient of the mistaken payments has applied the monies to a venture or investment intended to generate a profit (even if they in fact realise a loss due to an improvident decision).

 

FOS approach to interest
In the disputes we see the FSP is not aware of their error until just before, or at the time, the customer lodges a dispute with our office.  As a consequence, there has been little opportunity for the FSP to make a demand for repayment of the monies mistakenly made available to the customer, and for interest to accrue. 

 

As a matter of fairness, we consider that interest should not be levied if the customer is able to repay the mistaken payment within a reasonable period. 

 

If repayment is over an extended period of time, interest at a simple rate can exceed the cost of compounding interest on a reducing balance loan.  In those circumstances, it may be fairer (and easier for the FSP’s systems to accommodate) for interest to be charged at the facility rate. 

 

In any event, the FSP should work with their customer to agree on a repayment arrangement that sees the debt repaid over a reasonable time frame, or if that is not possible, the applicant may be provided a reasonable period of time to sell assets to repay the money.

 

FSP process for identifying cancelled credit accounts that are still operating

As part of our investigation of this type of dispute, we contacted four FSPs to ascertain:

  • if they had any practice or system for detecting an error in failing to close a line of credit and,
  • if so, when the fact that the facility was still open would be likely to be detected. 

 

While the surveyed FSPs had in place sophisticated systems to identify whether accounts were operating below their credit limit and other activity, none had a system to detect credit facilities still operating which should have been cancelled.

 

Our decision making criteria allows us to consider good industry practice and it is our view that a diligent and prudent FSP performing in accordance with good industry practice would have in place a process to ensure that credit facilities that come to an end are actually closed. The value of such a process includes protecting the FSP’s credit exposure to its customers.

 

We encourage FSPs to have such systems in place and to ensure they are adequate to meet these needs.