Business and consumer lending

9.1 Introduction

This chapter examines the role of banks in providing finance via lending. It explains the fundamental distinction between supplying credit in the form of an overdraft and in the form of a term loan. The chapter begins with some general legal principles that apply to all types of lending including the legal nature of overdrafts and term loans, security interests and the transfer of loans. After that, it focuses on business lending and examines common contract terms in credit facilities and loan syndication. Then the discussion focuses on consumer lending and covers the regulation of overdrafts, credit cards, personal loans and residential mortgages.

This chapter will not examine capital market-based techniques of corporate finance, such as the issuing of bonds and will only provide a brief overview of the concept of security rather than a detailed examination of the various types of security in English law. This is in line with the scope of this book which limits itself on core banking law and does not seek to cover capital markets law, corporate finance and commercial property law.

Bank lending in general

Overdrafts: legal nature and principal terms

As mentioned in Chapter 7, a current account is overdrawn when its balance is negative, and the customer owes a debt to the bank rather than the other way around. If there is express agreement between the bank and customer that she/he is entitled to overdraw his account up to a maximum amount, this is called an authorised overdraft. According to the agreement between the bank and its customer, interest may or may not be charged. If there is no such agreement, and the customer draws a cheque or attempts to make a payment in another way that, if honoured, would lead to a negative account balance, and the bank honours the cheque or completes the payment, this can be described as an unauthorised overdraft. When an unauthorised overdraft occurs, banks’ standard terms and conditions typically impose certain charges and a (relatively high) rate of interest applicable to the account balance. As succinctly put by Wall J:

If a current account is opened by a customer with a bank with no express agreement as to what the overdraft facility should be, then, in circumstances where the customer daws a cheque on the account which causes the account to go into overdraft, the customer, by necessary implication, requests the bank to grant the customer an overdraft of the necessary amount, on its usual terms as to interest and other charges. In deciding to honour the cheque the bank, by implication, accepts the offer.^[1]

This analysis explains how the contractual relationship of an unauthorised overdraft facility comes into existence: by implication, the drawing of the cheque constitutes the offer made by the customer, while the honouring of the cheque constitutes the acceptance by the bank. It is worth noting that it is common for UK banks to charge compound interest, which means that interest is charged not only on the original amount borrowed but also on accumulated unpaid interest from previous periods. Typically, interest accrues daily and is applied to the borrower’s current account in arrears on a quarterly basis.

Unless there is explicit agreement to the contrary, an overdraft is repayable on demand by giving notice to the customer. However, until such notice has been given the bank is bound to honour any cheques drawn within the limit of the overdraft. A crucial matter is the length of the notice period given by the bank. As the bank is entitled to be paid immediately, English law does not require banks to provide sufficient time for customers to raise the relevant funds. Before treating the debtor as in default, the bank needs only allow the time necessary to give the debtor ‘a reasonable opportunity of implementing whatever reasonable mechanics of payment he may need to employ to discharge the debt’. For instance, the court upheld the appointment of a receiver by a bank only one hour after demand was made on a company to repay all monies due to the bank under an overdraft facility. In Sheppard. & Cooper Ltd v TSB Bank Pic, the court ruled that the bank was entitled to appoint a receiver within 30 minutes from demanding repayment. Balckburne J provided additional obiter guidance on the application of the mechanics of payment test emphasising that the length of time that needs to lapse after demand before a debtor can be deemed to be in default is a practical question. Relevant factors include whether the debtor could reasonably be expected to hold the necessary amount in a bank account and whether the demand is made during normal banking hours or not.

• [1] Lloyd’s Bank Pic i’ Vollcr [2000] 2 All ER (Comm) 978,982. 2 The practice has been upheld by the courts and has been characterised as ‘a usual and perfectly legitimate mode of dealing’ (per Lord Atkinson in Yourell p Hibernian Bank Ltd [1918] AC 372, 385). It was also hailed as ordinary usage by the House of Lords in National Bank of Greece (SA) p Pinios Shipping Co Ltd (No. 1) [1990] 1 AC 637. 3 A case in point is Titford Property p Cannon Street Acceptances Ltd (Unreported, QBD, 22 May 1975). The bank, in a letter to the customer, had specified that it made available an overdraft of £248,000 for a period of 12 months for the customer to purchase and develop a property. It was held that the bank could not demand early repayment. 4 Rouse p Barford Banking [1894] AC 586, 596. 5 Bank of Baroda p Panessar [1987] CH 335, 348. 6 [1996] BCC 965. See also Lloyd’s Bank Pic p Lampert [1999] BCC 507.