What types of business and investment lending will be regulated under the national credit laws?

Residential investment property

Example
Anthony is planning to buy an apartment as an investment this year. He is going to borrow part of the purchase price, so he can get the benefits of negative gearing.

If the loan contract is made by 30 June 2010, his loan will not be regulated under the Uniform Consumer Credit Code (UCCC). But if he enters into the loan contract after that date, his loan will be regulated under the National Credit Code (NCC), which commences on 1 July.

Unlike the UCCC, the NCC will regulate loans for residential investment properties. This includes the following types of residential investment lending:

• loans to purchase residential property for investment purposes;
• loans to renovate or improve residential property for investment purposes; and
• loans to refinance credit provided to purchase, renovate or improve residential property for investment purposes.

What is ‘residential property’?
There is a definition in the NCC. It includes land on which a dwelling is affixed predominantly for residential purposes. It also includes land on which such a dwelling will be affixed in the future (i.e., vacant land for residential development). Property in this context also includes crown leases and equivalent, company title shares, and a right to occupy a dwelling in an aged care facility or retirement village.

Look at purpose not security type
It is the purpose of the loan and not the security type that determines if a loan will be regulated by the National Credit Code.

Example
In October 2010, Anthony finances the purchase of his apartment as an investment as planned, then heads off to work overseas. When he returns from overseas, he moves into the apartment. He then arranges a line of credit secured against the apartment to finance his new online business. Unlike his loan to buy the apartment, the line of credit will not be regulated, because it is for a business purpose.

Compare this with Beatrice, who has a commercial property in her own name for her business. She buys a holiday house for herself, and borrows the entire purchase price, using the commercial property as security. The loan will be regulated by the National Credit Code, as the credit is for personal, domestic or household purposes.

Corporate borrower exemption

Example
Chris has a business of investing in residential properties. He buys small, run down blocks of flats, renovates them and then sells them. His financing for these purchases will be regulated – unless the borrower is a company.

When the borrower is a company, it doesn’t matter what the purpose of the loan is. Loans to companies are all unregulated (except if the company is a strata corporation). So if Chris operates the business through Chris Pty Ltd, and borrows through that entity, his loans will not be regulated.

Predominant purpose
When there is a combination of purposes, the predominant purpose will determine if the credit is regulated or not.

Example
Diana has an existing home loan, secured by the home. She takes out a second loan of $200,000 with the same lender, using her home as security. Most of the loan ($150,000) is being used to buy into an accounting partnership. She will pay the remainder to her daughter, to help her daughter buy an apartment to live in. Because the predominant purpose is business, the new loan will not be regulated. Diana’s two loans are secured by the same ‘all moneys’ mortgage.

The National Credit Code applies to the mortgage to the extent only that it secures obligations under a regulated credit contract, so it will not apply to her mortgage in relation to the second loan.

Business purpose declaration

A business purpose declaration can put a loan outside the National Credit Code, but only if it is used as the law intends.

Example
Eugene wants to borrow to refinance some of his personal debts. He approaches a lender and tells the lender what he wants to do. The lender insists that he sign a business purpose declaration, so that it can provide an unregulated, high interest loan. The lender has committed an offence under the National Credit Code, punishable by a fine of up to $11,000 or 2 years in jail, or both. What’s more, the business purpose declaration is ineffective, so the loan will be regulated under the Code.

If the lender took a ‘no questions asked’ approach, what would happen?
The declaration will still be ineffective, as the lender would have known (or had reason to believe) that the loan was for a regulated purpose if it had made reasonable inquiries about the purpose. Credit providers will therefore need to make reasonable enquiries about the purpose of each proposed loan before the debtor signs a business purpose declaration.

Margin lending

Margin lending is a type of borrowing for an investment purpose. It has been specifically excluded from the National Credit Code. Margin loans will be treated as financial products under the Corporations Act.

Other types of investments

The National Credit Code states that investment by the debtor is not a “personal, domestic or household purpose” under the National Credit Code. So any type of investment other than residential property is exempt. (Margin lending would have been excluded on this basis, even if it had not been specifically excluded elsewhere in the legislation).

Example
Flavia wants to finance the purchase of a share portfolio, but she doesn’t want to use a margin loan (where the shares are used as security). She has a lot of equity in her home, so she plans to take out a new loan using her home as the security to buy the shares. The loan will not be regulated by the National Credit Code (nor will it be regulated as a margin loan under the Corporations Act).

The ASIC Act is different
Although Flavia’s loan will not be regulated under the National Credit Code, it still may be regulated credit under the ASIC Act (the Australian Securities and Investments Commissions Act 2001 (Cth)).

How does the ASIC Act regulate credit?

The unconscionable conduct provisions in the ASIC Act basically say that you must not act unconscionably in relation to credit. And the consumer protection provisions in the ASIC Act cover a wide range of unacceptable trade practices such as misleading and deceptive conduct, bait advertising etc. (the same consumer protection provisions that apply under the Trade Practices Act for businesses outside the financial sector).

Some of these provisions only apply to the supply of services to consumers. For the consumer protection provisions in the ASIC Act, a person will be a consumer if the price of the services is not more than $40,000, or the consumer is a small business, or the credit is “of a kind ordinarily acquired for personal, domestic or household use.”

The unconscionable conduct provisions in relation to consumers only apply where the credit is of this kind (although there is a separate provision dealing with business-to-business unconscionable conduct).

As well as these two aspects of credit regulated by the ASIC Act, the Act is also being amended to regulate unfair contract terms. As currently proposed, these provisions will only apply to a ‘consumer contract’, which is a contract for the supply of goods or services, or a sale or grant of an interest in land, to an individual whose acquisition of the goods, service or interest is wholly or predominantly for personal, domestic or household use or consumption.

Consumer credit contracts will be covered by this definition, but unlike the National Credit Code, residential property investment is not expressly included. However, while investment is definitely not a “personal, domestic or household” purpose under the National Credit Code, it may be under the ASIC Act.

In a recent case, Goodridge v Macquarie Bank Limited [2010] FCA 67, the judge held that the unconscionable conduct provisions of the ASIC Act applied to a margin loan: he said that the loan was “of a kind ordinarily acquired for personal use.”

So Flavia’s loan in our example may be regulated by the ASIC Act, even if it is not regulated by the National Credit Code.

Small business lending – Phase 2 of the credit reforms The government has indicated that regulation of small business lending is on the agenda for consideration in the next phase of the national credit reforms. Small business lending could therefore become subject to the National Credit Code. Any such changes would not be in place until 2011 at the earliest.