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Allens Arthur Robinson

Focus: Banking & Finance – August 2003

Impact of the new Code of Banking Practice on project and structured finance SPVs – the 'small business' test

In brief: Banks with both retail and corporate businesses should be aware that the new Code of Banking Practice will not only affect their retail activities, but may also impinge on corporate business, such as in project and structured financing transactions where the borrower is a special purpose vehicle, as it may be regarded as a 'small business'. Senior Associate Trudi Lodge outlines when the new Code could apply to project and structured financing transactions, and highlights some of the possible implications.

Introduction

The new Code of Banking Practice (the New Code), released by the Australian Bankers' Association on 1 August 2003, replaces the existing Code of Banking Practice 1993. While subscribing to the New Code is voluntary, once a bank has publicly announced its adoption of the New Code, the New Code will have effect as a contract between the bank and its customer.

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Application of the New Code

The New Code applies to all banking services that are, or are to be, provided to individuals and small business customers. There is no provision in the New Code for selective 'opting in'.

What is a 'banking service'?

Banking services are broadly defined to include any financial service or product provided by a bank in Australia, whether supplied directly or through an intermediary.

The New Code does not apply where the financial service or product provided to a small business customer is regulated under the Financial Services Regulation (FSR) provisions of the Corporations Act and the customer is not a 'retail client', as defined in the Corporations Act.

Products such as credit facilities are not financial products for the purposes of those FSR provisions. This means that where a credit facility is offered to a customer who falls within the 'small business' definition, the New Code will apply to the bank's dealings with that customer with respect to that credit facility.

Who is a 'small business' customer?

Small business in the New Code means a business having:

  • less than 100 full-time (or equivalent) people if the business is, or includes, the manufacture of goods; or
  • in any other case, less than 20 full-time (or equivalent) people,

unless the banking service is provided for use in connection with a business that does have more than 20 (or 100 if in manufacturing) people.

This is to be determined at the time the banking service is provided. Whether that means the date the loan agreement is signed, or the date of the first drawing, is not clear from the New Code.

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Determining if an SPV is a 'small business'

When lending to a special purpose vehicle (SPV), the following questions must be answered to ascertain whether the SPV is a 'small business'.

Does the SPV have less than 100 (in the case of a manufacturing business) or 20 full-time (or equivalent) people? 

Typically, SPVs comprise very few personnel. As the 'small business' definition refers to 'people', rather than simply to 'employees' (which was the term used in earlier drafts of the New Code), it may be possible to argue that contractors and service providers to the SPV under any major service contract should be included when calculating that defining number.

However, as mentioned above, the relevant time for determining whether an SPV is a 'small business' is when the banking service is provided. If, at that time, not all contractors have yet been appointed, or the work under any major services contract has been substantially completed (which may be the case at the time of a refinancing of the original loan), the SPV may still not have enough people to avoid being classified as a small business for the purpose of that banking service.

If so, are the banks providing financial accommodation to the SPV for use in connection with another business?

This will depend on the project arrangements. What is the connection, for example, between the SPV and the sponsor? Is the sponsor providing any support for the SPV's borrowings (in which case it may be possible to argue that the financial accommodation is being lent to the SPV for use in connection with the sponsor's business)? Or is recourse limited to the SPV? In the latter, more usual, case, it may be difficult to argue a connection with the sponsor.

If the financial accommodation is not being provided for use in connection with another business, and the SPV has less than 20 (or 100) people, then it will be a small business, and the New Code will apply.

If the financial accommodation is being used in connection with another business, then the following test is relevant for determining the application of the New Code.

If the financial accommodation is being used in connection with another business, does that business have more than 20 (or in the case of a manufacturing business, more than 100) people?

If so, the SPV would not constitute a small business and the New Code will not apply. If not, the New Code will apply.

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Practical consequences of the New Code

If the New Code applies, a bank's procedures will be affected in a number of areas.

Loan agreements

Loans provided by banks to the SPV will be subject to the New Code, and the banks will need to comply with the numerous disclosure and information requirements. These requirements are listed in detail in the New Code. Of particular note are the following requirements:

Acting fairly and reasonably – The New Code contains a requirement to act fairly and reasonably. This is stated to be a 'key commitment' of banks that adopt the New Code. How this will impact on a bank's negotiating position with 'small business' SPVs is not clear.

Variation to terms and conditions – The New Code imposes certain minimum notice requirements before amendments to credit contracts will become effective. For example, a bank must provide written notice to the customer at least 30 days before any of the following changes to a banking service take effect.

  • Introduction of a fee or charge (other than a government charge).
  • Variation of the method by which interest is calculated.
  • Variation of the balance ranges within which interest rates apply to a deposit account.
  • Variation of the frequency that interest is debited or credited.

Co-debtors – If SPVs borrow jointly with another entity, and if it is clear to the bank, on the facts known to it, that a proposed co-debtor would not receive any direct benefit, the bank must not accept that person as a co-debtor. Co-debtors also have certain rights to terminate their liability for future advances on giving written notice to the bank.

Customers in financial difficulty – The New Code encourages banks to try to help the customer overcome any financial difficulties with a credit facility, if the customer agrees to accept the bank's assistance. The example provided in the New Code is that a bank may help a customer develop a repayment plan.

It is not clear whether this imposes on a bank a positive requirement to offer assistance if a customer faces difficulty in repaying a credit facility, or only to respond in a constructive way to a customer who requests assistance.

It raises a question as to whether banks will be prevented from taking enforcement action immediately following a payment default or breach of financial undertaking by the SPV, or whether doing so would be deemed to be contrary to the bank's obligation to act fairly and reasonably.

Electronic communications – The New Code makes it clear that information may not be provided by email or made available at the bank's website unless a customer has made a 'specific positive election' after receiving an explanation of the implications of choosing to receive information electronically.

Foreign exchange – The New Code requires a bank to give a debtor a general written warning about the risks arising from exchange rate movements, before granting a foreign currency loan in Australia. The bank must also tell the debtor about relevant available mechanisms for limiting such risks (if available).

It is unclear whether a general statement about the availability of hedging mechanisms, which does not take into account the individual circumstances of the debtor and the nature of the relevant transaction, will suffice. Arguably the obligation is to tell the debtor about available mechanisms for limiting such risks relevant to the debtor's particular circumstances.

Transitional provisions – The New Code will even apply (although in a more limited respect) if the loans with an individual or small business are entered into before the relevant bank subscribes. Further, if it is proposed that existing loan documentation will be varied after a bank subscribes to the New Code, and if an essential feature of the contract is varied as a result, it may be argued that there is in fact a new credit contract – in which case, all the New Code provisions will apply.1

Third party mortgages

The New Code will also impact on third party limited recourse mortgages provided in respect of the SPV's obligations and guarantees given by individuals of the SPV's obligations.

The New Code provides that such third party mortgages will be unenforceable for future credit contracts or guarantees, unless the bank has given the mortgagor a copy of the relevant credit contract or guarantee, and subsequently obtained the mortgagor's written acceptance of the extension of the mortgage.

This means that the description of 'secured moneys' in the limited recourse mortgage should be limited to amounts under specific loan agreements, and other fees, costs and charges, rather than including an 'all moneys' definition.

Guarantees

Any individual who provides a guarantee of the obligations of a 'small business' SPV will also have the benefit of the New Code. A bank must comply with a number of disclosure requirements before the guarantee is taken.

Any such guarantee must either be limited to a dollar amount or to the value of specified security. Further, except in certain circumstances, the guarantee will not extend to future credit contracts, unless the credit contract has been provided to the guarantor and the guarantor has subsequently consented to the extension.

The New Code also provides that a guarantor can limit its liability and that it can extinguish its liability by paying the outstanding liability of the debtor, or (if less) the amount to which the guarantor's liability is limited at that time. The guarantor may also withdraw from the guarantee before the credit is provided, and afterwards if there is a material difference between the credit contract that was entered into and the version given to the guarantor before it signed the guarantee.

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Observations

It is doubtful whether the New Code was intended to apply to all 'small business' SPVs involved in project and structured financing transactions. However, the New Code neither provides for selective 'opting in' nor for selectively contracting out. Nor does it have a dollar threshold. Consequently, once the New Code has been adopted, banks need to be aware of their additional obligations and disclosure requirements when dealing with all retail and corporate 'small business' customers – not only for new, but also existing, transactions.

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Footnote
  1. The New Code will not, however, apply to any banking service or to a guarantee given by an individual guarantor of the obligations of a small business or individual if it is provided in connection with a 'commercial asset financing facility' where the banking service or guarantee is provided or taken before 1 June 2004, and the bank is not disclosed as the provider of the banking service or as taking the guarantee.

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For further information, please contact:

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