When you take out a loan, you’re the one who is responsible, right? Yes, that is so but you are not the only party.
The lender must perform their duties to a reasonable standard as well. The lender must act in with a duty of care that is consistent with the country’s laws.
Frequently, when I look at franchise industry lending practices, I have some serious questions.
As an example, in Canada lending is primarily regulated by the Bank Act (1991, c. 46). It says the lender shall:
DIRECTORS and OFFICERS
Duty of care
158. (1) Every director and officer of a bank in exercising any of the powers of a director or an officer and discharging any of the duties of a director or an officer shall
(a) act honestly and in good faith with a view to the best interests of the bank; and
(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
Investment standards
465. The directors of a bank shall establish and the bank shall adhere to investment and lending policies, standards and procedures that a reasonable and prudent person would apply in respect of a portfolio of investments and loans to avoid undue risk of loss and obtain a reasonable return.
GUARANTEED SMALL BUSINESS LOANS
There is a Canada Small Business Loan Program which is administered by a federal department called Industry Canada. The legislation that provides for these leasehold and equipment loans of up to $250,000 is the Canada Small Business Financing Act (1998, c. 36) and Regulations.
The franchise industry just loves this program. A similar program would be the U.S. Small Business Administration, 7(a) Loan Program. The United Kingdom, California, Korea, Japan and EU also have programs.
This is what the Canadian Small Business Financing Act says about the lender’s duties.
Offence
16. (1) Every person commits an offence who, in respect of a loan,
(a) knowingly makes any false statement or misrepresentation in an application, report or other document or wilfully furnishes any false or misleading information;
…
Punishment
(2) Every person who commits an offence under subsection (1)
(a) is guilty of an indictable offence and liable to a fine not exceeding $500,000 or to imprisonment for a term not exceeding five years, or to both; or
(b) is guilty of an offence punishable on summary conviction and liable to a fine not exceeding $50,000 or to imprisonment for a term not exceeding six months, or to both.
This is what the Canadian Small Business Financing Regulations says about the lender’s duties.
DUE DILIGENCE REQUIREMENTS
8. In making and administering a loan, the lender must apply the same procedures as those that would be applied in respect of a conventional loan in the same amount, including, before making the loan,
(a) obtaining credit references or conducting a credit check on the borrower; and
(b) completing an assessment of the repayment ability of the borrower, taking into account all other financial obligations of the borrower.
In summary, a Canadian lender must act prudently and with honesty, care, diligence, and skill. And if they lend under the Canada Small Business Loan program they must in addition:
- lend as if it were a normal loan (ie. one that is not guaranteed 85% by Canadian taxpayers) and
- assess the ability to repay (lender due diligence) while keeping in mind the borrower’s other obligations (ie. if the business goes down the tubes, they won’t lose their house).
If a Canadian lender fails to meet these standards, he or she and their institution may be held found partially responsible for the losses of the borrower.
I wrote a paper to Industry Canada in 2005 about franchise financing. Franchising Opportunism (free pdf.) explains why Harold Brown called franchising a Trap for the Trusting.
see FranchiseBanker.ca for a more detailed explanation.
