There are often times when individuals and businesses need to borrow money, and usually, there is nothing wrong with this. Whether it is for improvements, expansion or to purchase additional inventory, there are individuals and businesses that engage in what is otherwise known as “high-risk” lending. Due to the high risk, these lending arrangements are backed by terms and conditions that are significantly more onerous on the borrower than traditional unsecured credit, SBA loans and plain-vanilla secured financing.
Loan-to-own schemes involve high-risk lenders that loan money upfront for short-term (or long-term) financing at high-interest rates, secured by stable and floating liens, and otherwise obligate individuals personally so that they are no longer protected by the ambit of their corporate fiction. Usually, the lender will see a business in need of rehabilitative financing and will extend a loan with terms that oftentimes include traps for the unwary allowing the lender to “default” the borrower(s) and leverage against collateral. If the business is successful in repaying the loan, great! If, however, the business or individual is not successful, the lender then has the ability to swoop in and take control of the business and substitute the original proprietors. Here are some tips to avoid a loan-to-own scheme.
1. Explore all of your financing options first. Borrowing unsecured money is good, however the unsecured lender will usually charge much higher interest rates than a secured lender. In Florida, the statutory maximum amount of interest that can be charged is 18% per annum. There are however exceptions for the calculation of automotive financing (using a point-system) and a maximum allotment of 25% for pawn broking, which is a secured possessory lending model.
2. If a lender is insisting that you secure a loan with personality, business assets, accounts receivable, stocks, inventory, equipment, etc..., try to negotiate the interest rate. A lender should not charge both a high rate of interest and take a secured interest on the items mentioned above.
3. Read the terms closely. Make sure that the lender must provide you with “notice” and “presentment” in the event of a default. Oftentimes, lenders will have borrowers waive these two requirements at the inception of the loan. It is a tactic that sometimes leaves the borrower in the dark and unaware of a default and a subsequent takeover.
4. Beware of terms that may cause you to default beyond simply not making a payment. Sometimes lenders will insist on such strict terms as to almost re-characterize themselves as an owner of the property that they are making a loan towards. This includes high levels of control and terms that require a business proprietor to seek permission on certain business decisions going forward. This is one way that a loan-to-own model can seriously and irreparably affect the relationship. It is important to note that if you are able to, in the future, have the lender because of its overbearing terms re-characterized as an owner. There may be fiduciary duties that the lender will now owe the borrower. Determining whether the lender has breached any of these duties may provide the borrower with some recourse. Further, in the event of a re-characterization, there are circumstances where the “Deeprock” doctrine may be applicable thus requiring the re-characterized lender to be repaid after other creditors. It is crucial that you understand all instances (and potential instances) of default and what your options to cure are.
5. Fixed versus adjustable rate loans. It is crucial that you know the terms of your loan. Is it a balloon (interest only for a period of time and then a lump-sum principal payment at some point in the future) or a fixed-rate loan (one that is certain in repayment terms); or, is it adjustable (tied to some market in which the interest amount may change at some point in the future). These are all important terms to know.
6. Finally, if the loan is secured, understand exactly what you are securing the loan by and whether the lender has followed all necessary attachment and notice procedures provided by your state’s adoption of article 9 of the Uniform Commercial Code and/or whether certain state statutory guidelines have been followed beyond what UCC-9 provides. It is also important to understand what a “floating-lien” is (a lien on now existing and after acquired goods or property); and if a personal guarantee is required, what is your maximum extent of personal exposure. Understand, however, that a lender will tell you that the security is “depreciating,” and therefore, there is a need for higher interest rates. It is always appropriate that the business should be valued as a “going-concern” (an operation that is making money) so that the lender doesn’t feel insecure. Also, with a floating lien, the lender acquires its rights in after-acquired goods, property and equipment so if the business is operating normally and acquires the continued attainment of these things, this should be a non-issue.
If you are an individual or a business and you have questions about a prospective lending arrangement, contact Romano Law Group at 561-533-6700 to speak with an attorney so that all of your questions can be answered.