FCA publishes finalised guidance for consumer credit firms regarding the requirement to serve default notices before enforcing guarantees

30th January 2017

Following draft guidance being released by the Financial Conduct Authority (FCA) in October 2016, the FCA has now published finalised guidance to consumer credit firms which confirms its interpretation of the requirement in section 87 of the Consumer Credit Act 1974 (CCA) for the creditor to serve a default notice before enforcing a guarantee or indemnity following a breach of a regulated agreement.

The guidance relates to regulated credit agreements and regulated consumer hire agreements under which an individual (which can be a partnership of two or three people) other than the borrower or hirer provides a guarantee or indemnity (or both). These agreements are referred to in this document as ‘guarantor loans’ and the person providing the guarantee or indemnity is the ‘guarantor’.

The CCA requirements

• Any security provided under a regulated agreement must be expressed in writing [1].
• Following a breach of the agreement, a default notice must be served on the borrower before the lender can enforce the security [2].
• A copy of the default notice must be served on any guarantor [3].
• The default notice must meet certain requirements [4] , and must contain specified information, including:
  • the nature of the alleged breach of the agreement;
  • if the breach can be remedied, what action is required and the date before which that action should be taken (the date must not be less than 14 days after the notice is served), and
  • a clear and unambiguous statement of the action the lender intends to take if the breach is not remedied.
• The FCA’s view is that ‘enforcement of security’ is not limited to obtaining a court judgment; enforcement can include some forms of ‘self-help’ if the remedy is sufficiently coercive.

Enforcement of guarantees

• The FCA’s view is that a guarantee is enforced if, following breach of the agreement by the borrower:
  • the lender demands payment by the guarantor, or
  • the lender takes payment from the guarantor by using a continuous payment authority (CPA) or direct debit mandate that was previously provided and without at least appropriate prior notification to the guarantor.
• In contrast, the FCA deems that a guarantee is not enforced if:
  • payment is made voluntarily by the guarantor, following notification of the breach by the borrower, and without any element of compulsion, or
  • the lender requests payment by the guarantor, but making clear that this is not a demand for payment (and so the communication does not seek to force or pressurise the guarantor to pay) [5].
• In the FCA’s view, exercise of the CPA or direct debit without appropriate prior notification would be sufficiently coercive as to constitute the enforcement of the security within the meaning of section 87 CCA.
• However, allowing the guarantor an opportunity to object or cancel the payment authority by informing them that the payment would be taken on a certain date would not be sufficiently coercive and may not constitute enforcement of the guarantee.
• Before the payment is taken, the FCA would expect the lender to clearly inform the guarantor:
  • that the borrower has breached their obligations under the agreement, and the nature and extent of the breach;
  • the amount of the breach and the lender’s intention to take payment from the guarantor using the CPA or direct debit;
  • the likely timing of the payment or payments to be taken, and
  • the guarantor’s right to cancel the authority (but making clear that cancellation will not extinguish the guarantor’s obligations under the terms of the guarantee).
• The FCA expects the lender to allow a reasonable period before taking payment to enable the guarantor to respond, or to cancel the CPA or direct debit. A ‘reasonable period’ will depend on the circumstances, but should be at least five working days following notification.
• Where the guarantor is pre-notified and does not object or cancel the payment authority, the FCA would not regard the subsequent use of the CPA or direct debit facility as ‘enforcement’ of security requiring a default notice.

The three options

In light of the above, according to the FCA, the lender has three options:

1. obtain the guarantor’s express consent to payment being taken, or
2. pre-notify the guarantor (in writing and with sufficient detail to enable the guarantor to make an informed decision as to how to respond) and wait a reasonable period (at least five working days), during which the guarantor can cancel the payment authority, or
3. issue a default notice in accordance with the CCA and wait 14 days.

The last of the three options would remove any legal uncertainty about whether security is being enforced, but, as the FCA has now confirmed, is not the only option.

Points to note

• Where a default notice is required under the CCA, failure to serve a valid notice (or to wait the required period before taking action) would be a breach of the CCA. If payment is taken, contrary to section 87, the borrower or guarantor may have a cause of action against the lender. Where these cases occur, the FCA may consider taking regulatory or disciplinary action against firms.
• There is no minimum period before a lender may issue a default notice. In particular, there is no requirement to serve an arrears notice before issuing a default notice, or to wait until two payments have been missed. For example, the CCA would not prevent a lender issuing a default notice on (for example) day five after the breach by the borrower (with a copy sent or given to the guarantor). Allowing for postal delivery, the notice might expire on day 21, with the lender taking payment from the guarantor on day 22. In this way, the breach could be remedied within the same month. The FCA would not object to this, in principle, provided that the firm can demonstrate compliance with FCA rules and principles.

Regarding the provisions for reporting defaults to credit reference agencies (CRAs)…

• The Standing Committee on Reciprocity (SCOR) guidelines explain that a missed payment may lead to a consumer’s account being reported as ‘in arrears’, whereas a ‘default’ is limited to a situation where the relationship between the parties has broken down. The guidelines state that, as a general guide, this may occur when the consumer is three months in arrears, and normally by the time he or she is six months in arrears. The guidelines also specify other circumstances when a ‘default’ may be recorded, such as where there is evidence of fraud, or the account has been included in a bankruptcy or County Court judgment.
• It follows that a ‘default’ on a credit file would not normally be recorded before the account is at least three months in arrears. In contrast, a default notice under the CCA has to be served before the lender can take certain actions, but can be served at any time following breach of the agreement, subject to this following the FCA’s rules and principles. Issuing a default notice is not, in itself, an event that has to be reported to a CRA (and indeed, it would be contrary to the SCOR principles to do so if the relationship has not broken down – for example, if the lender is merely seeking payment of one or more missed payments rather than calling in the entire debt). Equally, a lender can register a ‘default’ with a CRA without having previously served a default notice.
• The SCOR guidelines state that the lender must generally notify the consumer of its intention to register a ‘default’ at least 28 days before doing so. This is to give the consumer time to make an acceptable payment or to reach an arrangement. This is an entirely separate and distinct matter from the CCA default notice provisions. As noted above, any communication with a customer in relation to a credit agreement must be clear, fair and not misleading under CONC 3.3.

REMEMBER: ‘Default’ in the context of a default notice under the CCA concerns where, for example, the borrower has failed to pay, whereas ‘default’ has a different meaning in an accounting context and in relation to CRA reporting.

If you have any queries arising from this briefing, please do not hesitate to contact Jeanette Burgess or any member of Walker Morris’ Regulatory and Compliance team.

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[1] Section 105 CCA
[2] Section 87 CCA
[3] Section 111 CCA
[4] Contained in section 88 CCA
[5] Any communication must be clear, fair and not misleading in line with CONC 3.3 in the Consumer Credit Sourcebook of the FCA Handbook (CONC).