There are a lot of regulations in the business world. There are plenty in my industry — real estate and business financing — in particular. There are rules that govern how much interest can be charged. There are laws for when the interest clock can start ticking. There is legislation around granting mortgages and signing personal guarantees. And it all can vary based on the jurisdiction. Some areas are relatively easy to navigate, while others can be an administrative nightmare.
I have recently cut back on the business I do in one Canadian province because of its lending laws. I won’t specify which one in this article. However, its regulations are so burdensome, confusing and expensive to comply with that it’s seldom worth it to provide financing there. That province essentially assumes that all borrowers — whether they are large, established businesses or desperate and vulnerable people — are meek, helpless and unable to fend for themselves. Moreover, there are at least three separate acts that govern lending in that province, not to mention federal rules.
I don’t need sympathy. There is plenty of opportunity available. However, I would like readers to understand that ineffective lending regulations make it more expensive to borrow money. That’s because lenders will either charge compliance costs to borrowers, or less capital will be available, causing rates and fees to rise. I (for the purpose of this piece, I’m referring to the companies I operate) am a comparatively tiny lender. But I wonder how many other private lenders have walked away from that province because of overregulation.
In the province I’m referencing, the solution to predatory lending, apparently, is to force lenders to beef up their paperwork. Just throw more big words, like “amortization,” on the page. That will make sure borrowers don’t get screwed! Other times, it’s to ensure that a licensed broker — frequently a rubber stamp — is involved in the transaction, which also generates more paperwork and costs to the borrower.
In my practice, I have always instructed lawyers to make the loan agreements and promissory notes as basic as possible. Of course, they must be effective. But they should also be clear and easy to understand. The added rules in this province had the opposite effect: our contracts became harder to comprehend and required more legal expenses. They also required more ongoing account maintenance. Those costs were ultimately passed onto the borrowers. I’m a businessman — I sure as hell am not going to pay them.
I am not a hardcore capitalist. I don’t scoff at the government and view it as an obstacle to my profits. In fact, I don’t even want “small government” — to use a common conservative phrase. I believe that civil society needs laws, commissions and regulators to protect us from abuse by the rich, greedy and powerful, and to help provide for an even playing-field. Government employees should be well-paid, not just because many of them work hard and deserve it, but also to help stave off corruption.
But the solution cannot be more paperwork. In fact, it should be less. Here’s a better, simpler way to protect borrowers:
1. Loan contracts should be short and clear
Lending money is usually an easy transaction. A borrower borrows money and has to make scheduled payments — often monthly. There’s an interest rate. It has to be repaid by a certain time. There may be fees. There may be security (a mortgage, etc.). That’s about it.
Loan contracts should contain core information. They should be written in plain English. I have seen ones that begin with “Now therefore this agreement witnesseth,” which, to me, seems ridiculous. Nobody speaks like that (at least I’ve never witnessethed it), so why put it in a contract? And that’s just the tip of the iceberg. Other notable words include inter alia, ultra vires, mutatis mutandis and a mensa et toro — all of which are ancient Latin, not English.
Governments should either provide loan agreement templates, just like many do for tenancy agreements, or mandate basic disclosures. In many cases, there’s no reason for a loan contract to be more than two pages long.
2. If a contract is complex, then lawyers for both parties should be required
Sometimes loan contracts have to be complicated. For example, the ones we use when mortgages are involved are lengthy and complex, even when they are simplified. In those cases, I always require borrowers to get independent legal advice. Some jurisdictions actually require it.
Indeed, it’s for our mutual protection. On the one hand, it will be harder for me to bury anything in the fine-print (not that I would, anyway). The borrower’s lawyer has a fiduciary duty to explain all details to the client, especially the risks. On the other hand, the borrower will have a hard time claiming they didn’t know what they were signing.
Mandating simple loan contracts, or the presence of legal counsel for complex ones, would be a more effective way of protecting borrowers, regardless of whether they are consumers or corporate entities. If the problem is that borrowers risk being duped into paying excessive fees or rates of interest, then the solution should be to ensure that they understand what they’re about to sign. I believe it’s better than the use of more legal or financial jargon, brokers and licensing courses.
I am not proposing that all lending regulations should be eliminated so long as the borrower is cognizant of the agreement. Rather, I posit that a lot of the fat could be trimmed by implementing my two elementary suggestions. Costs would go down. Borrowers would get cheaper money while simultaneously being adequately informed.
To be sure, there are other issues in the lending space that are outside of the scope of this article. Oftentimes, people are desperate and will take a loan at any cost. They then enter a dangerous downward spiral if they can’t repay it. I don’t know how that can be regulated, other than setting a maximum interest rate. In Canada, you can’t charge more than 60% a year. However, the payday industry has somehow wiggled their way out of that. Their interest rates are often in the triple-digits when annualized.
Like it or not, lending is the foundation of the modern economy. Borrowers should be protected because a bad loan can be financially ruinous. But, in my view, the best way to protect borrowers is to simplify matters — not to make lenders jump through more hoops.