Decades ago there was a TV commercial in Brisbane for a used car yard that had as its tag line “Don’t sign anything until you have seen Big John Zupps”. I am thinking that the Law Society or Office of Fair Trading should pick up that tag line as advice to some would be investors.
This article follows on from last month’s article “What Could Go Wrong?”. That article highlighted the circumstances behind one particular bad investment decision. These circumstances are not uncommon. We have come across many other ‘victims’ of their own bad investment decisions in other files.
One involved someone who leased a variety of assets (that may or may not have actually existed) through different companies he had set up for the purpose and targeted a variety of finance companies. There are numerous actions before the courts involving these companies and the (now bankrupt) director, but the money has disappeared. The finance companies should not have signed anything until ..
The case that brought this old tag line to my mind involved two people that lent significant amounts of money ($176,000 and $90,000) on a secured short term basis. They lent the money to somebody who they had previously briefly dealt with in another capacity. The loans were meant to have been secured by way of second mortgage over real property, only for a few months and were to earn a decent rate of interest.
Whether the borrower’s intentions were honest or not is not the subject of the article – honest borrowers can also lose money on investments. The topic of this article is about what actions the lenders should have taken to protect their investment.
In our case, the loan agreement was entered into verbally (along with all of the usual promises of how much money they would make and how secure the loans would be). The money was physically paid across based on this agreement. Unfortunately this was done before the terms of the loan and the security were reduced to writing – and of course they never were.
Also unfortunately the advance was made before the lenders had made even the most simple of inquiries into the borrower, the asset to be secured and the reasons for the money. If they had done so, it is very debatable whether any money would have been advanced, or if it had been advanced what security would have been put in place at the time.
All lenders should consider the following points before making a loan:
(a) make sure that the entire arrangement (loan, guarantees and security) is in writing and executed by all of the relevant parties before money is handed over;
(b) make sure that they keep one complete set of executed originals. Usually a number of originals will be executed – one for each party.
(c) determine whether guarantees from the individuals involved or other entities behind the borrower should be sought.
(d) check that any asset offered as security actually exists and determine who owns the asset. Lenders should determine whether the owner (and that may not be the borrower – as was the case in last month’s article) is willing to and has the capacity to grant a security.
(e) check whether the security requires registration and who is to register it.
(f) check whether there are other securities that have a higher priority over the asset than your security.
(g) check whether the asset secured is worth more than the secured debts on a forced sale basis – as this is usually how the asset will be sold.
(h) check that the rights for enforcement of any security or guarantee are set out clearly and make sense. Do they create unnecessary hurdles before rights can be exercised?
What should the tag line be? “Don’t sign anything until you have done some research, received independent advice, have all of the paperwork prepared and ready for execution by all parties”.
OK, it is not as catchy as the original, but it is good practice and would save a lot of bad business decisions.