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19 February, 2020
As at 31 December 2019, there were more than 2,300 licensed money lenders in Hong Kong. Licensed money lenders, which are outside the banking system, provide an alternative source of financing for individuals and companies. They are currently regulated under the Money Lenders Ordinance (“MLO”) in Hong Kong.
The existing MLO was enacted in 1980 with an aim to respond to social problems created by loan sharks. It provides a framework for the licensing of money lenders, the control of money lending transactions and the prohibition of charging excessive interest rates.
Almost 40 years have passed, consumer lending practices and technology have evolved. However, no major reform on the MLO has been carried out. It is sometimes difficult for licensed money lenders to fit their current business models into a relatively old piece of legislation. It is also not uncommon for borrowers to raise technical arguments about the validity and enforceability of a loan agreement, i.e. whether a money lender has complied with all the relevant provisions of the MLO in making the loan. In the year of 2019, there were already more than 30 court cases on the MLO.
Some notable requirements under the MLO
Amongst other requirements, a licensed money lender is required:
- Not to carry on business as a money lender at any place other than the premises specified in such licence (section 7, MLO)
- To have a written note or memorandum, which contains certain mandatory information, personally signed by the borrower within 7 days after the making of a loan agreement (section 18, MLO)
- To allow prepayment and/or repayment of a loan by instalments (sections 21 and 22, MLO)
- Not to charge default interest at a rate which is higher than the original effective interest rate (section 22, MLO)
- Not to charge interest at an effective interest rate above 60% per annum (section 24, MLO). Lenders should also bear in mind that a loan with an effective interest rate exceeding 48% is presumed to be extortionate (section 25 MLO)
- Not to charge any fees incidental to or relating to the negotiations for or the granting of the loan or proposed loan (section 27, MLO).
We will discuss some of the above issues with reference to certain recent cases.
Section 18 (note)
As summarised above, section 18(1) of the MLO requires a note that meets the minimum content requirements under section 18(2) to be personally signed by a borrower within 7 days after the making of a loan agreement, failing which the loan agreement shall be unenforceable. Where there is non-compliance with section 18(1) and (2), pursuant to section 18(3), the burden then falls on the money lender to satisfy the court that in all the circumstances it would be inequitable to refuse enforcement. Section 18(3) gives the court a very wide spectrum of discretion, which enables the court to re-write the loan agreement in such terms as the court considers equitable. It ranges from annulling the loan agreement on one end to enforcing the agreement in its entirety on the other. If in all the circumstances it will be inequitable not to allow such agreement or security to be enforced, the court has an absolute discretion to order enforcement to such extent, and subject to such modifications or exceptions, as the court considers equitable.
The Court of First Instance has examined the effect of section 18 in the case of Fast Billion Holdings Ltd v Sun Pui Yuk (2019). In the case of Fast Billion, the lender took an extra HK$60,000 of “upfront interest”, without that being mentioned in the section 18 memo, which increased the effective interest rate from 30% per annum to almost 42% per annum. The court did not like the way the lender hid that and the fact that the lender’s representative seemed to twist the truth in his affidavit. The court therefore decided that it would not be inequitable to hold the loan irrecoverable.
This case highlights the importance of not only complying with section 18 and the rest of the MLO but also having an understandable set of documentation which cannot be held to be misleading. Money lenders should therefore bear in mind that courts do not always enforce a non-compliant loan by allowing the recovery of the principal and a market rate of interest. The court expects licensed money lenders to have documentation and practices that enable the borrowers to understand what they are agreeing to. It is therefore important for licensed money lenders to draft clear, simple and MLO-compliant loan documentation.
Sections 22 (default interest), 24 (excessive interest rate) and 27 (irrecoverable fees)
These three issues were looked at in some detail by the Court of Appeal in the case of Easy Fortune Property Limited v Yung Chun Him (2019). We should start with section 24 (interest rate) first.
What is the difference between the “actual rate” and the “deemed rate” of interest for the purpose of testing whether the effective interest rate exceeds the 60% pa absolute bar? The court in Easy Fortune confirmed that, where an actual rate was specified in the section 18 note, Schedule 2 to the MLO, which contained a formula for calculating a “deemed rate” of interest in some situations, had no application. The “actual rate” refers to a single, constant rate charged on the entire loan and does not admit of a rate varying from time to time. As such, it cannot apply to agreements where repayments comprise elements of both principal and interest. In those agreements, even though the borrower is making the same monthly repayment at ostensibly the same rate of interest, the truth is that (since the principal is steadily reducing) there is a hidden increase in the interest rate. There is no single constant rate of interest and the “actual rate” formulation does not apply. In those situations, the statutory calculations should then be applied. The repayments have to be apportioned between principal and interest to arrive at a “statutorily averaged” true rate of interest. The calculations in Schedule 2 are then relevant to produce a “deemed rate”. The court confirmed that in situations where the “actual rate” formulation applied, when the context required that “effective rate” to be used under section 24, it still meant the “actual rate” but not the “deemed rate”.
The court made it clear that, when one sought to analyse whether section 24 had been contravened, one did not analyse it on a scenario of default. We could simply look at the agreed interest rate and compared it with the statutory maximum of 60% per annum. If a higher rate of interest is charged by reason of default, it becomes a potential issue under section 22 but not section 24. Under section 22, simple interest can be charged on the overdue amount at a default interest rate not higher than the contractual interest rate, provided that it does not render the effective rate to exceed 60% per annum payable in respect of the principal apart from any default.
On section 27, the court drew a distinction between a set-up fee and a collection fee. Section 27 prohibits “costs, charges or expenses… for or in connection with or preliminary to procuring, negotiating or obtaining any loan made or guaranteeing or securing the repayment thereof”. Since the collection fee in the Easy Fortune case comprised fees and expenses incurred by the money lender in demanding payment of the overdue amount, it was not for procuring, negotiating or obtaining the loan in question. There was no contravention of section 27. The collection fee was arguably a breach of section 22(1)(c) because it would have increased the interest rate under the default, but the court upheld the enforceability of the loan agreement to a certain extent.
Section 7 (approved premises)
In the case of Tong Bo Finance Company Limited v Veronica Ella (2019), the defendant sought to argue that the plaintiff contravened section 7 of the MLO by carrying on a money lending business outside the specified premises. The court took into account the fact that the defendant (a) had not attended the office of the plaintiff itself and (b) had entered into the transaction in the offices of the solicitors’ firm in question where the documents were explained to the defendant and her husband and signed by them, but considered that such fact was not sufficient to establish that the plaintiff was carrying on business at any place other than its own premises as specified in the licence.
Although the court did not give any guidance on where a money lender is considered to be carrying on its business, we suggest, based on this decision and other “carrying on business” decisions, that this is where credit decisions are made by the money lender, even if the borrower is physically elsewhere when he or she commits to borrow.
Recent developments
The Consumer Council published a report named “Money Lending – Reforming Law and Trade Practices for Consumer Protection” in September 2019. The report sets out certain recommendations for consideration by the Government, licensed money lenders and other market players in the money lending market. One of the recommendations is to amend the existing legislation. The four proposed amendments include
(i) establishing a sector specific regulator to oversee the money lending industry;
(ii) imposing a duty of carrying out prudent credit assessment;
(iii) adjusting the interest cap to a maximum of 48% and (iv) having additional requirements on advertising practices.
When the MLO was first enacted, it was expected that consumers would go to a physical shop, complete application forms and sign all documents by hand. As consumer lending practices and technology have evolved, online lending and crowdfunding (aka P2P lending) have been topical issues. While the situation in the Tong Bo Finance case is relatively straightforward, the question on whether a money lending business is being carried on at the approved premises can be complicated when we look at online money lending platforms. Apart from the issue on premises under section 7, online money lenders have to also carefully consider how they should structure their platform such that a section 18 note can be “personally signed” by each borrower.
Reference should be made to the Electronic Transactions Ordinance. It can get tricky when online money lenders have to fit their new business models into a piece of legislation drafted decades ago, so it will certainly be beneficial to market participants for the MLO to be modernized.
For further information, please contact:
Katherine Liu, Partner, Stephenson Harwood
katherine.liu@shlegal.com
