Thursday, April 29, 2010

Ethical Obligation of Lenders


A struggling small business hires a consultant a few years ago (prior to the recession). The business would like to secure some additional funds to finance its struggling operations. The analyst, after reviewing the financial statements of the business, informs the owners that financing will be difficult to secure given the current state of the business, namely negative owner's equity, and sets to work with the company to begin to write a business plan to move the company through the existing troubles and position it to be able to acquire the financing that it needs.

Just prior to this the owner had moved his bank accounts to a different bank in order to refinance some existing high interest credit card debt into a long-term loan with a better interest rate. Concurrently to writing the business plan, the owner continues to talk with his new bank, and they offer the owner an unsecured line of credit without requiring any financial statements from the company. Rejoicing with the company owners at their happiness, the bank does not take the time to explain to the owner what the bank expects to see as far as managing a line of credit.

The consultant is not only flabbergasted, but has also now had her credibility undermined since the very thing she said would be impossible happened.

Continue the story:

Work on the business plan stopped. The business continues operating in much the same manner as before, drawing on the line of credit to finance the company’s short-falls, but never paying the line back down. The consultant repeatedly warns the owners that the bank will want to see the line of credit used and then paid down, but why should the owners listen to the consultant when she was so wrong the first time? Then the recession hit. The business took a hit and proceeded to draw even more on the line until it reached its credit limit. Given the pressures to the banking industry, the bank reviews the line, NOW asks to see the financial statements, visits the company, and determines that the line is operating as a long-term loan and thus they are pulling the line and refinancing it as a long-term loan which, by the way, they would now like secured by the owner’s home and the interest rate has doubled. All perfectly within the bank's rights.


Does the bank have an ethical obligation to clearly explain the different financing options to a small business owner? Should the banker assume that the owner is knowledgeable about the difference between a loan and a line of credit, for example? Should they be required to clearly explain that they have every right to reevaluate the line of credit at any time and call it or change the terms? My pharmacist asks and explains to me how my medication works…banks are also dealing with lives, the lives and fortunes of small business owners. What’s your opinion?

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