First things first: Are Friendly Loan Agreements legal?
Yes, Friendly Loan Agreements are legal in Malaysia. Parties are allowed to give out loans, and even charge interest on the loan, as long as the lender is not carrying out money lending ‘as a business’. Only institutions who have the necessary licences issued under the Moneylenders Act 1951 can carry out money lending as a business.
If you are lending money to someone, you will want to make sure you do not accidentally become an unlicensed moneylender, as that is an offence punishable under the Moneylenders Act (explained below).
How do I ensure that my loan is not given out ‘as a business”?
The Court will take into consideration factors such as: How many times the lender has lent money; Whether the interest charged on the loan is high; and What is the relationship between parties.
If it is a one-time loan with a reasonable interest rate between individuals who are friends or relatives, it is likely that the Court will consider the transaction to be legitimate Friendly Loan Agreement that is legally valid and enforceable.
However, if the lender has given out several loans in the past, or if the interest rate being charged is high, or if the parties have no personal relationship, the Court may end up concluding that the lender is carrying out money lending as a business, which is an illegal activity if the lender does not have the necessary license. Every case is judged on its own facts, and these are just examples of factors that the Court will consider.
Can interest be charged in Friendly Loan Agreements?
Yes, interest can be charged. However, as mentioned above, the Court will consider whether the interest charged is reasonable. The higher and more unreasonable the interest is, the more likely the Court will form the view that the lender is carrying out the transaction as a money lending business, and consequently strike down the agreement and preclude the claim for interest.
In Menta Construction Sdn Bhd v SPM Property & Management Sdn Bhd & Anor [2017] MLJU 526, High Court recognised that it had the power to, “strike down the interest element in a friendly loan transaction if the interest is exorbitant, excessive and unconscionable”.
A simple interest rate close to what banks normally charge is often acceptable to the Court. In the Menta Construction case, the Court refused to enforce the agreed interest rate of 8.8% per annum, and instead applied a simple interest rate of 5% per annum.
What happens if the Friendly Loan Agreement is found to be an illegal money lending transaction?
If the Court determines that the lender is carrying out a money lending business without the requisite licence, there are two immediate implications.
The first implication is that the Friendly Loan Agreement will be deemed void in law. This does not mean, however, that the borrower does not need to repay the loaned sum. The loan still has to be repaid by virtue of section 66 of the Contracts Act 1950 which states that:
“When an agreement is discovered to be void, or when a contract becomes void, any person who has received any advantage under the agreement or contract is bound to restore it, or to make compensation for it, to the person from whom he received it”
(see also the case of Muhibbah Teguh Sdn Bhd v Yaacob Mat Yim [2005] 4 CLJ 853).
Other than the loan having to be repaid, other terms of the Friendly Loan Agreement (such as the chargeable interests and enforcement of securities) will become invalid and unenforceable once the agreement is deemed void in law.
The second implication is that the lender will be deemed to have committed an offence for carrying out an unlicensed money lending business, and will be liable under section 5 of the Moneylenders Act 1951 to a fine between RM 250,000 and RM 1 million, or to imprisonment for a term not exceeding 5 years, or to both. In the case of subsequent offences, the person shall also be liable to whipping.
As a lender, how to better secure your loan?
Sometimes borrowers fail to repay the loaned sum. It could be that the borrower is being difficult and uncooperative, or the borrower simply has no money to repay the loan. Lenders can avoid these frustrations by ensuring that, at the time the loan is given, the borrower agrees to provide security in exchange to the loan. The types of securities discussed below are Personal Guarantees, Land, and Shares.
Securing with Personal Guarantees
An easy and relatively straightforward way is to have the borrower bring in a third party to act as a guarantor to the loaned sum. In the event the borrower defaults on the payment, the lender can call on the guarantee to recover the remaining loan sum. The guarantor can be a company or an individual. The lender will want to make sure that the person or company giving the guarantee is financially stable to better ensure a viable chance of recovering the loan.
If both the borrower and the guarantor fail to repay the loan, the borrower can bring legal actions against both the borrower and guarantor to recover the loan. Although the lender has a right to sue both the borrower and guarantor, the recoverable amount will still be only the outstanding loan. The lender cannot recover twice over as that will result in what is known as ‘double recovery’ and the lender becoming unjustly enriched.
Securing with Land
Land (i.e. immovable property) is a good method of securing the loaned sum. There are five steps to achieving this:
Step 1 – Prepare a Friendly Loan Agreement. Make sure it is in writing.
Step 2 – Make sure the Friendly Loan Agreement has clauses to state that:
The borrower agrees that his land shall be used as security for the friendly loan.
The borrower agrees to deposit the original land title (IDT) with the Lender or the Lender's lawyer. This is important for Step 3 below.
Step 3 – After parties sign the Friendly Loan Agreement, the lender should register a “Lien-Holder’s Caveat” with the Land Office (the original land title is required to do this). The “Lien-Holder’s Caveat” does not give the lender any proprietary rights over the land – merely an equitable right. The lender becomes a secured creditor only.
Step 4 – If the borrower defaults, the lender sues the borrower for the outstanding sum and gets a judgment.
Step 5 – After obtaining judgment, and with the Lien-Holders Caveat in place, the lender can make an application to Court for an Order for Sale. The property will then be sold, and the lender is entitled to take the outstanding balance of the loan from the proceeds of the sale. And any balance from the sale will go back to the borrower.
There is no need to have a Sale & Purchase Agreement or a Memorandum of Transfer for you to have the land as security; these documents do not help strengthen your claim to the land as security.
Importantly, before agreeing to accept the land as security, the lender should check that the land belongs to the borrower. A land search can achieve this. If the borrower is a company and the land belongs to the company, then make sure the borrower prepares all the necessary company resolutions as well. Furthermore, also check if the land already has a charge on it by other companies or a bank. If there is already a charge, then the land may no longer be good security and the lender should consider asking for other forms of security.
Two useful cases discussing the use of land as security are the Court of Appeal’s decision in Lekchumanan a/l Suppiah & Anor v Ravi a/l Raju [2016] MLJU 1316 and the Federal Court’s decision in Perwira Habib Bank Malaysia Bhd v Lum Choon Realty Sdn Bhd [2006] 5 MLJ 21.
Securing with Shares
Friendly Loan Agreements can also be secured with shares in a company and this can be achieved in four steps.
Step 1 – Prepare a Friendly Loan Agreement. Make sure it is in writing.
Step 2 – Prepare a share charge document. This is to create security over the shares that can be exercised when there is a breach of the loan agreement.
Together with the Friendly Loan Agreement, there should be clauses to state that if the borrower defaults, the lender is allowed to either absolutely transfer the shares to the lender or sell the shares and recover the outstanding loan sum from the sale of the shares, and any balance to be returned to the borrower.
Should also stipulate how much notice is to be given for the Lender to sell the shares. This will prevent the Borrower from complaining that insufficient notice was given.
Step 3 – Along with the Friendly Loan Agreement and share charge document, should also ask the borrower to hand over to the lender or the lender’s lawyer:
Pre-signed but undated share transfer forms. This is so that in the event of a default, the lender does not have to wait for the Borrower to execute these documents; and
The original share certificates. The company secretary won’t allow the transfer of shares without original share certificates.
In some situations, the Lender can also consider asking for the Borrower to execute a Power of Attorney in favour of the Lender. But this is not strictly necessary.
Step 4 – If the Borrower defaults, the Lender can exercise the rights to transfer the shares to himself or to sell the shares.
Additional things for the lender to check:
The articles of association of the company whose shares are to be pledged allow the granting of such a security and there are no specific restrictions;
All appropriate corporate approvals and board resolutions have been obtained;
There are no other charges or encumbrances registered against the pledged shares; and
The pledged shares are fully paid up at the time of taking the security.
Two useful cases discussing the use of shares as security are Gan Eng San & Anor v Alliance Investment Bank & Ors [2010] 7 MLJ 615 and Public Bank Bhd v Siaw Sat Lin [2002] 1 MLJ 449.
Conclusion
Friendly Loan Agreements are valid and can be a useful mechanism to allow the public to assist one another in times of need. It is important to ensure from the outset that the Friendly Loan Agreement is drafted carefully to ensure that the lender does not breach the Moneylenders Act 1951, and also to ensure that the loan is secured and can be recovered fairly easily in the event of a default.