Purpose clauses: Can Lenders claim breach of trust?

Purpose clauses: Can Lenders claim breach of trust?

Published:

Author: Shaun McCabe

In most facility agreements, lenders include a clause that the loan can only be used for a specific purpose (for example to assist with the costs of development of a property).

In the rare cases where funds are used for another purpose (often in cases of fraud) lenders may attempt to claim that the purpose clause creates a trust in their favour. The advantage for the lender in establishing a trust is that the funds transferred remain the property of the lender unless the borrower applies them for the agreed specified purpose.

In the Gabriel v Little and others case, the High Court considered whether the borrower received loan monies as a trustee pursuant to a purpose clause whereby the loan was to be used for the development of a property.

It was found that the trust was not created. The fact that the purpose clause did not state that the loan had to be used for the sole or exclusive purpose of development of the property did not in itself prevent a trust from being created, but the absence of these words could be material. Additionally, a wide range of matters could be considered to be "development" and, therefore, there was too much uncertainty to create a trust.

If lenders have particular concerns to ensure that a loan is used for a specific purpose, they should consider requiring loan monies to be segregated (e.g. in a separate account) or that, as a condition of drawdown, the monies are drawn into a solicitors account with the solicitor undertaking to apply the monies for the stated purpose.

In their standard facility agreements, lenders should also consider using the words "sole" or "exclusive" to help establish the trust.