Payroll Loans – What’s the Risk?
Payroll loans are becoming increasingly popular in Latin America and the Caribbean as they are considered relatively low-risk and easily introduce credit to a traditionally underserved sector of the market. In 2013 they accounted for 60% of all personal credit in Brazil, the region's largest economy. However, they may well be risky to the employer and the lender, depending on the contractual arrangements in place. Every effort should therefore be made to ensure that the documentation is sound.
Almost all employers have had to deal with this scenario – an employee presents a salary deduction form from a third party lender authorising the employer to deduct a monthly sum from the employee's salary and pay it over to the lender. Typically, the employer, without doing much more, signs the form and starts making the authorised deduction, the loan is repaid and everyone goes their merry way. Most people do not understand the legalities of what is occurring and most never have to consider it because the loan is repaid and the transaction never questioned. However, sometimes things don't go as planned.
Because of changed circumstances, the employee, the guarantor or the employer may later question the transaction. For example:
- The employee may begin to feel the pinch in his pocket and all of a sudden notice that his name is wrongly stated on the salary deduction form. He argues that the employer has no real authority for making the salary deduction and demands that the employer stop making the payments.
- The employee's employment is terminated, for whatever reason, and the monthly payments stop being made. The lender calls on the guarantor, often a co-worker who still remains in the employer's employment. Errors on the documents may be noticed and/or questions arise about the extent of the employer's authority to deduct funds from the guarantor's salary.
- The employee dies and the lender wants to be repaid the balance due out of various sums being held by the employer. To what extent is the employer authorised or obligated to make such payments?
Each of these scenarios raises different considerations. Ultimately, the answer to each will only be found in the legal effect of the particular contractual details between the parties. However, there are a few things to keep in mind:
- Generally, a payroll deduction form that is provided to a lender may contain in it and have the legal effect of being a legal assignment, an equitable assignment and/or a revocable mandate, depending on the words used. A lawyer is best positioned to advise you on which category or categories your document falls into.
- Assignment is the process by which the benefit of a contract may be transferred to a third party. In payroll loans the benefit of the employment contract (the employee's salary) is being transferred to the lender. This can be done for an ascertainable sum in an absolute and irrevocable way, which may entitle the employer to receive a good discharge from the lender for paying over the benefit, if other statutory requirements are met (legal assignment); or, it can be done by way of charge for a portion of the benefit until liquidation of the debt due (equitable assignment); or, it can simply be an instruction to the employer which the employee is capable of withdrawing at any time (revocable mandate).
- More often than not the payroll deduction form for a payroll loan is an irrevocable mandate or assignment, as the form usually indicates that the instruction to the employer cannot be revoked at any time without the consent of the lender. Sometimes, for example when deductions are made for internal purposes like contributions towards a staff recreation fund, they are merely revocable mandates as it would be unusual for such a form to indicate that the employee had no possibility of opting out at any time in the future.
- Often, because payroll loans are used to pay off debts, the assignment is by way of charge or conditional upon there being an outstanding debt. These are equitable assignments. The important thing to note about these kinds of assignments is that the lender is unable to give the employer a discharge for any money paid out of the employee's salary. If the employer pays the sums he may be liable to be sued by the employee (or the guarantor) if the assignment is successfully challenged.
- Rarely, the form amounts to a legal assignment, where the lender is capable of giving the employer a good discharge for the payment so the employer has no legal exposure to a claim by the employee if it pays the lender the agreed sums.
In the examples given above, the employer has to properly identify which legal transaction has occurred and act accordingly. If there's been an equitable assignment, the employer may not be obliged to pay the lender (until the necessary steps have been taken to ensure that he receives a good discharge). However, the employer may be obliged to deduct the funds from the employee and not deal with them in a manner prejudicial to the lender until the rights of the respective parties have been resolved between them. In such a case the employer becomes a stakeholder – willing to pay the person rightfully entitled, but uncertain as to whom that may be. Where the lender is an equitable assignee, he is unable to sue in his own name and must join the employee as a party to any action for recovery. The employer also has the option of asking the court for directions, which, if taken, will usually mean that his legal fees will be paid out of the disputed fund.
Payroll loans are quite popular in Jamaica and certainly have their place in the financial system. For them to be truly low risk it is important for the documents to be clear and capable of discharging the employer by payment to the lender. If this is achieved, the employer is able to assist the employee and provide low-risk to the lender, while protecting himself from legal liability – a truly win-win scenario.