The Risks of Peer-To-Peer Lending:
A Cautionary Tale and What You Should Know

Peer-to-Peer lending brings investors together with individuals or businesses who want to borrow money without the involvement of traditional financial institutions like banks or other lenders. P2P platforms are generally websites that outline the opportunities for lenders and allow investors to choose which individuals or businesses to lend to and how much to invest. Often, the total requested by the borrower will consist of several investors.

The benefits for borrowers include:

• a faster route to finance.
• a wider range of loan sizes.
• the ability to access finance with a lower credit rating.

The benefits for investors:

• They may be able to access higher interest rates than other savings accounts.
• P2P lending may offer a broader range of investment opportunities.

Investors can also receive tax-free P2P lending income within an Innovative Finance Individual Savings Account (IFISA), up to £20,000 a year, which makes it an attractive alternative to traditional savings accounts.

Despite the on-paper benefits – and as with all investments – P2P lending does come with its own risks, so it is very important that investors understand these risks from the outset.

One of the main pitfalls of P2P lending is that, if the individual or business you lent your money to defaults on their loan, you may lose all the capital you invested. Most P2P platforms aim to mitigate this risk by providing risk ratings with borrower details, but this is not always transparent.

Additionally, it is not unheard of that the P2P platform itself goes bust – as some have – which may also see you lose your investment. City watchdog, the Financial Conduct Authority (FCA) expects P2P platforms to ring-fence investors’ money in the event of a collapse.

P2P investments are not covered by the government-backed lifeboat scheme, the Financial Services Compensation Scheme (FSCS). So if you lose your money to a P2P investment – whether through borrower default or the collapse of the P2P platform in question – you would not be able to claim any compensation under the scheme.

However, there have also been reports of P2P investors not being given the entire picture regarding the risks involved with their investment. The Financial Ombudsman Service (FOS) has investigated these and, in some cases, compensation has been awarded to investors who have lost out to P2P schemes.

FOS is the independent, government-backed body responsible for investigating and resolving disputes between financial institutions and consumers, including those where consumers have been left out of pocket.

Complaints and claims can be made directly to the P2P platform, and if you’re unhappy with their response, you can escalate the matter to the Financial Ombudsman Service, but whether you will have a claim will depend on the actions of the P2P platform. You may not be able to claim if you are simply disappointed about the performance of the loan or if the borrower has defaulted.

If you were advised to invest in P2P lending and your circumstances were not adequately considered when you invested, then you may be able to bring a claim against the parties who either advised you or signed off on the investment.

Mr W’s story is one such example of a P2P investment gone wrong; he invested a total of £38,000 with a P2P platform, Business Loan Network Limited (trading as ThinCats.com), which was lost when the businesses he invested in, and their director, went bankrupt.

Mr W took his complaint to FOS as he believed ThinCats did not provide accurate information on the loans he invested in.

Mr W invested in three companies, owned by the same director, over the course of a year, making payments of between £4,000 and £12,000 each time. For each company, the security for the loans included “a first fixed and floating charge over the company, a first legal charge over freehold land and buildings, intercompany guarantees from all associated businesses and a personal guarantee from the company director” as well as the director’s personal assets.

The information pack relating to the loans also set out a fallback and recovery process “in the event of a distressed situation” and stated that “it would be highly undesirable for the company to fail, and so considerable safeguards are put in place to cover this position.”

Unfortunately, in May 2018, all three companies went into administration, and the director was declared bankrupt.

Mr W complained that he chose these loans to invest in precisely because of the securities in place and his confidence that he would be able to recover his capital if the market crashed, so took his case to FOS.

An initial investigation by an FOS claims handler, and subsequently an Ombudsman’s final decision, found in favour of Mr W on the grounds that ThinCats had not provided “clear, fair and not misleading information about the loans”.

Based on the information packs Mr W received for each loan, the investigation agreed that this would give him the impression that the securities would mitigate the risk and that there was a reasonable strategy to safeguard his funds.

ThinCats should also have evidenced its own due diligence checks on the loan rather than relying on conditions set out in its terms and conditions, coupled with the ‘assurances’ provided by the borrower and sponsors.

It was concluded that, had Mr W had accurate details relating to the loan-to-value and security of the loans, he would not have invested as it would have been a higher risk than he was willing to take.

The Ombudsman instructed ThinCats to rectify the issue by putting Mr W back as close to his financial position as he was before the investment by:

• Calculating how much Mr W has received back from his initial investment – including any funds that have been recovered and returned to him (A) – the actual value.
• Then calculating how much Mr W would’ve received, had he received an average net rate of return for loans across the platform from the date of investment until the date of settlement. (B) – the fair value.
• If B is greater than A, ThinCats should pay Mr W the difference. If A is greater than B, then Mr W hasn’t suffered a financial loss, and there will be no financial compensation to pay.

Sarah Spruce, Legal Director at TLW Solicitors, commented:

“While P2P lending may seem like an attractive alternative to traditional investing, it can come with some – rather significant – risks. You should be fully informed of any risks associated with the opportunity you are investing in before you do so, and if you were encouraged to invest without your circumstances being taken into account, you might have a case with the Financial Ombudsman Service; my team may be able to help if you, your loved one or even your business are in this situation.”