A mortgage-backed loan by a non-bank lender was recently set aside by the Supreme Court of Victoria.
The borrower successfully argued that the lender engaged in unconscionable conduct. This was despite the borrower having provided a solicitor’s certificate and accountant’s certificate to the lender prior to draw down.
The lender’s solicitor had a system of using an intermediary so as to deliberately avoid obtaining any information regarding the borrower (other than a valuation of the property). This system, which attempted to ‘immunise’ the lender and its solicitor, was strongly criticised by the Court and had the opposite effect.
The judgment delivered by Justice Robson is detailed and followed a long trial (Jams 2 Pty Ltd & Ors v Stubbings (No 3)  VSC 150). Key points of interest are as follows.
A loan is not regulated by the National Consumer Credit Code if the borrower is a company.
In this matter, the borrower was a company but it had never traded and had no assets. The guarantor and mortgagor was an individual. The monies advanced were used to benefit the guarantor and not the borrower company.
Despite these facts and others, the guarantor was unsuccessful in arguing that the loan to the company was a ‘sham’ and was in fact made to the guarantor. In reaching this conclusion, the Court looked at the terms of the loan documentation and followed other decisions where guarantors were unsuccessful in making this ‘sham’ argument.
Solicitor’s and accountant’s certificates
As is common practice, the lender required the guarantor to obtain certificates of independent advice from a solicitor and accountant. The guarantor did so, but the Court gave no weight to the certificates.
This was because of a set of unusual facts.
First, the advice given by the solicitor and accountant appeared to be woeful. A negligence claim against the solicitor was settled and the claim against the accountant was successful.
Second, the solicitor and accountant were chosen by the intermediary. The court disapproved of the intermediary’s general conduct, and found that the lender’s solicitor must have suspected that the guarantor would be guided by the intermediary as to which solicitor and accountant to approach. The Court found that this conduct was part of the system adopted by the lender’s solicitors to immunise the firm from knowledge that might threaten the enforceability of the loan. For example, the Court found that the lender’s solicitor knowingly and deliberately failed to make any inquiries about the guarantor’s financial position.
Third, the lender’s solicitor knew the accountant and solicitor would only be paid if the loan was approved and that there was no incentive for them to withhold the certificates if they were not satisfied that the guarantor understood the documentation.
The guarantor alleged the loan was unconscionable because the lender took advantage of his special disadvantage under the principles of Commercial Bank of Australia Ltd v Amadio.
The guarantor had repeatedly failed school-level mathematics. He was unable to calculate 10% of an amount and his demeanour at trial indicated he was ‘completely lost, totally unsophisticated, incompetent and vulnerable… he behaved, much as you would expect a child to behave’.
The group of individuals which together made up the ‘lender’ had no dealings with the guarantor. It was their solicitor who sourced the opportunity to lend money via an intermediary and then took it to his clients. The lender relied upon a valuation procured by the lawyer and had no knowledge of the borrower or guarantor. However, the conduct of the lender’s lawyers was attributed to the lender as its agent.
The Court held that the lender acted unconscionably for the following reasons:
- The lender’s lawyers had a deliberate system to ensure they did not ascertain any information on the guarantor’s financial circumstances and ability to service the loan, particularly in circumstances where they believed that there was a real risk he may not have had a sufficient income.
- The lender’s lawyers knew that the loan they were involved in making could cause severe damage to the guarantor if he could not service the loan.
- The lender’s lawyers relied on the intermediary to obtain the relationship with the guarantor and took deliberate steps to ensure they did not know what the intermediary had told the guarantor or what the guarantor understood about the loan.
- The lender’s lawyers attempted to ‘immunise themselves’ from the taint of any knowledge that might expose them to a claim they acted unconscionably. For example, they chose not to meet with the guarantor or obtain information from him, and tried to use the intermediary as a ‘shield’.
- The intermediary made false representations to the guarantor, or at least knew the guarantor misunderstood the loan.
- The failure of the lender’s lawyers to utilise the lender’s right to obtain information from the borrower.
- The system of conduct used by the lender’s lawyers to procure and make the loan.
The particular facts relating to the guarantor and lender’s solicitor make this an unusual case. There are, however, several important lessons for all lenders:
- A deliberate strategy of wilful blindness is fraught with risk.
- Asset-based lending itself is unlikely to be found to be unconscionable. However, when taken with other factors it can lead to a finding of unconscionable conduct.
- A lender should avoid being involved in payment arrangements for independent solicitors and accountants. Such professionals should be engaged and paid by the guarantor and they should have no financial interest in whether the guarantor goes ahead with the loan.
- Beware of intermediaries. While the court found that the intermediary was not an agent of the lender, the lender was still tainted by his conduct because the lender’s lawyer deliberately used him in a (failed) attempt to shield themselves.
- A corporate borrower is effective to avoid the operation of the NCCC. While there is now a substantive amount of case law confirming this, we think this remains a potential area of risk and expect that given the ‘right’ facts a borrower will succeed in establishing the sham argument. Lenders should be very careful in how they explain and impose a requirement that borrowers must be a company.