Unconscionable conduct: lenders and agents beware!

By Mark Petrucco and James Pinkerton

The recent decision of the High Court in Stubbings v Jams 2 Pty Ltd [2022] HCA 6 provides a clear cautionary tale for lenders of last resort regarding asset-based lending and a failure to consider the financial circumstances of borrowers and guarantors. This article sets out the facts of the case, the decision of the High Court and the key learnings for lenders and their agents, particularly when considering high-risk loans guaranteed by individuals.

Facts – what happened?

• The case concerned Mr Stubbings, an individual who owned two houses mortgaged to the Commonwealth Bank. The debt secured by the Commonwealth Bank totalled approximately $240,000 and the market value of the properties was approximately $770,000, so Mr Stubbings’ total equity was $530,000.
• Mr Stubbings was seeking to purchase another property, but was unemployed and had no regular income. His financial circumstances were bleak.
• Mr Stubbings’ loan application with ANZ Bank was rejected. He was introduced to Mr Zourkas who introduced him to a law firm that helped facilitate its clients to make secured loans.
• On 30 June 2015, Mr Stubbings signed a contract to purchase a third property for $900,000. The price was renegotiated to $815,000 on 28 August 2015.
• In late July or early August 2015 Mr Zourkas introduced Mr Stubbings to Mr Jeruzalski, a partner at the law firm. Mr Jeruzalski only made loans via intermediaries.
• The three properties owned by Mr Stubbings were valued by the law firm at $1,570,000 and two letters of offer were provided on behalf of the law firm’s clients to provide first and second mortgage finance.
• The borrower pursuant to the loans was a company owned and controlled by Mr Stubbings, Victorian Boat Clinic Pty Ltd. The company had no assets and, contrary to Mr Jeruzalski’s alleged understanding, had never traded or carried on any boat repair business.
• The offers were conditional on Mr Stubbings providing a guarantee and using his three properties as security for that guarantee.
• The first mortgage loan was for $1,059,000, with an interest rate of 10% p.a. and a default rate of 17% p.a. The second mortgage loan was for $133,500 at a rate of 18% p.a. and a default rate of 25% p.a.
• Mr Stubbings accepted the offers on 21 or 22 August 2015.
• On 19 September 2015 Mr Zourkas gave Mr Stubbings two approval letters dated 16 and 17 September 2015 enclosing documents for signing.
• The documents for signing included a certificate of independent financial advice to be signed by an accountant and a certificate of independent legal advice to be signed by a lawyer. Mr Zourkas provided the contact details for a lawyer and an accountant and the forms were completed by Mr Stubbings.
• The certificate of independent financial advice stated the loan was for a business purpose to avoid the National Credit Code,^[1] which imposes further requirements on loans for personal, domestic or household purposes.
• Mr Jeruzalski knew that the property being purchased could not be used for commercial purposes and that Mr Stubbings’ family were residing in the two existing properties.
• The loans were settled and the mortgages were registered, allowing the third property to be purchased by Mr Stubbings’ company on 30 September 2021.
• Mr Stubbings’ company defaulted on the third month’s interest payments on 30 December 2015.
• Mr Stubbings was incapable of understanding the risks involved in the mortgages. He was financially naïve, lacked business acumen and could not complete simple calculations.

Mr Stubbings' arguments – unconscionable conduct

Mr Stubbings argued that the law firm’s clients should not be entitled to enforce their rights under the mortgages on the basis that they had engaged in unconscionable conduct pursuant to section 21 of the Australian Consumer Law as set out in Schedule 2 to the Competition and Consumer Act 2010 (Cth) (ACL), pursuant to section 12CB of the Australian Securities and Investment Commission Act 2001 (Cth) (ASIC Act) and pursuant to the law of equity. The High Court did not consider it was necessary to consider section 21 of the ACL.

Law – what is unconscionable conduct?

Unconscionable conduct has three key components, each of which are considered comprehensively in the context of the real justice of the case:^[2]

• a relationship that places one party at a special disadvantage in relation to another;
• knowledge of the special disadvantage by the stronger party; and
• an unconscientious exploitation by the stronger party of the weaker party’s disadvantage.

Special disadvantage has previously been defined by the High Court in the context of unconscionable conduct as something that ‘seriously affects the ability of the innocent party to make a judgment as to his [other] own best interests’.^[3] Special disadvantage may be inferred from ‘poverty or need of any kind, sickness, age, sex, infirmity of body or mind, drunkenness, illiteracy or lack of education, lack of assistance or explanation where assistance or explanation is necessary’,^[4] and unconscionable conduct will generally arise from a combination of circumstances.^[5]

Section 12CB of the ASIC Act prevents a person engaging in conduct in trade or commerce in connection with the supply of financial services that is, in all the circumstances, unconscionable.  Unconscionability under the ASIC Act is informed by what constitutes unconscionable conduct in equity but is broader because it can apply to a system of conduct or pattern of behaviour, and therefore it is not necessary than an individual affected by the system or behaviour suffer from a special disadvantage.^[6]

The decision – what did the High Court say and why?

The High Court unanimously found that it was unconscionable for the clients of the law firm to rely upon their rights under the mortgages. The majority of the High Court (Chief Justice Kiefel and  Justices Gleeson and Keane) arrived at this conclusion in reliance on law of equity and did not consider it necessary to consider s 12CB of the ASIC Act.^[7] Justice Steward delivered a separate judgment but came to the same conclusion.^[8] Justice Gordon found that the conduct was unconscionable under s 12CB of the ASIC Act and under the law of equity.^[9]

The following factors were relevant to the High Court’s conclusion:

• Mr Stubbings was vulnerable due to his financial circumstances and financial naivety;
• Mr Jeruzalski had sufficient an appreciation of Mr Stubbings’ vulnerability, either directly (as asserted by the majority) or as a result of the system of making loans which he had adopted (as asserted by each of Gordon J and Steward J);
• the certificate of independent financial advice and certificate of independent legal advice were lacking as they were bland and standardised and designed to protect Mr Jeruzalski from allegations of wilful blindness on his part to Mr Stubbings’ circumstances; and
• Mr Jeruzalski deliberately avoided information regarding the financial circumstances of the borrower and guarantor, including by acting through intermediaries.

Final relief – what did the High Court order?

To restore Mr Stubbings to his equity position prior to the loan, the High Court ordered that:

• the lender discharge the first mortgage securing a principal amount of $1,059,000;
• Mr Stubbings pay to the lender $109,315.00 as the likely proceeds of sale of the third property; and
• the lenders pay Mr Stubbings’ costs.

Takeaways – why does it matter to me or my business?

Lenders, and particularly lenders of last resort, need to ensure that they properly consider the financial circumstances of the borrowers and guarantors when deciding whether or not to approve a loan.

The decision in Stubbings v Jams 2 Pty Ltd [2022] HCA 6 makes it clear that a lender, including when acting via its agent, cannot elect to avoid making further inquiries into the underlying financial circumstances of the borrower and any guarantors in an attempt to protect its rights to enforce a mortgage against secured assets. This will be the case particularly where the borrower and guarantor are in a poor position financially and lack business acumen, the terms of the loan are risk-laden for the borrower and the lender is entering into the loan entirely in reliance on the assets of the borrower or guarantor, rather than for example serviceability considerations.

Similarly, uniform template independent financial and legal advice certificates cannot be relied on in answer to allegations of unconscionable conduct if they are designed to circumvent the disclosure of a borrower or guarantor’s true financial circumstances, or the nature of the transaction.^[10] Potential issues in a business loan transaction, such as the nature of the borrower’s business and the viability of its business plan, need to properly investigated to avoid the loan being held to be unenforceable at law.^[11] Further investigations will be particularly important where the lender or their agent discovers information that indicates that the loan is not for a business purpose.^[12]

[1] National Consumer Credit Protection Act 2009 (Cth), Schedule 1.
[2] Stubbings v Jams 2 Pty Ltd [2022] HCA 6 [39].
[3] Ibid [40], citing Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447, 462.
[4] Ibid, citing Blomley v Ryan (1956) 99 CLR 362, 405 (Fullagar J).
[5] Ibid.
[6] Ibid [55], citing Australian Securities and Investments Commission v Kobelt (2019) 267 CLR 1, 78 [232].
[7] Ibid [52].
[8] Ibid [153].
[9] Ibid [94].
[10] Ibid [49].
[11] Ibid [48].
[12] Ibid [90].