The High Court has ruled to hold lenders liable when they willfully ignore a guarantor’s position or take advantage of an individual’s lack of business acumen or financial resources. This has extended to the use of independent legal and financial advice certificates (certificates) with respect to asset-backed lending. The decision serves as a useful reminder of the importance of performing due diligence before lending to borrowers.
Mr. Stubbings, the appellant, owned two properties and wished to purchase a third; however, at the time he was unemployed, could not afford the required 10% down payment, and had no regular income. While acting as sole guarantor, director and shareholder, Mr Stubbings used his front company, Victorian Boat Clinic Pty Ltd (Borrower), to arrange an asset-backed loan in the amount of $1,059,000 with multiple lenders (Jams 2 Pty Ltd, Conterra Pty Ltd and two other companies).
The parties attempted to circumvent the National Credit Code by extending credit to Mr. Stubbings’ company rather than to him as an individual. The lenders then obtained a personal guarantee from Mr. Stubbings and secured mortgages on Mr. Stubbings, two existing properties and one new property.
Shortly after settling the property, Mr. Stubbings defaulted on the loans. The lenders sought collection of the debt owing ($1,149,944.56) through possession of the secured property.
First instance: inadmissible conduct
The Supreme Court of Victoria held that the appellant was at “particular disadvantage” because of his unemployment, lack of income and lack of business acumen. The Supreme Court went so far as to say that Mr Stubbings was ‘unrealistic in the management of his financial affairs and showed a complete lack of business understanding’. It was later found that the lenders had acted in a ‘willful blindness’ to Mr Stubbings’ personal and financial circumstances, including the fact that the facility was provided for business purposes but was in fact used for the purchase of a principal residence.
The Supreme Court determined that there had been a conscious and deliberate failure to inquire into Mr. Stubbings’ situation, even though the loan was “a risky and dangerous undertaking” for the borrower (Jams 2 Pty Ltd v Stubbings [No 3]  VSC 150 ). The trial judge went on to find that the system involved[TRADUCTION]”a high level of moral obscenity” () for a number of reasons, including the fact that the certificates were not provided by truly independent sources. As a result, the trial judge ordered the release of the mortgages on the properties and the loan agreement was deemed void and unenforceable.
On appeal: Canceled
An appeal by the lenders to the Victoria Court of Appeal overturned the decision of the Supreme Court of Victoria and found the mortgage and loan agreement to be enforceable for two main reasons:
- asset-based lending is not inherently unreasonable; and
- the lenders and his agents were entitled to rely on the certificates as evidence that Mr. Stubbings had consulted an independent lawyer and accountant for advice and as to the veracity of the matters stated in those certificates, without doing any further searches (Jams 2 Pty Ltd v Stubbings  VSCA 200 ).
This reasoning was supported by the High Court’s finding that bank charges charged on a ‘take it or leave it’ basis were not unreasonable to Paciocco [Appeal, 99].
Ultimately, this led to the conclusion that it was not unreasonable for asset-backed loans to be available at face value. This was extended to include the assertion that the lenders were entitled to rely on the certificates as being true “both as evidence that Stubbings had consulted a lawyer and an accountant for advice” and determined that they “should therefore not be repaired with the knowledge of Stubbings”. personal and financial circumstances such that default on the loans was unavoidable, as the trial judge appears to have concluded” .
High Court of Australia: Inadmissible Conduct
The High Court unanimously overturned the decision of the Victoria Court of Appeal, finding that Mr Stubbings had been the subject of unconscionable conduct. The High Court determined that such inadmissible conduct required:
- a particular disadvantage;
- knowledge of particular disadvantage; and
- exploitation of particular disadvantage.
Moreover, the certificates were insufficient to reverse this decision.
The caller’s entry into the risky transaction demonstrated obvious vulnerability, as he was unemployed with no income and could not make a realistic assessment of the consequences of the transaction .
Did the lenders through an agent have knowledge?
While the majority found that there was no actual knowledge of Mr. Stubbings’ situation, it was found that there was a “sufficient appreciation” of the appellant’s vulnerability and the likelihood that the loss be attributed to the Appellant’s lack of financial capacity and absence. income . This was sufficient to establish equitable inequity.
Further, in a separate judgment, Judge Gordon noted that there would have been legal unfairness under section 12CB of the Australian Securities and Investments Commission Act 2001 (Cth) (relating to unreasonable conduct in the provision of a financial product to a person), relating to the “system” constructed by the agent . Essentially, special disadvantage is not a prerequisite for unfairness in the legislative context .
In conjunction with the above, willful blindness has been used to establish actual knowledge -; it followed the doctrine in R vs Crabbe (1985). In particular, the need to make further inquiries on behalf of the lenders has not been negated by:
- the deliberate use of a “driving scheme” that involved asset-only lending to businesses,
- the use of an intermediary to deal exclusively with the caller, and
- obtaining certificates to improve the enforceability of the loan.
Essentially, reliance on this system and failure to conduct further investigations amounted to “willful blindness”.
Use of certificates of independent legal and financial advice?
The High Court considered whether certificates of independent legal and financial advice could protect lenders from a finding of unreasonable conduct. In reaching its decision, the High Court took into account that the financial and legal advice certificates had material defects, finding that the financial certificate did not take into account that the appellant was receiving advice in his capacity as guarantor; and the legal certificate did not adequately mention the service record and the financial risk to be assumed by the appellants. Ultimately, it was held that the certificates could not be relied upon solely for the purpose of denying the risky nature of the transaction and the particular vulnerability and disadvantage of the appellant.
This is of particular importance to lenders in general, as the mere existence/obtaining of the certificates is probably insufficient to protect lenders from unreasonable behavior where there is suspicion of borrower vulnerability. The decision underscores the importance of lenders carrying out adequate due diligence rather than relying on certificates of legal and financial advice.
Take away key
- Attempts to circumvent the National Credit Code, in particular with vulnerable customers, are not admissible by the Courts.
- If there are suspicions about a borrower’s vulnerability, the lender should investigate their personal and financial situation further; the absence of actual knowledge will not prevent lenders from unreasonable claims.
- Relying on certificates of legal and financial advice by itself is not adequate protection against a finding of unfairness and unenforceability of the loan facility in court. In particular, financial and legal advisory certificates should adequately address the parties involved and make clear to the party assuming the risk its responsibility for the maintenance of the facility, as well as the financial risk to be assumed.