High Court pounces on predatory lending practices

Numerous cases have examined the conscionability of asset-based lending. The cases say asset-based lending is not of itself unconscionable. A recent High Court decision[1] strikes at the foundation of the practices of asset-based lending. The decision erodes the ability of asset-based lenders to rely on artificial structures to disregard the borrower’s or guarantor’s financial and other circumstances. In fact, it stated that the deployment of certain generally accepted practices to protect lenders may in certain circumstances be evidence pointing to an exploitive state of mind on the part of the lender.[2]

Asset-based lending

Asset-based lending is a type of lending where the loan is made exclusively, based on the value of the assets securing the loan, “without regard to the ability of the borrower to repay by instalments under the contract”. The lender knows that if the borrower defaults there is adequate security to repay the loan.[3]

By definition, asset-based lending cannot work if the National Consumer Credit Protection Act 2009 (Cth) (National Credit Code) applies. In this case, the lenders obtained various documents and certificates stating that the purpose of the loan was for business purposes. The loan was also made to a company, not an individual. The National Credit Code therefore ostensibly did not apply, and so responsible lending obligations imposed on a credit provider under the National Credit Code did not apply.

In this case, the primary judge found that a guarantor’s indebtedness was procured by unconscionable conduct on the part of the agent of the lenders, and such unconscionable conduct was attributable to the lenders. The conduct was also contrary to section 12CB of the Australian Securities and Investment Commission Act 2001 (Cth). 

The Court of Appeal overturned the primary judge’s decision because it said the primary judge had an adverse view of asset-based lending, and it said the lenders could rely on the certificates to demonstrate that there was no unconscionable conduct. 

The High Court said that:

“The outcome of the appeal … turns on the extent to which [the lenders’ solicitor’s] knowledge of the appellant’s circumstances and whether [the lenders’ solicitor] exploited that disadvantage so that the [lenders] attempt to enforce their rights under the loans and mortgages was unconscionable.”

It then went on to conclude that:

“A case for relief against an unconscionable attempt to enforce legal rights is established in this case because [the lenders’ solicitor] appreciation of the appellant’s vulnerability, and the disaster awaiting him under the mortgages, that his conduct in procuring the execution of the mortgages is justly described as unconscientious”,

and accepted the findings of the primary judge that the lenders’ solicitor appreciated the likelihood that the guarantor would lose the equity in the properties that he owned because of his financial naivete and lack of means. The High Court pointed out that the Court of Appeal had no basis for disregarding the finding of the primary judge in relation to the knowledge of the lenders’ solicitor and that various certificates obtained by the lenders’ solicitor from the guarantor were no basis for doing so.

Unconscionable conduct

It is well established that equity does not intervene to relieve a person from the consequences of entering an improvident transaction in the ordinary course of a lawful business. That’s just the notion of freedom of contract. The relevant equitable principle was discussed in Kakavas v Crown Melbourne Ltd.[4] 

If a person wants to enter risky business, that person cannot call on equity for help when that risk is realised. For a person to ask equity’s assistance, the person must be able to point to the conduct of the other party, “beyond the ordinary conduct of the business, which makes it just to require the defendant to restore the plaintiff to his or her previous position.”

Where the plaintiff can point to unconscionable conduct equity will, all other things being equal, step in to relieve the plaintiff from the consequences of a bad or foolish transaction. 

The High Court noted that,

“In Commercial Bank of Australia Ltd V Amadio, this Court held that unconscionability involves: a relationship that places one party at a ‘special disadvantage’ vis-à-vis the other; knowledge of that special disadvantage by the stronger party; and unconscientious exploitation by the stronger party of the weaker party’s disadvantage.”[5]

The law in respect of unconscionable conduct has been so clear for such a long time that lawyers for lenders go to great pains to ensure that they obtain all the right paperwork to prove, if questioned, that the borrower or the guarantor was at no special disadvantage in the transaction. The paperwork required to be signed by borrowers and guarantors in a standard lending transaction is designed to show that the borrower or guarantor was fully aware of the legal and financial risks and consequences of the transaction. The rationale being that if the borrower and/or guarantor is fully aware of the legal and financial risks and consequences, he or she cannot be at any special disadvantage vis-à-vis the lender in the transaction. 

Lenders’ paperwork generally, as in this case, contain several declarations to indicate that the borrower and/or guarantor:

  • obtained independent legal and financial advice regarding the transaction;

  • had the opportunity not only to read the relevant transaction documents but also understood them;

  • acknowledged (whether from his or her own reading of the transaction documents) or as explained to him or her by the ‘independent’ solicitor and financial adviser, that he or she understood the consequences of a default including the loss that he or she is likely to suffer because of default; and

  • also understands that the lender is relying on the above representations by the borrower and/or guarantor in deciding to make the loan.

The usual paperwork was obtained by the lenders in this case to demonstrate that:

  • the loan was not regulated by the National Credit Code and therefore responsible lending obligations did not apply; and

  • the borrower and/or guarantor was fully informed of the terms of the loan and understood not only the legal obligations arising from the transaction but also the financial consequences.

Window dressing doesn’t work?

What went wrong for the lenders? As the old Scottish proverb says “Ye can ne make a Silk-Purse of a Sowe’s Luggs” which today is commonly stated as “you can’t make a silk purse out of a sow’s ear.”

No matter how the lenders, or their lawyers, tried to dress up the transaction and distance themselves from the truth, the High Court agreed with the primary Judge’s findings. 

The appellant guarantor was:

  • unemployed and had no regular income;

  • had not filed tax returns in several years;

  • was in arrears on rates payments in respect of two properties that he owned;

  • had a loan application with ANZ rejected for lack of financial records; and

  • unsophisticated, naïve and had little financial nous.

Contrary to the:

  • stated purpose of the loan, which was to ‘Set up & expand the business’; and

  • signed documents by the borrower and guarantor stating that the loan was for “business purposes’, ‘not for personal, domestic or household purposes’, ‘not to purchase, renovate or improve the residential property for investment purposes’ and not to ‘refinance credit that [had] been provided wholly or predominantly to purchase, renovate or improve residential property for investment purposes’,

the primary judge found that the true purpose of the loan was “to enable [the appellant] to purchase, in his own name, a property as a home.”

The primary judge found that the solicitor for the lenders must have known, the statement of the purpose of the loan in the relevant certificates and documents did not reflect reality. The solicitor knew that the property that was being purchased with the money being advanced was zoned “green wedge’ and so could not be used for commercial purposes.

Accordingly, the primary judge concluded that the solicitor for the lenders “knowingly and deliberately failed to make any inquiries about [the appellant] and whether Mr Zourkas had mislead him about [the appellant’s ability to service the loans, about [the appellant’s] understanding of the loans, or about [the appellant’s] financial nous and vulnerability.” 

Who is Mr Zourkas?

Mr Zourkas described himself as a consultant in the business of introducing potential borrowers to AJ Lawyers. AJ Lawyers facilitated loans by their clients. Importantly, the primary judge found that Mr Zourkas played an important and essential role in these loan transactions because his involvement meant that AJ Lawyers never dealt directly with the borrower or guarantor. He also said several things to the borrower/guarantor which were to say the least, not helpful. Amongst the things he said to the borrower/guarantor which were inappropriate were that he could amalgamate his loans, sell some properties, and then refinance the debt with a bank at a lower interest rate. This was not true or at least very unlikely.

Furthermore, he gave the borrower/guarantor the documents and certificates and sent him to a nominated lawyer and a nominated accountant to respectively get ‘independent’ legal and financial advice. 

Why is this case significant?

The lending practices in this case, involved going through the motions, so it would seem [6]the borrower/guarantor was at no special disadvantage vis-à-vis the lender, that borrower/guarantor was properly advised of and knew the legal and financial risk involved with the loan. Going through the motions won’t cut it when the lender or its agents know otherwise or distance themselves from evidence of exploitation.

This case is important because the High Court said that:

  • bland boilerplate language in certificates;

  • statements as to purpose of loan;

  • commercially unnecessary interposing of a company as a borrower,

were merely window dressing and steps calculated ‘to prevent or impede scrutiny of the fairness of the transaction under the Code’. The High Court went so far as to state that:

“Indeed, one might regard the deployment of such artifices in a contract where the lender or its agent deliberately distances itself from evidence that must confirm the dangerous nature of the transaction for the borrower or its guarantor as evidence pointing to an exploitive state of mind on the part of the lender.”[7]

Asset-based lenders rely on such certificates in their business. Can they still do so when the High Court said those certificates are no basis for avoiding the knowledge of the lender or it’s agent?

Finally, the case is also significant because it highlights an often-overlooked difference between equity and the common law. Although it is said that equity follows the law, the process equity takes differs. The High Court explained, when considering what unconscionability involves, the,

“considerations should not be understood as if they were to be addressed separately as if they were separate elements of a cause of action in tort.”[8]

Rather, quoting from Jenyns v Public Curator (Qld)[9], it said that the application of equitable principles:

“calls for a precise examination of the particular facts, a scrutiny of the exact relationships established between the parties to the transaction and a consideration of the mental capacities, processes and idiosyncrasies of the [vulnerable party]. … ‘A court of law works its way to short issues, and confines its view to them. A court of equity takes a more comprehensive view, and looks to every connected circumstance that ought to influence its determination upon the real justice of the case’.”

The path equity takes doesn’t involve ticking off distinct issues or elements. Instead, it examines every connected circumstance and takes a comprehensive view of the facts and then weighs them up to determine the real justice of the case. To determine the substance of the transaction and real justice of the case, equity looks through artificial structures designed to protect a party, even if they involve normal commercial practice. 

Author: Norman Donato

 

[1] Jeffrey William Stubbings v JAMS 2 Pty Ltd & Ors [2022] HCA 6

[2] Ibid at [49]

[3] Ibid at [1]

[4] (2013) 250 CLR 392 at 401-402 [20]

[5] Jeffrey William Stubbings v JAMS 2 Pty Ltd & Ors [2022] HCA 6 at [39]

Ibid at [49]

[7] Ibid at [49]

[8] Ibid at [39]

[9] (1953) 90 CLR 113 at 118 - 119