Unconscionable lending practices and guidance for lenders
We recently examined how fraud can undermine indefeasibility and the resulting risks for lenders. You can read that article here: Indefeasibility of title - legal certainty in an age of rising fraud
This article analyses the High Court of Australia’s decision in Stubbings v Jams 2 Pty Ltd [2022] HCA 6, which remains the leading authority on responsible lending practices, notwithstanding the passage of four years since judgment. The decision confirms that lenders cannot rely on form over substance: documentary protections, including advice certificates, will not shield a lender where the transaction exploits a borrower’s vulnerability.
We also outline the practical measures lenders can implement to mitigate the risk of unconscionable conduct findings.
Background
The Stubbings case arose from a series of transactions involving Mr Stubbings, an unemployed individual with limited financial literacy and no regular income. Mr Stubbings owned two unencumbered properties, which he used as security for loans provided by Jams 2 Pty Ltd, a private lender. The loans were arranged through a broker and structured as business loans, despite the fact that Mr Stubbings had no business and the funds were intended for personal use. Critically, the lending model relied on the value of the security, with no assessment of Mr Stubbings’ income or capacity to service the loans.
The loans were subject to high interest rates and significant fees, and the repayment terms were onerous. Mr Stubbings was required to provide certificates from a solicitor and an accountant, purportedly confirming that he had received independent legal and financial advice. However, the evidence revealed that these certificates were obtained in a hasty manner, with no genuine advice being provided.
When Mr Stubbings defaulted on the loans, Jams 2 Pty Ltd sought to enforce its security over the properties. Mr Stubbings challenged the enforcement, arguing that the loans were unconscionable and should be set aside. The case ultimately reached the High Court, which delivered a landmark decision on the scope of unconscionable conduct in lending practices.
Why the High Court found the conduct unconscionable
The High Court unanimously held that the conduct of Jams 2 Pty Ltd and its agents was unconscionable. The Court’s reasoning centred on the concept of “special disadvantage” and the lenders’ deliberate ignorance of Mr Stubbings’ financial vulnerability.
Special disadvantage
The Court found that Mr Stubbings was in a position of special disadvantage due to his lack of financial sophistication, unemployment, and reliance on the equity in his properties. This disadvantage was exacerbated by the structure of the loans, which were designed to circumvent consumer protection laws by being framed as business loans. The High Court emphasised that the lenders and their agents were aware, or ought to have been aware, of Mr Stubbings’ vulnerability and the high likelihood that he would be unable to meet the repayment obligations.
The Court emphasised that lenders cannot avoid liability by maintaining deliberate or engineered ignorance, particularly where they knew or ought to have known of the borrower’s special disadvantage.
Deliberate ignorance
The High Court placed significant weight on its finding that the lenders had adopted an ‘intermediary consultant system’ designed to avoid knowledge of the borrower’s financial circumstances. By relying on the solicitor’s and accountant’s certificates of independent advice, the lenders sought to insulate themselves from inquiry into Mr Stubbings’ ability to repay the loans. The Court held that this deliberate ignorance amounted to unconscionable conduct, as it enabled the lenders to exploit Mr Stubbings’ vulnerability, or special disadvantage, while avoiding the legal and ethical responsibilities associated with responsible lending.
Key lessons for lenders
The Stubbings decision provides several important lessons for lenders, particularly those operating in the private lending sector. These lessons highlight the need for lenders to adopt practical measures that prioritise the interests and welfare of borrowers, especially those who may be in a position of vulnerability.
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Important lessons |
Practical measures |
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Conduct genuine inquiries into borrowers’ financial circumstances |
Lenders must take proactive steps to understand the financial circumstances of their borrowers. This includes conducting thorough assessments of a borrower’s financial capacity to repay the loan and ensuring that the loan is suitable for the borrower’s needs. Reliance on third-party certificates or representations is not sufficient to discharge this obligation.
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Lenders should establish and maintain comprehensive processes to assess a borrower’s ability to repay a loan. This should include: · obtaining detailed and up to date financial information; · verifying income, expenses, and liabilities through reliable and independent sources; and · assess the borrower’s overall financial position to ensure the facility is suitable and does not expose the borrower to substantial hardship. |
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Verify the authenticity of advice certificates |
The Stubbings case highlights that lenders cannot rely on advice certificates at face value, particularly where there are indicators that the advice may have been obtained in a cursory or non-substantive manner. Lenders are expected to take reasonable steps to form an independent view as to whether the advice was genuinely obtained and whether it meaningfully addresses the borrower’s circumstances. Reliance on standard-form or unsupported certificates, without further inquiry, may be insufficient to discharge a lender’s obligations. |
Lenders should implement processes to verify that advice certificates reflect genuine, independent, and tailored advice. This may include: · confirming the identity and qualifications of the adviser; · making reasonable inquiries to ensure the advice provider is independent of the borrower and transaction; · considering whether the content of the certificate demonstrates that the borrower’s specific circumstances have been addressed; and · identifying and following up on any inconsistencies or red flags suggesting the advice may be superficial or not genuinely obtained. |
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Avoid systems designed to limit knowledge |
Lenders should avoid adopting practices or systems that are designed to shield them from knowledge of a borrower’s financial vulnerability. Such systems may be viewed as an attempt to circumvent legal and ethical obligations, and may support a finding of unconscionable conduct. |
Lenders should implement processes that support direct engagement with borrowers and facilitate a proper understanding of their financial circumstances. This may include: · making reasonable inquiries into the borrower’s objectives, needs, and financial position; · identifying and responding to indicators of financial difficulty or vulnerability; and · ensuring that the loan is suitable and does not place the borrower in a position of substantial hardship. |
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Identify and respond to special disadvantages |
Lenders are expected to be alert to indicators of vulnerability or special disadvantage in their borrowers, such as financial illiteracy, unemployment, or reliance on a single asset for security. Where such disadvantages are identified, lenders must take additional steps to ensure that the borrower is not being exploited.
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Lenders should implement systems, processes and training to support the identification and management of borrower vulnerability. This may include: · providing targeted training to staff on recognising indicators of vulnerability or financial difficulty; · establishing escalation pathways where heightened risk or special disadvantage is identified; · making additional inquiries or providing further explanations to ensure borrower understanding; and · maintaining records of steps taken to address identified risks. |
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Ensure appropriate valuations and security structures |
Security arrangements must be proportionate to the loan and justified by the underlying risk. Over-securitisation, particularly where the borrower is in a position of vulnerability, may be viewed as evidence of unconscionable conduct. |
Lenders should implement processes to ensure that valuations and security structures are appropriate and well-supported. This may include: · obtaining independent and reliable valuations appropriate to the nature of the security; · critically assessing valuation assumptions, limitations, and any indicators of risk; and · maintaining clear records of the rationale for the valuation and security structure adopted. |
The decision reinforces that courts will scrutinise the substance of lending arrangements, not merely their form. Practices designed to streamline or externalise risk, such as reliance on intermediaries or standardised advice certificates, will not protect lenders where they mask a failure to engage with a borrower’s circumstances. Robust inquiries, documented assessments and proportionate structuring are now critical to managing enforcement risk.
If your organisation would benefit from a review of its lending policies or advice on mitigating unconscionability risk, please contact our specialist Banking and Finance team at Bartier Perry.
Authors: Emma Boyce, Karunya Vetcha and Rezwan Attai
Contributing partner: Adam Cutri
This publication is intended as a source of information only. No reader should act on any matter without first obtaining professional advice.