Unreasonable Conduct in Asset Based Lending: Stubbings v Jams 2 Pty Ltd  HCA 6
Recently, the High Court of Australia found impermissible conduct by a lender in an asset-based lending and ruled that the lender could not rely on certificates of legal and financial advice obtained from the borrower to immunize the transaction against objectionable conduct laws. .
The loan was granted to a shell company with no assets and was backed by collateral taken on properties owned by an unemployed person with no regular income and low level of financial knowledge. The defect was unavoidable and happened quickly. In these circumstances, the High Court’s finding of unfairness and the decision to cancel the mortgages and loans seem trivial.
However, lenders should take note of the advice provided in this case, noting in particular that the Supreme Court of Victoria Court of Appeal did not find the lender’s practices to be unreasonable.
Key points to remember
- Asset-based lending is not necessarily unreasonable per se. However, since equity will kick in if a transaction is ineligible, lenders need to consider the extent to which they need to interview and understand the business position of prospective borrowers and guarantors from their perspective before agreeing to lend.
- Courts are willing to look beyond certificates of independent legal and financial advice that are designed to immunize a transaction against allegations of inadmissible conduct.
- Lending systems, procedures and processes may be ineligible under the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Law) when they are designed to avoid knowledge of the financial situation or a particular disadvantage of a borrower/guarantor.
- Lenders should always review the borrower’s financial position and status, regardless of the loan term.
- Pro forma deeds or other documents designed to avoid a loan being subject to certain statutes or common law protections should be reviewed as they may instead weigh in favor of a finding of unreasonable conduct.
- Standard, generic and vague pro forma certificates of independent legal and financial advice should be avoided.
- Courts are willing to review information asymmetry and lenders’ processes and systems, and can make an objective assessment of the commercial effect of the transaction when considering a complaint of impermissible conduct.
- Before taking out loans, lenders should consider the commercial effect of the proposed loan from an objective point of view. They should also consider the extent to which any particular disadvantage of the borrower, or some aspect of the lender/client relationship or the lender’s process/procedure contributes to the borrower’s decision to take out the loan.
- The High Court did not address the issue of whether particular disadvantage is a required element for a statutory unfairness claim, as discussed in our previous update.
The respondent lenders made two asset-based loans to Mr. Stubbings’ company, Victorian Boat Clinic Pty Ltd (VBC) so that Mr Stubbings could buy a house in Fingal, on the Mornington Peninsula, to live in.
The security for the loans was security given by Mr Stubbings backed by mortgages on two properties he already owned in Narre Warren and the new house in Fingal. Prior to the loans, Narre Warren’s properties were mortgaged to CBA and leased.
VBC was a front company. It was never a boat repair business and had no assets. Mr. Stubbings (the sole director and shareholder of VBC) was unemployed with no regular income, had not filed a tax return in years, left school after Form 4 and had poor financial knowledge. He was judged by the main judgment as “completely lost, totally simplistic, incompetent and vulnerable”.
The loans were short-term loans with high monthly interest rates and default rates.
Shortly after the loans settled, Mr Stubbings defaulted and the lenders sought to enforce their mortgages.
The Loan System and Usual Practices
The private lenders engaged the services of an intermediary consultant, in this case Mr. Zourkas, to secure the provision of short-term, high-risk, high-interest, asset-based loans to the borrowers.
The intermediary consultant in turn retained the services of AJ Lawyers to facilitate the granting of the loan on behalf of the lender.
AJ Lawyers has never dealt directly with or liaised with a borrower/guarantor (except with respect to loan documentation).
Lenders only lent to corporate borrowers, provided the purpose of the loan is not for household or personal use. The guarantors would sign a deed to that effect prepared by AJ Lawyers.
AJ Lawyers’ standard practice was not to require application forms from potential borrowers, not to research a borrower’s ability to repay the loan, and not to conduct credit checks.
If AJ Lawyers considers that there is sufficient security in a property, it will approve the loan on behalf of the lender and provide pro forma loan documentation and supporting documents to the intermediary. Among the documents were a deed relating to the purpose of the loan and pro forma certificates of independent legal and financial advice to be signed by a lawyer and an accountant acting respectively for the borrower/guarantor.
Guarantor position: Mr Stubbings and VBC
The real purpose of the loan given to Mr Stubbings was to enable him to buy a house, in his own name, to live in, and the deed to be signed was to avoid the loans being governed by the National credit code.
AJ Lawyers approved the loans to VBC on behalf of the lenders, knowing that there was only a nominal amount of funds to pay the deposit on the Fingal property, and assuming she had no income, in meaning that she did not have enough income to service the interest on the loans for 6 to 12 months.
The lead judge inferred that Mr. Jeruzalski’s apparent indifference to Mr. Stubbings’ financial situation reflected a concern on his part that evidence of his knowledge of these matters would somehow compromise another is the ability of lenders to collect their loans.
- The senior judge found that Mr. Stubbings was at a particular disadvantage.
- According to Mr. Jeruzalski’s own testimony, if Mr. Stubbings had no income, a top-tier bank would not lend him a loan and he would not help someone like Mr. Stubbings obtain a bank loan.
- Mr. Jeruzalski had sufficient appreciation of Mr. Stubbings’ vulnerability and lack of business and financial acumen, and that the loans would significantly reduce the equity available in the properties due to high interest rates.
- The High Court found that Mr Stubbings’ particular disadvantage had been exploited by Mr Jeruzalski of AJ Lawyers on behalf of the lenders. The Court considered that the “dangerous nature of the loan” was “at the heart of the question whether the particular disadvantage of the appellant had been exploited by the respondents”.
- The boilerplate language contained in certificates of independent legal and financial advice was just a “window dressing”, as was the requirement that the borrower had to be a legal entity. In fact, the Court found that it was further evidence indicating an exploitative mindset on the part of the agent and the lender and the intent to avoid the loan being forced to comply with National credit code.
System of unreasonable conduct under ASIC law
- Pursuant to Section 12BC(1)(a) of the ASIC Act, persons are prohibited from engaging in conduct that is, in all circumstances, impermissible. This can apply to a system of conduct or a pattern of behavior, whether or not a particular individual is identified as having been disadvantaged by the conduct or behavior.
- Judge Gordon, in separate reasons, also found this “system of lending money secured by the property of a guarantor, suspecting that the guarantor had no income or ability to repay the loan, while deliberately avoiding information about the financial or personal circumstances of the guarantor in order to immunize against knowledge of the vulnerability, constituted, in all circumstances, inadmissible conduct in connection with the provision of financial services in the course of a trade or business contrary “.
- Judge Gordon found that the system used unfair tactics, lacked good faith, lacked transparency, fell outside societal norms of acceptable behavior, and was developed in order to avoid the application of legal and general protections. His Honor found that this lending system violated ASIC law.
Asset-based lending is not inherently unreasonable, and with the right lending processes and procedures in place, there is a place for it in the market. Lenders should always inquire about a borrower’s reason for seeking financing, their financial situation and their capacity to avoid the risk of exploiting the borrower.
If you would like more information or would like us to review your company’s lending systems, processes or procedures, please do not hesitate to contact Edward Martin or Trish Kastanias.