The High Court has resolved to hold lenders responsible where they are wilfully blind to the position of a guarantor or take advantage of an individual’s lack of business acumen or financial resources. This extended to the use of independent legal and financial advice certificates (certificates) in relation to asset-based lending. The decision serves as a useful reminder as to the importance of conducting due diligence prior to lending to borrowers.
Mr Stubbings, the appellant, owned two properties and wanted to purchase a third property; however, at the time he was unemployed, could not pay the necessary 10% deposit, and had no regular income. While acting as sole guarantor, director, and shareholder, Mr Stubbings used his shell company, the Victorian Boat Clinic Pty Ltd (Borrower), to enter into an asset-based loan in the sum 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 issuing the credit to Mr Stubbings’ company rather than him as an individual. The Lenders then obtained a personal guarantee from Mr Stubbings and secured mortgages over Mr Stubbings two existing properties and new property.
Shortly after the property being settled, Mr Stubbings defaulted on the loans. The Lenders sought recovery of the debt owing ($1,149,944.56) through possession of the secured properties.
The Supreme Court of Victoria held that the appellant was under a ‘special disadvantage’ due to his unemployment, absence 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 demonstrated a complete lack of business understanding”. It was then concluded that the Lenders displayed a ‘wilful blindness’ to Mr Stubbings’ personal and financial circumstances, including the fact that the facility was provided for business purposes but was actually being utilised for the purchase of a primary residence.
The Supreme Court determined that there had been a knowing and deliberate failure to make inquiries about Mr Stubbings’ circumstances, 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 “a high level of moral obloquy” () for a number of reasons, including the fact that the certificates were not provided by truly independent sources. Accordingly, the trial judge ordered the mortgages over the properties be discharged and the loan agreement was deemed to be void and unenforceable.
An appeal led by the Lenders in the Victorian Court of Appeal reversed the Supreme Court of Victoria’s decision, and held that the mortgage and loan agreement was enforceable based on two main reasons:
Underpinning this reasoning was the High Court’s finding that bank fees charged on a ‘take it or leave it’ basis were not unconscionable in Paciocco [Appeal, 99].
Ultimately, this led to the determination that it was not unconscionable for asset-based loans to be available on face value. This was extended to include the contention that the Lenders were entitled to rely on the certificates as truth “both as evidence that Stubbings had consulted a solicitor and an accountant for advice” and determined that they therefore “should not be fixed with knowledge of Stubbings’ personal and financial circumstances such that default under the loans was inevitable, as the trial judge appears to have found” .
The High Court unanimously overturned the Victorian Court of Appeal’s decision, finding that Mr Stubbings was the subject of unconscionable conduct. The High Court determined that such unconscionable conduct requires:
Further, the certificates were insufficient to overturn this ruling.
The appellant’s entry into the risky transaction demonstrated a clear vulnerability, as they were unemployed with no income and could not make a realistic assessment of the consequences of the transaction .
Whilst the majority held that there was no actual knowledge of Mr Stubbings’ circumstances, it was found that there was a “sufficient appreciation” of the appellant’s vulnerability and of the likelihood that the loss would be attributed to the appellant’s lack of financial nous and absence of income . This was sufficient to establish equitable unconscionability.
Further, in a separate judgement, Justice Gordon noted that there would have been statutory unconscionability under s 12CB of the Australian Securities and Investments Commission Act 2001 (Cth) (relating to unconscionable conduct in the supply of a financial product to a person), pertaining to the ‘system’ constructed by the agent . In essence, the special disadvantage is not a prerequisite of unconscionability in the statutory context .
In conjunction with the above, wilful blindness was used to establish actual knowledge -; this followed the doctrine in R v Crabbe (1985). In particular, the need to make further enquiries on the Lenders’ behalf was not negated by:
In essence, the reliance on this system and failure to make further enquiries amounted to ‘wilful blindness’.
The High Court considered whether the independent legal and financial advice certificates could protect the Lenders from a finding of unconscionable conduct. In making their decision, the High Court took into account the fact that there were material defects in both the financial and legal advice certificates, finding that the financial certificate failed to address the fact that the appellant was receiving advice in his capacity as a guarantor; and the legal certificate failed to adequately reference serviceability and the financial risk to be assumed by the appellants. Ultimately, it was held that the certificates were unable to be solely relied upon for the purpose of negating the risky nature of the transaction and the appellant’s vulnerability and special disadvantage.
This is of particular importance to Lenders in general as the mere existence/procurement of the certificates are likely insufficient to protect Lenders from unconscionable conduct where there are suspicions of the borrowers’ vulnerability. The decision highlights the importance that Lenders conduct adequate due diligence rather than relying on legal and financial advice certificates.
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Liam Hennessey, Partner
Taylor Green, Associate