Unconscionable conduct in asset based lending: Stubbings v Jams 2 Pty Ltd [2022] HCA 6

Recently, the High Court of Australia found unconscionable conduct on the part of a lender on an asset based loan and held that the lender could not rely on the certificates of independent legal and financial advice procured from the borrower to immunise the transaction against unconscionable conduct laws.

The loan was made to a shell company with no assets and was backed by security taken over properties owned by an unemployed man with no regular income and low financial literacy. Default was inevitable and occurred quickly. In those circumstances, the High Court’s finding of unconscionablility and decision to set aside the mortgages and loans seem unremarkable.

However, lenders should take note of the guidance provided in this case, particularly noting that the Court of Appeal of the Supreme Court of Victoria did not find that the lender’s practises were unconscionable.

Key takeaways

• Asset based lending is not necessarily unconscionable in and of itself. However, as equity will intervene if a transaction is unconscionable, lenders need to consider the extent to which they need to interrogate and understand the commercial position of applicant 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 immunise a transaction against allegations of unconscionable conduct.
• Lending systems, procedures and processes may be unconscionable under the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) where they are designed to avoid having knowledge of a borrower/guarantor’s financial position or special disadvantage.
• Lenders should always scrutinise a borrower’s financial position and circumstances, regardless of the length of the loan.
• 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 favour of a finding of unconscionable conduct.
• Boilerplate, generic and vague pro forma certificates of independent legal and financial advice should be avoided.
• Courts are willing to scrutinise information asymmetry and lender processes and systems, and may make an objective assessment of the commercial effect of the transaction when considering a statutory unconscionable conduct claim.
• Prior to entering into loans, lenders should have regard to the commercial effect of the proposed loan from an objective standpoint. They should also consider the extent to which any special disadvantage of the borrower, or aspect of the lender/client relationship or lender process/procedure is contributing to the borrower’s decision to enter into the loan.
• The High Court did not address the question as to whether a special disadvantage is a requisite element for a claim in statutory unconscionability as discussed in our previous update.

Background

The respondent lenders made two asset based loans to Mr Stubbings’s company, Victorian Boat Clinic Pty Ltd (VBC) so that Mr Stubbings could buy a house in Fingal, Mornington Peninsula to live in.

The security for the loans was a guarantee given by Mr Stubbings supported by mortgages over two properties he already owned in Narre Warren and the new house at Fingal. Prior to the loans, the Narre Warren properties were mortgaged to CBA and rented out.

VBC was a shell company. It never traded as a boat repair business and had no assets. Mr Stubbings (VBC’s sole director and shareholder), was unemployed, without a regular income, had not filed tax returns for years, left school after form 4 and had low financial literacy. He was found by the primary judgment to be ‘completely lost, totally unsophisticated, incompetent and vulnerable.’

The loans were short term loans with high monthly interest rates and default rates.

Soon after settlement of the loans, Mr Stubbings defaulted and the lenders sought to enforce their mortgages.

The lending system and standard practises

Private lenders engaged the services of an intermediary consultant, in this case Mr Zourkas, to procure the making of short term, high risk, high interest, asset based loans to borrowers.

The intermediary consultant in turn engaged the services of AJ Lawyers to facilitate the making of the loan on behalf of the lender.

AJ Lawyers never dealt directly with or liaised with a borrower/guarantor (other than in relation to loan documentation).

The lenders only loaned to corporate borrowers, on the condition that the loan purpose was not for domestic or personal purposes. Guarantors would sign a Deed to this effect prepared by AJ Lawyers.

The standard practise of AJ Lawyers was not to require application forms from prospective borrowers, not to make no inquiries as to a borrower’s capacity to repay the loan, and not to conduct credit checks.

If AJ Lawyers considered that there was sufficient security in a property, he would approve the loan on behalf of the lender and provide pro forma loan documentation and ancillary documents to the intermediary. Amongst the documents were a Deed pertaining to the loan purpose and pro forma certificates of independent legal and financial advice to be signed by a lawyer and accountant respectively acting for the borrower/guarantor.

The guarantor’s position: Mr Stubbings and VBC

The true purpose of the loan to Mr Stubbings was so that he could buy a home, in his own name, to live in, and the Deed required to be executed was designed to avoid loans from 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 on the assumption that it had no income, in the sense that it did not have sufficient income to service interest under the loans for 6-12 months.

The primary judge inferred Mr Jeruzalski’s ostensible indifference to Mr Stubbings’s financial circumstances reflected a concern on his part that proof of his knowledge of such matters would in some way undermine the lenders’ ability to recover their loans.

Unconscionable conduct

• The primary judge found that Mr Stubbings was at as a special disadvantage.
• Mr Jeruzalski’s own evidence was that if Mr Stubbings had no income a tier one bank would not loan to him and he would not assist somebody like Mr Stubbings to 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 available equity in the properties because of the high interest rates.
• The High Court found that Mr Stubbings’s special disadvantage was exploited by Mr Jeruzalski from AJ Lawyers on behalf of the lenders. The Court considered the ‘dangerous nature of the loan’ to be ‘central to the question whether the appellant’s special disadvantage had been exploited by the respondents.’
• The boilerplate language contained in the certificates of independent legal and financial advice was mere ‘window dressing’, as was the requirement for the borrower to be a corporate entity. In fact, the Court found that this was further evidence pointing to an exploitative state of mind on the part of the agent and lender and intention to avoid the loan from needing to comply with the National Credit Code.

System of unconscionable conduct under the ASIC Act

• Pursuant to section 12BC(1)(a) of the ASIC Act, persons are prohibited from engaging in conduct that is, in all the circumstances, unconscionable. This can apply to a system of conduct or pattern of behaviour, whether or not a particular individual is identified as having been disadvantaged by the conduct or behaviour.
• Justice Gordon, in separate reasons, also found this ‘system of lending money secured against a guarantor’s property, suspecting that the guarantor had no income or capacity to service the loan, yet deliberately avoiding information as to the guarantor’s financial or personal circumstances in order to immunise themselves from knowledge of vulnerability, was, in all the circumstances, unconscionable conduct in connection with the supply of financial services in trade or commerce contrary’.
• Justice Gordon found that the system used unfair tactics, lacked good faith, lacked transparency, was outside societal norms of acceptable behaviour and was developed in order to avoid application of statutory and general law protections. Her Honour found this system of lending to be in breach of the ASIC Act.

Conclusion

Asset based lending is not in and of itself unconscionable, and with the right lending processes and procedures in place there is a place for it in the market. Lenders should always inquire into a borrower’s purpose for seeking finance, their financial position and their capacity so as to avoid the risk that they are exploiting the borrower.

If you would like further information or would like us to review your company’s systems, processes or procedures for lending, please do not hesitate to contact Edward Martin or Trish Kastanias.

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Authored by:

Edward Martin, Partner
Trish Kastanias, Senior Associate