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Where does responsible lending end and unconscionability begin? Australian courts have come to vastly different conclusions. An overview of current case law.

Australian Courts Assess Loan Repayment
AK

Andrew Kirby

August 31, 2021 02:20 PM

Following recent findings of misconduct in Australia’s Banking Royal Commission, the obligation of lenders to properly assess a prospective borrower’s ability to repay a loan has come under greater scrutiny. In Australian Securities and Investments Commission v. Westpac, the regulator suffered a defeat when it challenged Westpac Bank over its systems for assessing borrowers’ ability to repay home loans regulated under the National Consumer Credit Protection Act of 2009.

The unsuccessful guarantor in Jams 2 Pty Ltd v. Stubbings was recently granted special leave to appeal to the High Court from its Victorian Court of Appeal decision, which dealt squarely with the issue of asset based lending and whether it constitutes unconscionable conduct that should result in a guarantee and mortgage being set aside. This was all in the context of the “sub-tier” lending market, which encompasses borrowers who, unable to obtain a bank loan, go through private lenders for financing, which is unregulated and comes at a higher interest rate.

One key point at issue for the High Court is freedom of contract, and whether borrowers should be able to obtain short-term, high-interest loans if lower-interest bank financing is not available. As the Court of Appeal put it in Jams 2:

. . . the loans offered by [the lenders] . . . fulfil a legitimate demand by persons who, for whatever reason, cannot obtain finance from banks and other lending institutions at lower interest rates and choose to accept “third tier” loans of the kind offered. In that regard, they rely upon the decision of the High Court in Paciocco, where the High Court found that bank fees charged to customers on a “take it or leave it basis” were not unconscionable.

This case has had an intriguing procedural history. Stubbings, the guarantor and individual who sought the loan through his company as the borrower, lost a summary judgment against the lenders before an Associate Justice. He appealed this and won, and he then had a comprehensive victory at trial followed by a comprehensive loss in the Court of Appeal.

Jams 2 involved “asset-based lending,” which the Court of Appeal describes as follows:

Asset-based lending involves lending on the value of the assets securing the loan, without any consideration of the borrower’s ability to repay the loan from their own income or other assets. No credit-risk analysis other than the calculation of the loan amount to security value ratio is undertaken by the lender. Thus, the lender makes the loan without regard to the ability of the borrower to repay by instalments under the contract, in the knowledge that adequate security is available in the event of default.

The trial judge in Jams 2 held that the loan to a company owned and controlled by Stubbings was unconscionable, as he was unemployed and had no regular income. Stubbings sourced the loan through a series of intermediaries who regularly obtained financing from private lenders who were clients of a firm of solicitors. The signed documents included certificates of Independent Financial Advice and Independent Legal Advice provided to Stubbings.

One key point at issue for the high court is freedom of contract, and whether borrowers should be able to obtain short-term, high interest loans if lower interest bank financing is not available.”

At trial, Stubbings contended that the loan constituted asset[1]based lending in circumstances when the lenders’ solicitor knew that the lenders would have to rely on the secured properties for repayment, and no evidence had been sought or obtained as to the ability of Stubbings or his company to repay the loan. The trial judge accepted Stubbings’s unconscionability case and set aside the mortgage and guarantee as invalid. It was critical to this finding that the lenders’ solicitor was held to have acted unconscionably.

Between the trial judge’s decision and the Court of Appeal’s decision, the High Court handed down its decision in ASIC v. Kobelt, splitting 4-3 on the application of the facts to the relevant principles and not speaking with one voice regarding the content of the relevant principles. The case involved a man named Kobelt, who ran a store in outback Australia for remote indigenous communities and concerned whether his system of providing “book-up credit” to impoverished and often illiterate and innumerate Aboriginal customers involved unconscionable conduct in contravention of Section 12CB of the ASIC Act. “Book-up” credit involves the customer giving the storekeeper such as Kobelt their debit card with authority to withdraw funds from the customer’s account in reduction of the customer’s debt and in return for the supply of goods over the interval between the customer’s “pay days”.

The majority judges in Kobelt determined that the book-up system was not unconscionable because it did not entail Kobelt exploiting or otherwise taking advantage of customers’ lack of education or financial acumen, due to the long history of book-up credit as a legitimate source of finance in rural and remote indigenous communities.

In the Court of Appeal for Jams 2, the lenders argued that there was nothing unconscionable about the system employed by the lenders’ solicitors. It involved no more than making asset-based loans available on a take-it-or-leave-it basis to companies that lacked sufficient income (or financial records to demonstrate sufficient income) to service the loan—particularly a short-term loan pending asset sales and refinancing. In that regard, they contended that the loans offered fulfil a legitimate demand from persons who, for whatever reason, cannot obtain financing from banks or other lenders at lower interest rates and who therefore choose to accept “third-tier” loans of the kind offered.

The lenders relied upon the decision in Paciocco, in which the High Court found that bank fees charged to customers on a take-it-or-leave-it basis were not unconscionable. They also relied on Kobelt, in which the book-up credit the customers chose to accept—which would be patently unacceptable conduct elsewhere in modern Australian society— was held to be not unconscionable according to the circumstances of the case.

To support their contention that the lenders’ solicitor had not been put on inquiry as to Stubbings’s personal and financial circumstances, the lenders argued that there was no reason for their solicitor to think that Stubbings—with the benefit of advice from an independent solicitor and accountant—was not fully aware of the risks and did not have a plan to obtain sufficient money to repay the loan.

The trial judge had characterised the solicitor’s system of arranging asset-based loans as the agent for its clients as one involving deliberate intention to neither seek nor receive information about the personal and financial circumstances of the borrowers, and held that the purpose of the system was to protect or “immunise” the lenders from claims that the loans should be set aside as unconscionable.

The Victorian Court of Appeal took a very different view about the transaction, holding that the loan and securities were valid and that the lenders’ solicitor had not acted unconscionably. The High Court will now have the final say on this important financial law case.

Andrew Kirby is an experienced and successful trial advocate with particular expertise in banking and finance and property law. Andrew brings expert experience to his banking and finance and commercial cases having worked previously as an investment banker in London and Australia. He has successfully acted in many cases involving mortgage enforcement, negligent financial and legal advice, failed investments and loans and investment fraud.

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