Preferring substance to form in unconscionable conduct: the High Court’s recent judgment

5 minute read  29.03.2022 Melinda Smith, Anna Bowler, Matthew Paterson

Any lender engaging with individuals who may be at a 'special disadvantage' should carefully consider the effects of Stubbings v Jams 2 Pty Ltd [2022] HCA.

The High Court, in Stubbings v Jams 2 Pty Ltd [2022] HCA 6, reiterated the need for lenders to ensure that potential customers and guarantors truly understand the risks associated with a transaction before entering into it.

Significantly, the High Court held that despite the provision of certificates of independent legal and financial advice by the guarantor, it would be unconscionable for the lenders to exercise their rights under the relevant securities in circumstances where the guarantor was at an Amadio 'special disadvantage' in that he did not understand the transaction or the risks involved, and neither the borrower nor the guarantor had capacity to repay the debt.

Any lender engaging with individuals who may be at a 'special disadvantage' should carefully consider the effects of this judgment on their practices to ensure they have adequate measures in place to protect them from allegations of unconscionable conduct. This is particularly so where a lender acts through an agent.

Background

Mr Stubbings guaranteed two loans made by the respondent lenders to a company called Victorian Boat Clinic Pty Ltd, which was owned and controlled by him. The company had no assets and it did not trade. At the time the loans were made, Mr Stubbings was unemployed and had no regular income. Although the loans were described within the relevant documentation to be business loans, they were in fact to be used by Mr Stubbings to purchase a home.

The loans were secured by mortgages over three properties owned by Mr Stubbings. It was uncontroversial that they comprised pure asset-based lending – the loans were made on the basis of the value of the assets securing the loans, without any regard to the company’s or Mr Stubbings’ capacity to repay. Mr Stubbings conceded that there is nothing inherently unconscionable about asset-based lending, however, he argued that the loans and guarantee were entered into in circumstances which made the enforcement of the respondents' rights unconscionable.

The trial judge found that Mr Stubbings was at a special disadvantage in circumstances where his financial position was ‘bleak’ and he was ‘unsophisticated, naïve and had little financial nous’.

The lenders never dealt directly with Mr Stubbings. Rather, they operated through a law firm which engaged with prospective borrowers on their behalf. The trial judge found that the law firm was the lenders’ agent, and had, through a consultant engaged by it, knowledge of Mr Stubbings’ vulnerability at the time he entered into the transactions. As a condition to the loan transactions, Mr Stubbings obtained signatures from a lawyer and an accountant on two certificates, indicating that he had received and understood their advice about the risks associated with transactions.

Soon after entering into the transactions, the company was in default. The lenders sought to enforce under the securities. Mr Stubbings resisted the enforcement on the grounds that the lenders had acted unconscionably in lending and procuring his guarantee. Mr Stubbings was successful at trial in the Victorian Supreme Court, however, the lenders successfully appealed to the Victorian Court of Appeal. Mr Stubbings appealed by special leave to the High Court.

The High Court’s decision and its consequences

On appeal, the High Court unanimously held that the lenders had acted unconscionably. The High Court found that Mr Stubbings' lack of commercial understanding coupled with his inability to repay the loans from his own income or other assets meant that default in repayment, and the consequent loss by Mr Stubbings of his equity in his properties by way of interest payments to the respondents, were inevitable as a matter of objective fact.

As regards the certificates, the High Court held that ‘given the bland boilerplate language of the certificates’ and the statement of the purpose of the loan (which the lender's agent must have known to be inaccurate), it was open to draw the inference that the certificates were mere ‘window dressing’.

In a separate concurring judgment, Gordon J went further and held that the lenders had also breached the statutory prohibition on unconscionable conduct in connection with the supply of financial services in s12CB of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act). The prohibition 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’.

Gordon J found that the lenders’ 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 to s12CB of the ASIC Act.

The following key points should be noted from the judgment:

  • Courts will assess the relationship between the parties and the circumstances of the borrower and guarantor on a case-by-case basis;
  • Where a lender does not engage with a customer directly, but instead acts through an agent, the agent’s actual or implied knowledge in relation to the particular circumstances of a borrower or guarantor can be attributed to the lender;
  • Lenders should exercise caution when engaging in pure asset-based lending, which may be of a 'dangerous nature' and put a customer's equity in secured property at risk;
  • A customer may be at a special disadvantage as a result of their financial naïveté and lack of means; and
  • The provision of certificates of independent legal and financial advice may not be enough to cure any special disadvantage.

For further information on this judgment and unconscionable conduct at equity or under a statute, please contact us.

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https://www.minterellison.com/articles/preferring-substance-to-form-in-unconscionable-conduct-the-high-courts-recent-judgment

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