Summary
Having a borrower provide standard form certificates of advice from its accountant and lawyer may not be enough to enable an asset-based loan (ABL) to get subsequent legal approval, Australia’s High Court has ruled.
The court viewed an ABL as the practice of providing credit based primarily on an assessment of the assets acting as security for the loan, with very little consideration given to the borrower’s capacity to repay through conventional sources.
The court held that an ABL transaction may be characterised as ‘unconscionable’ (that is, unfair), and therefore liable to be ruled invalid. The reason is that under the law of unconscionability, a financier of an ABL may be deemed to know of facts or circumstances which on fairness grounds would rule out lending to the borrower in the first place.
Significantly, the court said that the lender’s knowledge of the borrower’s circumstances is the same as that of a broker in the transaction.
Discussion
In the case of Stubbings v Jams 2 Pty Ltd [2022] HCA 6, the loans were made through a lawyer-agent who basically arranged everything. The borrower company (VBC) owned nothing, but its sole director/shareholder, Mr Stubbings, did. With the aim of using the loan to purchase a third property, he re-mortgaged his existing two properties and signed a personal guarantee.
Mr Stubbings also signed certificates stating that he had obtained independent legal and financial advice, as well as a deed stating that the loan was not being used for personal, domestic of household purposes. These documents purported to put the transactions beyond the reach of the Consumer Credit Code.
The court recognised that Mr Stubbings was a willing participant in the transactions, but that he had been “victimised”. He was at a “special disadvantage” in that he was not capable of understanding the risks of the loans. His financial circumstances at the time of the ABL were “bleak”.
The court decided that the loans were unconscionable because the “inevitable outcome” of the transactions was, if not the borrower’s ultimate default the likely erosion of Mr Stubbings’s equity in his properties via interest payments.
Impacts for brokers
The conduct of the agent-lawyer in arranging the loans was described as consisting of unfair tactics and lacking in good faith. These factors invoked not just the common law of unconscionability but section 12CB of the ASIC Act. This section comprises the statutory prohibition of unconscionable conduct in trade or commerce. Financial penalties can apply under this legislation.
The lessons for lenders and brokers offering ABLs is that usual credit assessment must be undertaken, and they must be satisfied the borrower is not vulnerable but has an actual appreciation of the risks involved. The borrower signing off on standardised ancillary documents may not be enough.
Conclusion
An ABL is not of itself unconscionable, but the actions (or inaction) of the broker, deemed to be that of the lender, may jeopardise ultimate loan recovery. The circumstances of a prospective borrower should be fully reviewed before a broker puts up a transaction to a lender.
Allan McDougall,
Consulting Principal
Keypoint Law, March 2022