Asset lending is ok

In Provident Capital Ltd v Papa [2013] NSWCA 36, a mother borrowed on the security of her home and on-loaned the money to her son’s business . The son assured his mother that the business was going very well when this was untrue at the time. The introducer was aware of this but not the lender. Being a third party loan, the lender required the mother to obtain independent legal advice and she did so. The lender sought possession and the mother claimed that the loan was unjust under the Contracts Review Act and cross-claimed against her solicitor. The trial judge found in favour of the mother and reduced her liability by $500k being the amount applied for the benefit of the son’s business. This was because the trial judge imputed the knowledge of the introducer, who had actual knowledge of the desperate financial circumstances of the son, to the lender as its agent. The judge also found that the lender failed to make adequate inquiries of the mother’s ability to service the loan and as to why she would choose to invest in the business. The trial judge dismissed the borrower’s cross-claim against the solicitor. The lender appealed the Contracts Review Act finding and the mother appealed against her loss against her solicitor.

The Court of Appeal found for the lender determining the mortgage was not unjust. The court rejected the contention that the introducer was an agent of the lender. The court noted that the lender was not completely unconcerned about the borrower’s ability to service the loans because it required her assurance by signed declaration, undertook credit checks and stipulated the she must obtain independent legal advice and confirm that she had done so. The court held that the fact that the legal advice was inadequate was not the lender’s fault.

The decision has important ramifications for what are known in the industry as ‘asset lending’ and typically describes a loan provided on the strength of the security property alone, without regard to the ability of the borrower to make repayments.

In Papa, the lender’s requirement that the mother obtain independent legal advice was central to the court’s finding that the contract was not unjust in the circumstances. The improvidence of the transaction was instead sheeted home to the solicitor for negligent advice, with Macfarlan JA (Allsop P and Sackville AJA agreeing) commenting:

While it is well established that solicitors are not ordinarily required to advise upon the wisdom of transactions in relation to which they act, a reasonable solicitor in the position of Mr Caramanlis would have formed the view that Mrs Papa’s home, and the business which constituted her livelihood that she conducted from it, would be significantly endangered by her entry into the transactions with Provident and in giving her independent legal advice would have recommended that she obtain financial advice, independent of her son, concerning that business. A solicitor’s obligation is not simply to explain the legal effect of documents but to advise his or her client of the practical implications of the client’s entry into a transaction the subject of advice.

Papa would seem authority for the proposition that lenders can absolve themselves from liability by requiring that the mortgagor receives independent legal advice, and if the facts are such that the mortgagor needs independent financial advice it is the solicitor’s duty to ‘step in front of’ their client.

This case is an important decision because it appears to change the view the Courts have previously taken in relation to asset lending.

It used to be thought that asset lending was against public interest and therefore unjust. In Perpetual Trustee Company Limited v Albert and Rose Khoshaba [2006] NSWCA 41, Basten J said there was a public interest in treating a loan that amounts to asset lending as unjust, at least in circumstances where the borrowers have shown an inability reasonably to protect their own interests. Papa is less critical of asset lending per se and gives lenders a way to shield themselves from liability on low –doc loans, namely by requiring that the mortgagor receive independent financial advice. ,

But Macfarlan JA in Papa commented that ‘asset lending’ may, in some circumstances, be entirely acceptable:

“[asset lending] may advance the interests of the parties to many transactions, and facilitate commerce generally, for financiers to be able to lend on a “low doc” basis without requiring the expenditure of time and effort in ascertaining and verifying the ability of borrowers to service loans.”

This means hat borrowers must now show not only an in ability to protect their interests but also that the lender failed to require them to obtain independent legal advice in order to avoid their obligations under a loan that amounts to asset lending. A lender is not required to go behind the purpose of the loan and assess whether a borrower’s proposed purpose is a viable commercial decision.

Furthermore, it used to be thought that for the lender to be inoculated from liability, it was necessary to ensure mortgagors not only obtained independent legal advice but also independent financial advice. In Pasternacki v Correy & Ors [1998] NSWSC 288, Hidden J criticised the lender for not suggesting Mrs Correy obtain additional financial advice about her son’s business, as well as conventional legal advice about the mortgage. However, the Court of Appeal has indicated that the lender can exculpate them¬selves by requiring the mort¬gagor to simply obtain independent legal advice.

A borrower’s only option in such circumstances will be to sue the solicitor for negligent advice if the solicitor failed to draw attention to the risks of an improvident loan and failed to recommend that the mortgagor obtain independent financial advice.

The decision will no doubt result in an upsurge of lenders advising their mortgagors to obtain legal advice and for legal advisers in turn to advise that the loan appears improvident and that the mortgagors should obtain financial advice. Ultimately the detriment of proceeding with such a loan can only occur if a mortgagor insists upon acting against their own best interests, in which case lenders and lawyers will have taken the necessary steps to ensure that they are not blamed.

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