Donovan Oates v Reid [2009] NSWSC 221

This case involved a construction loan for $7,300,000. The lender took a mortgage over the development site, a guarantee from the sole director of the development company, and a mortgage over the director’s home. After several progress payments geotechnical investigation disclosed the need to amend the DA. The council dithered so the developer went to the Land & Environment Court (LEC) to get the DA amended. The LEC amended the DA and noted an undertaking by the director to use his best endeavours to negotiate an easement for overland drainage from the adjacent property and, failing success, to seek it by litigation.

The director did not satisfy the undertaking and so the lender refused to continue progress payments. The developer abandoned the site which was then sold under power of sale with the lender incurring a shortfall.  Proceedings were commenced by the lender for possession of the director’s home and judgment on the guarantee. The development company and the director cross-claimed for damages, and a declaration that the guarantee was not binding on the director.

The borrower failed on a claim of unconscionability with McCallum J noting:

I am not able to discern unconscionable conduct in Donovan Oates’ refusal to continue to fund the project. The touchstone of unconscionability is unfairly taking advantage of a person’s disability. The director did not strike me as having any such disability. He struck me as being an intelligent man who was capable of conducting the kind of transaction he entered into. I accept that many of the problems that followed would have been obviated if Donovan Oates’ response to the undertaking had paid greater regard to the mutual commercial interests of the parties. However, to say that its conduct was uncommercial is not to say that it was unconscionable.

However the borrower succeeded on a breach of contract claim. Her Honour determined that the terms of the amended DA permitted the developer to adopt an alternative method of drainage. The LEC’s orders approved the DA subject to the conditions but the undertaking was not a condition. It could not be regarded as a “deferred commencement consent” entitling the lender to stop progress payments. In fact nothing in mortgage entitled the lender to suspend progress payments on the pretext of the director’s non-compliance with the undertaking.

Her Honour remitted the case for separate trial on the question of damages, commenting: “I am satisfied that there is a strong prospect that the developer suffered substantial loss or damage as a result of Donovan Oates’ breach”.

The lender’s problems stemmed from poorly drafted mortgage documents. Had the lender purchased a copy of The Essential Guide to Mortgage Law in NSW (LexisNexis) by Matthew Bransgrove and Marcus Young, they would have read:

In Aziz v GIFC (1988) NSW ConvR 55-427 and Murphy v Zamonex Pty Ltd (1993) 31 NSWLR 439, each case turned on the proper construction of the respective loan documents. In Murphy after the initial advance,  further payments were entirely discretionary. Conversely in Aziz once payments had commenced, there was no entitlement under that clause to “decline” further advances (except in accordance with Quantity Surveyor sign offs and loan to value ratio parameters).

Thus a properly drafted construction mortgage will allow the lender to stop making progress payments without being liable for the subsequent failure of the project and financial ruin of the developer.

Her Honour next considered an argument by the director, based on the principle in Ankar Pty Ltd v National Westminster Finance (Aust) Ltd (1987) 162 CLR 549, to be released from his guarantee. The rule in the High Court decision of Ankar has been summarised by the Court of Appeal as follows:

 A guarantee is discharged when the creditor’s conduct has the effect of altering the surety’s rights, unless the alteration is unsubstantial and not prejudicial to the surety. (Schoenhoff v CBA [2004] NSWCA 161 at [5])

The Ankar argument was rejected because whereas Ankar concerned a breach of the contract between the surety and the creditor, this case involved a breach of the contract between the creditor and the borrower.

Finally, the Court considered the claim for possession against the director’s home. The mortgage over the home was badly botched. However the Court made rectification orders, on the lender’s application, after the defendant conceded the wording intended by the parties. Her Honour then upheld the mortgage but deferred the question of possession until the amount of damages payable by the lender had been determined (at the later hearing). This was because Her Honour held such damages could be set off against the mortgage shortfall and it could transpire that the guarantor owed nothing.

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