This was a decision of the Court of Appeal damnifying a lender who had loaned money on a mortgage given by elderly non-English speakers for the benefit of their property developer son. The Court of Appeal affirmed the decision of the trial judge in a unanimous judgement.
The only novel aspect of the transaction was that the Court of Appeal say it is now incumbent on lenders to check that guarantors can afford to repay a loan otherwise they will be asset lending.
However the asset lending is only one of the components necessary to set aside a mortgage under the Contracts Review Act. The other two requirements are that the transaction be improvident (foolish, risky, speculative), and that the borrower be in some vulnerable class where they cannot protect their own interests.
It is interesting to note that the parents who had little English were taken to a Serbian speaking solicitor. That did not cure the situation and they were found to have had insufficient inkling concerning the risk involved to allow them to lend.
Bransgroves has repeatedly warned lenders to avoid loans to non-English speaking persons who are elderly and loaning for the benefit of a third party. The legal reasoning may be more subtle but the results in the cases make clear that it is persons who are from non-English speaking back-grounds, who are elderly, who are talked into the loan by a third party, where the mortgage is set aside.
We even have a case note category for Elderly Non-English Speakers.
The Court of Appeal cited only five cases in its reasons and each one of them fits that profile. They are:
Beneficial Finance Corporation Ltd v Karavas (1991) 23 NSWLR 256
Kowalczuk v Accom Finance Pty Ltd  NSWCA 343
Perpetual Trustee Co Ltd v Khoshaba  NSWCA 41
Spina v Permanent Custodians Ltd  NSWCA 206
St George Bank Ltd v Trimarchi  NSWCA 120
The son, was a builder and property developer, and had been for about 13 years.
The father 77, was educated in the Serbian language, leaving school at 12, after which he worked on a farm. At 16, he began an apprenticeship as a fitter and turner and, apart from two years in the army as a young man, he worked as a fitter and turner until he came to live in Australia in 1970. In Australia, he worked in manual jobs, mainly welding work and was continually in work as an employee until his retirement in 1999. He had a basic knowledge of ordinary English sufficient to enable him to buy things in shops and communicate at a simple level. His English was not such as would enable him to talk about or understand commercial and financial matters. He could read English to a simple degree, but the primary judge found that though he knew what a mortgage was, his capacity was insufficient to enable him to understand the deed of loan.
The mother 70, was educated in the Serbian language and left school at 12, also commencing work on a farm. She continued farm work until she married the father in 1963. Like the father, prior to coming to Australia, she had never spoken English. Between 1970 and 1995 she worked in various factories. She had a sufficient knowledge of English to enable her to attend shops and converse with English speakers on a basic level. Like her husband, she understood what a mortgage was but was unable to converse in English concerning financial matters of any complexity.
The son entered into a call option for nine months to purchase a property in Forster for $1.4 million. The intention was to obtain development approval from the relevant council for the construction of apartments on the property. He immediately submitted a development application to the council.
The son then approached a finance broker to arrange finance for the purchase of the Forster property and the construction of the development. He was advised by the broker that unless further security could be obtained, all that he could expect from a lender on the security of the Forster property was $640k. The broker, however, advised the son that he could arrange a second loan with a short-term lender, but that this lender would require, in addition to a second mortgage over the Forster property, further security.
The term of the loan would be for three months and the interest rate would be in excess of 24 per with a 48 per cent default rate. The son’s expectation was that settlement of the purchase of the Forster property would occur in February 2008 and the development application would be approved later that month. After the approval of the application, he expected to be able to refinance the Forster property with construction finance and pay off both loans
The son met with the lender and his solicitor. The son told the lender that he had no other property to offer as security which was unencumbered, except for his parents’ house in Bowral.
The son rang his parents and said that he had a “big problem” and needed money for a property in Forster and asked for their help. He said he would come to see them and that they needed to sign some documents. Some days later, the son visited his parents and said that he needed to borrow money from the bank and required them to give the land in Bowral as security.
The parents were taken to Fairfield to attend upon a solicitor who spoke Serbian. She summarised the documents, explaining who the lender was, who was borrowing the money, the principal amount, the interest rate and the securities. The son was present during the explanation.
The parents were aware that by signing the documents they were placing their Bowral property at risk if the son did not repay the loan. The judge was not persuaded that they understood the significance of how high the interest rate was or that they understood the part played by the Forster property in the transaction. Nor did they have any knowledge about the financial position of the son or his company.
The parents were prepared to risk the property because they trusted their son and believed that he would be able to repay the loan at the end of three months. They had on one prior occasion guaranteed a loan for their son and mortgaged a property to assist him. The parents obtained no benefit from the transaction and, it was an improvident arrangement from their point of view.
The trial judge found the lender was indifferent to the parents ability to make payments under the loan because of the security they were providing. He found the lender was only concerned about whether there was adequate security available in case of default and that it must have been aware that there was a real likelihood of the the son defaulting.
The reality of the position, that the financial wherewithal of the son and the parents was, in a sense, irrelevant. The transaction was bridging finance in anticipation of development finance being obtained after a satisfactory approval of the development application. It was clear to the lender that there were only going to be two possible sources of repayment: a successful refinancing of the Forster property after approval of the development application or action against the parents security.
No one could be sure of what the council would do. No one could be sure what conditions would be imposed. No one could be sure that there would not be a court case. No one could conclude other than that there was a significant risk to the parents’ property by the transaction.
Application of the law to the facts
The trial judge began by finding the lender guilty of “asset lending”:
What the lender was told about the parents was that they owned and lived in the Bowral property which was unencumbered. By reference to the son’s age, the lender should have inferred that his parents were in their mid to late sixties. It is significant that he made no inquiries into he parents circumstances.
Accordingly, I conclude that the lender was not concerned with the ability of the parents to fulfil their obligations under the guarantee should the son default. All that the lender was concerned about was whether there was adequate security available in the case of such default.
The lender must have been aware of the “precarious” position in which the son would find himself in as a result of the delay in the development application being approved. In such circumstances the lender should have made enquiries as to the capacity of the parents to meet the obligations, if the the son was unable to do so. The fact that no such enquiry was made reinforced the inference that the appellant was not concerned about the eventuality of default provided that it had adequate security.
The trial judge found the parents were people unable to look after themselves:
The parents were disadvantaged by their limited education, experience and ability to speak and read English. They were not represented by a lawyer. The loan documents were explained to them and signed by them in circumstances of urgency and pressure being exerted by the son.
They clearly had great affection for Milan, were proud of him and trusted him. As a result, when advised by him that he would lose a large amount of money unless the Bowral property was put forward as security for the loan, as his parents they felt a moral obligation to assist him. That pressure was increased when they were required to sign the loan documents as a matter of urgency in circumstances where they did not fully understand them.
The lender argued that it was the innocent party, the judge rejected this as follows:
I am not persuaded that Fast Fix should be regarded as “an innocent party”. It knew that the deed of loan provided no benefit for the defendants. It was an improvident arrangement from their point of view. It was indifferent to their ability to make payments under the deed of loan because of the security which they were providing. Its ignorance of their financial affairs was of its own making, i.e. it made no inquiry.
The trial judge reminded everyone of the asset lending pargraph in the Khoshaba:
To engage in pure asset lending, namely to lend money 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, is to engage in a potentially fruitless enterprise, simply because there is no risk of loss. At least where the security is the sole residence of the borrower, there is a public interest in treating such contracts as unjust, at least in circumstances where the borrowers can be said to have demonstrated an inability reasonably to protect their own interests.
The arguments on appeal
The lender argued that the asset lending prohibition did not apply to guarantors. The Court of Appeal rejected that noting:
“Asset lending” is not a legal frame of reference. It is a convenient expression, to describe a form of lending where the lender has little, if any, regard for the capacity of the borrower to repay and rests satisfied with the security to protect itself. There is no reason why considerations such as those here cannot lead to the conclusion that a contract of guarantee is unjust if entered into by a lender who is uncaring of a guarantor’s capacity to repay where there is a real and significant possibility of default by the borrower and the guarantor takes no benefit under the borrowing.
The lender next argued he was innocent of any moral wrongdoing in taking the guarantee and therefore the guarantee could not be found to be unjust.
There is no need, for the purposes of the Contracts Review Act, to find a degree of moral obloquy in the third party. To frame unjustness in terms of the “innocence” (or otherwise) of the third party is to misdirect the enquiry. What is to be undertaken is an overall evaluation in determining both unjustness and the justness of granting relief, which involves a consideration of all the relevant circumstances of the case.
Meagher JA in Karavas spoke of the injustice in depriving an innocent person of valuable property, including contractual rights. His Honour was there referring to the jurisdiction to grant relief under the Act against a party who is unaware of the special disability of the party seeking relief. His Honour did, however, state that undoubtedly the jurisdiction to grant relief existed in those circumstances. It may be unjust in all the circumstances to do so. Meagher JA was not, however, laying down a rule, nor can his Honour’s statement be seen to import a requirement of mala fides into the Act.
As Mason P said in St George Bank Ltd v Trimarchi  NSWCA 120
… s 9 of the Act does not require the party seeking to enforce a contract to be on notice of the circumstances rendering it unfair.”