Lenders beware, the doctrine of agency found to apply to brokers

This decision is a sobering wake up call to the wholesale lenders who rely on originator-managers to distribute their products, and to originator-managers who rely on finance brokers.

10 October 2009

The decision of Justice Price in Permanent Trustee Company Limited v Gillian; O’Donnell Permanent Trustee Company Limited v Di Benedetto [2009] NSWSC 902, handed down 4 September 2009, is a watershed. Until now the courts have been quite rigid in finding that brokers are agents of the borrower and that misrepresentations and fraud by the brokers cannot harm the lender. In this case Justice Price found that the fraudulent broker was an agent of the lender and set-aside the mortgages pursuant to the Contracts Review Act. ASIC, which intervened in the case on behalf of the borrowers, issued a warning lenders may be engaging in “unconscionable conduct” if they try to recoup loans fraudulently arranged by external brokers1.

The decision encompassed three related cases were heard together. All involved a company known as Streetwise Property. Streetwise, as well as purportedly being a property developer, also traded as a finance broker. In each case Streetwise went to Tonto Home Loans Australia Pty Limited for the funds. Tonto acted as a mortgage manager for Permanent Trustee Company Limited, and in two of the three cases Permanent loaned the funds through the agency of Tonto. In the third case, Tonto loaned its own funds. When the mortgagees sued for possession the mortgagors cross-claimed, seeking to set aside the mortgages pursuant to the Contracts Review Act.

His Honour also found that there were oral terms, to the agreement between Streetwise and Tonto, including terms to the effect that: Tonto would not contact borrowers until after the loan had settled; that prior to settlement all loan application forms and other documentation to be given to borrowers would be branded with Streetwise’s name even if they in fact came from Tonto (Streetwise gave Tonto a jpeg file with its logo to aid in this masquerade); and that Streetwise would have “absolute administrative control” of the loan applications. The court found that in all three cases Streetwise not only defrauded the borrowers by having them borrow money and give it to Streetwise on false pretences, but also fraudulent misrepresentations were also made to Tonto by Streetwise by fabricating the borrowers financial particulars to satisfy Tonto’s lending requirements.

The key factual finding was that Streetwise was Tonto’s agent in dealing with the borrowers. In making this finding, Price J first acknowledged2 that the “a finance broker is… prima facie the agent of the borrower” however the position, “depends upon the individual circumstances of each case3”. His Honour then found that the circumstances of the present case justified departure from the general rule. In particular, under its agreement with Streetwise, Tonto completely entrusted to Streetwise all pre-settlement dealings with the borrower, which was of particular importance given the fact that this was Lo Doc lending in which particular reliance would be placed upon statements made by the borrower; Streetwise thus owed a duty in these dealings to Tonto and hence was acting as Tonto’s agent. As Tonto was Permanent’s agent, Streetwise was found also to be the agent of Permanent.

With the conclusion that the mortgagees knew (through the knowledge of Streetwise as agent) that none of the borrowers could repay the loans, it was a small leap to find that each of the loans constituted “asset lending”, that the asset lending was unconscionable, that the contracts were unjust, and that relief should be granted under the Contracts Review Act by setting aside the mortgages in each matter in their entirety, save that one mortgagor had to repay $50,872.60 and interest at 6.95 % due to a prior mortgage being paid out by the mortgage, this represented the only benefit that flowed to any of the mortgagors.

Price J noted4 a definition of “Lo Doc loans” in an expert report before him as being “loans where the savings history and/or income of the borrower is not fully verified by the lender when [assessing] the borrower’s capacity to pay”. In the cases before him, there were lending guidelines provided to Tonto in relation to entering into loans that provided for some limited degree of checking by Tonto of the borrower’s financial circumstances, even with Lo Doc loans, but Tonto did not comply with these guidelines. The judge was not especially critical of Lo Doc loans per se, but was critical of Tonto’s arrangement with Streetwise where Tonto was not to contact customers at all until after settlement and could therefore not itself verify information being provided to it, and where Streetwise as both a broker and property developer would have a conflict of interest in pursuing those due roles5. The judge noted the particular importance of proper preparation of the loan application and determination of the eligibility of borrowers in relation Lo Doc loans where full financial documentation was not required6.

The main implication of this decision is that lenders should ensure that neither themselves nor their originators enter into agreements with brokers in the nature of that between Tonto and Streetwise without complete confidence in the broker in question. The agreement put the mortgagees in a position where it was next to impossible to verify the financial circumstances of the borrowers due to an agreement not to contact the borrowers; the Lo Doc nature of the loans were such that there would be no documentary confirmation of the financial circumstances; yet the consequence of the arrangement was that the broker was effectively being appointed the mortgagee’s agent and hence the mortgagee would be fixed with the knowledge of the broker. Effectively Tonto and Permanent put themselves at the mercy of Streetwise’s honesty (and suffered the consequences).

1 The Herald Sun, 11 May 2009

2 At [339]

3 At [341]

4 At [5]

5 See [320]

6 At [350]

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