There is a practice in the commercial mortgage industry to refuse to lend except to company borrowers. We advise our lender clients to adopt this practice. The reason for the practice is that neither the commercial lender, or their solicitor, wants any doubt as to whether they are illegally making a coded loan.
Technically a non Code-regulated loan can be made to an individual (for their business). However if the individual uses more than half of the proceeds for personal purposes (or lies about the origin of the debt being refinanced) the lender can be found to have broken the law by making a Code-regulated loan without a licence and without the required paperwork & enquiries.
Fun fact: Under s13 of the Code if a lender honestly, after reasonable enquiries, in all good faith, asks a borrower to make a declaration that credit is for business purposes, and the borrower lies, the lender is subject to 2 years imprisonment (strict liability). Unsurprisingly after ASIC agitated to have that genius clause added to the Code back in 2010 no lender ever asked for a declaration again. It would less Orwellian to remove declarations from the Code entirely rather than have the section sit as a macarbe Kafkaesque intimidation of the commercial mortgage lenders by the buerocratic class.
Most of these loans, if fully vetted, would qualify as a business loan if made to an individual. However to avoid having to make enquiries (or be subject to to 2 years in prison strict liability) most non-bank commercial lenders simply apply a blanket rule that the borrower must be a company. It is what is called a safe harbour provision.
There are no anti-avoidance provisions under the Code so all loans to Company Borrowers are technically not coded.
If you read the High Court decision of Stubbings v Jams 2 Pty Ltd [2022] HCA 6 you will see the use of a contrived company borrower was mentioned in passing by the High Court in finding against the lender. Here is the quote:
[The] system facilitated the making of interest-only loans to companies (avoiding the operation of the National Credit Code), where the loans were guaranteed by persons who he assumed had no income and were otherwise unbankable, whilst deliberately avoiding any knowledge that might enliven the court’s equitable or statutory jurisdiction to set aside unconscionable transactions. It may be inferred that the system assumed that some borrowers and guarantors would be vulnerable in a sense capable of enlivening that jurisdiction.
Thus the crux of the decision against the lender was not the contrived avoidance of the Code, which is techniocally legal, but that the lender:
deliberately avoiding any knowledge that might enliven the court’s equitable or statutory jurisdiction to set aside unconscionable transactions
Thus where there is a company borrower (even if it is contrived) the application of the Code is not the danger, the real danger are Unjustness and/or Unconscionability defences because of either:
- Circumstances the lender or its solicitor discovered from enquiries;
- Circumstances the lender or its solicitor would have discovered had they made reasonable enquiries (wilful blindness).
Thus our advice and approach, so long as there is a company borrower, is to ignore the Code, and focus on making reasonable enquiries to ensure there are no unjust or unconscionable circumstances. For example: “Is the borrower a commercially unsophisticated or otherwise vulnerable person being scammed by a third party” or “Is it a wholly improvident investment that is bound to be lost by a commercially unsophisticated mortgagor like Khoshaba’s case?”
Get those questions right and you won’t end up in Court.
ASIC is currently suing Oak Capital, the pleadings can be found here. In those pleading what ASIC argues, in essence, is that lending to a company where the money is being used by an individual (and thus contriving to avoid the Code) is unconscionable under the ASIC Act.
Put another way, they are arguing that exploiting a legal loophole is unconscionable. This is not a novel argument for ASIC and it has never won. The argument is doomed to fail for the following reasons:
- Taken to its logical extreme the proposition is “what the law says is non-determinative, instead you need to abide by what ASIC thinks the law ought to be”.
- The High Court has repeatedly made clear the focus of statutory unconscionability is exploitation of the vulnerable.
Here is Gageler J’s majority High Court judgement in ASIC v Kobelt a case involving book-up credit provided to members of an indigenous community which ASIC argued was unconscionable:
The system of conduct occurred consensually, over a considerable period without more than occasional complaint or expression of dissatisfaction and at an ‘intersection’ between the distinctive culture of the Anangu people and the culture of wider Australian society. The continuation of the book-up credit relationship was not the involuntary consequence of the operation of the system but a matter of choice on the part of those customers. … The vast majority of the customers had a rudimentary but adequate understanding of the basic operation of the book-up system, but chose to continue to participate in the system. The system could not be characterised as involving exploitation of those customers’ vulnerability.
Applying this reasoning to the Oak case:
The system of conduct occurred consensually, over a considerable period without more than occasional complaint or expression of dissatisfaction. The deliberate avoidance of the Code was not the involuntary consequence of the operation of the system but a matter of choice on the part of those customers who could not obtain Code-regulated credit. … The vast majority of the customers had a clear and adequate understanding of the rights they would not have under the loans, but chose to continue to participate in the system because they would otherwise have no access to credit. The system could not be characterised as involving exploitation of those customers’ vulnerability.
In our opinion ASIC’s purpose in bringing this case is to be able to present the lost decision to the Attorney General with the argument that it “opens the floodgates” and is now incumbent on the legislature to close the loophole because otherwise the decision gives licence to all lenders to avoid the code.
It should be noted that the loophole existed in the old Uniform Credit Code and was deliberately left in place when the current NCCP code was drafted.
Arguments against closing the loophole
- Saying to a lender, “not only do you have to make reasonable enquiries as to the vulnerability of the borrower, you also have to investigate the provenance of the existing debt on the property (which with small business owners is often mixed up with their personal debt) and/or see to the application of the funds” is onerous to the point where most lenders will likely exit the market.
- Private lenders and small companies do not have the resources to undertake the enquiries which large banks carry out. They would simply be excluded. Their exclusion would reduce competition and send the cost of credit skyrocketing. In the current climate private lending has grown so large because the banks have been throttled by APRA. This would apply the throttle to the entire sector.
- Many loans would become unviable because even if a lender has the resources to carry out the enquiries (a bank) and the borrower has the paperwork, the cost of doing so would be too great.
- There are thousands of loans being done to willing borrowers with genuine businesses that would simply not be done anymore. This is because if they were bankable deals the banks would already be doing them.
- The contraction of credit availability in Australia will contract economic activity in Australia.
- The existing laws already protect the vulnerable, so what would be the purpose of all this additional paperwork and economic contraction? A: to expand the size and scope of ASIC. ie: bureaucratic gluttony for power is what motivates ASIC.
- Hernando de Soto, is a Peruvian economist best known for his books The Other Path and The Mystery of Capital, in which he argued that the inability of ordinary people in developing countries to formalise their assets and use them as collateral for loans is one of the main reasons those economies remain poor. His insights highlight the link between legal frameworks, access to credit, and national prosperity.
“The poor stay poor not because they lack assets, but because they lack the legal means to turn those assets into credit.”
(The Mystery of Capital)
“Without access to credit, the assets of the poor remain dead capital, incapable of generating investment or growth — and that is what condemns nations to underdevelopment.”
(The Other Path)
By closing this ‘loophole’, whose only offence is that it excludes the jurisdiction of ASIC , large numbers of legitimate loans would cease to be made and the resultant negative economic impact would hurt all Australians. Even ultimately, bureaucratic, CPI indexed incomes.