Introduction
A mortgage is improvident when, judged at the time it was given, it was plainly against the mortgagor’s interests. Typically the mortgagor gets little or nothing out of it. The property at risk is usually their home or only significant asset. And there is no realistic way the debt will be repaid other than by selling that property.
Improvidence is not a cause of action in itself. It is the common thread that runs through almost every case in which a lender loses its security, whether under the Contracts Review Act 1980 (NSW) (CRA), s 76 of the National Credit Code (NCC), or the equitable and statutory doctrines of unconscionable conduct. An improvident transaction does not of itself defeat a mortgage. What courts will not tolerate is an improvident transaction combined with a lender who knew, ought to have known, or chose not to find out that the mortgagor was in a vulnerable category and the loan was improvident.
What Makes a Mortgage Improvident
The warning signs we see most often are:
- No benefit to the mortgagor. The loan funds someone else’s business, debts or purchase, and the mortgagor receives nothing real in return.
- The home is the security. The mortgagor stands to lose the roof over their head, often late in life with no prospect of rebuilding.
- No exit except sale. There is no income, refinance or business revenue capable of servicing and repaying the loan.
- A speculative purpose. The funds go into an unproven venture, a failing business, or a “one last chance” rescue of existing debts.
- Terms that erode the equity. High default rates, capitalised interest and short terms mean the mortgagor’s equity is consumed even if nothing else goes wrong.
What Improvidence Is Not
A loan is not improvident merely because it went bad. The question is asked at the time the mortgage was given, not with hindsight. Courts are generally willing to hold borrowers to their bargain where they risk their own home on their own genuine business venture. The danger zone is the vulnerable mortgagor who risks everything for someone else’s venture, or who never understood what they were risking.
How Improvidence Defeats a Mortgage
| Route | What the court looks at | Where improvidence fits |
|---|---|---|
| CRA ss 7 and 9 | Whether the contract was unjust in the circumstances at the time it was made, including bargaining power, independent advice, and the mortgagor’s age, literacy and circumstances | A central factor. An improvident mortgage given by a vulnerable person with no real advice is the paradigm unjust contract |
| Unconscionable conduct: equity, and s 12CB of the ASIC Act 2001 (Cth) | Whether the lender took advantage of a mortgagor under a special disadvantage | Strong evidence that the disadvantage was exploited (Commercial Bank of Australia v Amadio [1983] HCA 14; Stubbings v Jams 2 Pty Ltd [2022] HCA 6) |
| Volunteer sureties | Whether a mortgagor who received no benefit understood the transaction | The absence of benefit is itself the trigger (Garcia v National Australia Bank Ltd [1998] HCA 48) |
| NCC s 76 | Whether the lender knew, or could have found out by reasonable inquiry, that the debtor could not repay without substantial hardship | Relevant wherever a loan turns out to be regulated (see our National Credit Code policy) |
Asset Lending: Indifference Is Not a Defence
Lenders who advance funds by reference only to the value of the security, and who are indifferent to whether the loan can be repaid, are treated harshly. A lender does not need actual knowledge of the mortgagor’s predicament. Shutting its eyes to serviceability and purpose is enough (Perpetual Trustee Company Ltd v Khoshaba [2006] NSWCA 41; Elkofairi v Permanent Trustee Co Ltd [2002] NSWCA 413). In Stubbings, the High Court described a system of company borrowers, intermediaries and boilerplate certificates as wilful blindness.
Lending to Companies Does Not Cure It
A director, parent or partner who mortgages their home to secure a company’s loan can still have that mortgage set aside. In Stubbings the borrower was a company with no assets that never traded, and the mortgages given by the individual behind it were still held unenforceable.
Certificates Do Not Cure It Either
Certificates of independent legal and financial advice are necessary, but they cannot turn an improvident transaction into a provident one. Form certificates obtained through the borrower’s broker or the lender’s agent carry little weight (Stubbings; Provident Capital Ltd v Papa [2013] NSWCA 36). If the transaction is a bad idea for the mortgagor, a certificate saying they were told so does not make it a good one.
The position changes when the lender ignores serviceability, the security is the home, and the mortgagor is vulnerable. Basten JA explained in Khoshaba at [128]:
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 categories of vulnerable mortgagor we see most often are:
- elderly mortgagors and pensioners (see Elderly Borrowers);
- parents securing a child’s venture (see Parent Mortgages);
- mortgagors with limited English, literacy or financial understanding;
- mortgagors under emotional pressure or dependence, typically from family or a partner (see Third Party Mortgages).
Our Approach
Before a loan proceeds, we ask four questions:
- Who actually benefits from the loan, and is the mortgagor’s benefit real or contrived?
- How will the loan be repaid without selling the security?
- What does the mortgagor lose if the venture fails?
- Would an experienced insolvency accountant advise their own parent or sibling to sign? (See our Third Party Mortgages policy.)
If the answers point to improvidence, we advise our clients to walk away. That applies with particular force where the mortgagor is elderly (Elderly Borrowers) or the security is a parent’s home (Parent Mortgages).
Conclusion
An improvident mortgage is the one most likely to be challenged and the one least likely to survive the challenge. No amount of documentation or making grandma a shareholder, or getting the daughter with the failed business to go on title as a tenant in common, will rescue it. The protection lies in declining the loan, not in papering over it.
If you are concerned about a scenario, contact Matthew Bransgrove by email for complimentary written advice.