In this case an 86 year old Mother sought relief under the Contracts Review Act and the doctrine of Unconscionability in relation to a mortgage entered into at the behest of her son and substantially for his benefit. The Mother was in a nursing home at the time of the loan but nevertheless the Khoshaba principle was applied by the Court of Appeal in granting her relief (and setting aside the mortgage). This case is therefore authority for the proposition that the Khoshaba principle, which requires the property to be the borrowers’ home and sole asset extends to a situation where the borrower has moved out. Although alive at the time of the trial the borrower was dead when granted relief by the Court of Appeal. The purpose of the Contracts Review Act is to ‘protect people not able to look after themselves’. The dead certainly fulfill that description.
The need for independent legal advice
The court reaffirmed the need for independent legal advice wherever a third party mortgage is involved, with Young JA noting:
Decisions of the courts over the last 30 years have shown that transactions where a third party puts up his or her house as guarantor for a child or niece or nephew’s business purposes are ones in which the guarantor needs to be seen personally and needs to understand the ramifications of the transaction or else it may be set aside.
In addition to this general principle there is a further compounding requirement for independent legal advice in the case of family members providing security, His Honour noting:
Where a lender is lending money in a scenario where a reasonable person would be put on inquiry that there is an emotional subservience between the person getting the benefit of the borrowing and somebody else whose property is being mortgaged, then the credit provider must take precautions if it wishes to be sure that the transaction will survive attack.
Power of Attorney
The Mother’s signature was made by her son exercising a Power of Attorney. The attorney received independent advice and the court had to consider whether or not this satisfied the rules. The court held that such an arrangement was not sufficient, noting:
If a lender is to rely on independent legal advice being given to the borrower, the latter herself must receive the independent legal advice. Of course, the position would be different if the borrower were clearly incapable, or if the transaction were clearly for her benefit, or if the transaction was a purely commercial one with no flavour of possible influence from or benefit to some relative or friend.
Contracts Review Act
The lender fell down on an extended version of the Khoshaba principle, articulated by Young JA as follows:
In my view, the transaction must be judged, so far as the lender is concerned, on its taking a security over an 86 year old lady’s major asset and apparent home in circumstances where it only relied on the co-borrower’s income to service the loan and had paid no attention at all, it would seem, to what would happen if the co-borrower ceased to produce income. The possibility of an 86 year old woman being deprived of her home given as sole security for a loan to her and her son where the latter, who is the only source of the interest repayments, defaults, is hardly a matter that can be blissfully ignored by a lender wishing to protect itself from an unjust contract claim.
Thus, the lender was not allowed to rely on the existence of a fit and income-producing son as co-borrower to service the loan. The lender had to consider the possibility that the son would die of a heart attack – which is what happened. One cannot help but think that the court is here applying the wisdom of hindsight. After all, generally, mothers die before sons. The Court of Appeal even acknowledged their 20:20 hindsight, noting
When one is looking to see whether there was injustice to the co-borrower, one must take into account the possibility that something might happen to that co-borrower to affect his or her ability to make payments. This does not seem to have occurred to the lender and with respect, it does not seem to have occurred to the learned trial judge.
Failure of the lender to follow its own lending guidelines
In addition to failing to obtain independent legal advice for the Mother and not considering that one of the borrowers might drop dead, the lender also fell down, as did the lender in Khoshaba’s case, because it did not comply with its own lending guidelines.
The lender was not innocent. It was the master of the situation; it knew what to do in its operations manual and that was not complied with in a case where it was quite clear that an 86 year old lady was putting her only substantial asset on the line in a situation where she may lose the lot without herself receiving independent legal advice.
The court commented on the circumstances of when a defence of Unconscionability would succeed but a Contracts Review Act would not. The court concluded that except in those rare circumstances where the Contracts Review Act on its terms do not apply it is best for the court to consider the Act first. The difference between the two defences was described as follows:
Under the Contracts Review Act, the focus is on the weaker party as to whether the contract operates unjustly towards the weaker party. Furthermore, under the Contracts Review Act relief may be given even if the relevant circumstances are not known to the other party when the contract was entered into, but this is not the case where the allegation is unconscientious conduct.