Introduction
Third party mortgages, where a mortgagor provides security over their property for another’s debt (often family members or partners), pose significant risks of being set aside or being only partly enforceable as unjust under the Contracts Review Act 1980 (NSW) (CRA) or s 76 of the National Credit Code (NCC) or the unconscionable under the law of equity or statute.
These risks arise particularly in improvident scenarios—transactions that are financially imprudent or reckless from the guarantor’s perspective, such as guaranteeing speculative ventures where the guarantor derives no benefit but faces loss of their home or destitution.
Lenders should avoid asset-based lending where third party loans are involved—advancing funds indifferent to repayment capacity, relying solely on security enforcement—as courts view this as unjust per Perpetual Trustee Company Ltd v Khoshaba [2006] NSWCA 41, Fast Fix Loans Pty Ltd v Samardzic [2011] NSWCA 260 and Teachers Health Investments Pty Ltd v Wynne (1996) NSW ConvR ¶55-785.
Key Legal Risks
Courts assess unjustness under CRA s 9 or NCC s 76(2) factors, including bargaining inequality, lack of negotiation, vulnerability (e.g., age, literacy, emotional dependence), absence of independent advice, undue influence, and public interest in protecting sole residences from destitution. A core concern is improvidence: entering into a loan that is inherently unwise, often where the guarantor gains little or no benefit, the venture is speculative, and default risks homelessness without realistic repayment means.
As noted in Pasternacki v Correy [2000] NSWCA 333, improvidence arises from the transaction’s folly, compounded by lender knowledge (or indifference) to the guarantor’s inability to service the debt. Asset lending to vulnerable parties, without verifying serviceability or loan purpose, offends even if the lender lacks actual knowledge of disadvantage (Khoshaba; Elkofairi v Permanent Trustee Co Ltd [2002] NSWCA 413).
Third-party guarantees for unproven businesses are inherently speculative and often unenforceable if the guarantor risks hardship without benefit, as in Melverton v Commonwealth Development Bank of Australia (1989) NSW ConvR ¶55-484. Public interest weighs against such improvident loans, balancing contract enforcement with protecting vulnerable parties from exploitation (Karamihos v Bendigo and Adelaide Bank Ltd [2013] NSWSC 172).
Firm Approach to Assessment
We evaluate third-party mortgages based: guarantor’s benefit (actual not contrived), relationship dynamics (e.g., de facto vs married; parents vs children), venture nature and inherent viability, and serviceability without recourse to the security. Loans are refused if they are improvident—e.g., where the guarantor (often elderly or dependent) pledges their sole asset for a high-risk venture with no personal gain, creating a “bridge too far” scenario (per Karamihos).
We assess for signs of emotional pressure or undue influence, which exacerbate improvidence.
We have found that all the myriad of tests, cases and rules can be boiled down to one simple hypothetical question, if the guarantor/mortgagor had a skilled, intelligent, sibling or child in their 40s, who had 20 years experience as an insolvency accountant, would they be likely to advice their sibling/parent to enter the transaction. If the answer is No then our clients should walk away.
Note that this is the test only for third party loans – not loans in general. The court’s are generally willing to hold people to their bargain where they are risking their home for a business, if it is a genuine business venture (and they are not simpletons being duped by a scammer – like in Khoshaba).
Mitigation of risks
Where the loan passes our experienced insolvency practitioner test we may still require the following steps to mitigate risks:
- Verifiable independent financial advice for guarantors, ensuring comprehension of risks, serviceability, and commercial wisdom (beyond form certificates; per Provident Capital Ltd v Papa [2013] NSWCA 36).
- Evidence of voluntary consent, free from undue influence or pressure.
- Verified enquiries into loan purpose, borrower’s/guarantor’s income, and exit strategies.
If you are concerned about a scenario contact Matthew Bransgrove by email for complimentary written advice.
