TGIF 20 May 2022 - High Court finds lenders not entitled to rely on certificates of independent advice

This week's TGIF considers Stubbings v Jams 2 Pty Ltd [2022] HCA 6, in which the High Court overturned a finding by the Victorian Court of Appeal and confirmed that certificates of independent advice will not always protect lenders from an unconscionability claim. This case was previously considered in a Corrs insight article around unconscionability in asset-based lending.

Key Takeaways

• As the law recognises that wilful blindness to the obvious constitutes knowledge, schemes designed by lenders to specifically avoid becoming aware of a borrower's inability to service a loan will not avoid a claim in unconscionability.
  
  
• Where there is a possibility or suspicion that the borrower does not entirely understand the implications of a financial transaction, active steps should be taken to ensure they do understand such implications before a borrower signs on the dotted line.
  
  
• Certificates of independent advice will not be an absolute defence to an adverse claim made by a borrower against a lender. Lenders should be careful not to influence the way in which a borrower obtains independent advice and should err on the side of caution by making their own inquiries. 

The facts

Stubbings wished to buy a house in which to live. However, he was in 'bleak' financial circumstances. He was unemployed, had no savings or income source and had little commercial knowledge. His only assets were two mortgaged investment properties in Victoria. He tried to obtain finance from a bank but was unable to do so. 

Stubbings met with Zourkas, a consultant, to discuss obtaining a loan from Jams 2 Pty Ltd (the Lender) to purchase a property. Stubbings eventually purchased a property for $900,000. The method by which the loan was advanced was complex. The loan scheme required the borrower to be a company, which in this case was a shell company of zero value, of which Stubbings was the sole director and shareholder. Stubbings provided a guarantee and indemnity and used his two investment properties as security.

The Lender used Mr Jeruazalski of AJ Lawyers as its agent and Mr Zourkas as its intermediary.

Stubbings never met directly with either the Lender or AJ Lawyers – Zourkas was always the intermediary.

To enhance the enforceability of the loan, Stubbings was required to obtain two certificates of independent advice, which were drafted by AJ Lawyers. Stubbings had each certificate signed by a professional, both of whom were recommended by Zourkas.

As expected, the borrower company defaulted and a demand was issued to Stubbings pursuant to the guarantee. Stubbings commenced proceedings on the basis that the loan was unconscionable.

Trial and Court of Appeal decisions

At trial, Justice Robson found that Stubbings was in a position of special disadvantage, noting that he misunderstood his rights and obligations under the loan agreements and was “completely out of his depth”.

Robson J further found that the actions of AJ Lawyers constituted willful blindness as to Stubbings' financial and personal circumstances and, as such, constitutedunconscionable conduct. Accordingly, as knowledge of the agent is imputed to the principal, the Lender was also wilfully blind as to Stubbings’ circumstances and guilty of acting unconscionably. This decision was appealed.

The Court of Appeal agreed that Stubbings was at a special disadvantage but disagreed that the Lender's conduct was unconscionable on the basis that Stubbings had provided the certificates of independent advice.

High Court's decision

The High Court disagreed with the Court of Appeal and, consistent with the trial judge, found that AJ Lawyers, as agent for the Lender, was wilfully blind and acted unconscionably in failing to make necessary enquiries concerning Stubbings' personal and financial circumstances.

The Court found that:

• AJ Lawyers’ knowledge that Stubbings had no income and that the structure of the loan was 'risky and dangerous' was sufficient to establish that Stubbings was in a position of disadvantage, such that relevant enquiries should have been made;
  
  
• the Lender, as the principal, was also fixed with its agent’s knowledge of the special disadvantage, about which they had deliberately abstained from enquiring; and
  
  
• the certificates of independent advice did not protect the Lender from being fixed with that knowledge because:
  
  
  • the certificates were general in nature and fell far short of a written warning about the risks Stubbings faced;
    
    
  • however construed, the certificates could not negate AJ Lawyers’ actual appreciation of the dangers of the loans and Stubbings' vulnerability;
    
    
  • the advisors who signed the certificates were not truly independent because their fees would be withheld if they refused to provide the certificate; and
    
    
  • the certificates stated that the advice was given to the borrower company and not to Stubbings.

Finally, the Court found that the lending structure and the way the lending was procured (such that Stubbings never met with AJ Lawyers or the Lender) had been deliberately designed to put a claim ofunconscionability out of the reach of Stubbings.

Conclusion

The mere fact that a certificate of independent advice has been provided will not be enough to protect lenders where the circumstances are such that further enquiries ought be made.

Rather, lenders should take care in financing loans and err on the side of caution in making all necessary inquiries themselves, separate from any independent advice. This will be particularly important in areas such as asset-based lending, where the ability to service repayments is inherently questionable.