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The Liability of Financial Lenders for Unjust Loan Contracts

Introduction

Pursuant to the National Consumer Credit Regime and various State legislation, the courts have the power to review loan contracts provided by credit providers which appear to be unjust.

Often credit providers use third party agents such as mortgage brokers and/or managers in the loan process. In the event that a third party agent breaches the relevant legislation with respect to unjust conduct, problems can arise in determining whether or not the financial lender should be held jointly and severally liable for the breaches of their third party agent.

These problems were recently considered in the Supreme Court of New South Wales case of Permanent Trustee Co Ltd v O’Donnell [2009] NSWSC 271 (the “case”) and the outcome has significance for all financial lenders who engage third parties as part of their lending process.

Background

The case involved a complex relationship between Mr and Mrs O’Donnell (the “Borrowers”) and three other entities:

  1. Streetwise Property and Projects Pty Ltd, and Streetwise Home and Investment Loans Pty Ltd (“Streetwise”), acting as financial broker;
  2. Tonto Home Loans Australia Pty Ltd (“Tonto”), acting as mortgage manager; and

  3. Permanent Trustee Co Ltd (the “Permanent”), acting as lender and mortgagee.

In summary, Streetwise approached the Borrowers with the proposition of entering into a joint venture. The joint venture agreement required that the Borrowers take out a loan. The loan application was prepared by Streetwise and submitted to Tonto. Permanent subsequently loaned the money to the Borrowers and secured the loan with a mortgage over the Borrowers’ family home. In 2005 Streetwise went into liquidation and subsequently the Borrowers defaulted. Permanent claimed against the Borrowers for the default and the Borrowers counter-claimed that the loan agreement and mortgage were unjust.

The Unjustness of the Loan Agreement and Mortgage

The court ultimately found that the loan agreement and mortgage entered into by the Borrowers were unjust under the Contract Review Act 1980 (NSW)*. However, it was primarily the conduct of Streetwise, rather than Permanent, which made the contracts unjust. This conduct included that:

  • Streetwise knew the Borrowers did not have enough income to service the loan and inserted false details on the application so that it would not be declined;
  • Streetwise persuaded the Borrowers not to obtain independent legal advice and advised them that they did not need their own lawyers; and
  • The signing of the documents was deliberately rushed by Streetwise without the practical effect of the loan documents being explained to the Borrowers.

As Streetwise had gone into liquidation, the main issue was whether or not Permanent could enforce the loan agreement and mortgage regardless of the unjust conduct, and despite the fact that it itself had not in any way participated in the circumstances which led to each being declared unjust.

The Court ruled that Permanent could not enforce the loan contract or the mortgage.

*The loan contract was found to be within the scope of the Contracts Review Act despite the fact that it was for an investment purpose because the Court held it amounted to asset lending under the principles established in the case of Perpetual Trustee Co Ltd v Khoshaba [2006] NSWCA 41.

Why was Permanent Penalised for the Unjust Conduct of Streetwise?

The Court’s treatment of Permanent was based on the legal principle of agency. The principle of agency refers to certain situations where the law treats two entities as standing in a special legal relationship with one another. In such relationships, one entity (the “Principal”) gives authority to the other entity (the “Agent”) to act on their behalf. Just one consequence of such a relationship is that the knowledge of the Agent is said to be imputed to the Principal.

In arriving at its conclusion, the Court first looked at the relationship between Streetwise and Tonto. Based on an agreement between the two, Streetwise was required to introduce loans to Tonto. In these circumstances it was held that the two stood in an agent – principal relationship.

Partly on this basis the Court further held that Streetwise was also in an agent – principal relationship with Permanent. The Court examined the agreement between Permanent and Tonto and found that it authorised the latter to appoint sub-agents, which is what it did with the appointment of Streetwise. This, the Court held, made Streetwise an agent of both Tonto and Permanent.

On this basis, the knowledge of Streetwise regarding the true financial position of the Borrowers and their inability to service the loan was imputed to both Tonto and Permanent and as a consequence, the Court declared that the loan agreement and the mortgage were void, and Permanent were also ordered to pay the Borrowers’ costs in the proceedings.

Implications for financial lending institutions

This case makes it clear that financial lenders can not expect to avoid liability for unjust conduct committed by third parties merely because they themselves have not directly participated in the conduct deemed to be unjust. This case is also important for financial advisors, financial brokers and any other party which may be offering services to facilitate loans or other related business transactions.

Please be advised that this article is not intended to be legal advice. All advice Berrigan Doube Lawyers provides is tailored to our client’s needs and therefore our advice is on a case-by-case basis after having consideration of our client’s circumstances.

If you are a party involved in credit services and would like to know more about our services and how we can protect your interests, please contact us on (02) 9251 6699.