The unreasonableness of asset-backed lending – lessons from Stubbings v Jams

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In the recent case of Stubbings v Jams 2 Pty Ltd [2022] HCA 6, the High Court allowed an appeal regarding asset-backed loans (ABLs) and the enforceability of collateral associated with such loans. The High Court held that while asset-based lending in itself is not unreasonable, certain behaviors can render loans and guarantees unenforceable. The decision recalls that lenders must ensure that the situation of potential borrowers is fully examined before lending.

In this preview, we discuss the decision and the lessons for lenders and borrowers.

context

ABL is the practice of providing credit based solely on an assessment of the value of the assets serving as collateral for the loan, without regard to the borrower’s ability to repay the loans through income or other assets .

The respondents, Jams 2 Pty Ltd, Conterra Pty Ltd and Janaco Pty Ltd (Lenders) granted an asset-based loan to Victorian Boat Clinic Pty Ltd (VBC). The appellant, Mr. Stubbings, was the sole director and shareholder of VBC. The loan was arranged through Mr. Jeruzalski, a lawyer, acting as the lenders’ agent.

Mr. Stubbings owned two properties that were already mortgaged and otherwise had no regular income. VBC had no assets. The purpose of the loan was to enable Mr Stubbings to purchase a third property in his own name. Mr. Stubbings guaranteed the loan granted to VBC and granted mortgages on its two buildings as well as on the acquired building. Soon after, VBC defaulted on the loans and two of the properties were sold.

The lenders sought possession orders on Mr Stubbings’ last remaining property. Mr Stubbings denied that the mortgage and loan agreements were enforceable on the ground that the respondents had engaged in misleading and deceptive conduct pursuant to section 18 of the Australian Consumer Law and section 12CB of the Australian Securities and Investments Act 2001 (Cth) (ASIC Law).

Further, Stubbings alleged that the National Credit Code (Coded) applied to the mortgage and loan agreements and had not been complied with by the respondents.

At trial, Robson J found that the loan had been obtained through the unreasonable conduct of the lenders’ agent, contrary to the principles of fairness and section 12CB of the ASIC Act. The Victoria Court of Appeal overturned that decision, finding that the evidence did not support the claim of unreasonable conduct. Notably, however, the lead judge’s findings that there were no circumstances in which the repayment plan was feasible were not challenged on appeal.

Decision

The Court held that the lenders, through their agent, understood that the exercise of their rights under the mortgages would be inadmissible and that fair intervention was therefore warranted to protect the appellant from victimization. The Court further held that having pro forma certificates of legal and accounting advice directed to the lenders was not capable of negating the lenders’ knowledge of facts that would otherwise render the loan transaction inadmissible.

The court’s reasons

In reaching its conclusion, the Court considered whether the actions of the lenders constituted impermissible conduct, including whether Mr. Stubbings was at a particular disadvantage. In separate grounds, Gordon J determined that the actions of the lenders’ agent violated ASIC law.

Unreasonable

The Court noted the particular disadvantage of Mr. Stubbings, in that he was unable to understand the risks of the transaction and that he was in a “bleak” financial situation. The Court concluded that objectively, the “inevitable result” of the transaction was that the lenders would deplete Mr Stubbings’ equity in his properties via interest payments.

As Mr. Jeruzalski had a “sufficient appreciation” of Mr. Stubbings’ vulnerability, his conduct in obtaining the mortgages was found to be irresponsible and an exploitation of Mr. Stubbings’ particular disadvantage.

The Court inferred that the standardized language of the certificates from independent legal and financial advisers and the misrepresentation regarding the purpose of the loan indicated that the certificates were only a “frontage” to prevent any future conclusion that the lenders were deliberately blind. danger to the caller.

Application of Section 12CB of the ASIC Act

Gordon J, in separate reasons, considered the application of ASIC law which prohibits persons from engaging in conduct in connection with trade or commerce which is impermissible in the circumstances.

His Honor has noted the following considerations regarding Mr. Jeruzalski’s actions as an agent:

  • Mr. Jeruzalski prepared and advanced all loans in the same manner using pro forma documents, and all loans were issued to companies to avoid such loans being subject to the Code. All loans had to be privately guaranteed, secured by a mortgage. Loans were invariably short-term, interest-only loans with high interest rates;
  • Mr. Jeruzalski assumed that all potential borrowers had no income and therefore assumed that the loans were unbankable;
  • Mr. Jeruzalski was aware of the risk that such a loan would present;
  • Mr. Jeruzalski lacked information about the borrowers and guarantors, did not consider the borrower’s ability to service the loan, and considered the borrower’s asset position to be irrelevant;
  • Mr. Jeruzalski refused to meet, communicate or negotiate with potential borrowers, instead communicating through intermediaries; and
  • Mr. Jeruzalski used pro forma documents to facilitate the loan, including a deed stating that the loan was not “for personal, household or household purposes”, and pro forma certificates of independent legal and financial advice.

His Honor noted that the conduct may be considered objectionable even where the innocent party was a willing participant, and that the Respondents’ conduct system, particularly through Mr. Jeruzalski, used unfair tactics and breached good faith contrary to ASIC law.

Take away food

We list our top takeaways on this below.

  • Lenders and borrowers should be aware of the risks involved in engaging in ABL;
  • Lenders should undertake a thoughtful credit assessment of borrowers to ensure that the borrower’s situation is carefully considered before lending;
  • A short-term loan will not be enough to reverse a borrower’s inability to service;
  • Lenders engaged in ABL must test the means of the borrower to service the loan and ensure that it is the borrower who benefits from the loan. As was the case here, engaging in ABL through an inactive company for the personal needs of a guarantor is inadmissible. In the above circumstances, it was all the more serious because Mr. Stubbings had no income or means to repay the loans;
  • Requiring accounting and legal certificates may be meaningless if the borrower does not have a real appreciation of the risk associated with a loan, and if this borrower is considered vulnerable;
  • Relying on transaction documents that do not accurately reflect the position of the borrower or the nature of the loan will not prevent a finding of unconscionability;
  • An agent’s actions, intentions, and knowledge of circumstances in such transactions can be traced to their principle; and
  • Intentionally not obtaining information about a borrower’s financial capacity will not prevent equity from stepping in in response to an unusable loan.

Conclusion

This decision should not inspire fears for the future of asset-based lending, but should be seen as a reminder to ensure that lenders are aware of the purpose of the loans they provide and the ability of borrowers to repay them.

As the courts have shown their willingness to intervene in certain factual circumstances, lenders must ensure that the situation of potential borrowers is fully examined before lending.

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