Unconscionability in asset-based lending: lessons from Stubbings v Jams

In the recent case of Stubbings v Jams 2 Pty Ltd [2022] HCA 6, the High Court has allowed an appeal relating to asset-based lending (ABL) and the enforceability of security associated with these loans. The High Court held that whilst asset-based lending itself is not unconscionable, certain conduct may render loans and security unenforceable. The decision is a reminder that lenders should ensure the circumstances of potential borrowers are fully scrutinised prior to lending.

In this Insight we discuss the decision and lessons for lenders and borrowers alike.

Background

ABL is the practice of providing credit based solely on an assessment of the value of assets acting as security for the loan, with no consideration of a borrower’s capacity to repay the loans through income or other assets.  

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

Mr Stubbings owned two properties that were already mortgaged and otherwise had no regular income. VBC had no assets at all. 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 over his two properties, as well as the property that was acquired.  Shortly after, VBC defaulted on the loans and two of the properties were sold. 

The Lenders sought orders for possession on Mr Stubbings’ last remaining property. Mr Stubbings denied that the mortgage and loan agreements were enforceable on the grounds 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 Commission Act 2001 (Cth) (ASIC Act). 

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

At first instance, Robson J held that the loan had been procured through the unconscionable conduct of the Lenders’ agent, contrary to principles of equity and section 12CB of the ASIC Act. The Victorian Court of Appeal overturned this decision, finding that the evidence did not support the assertion of unconscionable conduct. Notably however, the primary 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, via their agent, had understood that exercising their rights under the mortgages would be unconscionable, and therefore equitable intervention was justified to protect the appellant from victimisation. The Court further held that having pro forma certificates of legal and accounting advice addressed to the Lenders were not capable of negating the Lenders’ knowledge of facts that would otherwise have made the loan transaction unconscionable.

Court’s reasons

In reaching its conclusion, the Court considered whether the actions of the Lenders constituted unconscionable conduct, including whether Mr Stubbings had a special disadvantage. In separate reasons, Gordon J determined that the actions of the Lenders’ agent constituted a contravention of the ASIC Act. 

Unconscionability

The Court noted the special disadvantage of Mr Stubbings, in that he was not capable of understanding the risks in the transaction and was in “”bleak” financial circumstances. The Court found that objectively, the “inevitable outcome” of the transaction was that the Lenders would deplete Mr Stubbings’ equity in his properties via interest payments.  

As Mr Jeruzalski had “sufficient appreciation” of Mr Stubbings’ vulnerability, his conduct in procuring the mortgages was found to be unconscientious and an exploitation of Mr Stubbings special disadvantage. 

The Court inferred that the standardised language of the certificates of independent legal and financial advice and the inaccurate statement regarding the purpose of the loan indicated the certificates were merely a ‘window dressing’ to prevent any future finding that the Lenders were wilfully blind to the danger to the appellant.

Application of Section 12CB of the ASIC Act

Gordon J in separate reasons considered the application of the ASIC Act which prohibits persons engaging in conduct in connection with trade or commerce which is unconscionable in the circumstances. 

Her Honour noted the below considerations in relation to Mr Jeruzalski’s actions as agent:

• Mr Jeruzalski prepared and advanced all loans in the same way using pro forma documents, and all loans were made to companies to avoid those loans being subject to the Code. All loans were required to be guaranteed by an individual, secured by a mortgage. Loans were invariably short-term, interest only loans with high interest rates;
  
  
• Mr Jeruzalski assumed all potential borrowers had no income and therefore assumed the loans were unbankable;
  
  
• Mr Jeruzalski was aware of the risk that such a loan would present;
  
  
• Mr Jeruzalski had a lack of information about borrowers and guarantors, did not consider the ability of the borrower to service the loan and treated the asset position of the borrower as 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 that stated the loan was not ‘for personal, domestic or household purposes’, and pro forma certificates of independent legal and financial advice. 

Her Honour noted that conduct can be considered unconscionable even where the innocent party has been a willing participant, and that the respondents’ system of conduct, particularly through Mr Jeruzalski, utilised unfair tactics and lacked good faith contrary to the ASIC Act.

Takeaways

We list our top takeaways from this matter below.

• Both lenders and borrowers should be aware of the risks involved in engaging in ABL;
  
  
• Lenders should undertake considered credit assessment of borrowers to ensure that the  borrower’s circumstances are scrutinised prior to lending;
  
  
• A short-term loan will not be sufficient to negate a borrower’s inability to service;
  
  
• Lenders engaged in ABL must test the means of the borrower to service loan, and ensure that it is the borrower benefitting from the loan. As was the case in this matter, engaging in ABL via a shelf company for the personal purposes of a guarantor is unconscionable. In above circumstances it was all the more severe considering Mr Stubbings lacked the income or means to service the loans;
  
  
• Requiring accountant and legal certificates may be meaningless if the borrower does not have an actual appreciation of the risk involved in a loan, and if that borrower is considered vulnerable;
  
  
• Reliance on the transaction documents which do not accurately reflect the position of the borrower or the nature of the loan will not prevent a finding of unconscionability;
  
  
• The actions, intentions and knowledge of circumstances of an agent in such transactions may be attributed to their principle; and
  
  
• Intentionally failing to obtain information regarding a borrower’s financial capacity will not prevent equity intervening as a response to an unserviceable loan. 

Conclusion

This decision should not inspire fear for the future of asset-based lending but should be considered a reminder to ensure lenders are conscious of the purpose of the loans they are providing and the capacity of borrowers to repay them.  

As courts have shown a willingness to intervene in certain factual circumstances, lenders should ensure the circumstances of potential borrowers are fully scrutinised prior to lending.