A naive, simplistic salesman was talked into buying a two year old business where he worked as a salesman for $2 million. He had no inkling of the businesses financials but the bank did and encouraged him. The bank also fell victim to questionable documents emanating from a broker’s office.
The parents of the borrower guaranteed the loan and put their house up as security. These were set aside by the judge on the grounds of:
- Misleading and Deceptive Conduct
- Breach of the Banking Code
- Unjustness under the Contracts Review Act
The judge was unusually suscinct and accordingly we have extracted some his comments as they tell as well as we could what happened and why:
Misleading and Deceptive Conduct by the Bank Officer
The bank officer was probably only intending to convey to borrower that the loan looked as though it would meet the Bank’s lending criteria. But to a reasonable listener in Craig’s position the statements also looked as though the Bank was vouching for the reliability of the figures that the Bank had from the vendor its other client, and the financial health of that business. This ambiguity would not have arisen if the Bank did not appear to have access to information about the vendor’s business.
The guarantors say that two particular future events did not come to pass which are therefore actionable under the ASIC Act, the business proving to be a good financially sound business as represented (it was not), and the purchase of the Business proving to be a sound investment and a good idea, as represented (it was not).
As the above analysis shows the Bank had reason to believe the Business would fail. The Banks’ available documents tended to suggest the probability of failure. Nothing can be inferred from the fact of the missing documents in the Banks’ favour.
The guartantors submit that the Bank’s misleading and deceptive conduct led them to sign the guarantees by which they suffered loss and damage.
The Bank submits there is no evidence as to the falsity of the representations made. But the answer to that is many of them are representations as to future matters and the Bank has not adduced evidence to justify the making of those representations. Had the Bank acted as a prudent banker in this transaction such evidence probably would be available.
Prudent lending – required by the banking code
It seems to me that the Banking Code means what it says, that before offering a credit facility the Bank “will exercise the care and skill of a prudent banker”. This term imports more than mere “accepted” practice, if what is “accepted practice” is not prudent practice.
Lenders who are not subscribers to the Banking Code should be aware that it is being applied, nonetheless by FOS. In Bulletin 46 FOS states:
‘We also think that the Code of Banking Practice refl ects good industry practice and is relevant to our assessment of a dispute under that criterion in our Terms of Reference’. In this way FOS applies the terms of the Code of Banking Practice to lenders who do not subscribe to the Code.
Prudent lending – failure to understand the level of risk
I accept the experts opinions that it was imprudent for the Bank to have provided these finance facilities. They said that “if the Bank had complied with its own policies and conducted itself prudently….that would have resulted in the facilities not being provided”. The Bank failed to undertake sufficient analysis to understand the level of risk in this transaction.
The expert’s opinion was that the Bank had merely inputted forecast figures into its financial model and failed to do any analysis as to what the figures were really indicating: what were the key assumptions behind the projections; were the assumptions valid; and were the assumptions justified against the historical performance of the company. I accept these opinions.
The expert agreed that it could be inferred from the historical management accounts that the business would be unable to meet its principal and interest payments on the facility being offered. The principal problem was that serviceability depended on a 47 per cent increase in revenue that was evident only in the September quarter of 2004. All the witnesses agreed that the trading for this three month period needed to be investigated further, because so much of the future loan serviceability depended on it. There is no evidence the Bank did such an investigation and that the results may have since been lost. I am not prepared to infer that such an investigation was done and is now lost. Not to do such an investigation did not confirm with prudent banking practice.
The Bank failed to undertake other relevant steps that fell short of prudent banking practice. It failed: to obtain 2 or 3 year cashflows; to undertake a marking capital analysis; or, to undertake a goodwill analysis.
The guarantors adduced expert accounting evidence that the loans were unserviceable and that that should have been obvious to the Bank. The Bank did not call any expert accounting evidence in reply. I accept the guarantor’s expert evidence that it should have been apparent to the Bank in November 2004 that its loans to Statewide could not be serviced out of the revenues of the business to be acquired.
The cashflow forecasts were “optimistic and unrealistic” in that it projected a 47 per cent increase in sales revenue despite the fact Statewide was a new company and existing management had only achieved growth of approximately 15 per cent.
Prudent lending – the forged financial advice certificates
The Financial Advice certificate bore a cluster of prominent deficiencies. In the face of such deficiencies the Bank could not reasonably, have accepted the certificate in satisfaction of the Bank’s financial advice requirement. The certificate: lacked a date for the advice given; contained inaccurate information; and claimed obsolete qualifications of the adviser. The peculiarities of the certificate strongly suggested that they had been prepared by someone other than a licenced financial adviser with current accounting qualifications. The certificate would prompt any reasonable reader (whether within the Bank or elsewhere) to verify their authenticity and accuracy directly.
I conclude that the proper financial advice (had it been obtained) would have stopped this transaction, largely because of the wife’s influence. She was a counterfoil to her husband. He was an exuberant enthusiast for acquiring the business. On his own he would have been inclined to ignore the hypothetical financial advice. He was more of a risk taker than his wife. He was focussed on his goal of acquiring and operating what he was convinced would be a profitable business; a conviction to a degree induced by the Bank’s representations.
The wife was more prudent than her husband. She impressed the Court as a woman of good judgment and where necessary firm resolve. She was quite prepared to indulge her husband’s business ambitions to a degree for the sake of marital harmony. But she was not the kind of person who, informed by the hypothetical financial advice, would have consciously accepted any significant risk of losing her Oyster Bay home. She then had young children. She seemed content with what she had. Given the hypothetical financial advice she would have refused to enter this transaction.
Prudent lending – Credit Memorandum
The expert expected, and I accept as prudent banking practice, that the Credit Memorandum was where all the relevant information about the loan should be found. That being so there was therefore little basis for the Bank to suggest that documents that were now missing from the Credit Memorandum might have made a difference.
All the experts agreed that the Bank should have obtained the original financial advisors certificates. I accept these certificates were faxed to the Bank. But no originals were obtained. If they were obtained good banking practice would have been to keep them with the Credit Memorandum. It was found but they were not. The Bank’s witnesses cannot say they obtained them. I infer they were never obtained.
These proceedings were shadowed throughout by missing Bank files.
By the time the trial started the Bank’s affidavit evidence did not make clear what had happened to its missing files. The Bank’s barrister submitted during the first week of the trial that these were “lost” files. But the then state of the Bank’s evidence was so lacking in detail that did not really justify that description.
The Bank has not adequately explained what happened to its missing and incomplete documents.
Broker not an agent
The broker agreement here is in substance indistinguishable from the agreements which in Tonto and Papa resulted in findings of no agency. Its terms, summarised here non-exhaustively, are crafted with some care to ensure the mortgage broker receives no implied or apparent authority from the Bank: the broker is appointed as an independent contractor and not as an agent; the broker undertakes to maintain its own professional indemnity insurance, to comply with all relevant laws, will assist the Bank in complying with all relevant laws, will notify the Bank if the broker becomes aware that the broker has breached the relevant law, will act at all times in good faith and with due care skill and diligence and upon the Bank’s reasonable request will provide the Bank “with access to your records relating to any applicant”, will not do anything to bring the Bank’s name into disrepute, and will not make any statements or advertisements without the Bank’s prior written consent and will not purport to act beyond its authority under the agreement.
Unjustness – the need for precautions against broker fraud
But short of proof of agency, the broker’s conduct is still relevant in other ways, especially to the guarantor’s Contracts Review Act case. When evaluating the unjustness or otherwise of a contract under the Contracts Review Act by, for example, the Court is entitled to look at the position of the mortgage originator in the overall enterprise of the Bank’s lending programs and its business structures, to see whether those structures are responsible for any misconduct of the mortgage originator towards the borrowers.
If the Bank for example, has created business structures in the operation of which mortgage originators are given the opportunity to mislead or prey upon prospective borrowers that may be a factor favouring a finding of unjustness in any resulting transaction between the borrowers and the Bank.
As the Court has already found, the financial adviser’s certificates were forged, at some point whilst these certificates were within the broker’s offices and before they were sent to the Bank. But the deficiencies in those certificates should have been obvious to a prudent banker. The Bank’s case did not explain: how the Bank vetted the character of its mortgage brokers; why the Bank’s officers failed to notice those deficiencies; what systems the Bank had in place to ensure broker fraud was either prevented or at worst detected; why the Bank had failed to utilise its powers under the broker agreement to call for original documents within the broker’s possession to verify the provenance of the financial adviser’s certificates; or, why the Bank did not take steps to find out by direct enquiry of Mr Stubbs whether he had signed the certificates. The Bank did not give a sensible account of its practices to deal with the obvious objective risks of fraud or other malpractice of brokers incentivised by commission that were realised in this case. The Bank did not establish actual practices that it had in place to ensure that it was alert to and had contained the risk of malpractice on the part of its brokers.
The situation here echoes what was said in Tonto at that some Bank – broker structures “should have guidelines enforced with real vigour to deal with the obvious risks of fraud and deception”. In my view the Bank’s failure to demonstrate in these proceedings that it had such established practices, meant that the structures behind its engagement of mortgage brokers risked that its borrowers may fall prey to fraud or malpractice on the part of mortgage brokers it had engaged. This factor is significant when considering under the Contracts Review Act the unjustness of the guarantees.
I do not find labels such as “asset lending” particularly helpful in analysing whether Contracts Review Act relief should be granted in a case such as this. But what is clear is that the Bank had reason to know the guarantors had not received financial advice.
The financial advice certificates that the Bank received were too uncertain a basis to infer such advice had been given. Moreover the Bank knew that due diligence had not been done on the vendor’s financial statements because the Bank had neither asked for, nor been given, material which would show that such due diligence had been done.
Added to that the multiple departures from prudent banking practice on the Bank’s side had the capacity to increase the riskiness of this transaction for the guarantors, warranting a finding of unjustness. The appropriate intervention in my view is that the guarantees and mortgages be declared void.