A securitisation funder bought a loan book associated with mortgages originally funded by a bank and became subject to the bank’s obligations in its origination deeds. The originator’s employee stole money from borrowers by carrying out fraudulent redraws, which went undetected for 7 years because the originator had no system in place to cross-check redraws placed in the software system against written borrower requests and admitted this in evidence. The fraud was only uncovered when the fraudster went on leave and a disgruntled customer complained to another employee. The money was not recovered from the fraudster and the funder suffered loss. The funder sued the originator, the guarantor of the originator and the fraudster for damages, alleging the circumstances on the fraud were a breach of the origination deeds and also constituted misleading and deceptive conduct. The funder ceased to pay management fees as a result of the breach.
However the primary action was brought by the originator against the funder claiming breach of contract and misleading and deceptive conduct for charging an annual fee and the originator sought final injunctions restraining the funder from doing so. The funder denied any breach.
Cross-claim for breach of contract
The terms of the deeds required the originator to take such steps as would be taken by a reasonably prudent mortgagee in relation to each re-draw. The court found that the originator breached this obligation. The court said:
This flaw in procedure was particularly egregious in circumstances in which redraws could be obtained from ANZ without any signature from a borrower but through the simple completion of an on-line form by an employee of the originator, which form could then be forwarded to ANZ electronically.Because of the above, the originator effectively equipped their fraudulent employee with the wherewithal to:
- Identify (through personal contact with borrowers and access to their account balances) those borrowers less likely to notice fraud;
- Plausibly assert that the those borrowers had made redraw requests;
- Complete and submit redraw requests to ANZ;
- Avoid any audits by knowing the audit procedures (for example by limiting redraw amounts to less than $10,000 per redraw) and being the boss of those conducting such audits; and
- Hide any complaints made by the borrowers.
The court found that if a proper system had been in place, the frauds would have been detected quickly. The court found that the originator breached the deeds. The court held the funder entitled to damages and rejected that damages were too remote upon either basis put forward by the originator, namely (a) on the basis that the funder acquired the loan through a trust of which it was sole beneficiary or (b) on the basis that the funder was a securitisation funder and so suffered loss through funds being used from the reserve account that the structure provided for or because the receipts would be less because the defrauded borrowers would not be paying any interest. The court said:
A reasonable person in the originator’s position would have recognised that if there was fraud on any loan account (itself a matter within reasonable contemplation) it was more likely than not that the legal owner of the loan would not suffer any loss, but that the loss would be incurred by the beneficiary for which the legal owner held title. This is precisely what has occurred.
The court noted this was indeed not unusual where the funder proposed to securitise the loans.
The court held that the originator was liable for the fraud and it did not matter that the act was a criminal act if the act was within the scope of employment. The court said:
The employee’s actions did not involve assault or pick-pocketing but using the very procedures and computer systems she was trained in and given access to in the course of her employment.
The court found that so far as the lender was concerned, the originator had the requisite authority to effect the redraws because she had been given access to and capacity to use the software system to effect redraws and did so as part of the originator’s business. The court found the originator breached its obligation in the deeds to manage the loans in an efficient and businesslike matter.
The court said:
Whatever the precise test for scope of employment in the context of vicarious liability in the case of the fraud of an employee, the test is satisfied in the present case. Her action were undertaken in ostensible pursuit of the originator’s business and in the apparent execution of authority which the originator had held out to the funder and which she, in her role as Client Services Manager, enjoyed. It is the identification of what the employee was actually employed to do and held out as being employed to do that is central to any inquiry about course of employment.
The court found that the employee committed her fraudulent acts as a representative and in the course of the originator’s business and as such, were taken to be those of the originator.
Cross-claim for misleading and deceptive conduct
The court also found that the originator engaged in misleading and deceptive conduct because it represented falsely that customers had requested redraws. In this regard, the court noted that the test under the Trade Practices Act in section 84 for performing an act “on behalf of” a corporation is more widely cast that the test under the law of vicarious liability, as the expression includes any act engaged in the conduct in the course of the corporation’s business, affairs or activities.
The court held the guarantor of the originator also liable for the breaches and conduct. The court found that the guarantor’s release in respect of matters after a certain date did not save him from liability because whilst the fraud only came to light after that date, the fraud was committed before that date. The court noted that guarantees are construed according to their reasonable commercial meaning. The court found that the funder suffered loss when it paid for the purchase of the book on the basis of the loan amounts, irrespective of the fact that it did not know at that time of the fraud.
The court found that the funder was entitled to treat each breach as an Event of Default under the deeds and to require the originator to repurchase the loans based on the deeds. The court rejected that the funder’s notice of default to the originator was invalid because it failed to specify a payout figure and found that it just meant that the originator was not in breach by failing to pay the payout figure within seven days after notice was given. However this was ultimately immaterial because the originator was not entitled to management fees in the event of there being an Event of Default, which had occurred, and the deed made the determination of that a matter for the funder to determine. Further, the fact that the fees were disputed by the originator did not mean that the funder had to keep paying fees while the issue was being resolved. The court found that the funder did not act unconscionably in its dealings with the originator by doing business with the originator after the fraud was discovered, noting that it did serve a default notice and made clear it reserved its rights under the deed.
Originator’s misleading and deceptive conduct claim against the funder
The court found that the funder was entitled to impose new fees and it was not unconscionable or misleading and deceptive in doing so and was not done to introduce a new term into the loan agreements. The court said:
The idea that the funder had to audit its own costs before it could properly say to borrowers that it was imposing a fee to contribute to loan administration costs is fanciful. No one is suggesting that there were no such costs or that the annual fee was so far outside the bounds of an amount that would contribute to the covering of those costs that a reasonable person could not have reasonably believed a fee of that amount would perform the cost contribution function…The fact that the fee would be likely to increase the funder’s profit does not mean it was not a cost covering exercise.
Originator’s breach of contract claim
The court also noted that the related breach of contract claim was misconceived because even if the introduction of the fee breached the loan agreements which it did not, any loss was that of the borrowers not the originator, who was not a party to the loan agreements.
The originator’s claims were dismissed, the injunction dissolved and the funder succeeded on its cross-claim.