Small v Gray [2004] NSWSC 97

The case concerned a loan taken by a couple to purchase a house. Because the couple did not have any savings, the loan taken covered both the cost of the house and the stamp duty and legal fees associated with its purchase. The lenders required the mother and father of the husband to put up their family dwelling as security for the loan.

When the couple fell into default of the loan, the lenders sought to enforce the mortgage over the parents’ property. It is accepted between the parties to the proceedings that the father’s signature was forged and only the mother had signed the mortgage. The mother sought relief from the mortgage on the basis that the mortgage was unjust under the Contracts Review Act 1980, or alternatively, the lenders’ unconscionability.

1. Review of the mortgage under the Contracts Review Act

Under the provisions of the Contracts Review Act, the Court has the discretion to refuse to enforce a contract, or a provision therein, if the contract or its provision is unjust.

As held in West v AGC (Advances) Ltd [1986] 5 NSWLR 610, a contract will not be unjust unless the contract or one of its provisions is the product of unfair conduct on the part of the lender either in the terms which the lender has imposed or in the means which he has employed to make the contract.

These two kinds of injustice are often described “substantive injustice” and “procedural injustice”.  Most unjust contracts will be the product of both procedural and substantive injustice.

As noted by McDougall J in paragraph 84(2) and (3)

A contract may be found to be unjust but nonetheless, in the exercise of its discretion, the court may refuse to grant relief.

Where a contract has been found to be unjust, it would in general be unsound to grant relief under s 7 where the party against whom relief is claimed was both innocent and ignorant of the circumstances giving rise to that injustice.

(a) Is there a contract?

The preliminary question is whether there exists a mortgage contract between the mother and the lender, which can be the subject of a review.

McDougall J held that even though the husband had not signed the mortgage, the fact that the wife had signed the mortgage meant that at law, there was a mortgage contract between the lenders and the wife because of a clause in the contract, which provided that a singular term includes the plural and vice versa. The result is that the contract can be reviewed for ‘unfairness’ under the Contracts Review Act.

(b) Was the mortgage unjust?

McDougall J found that the mortgage was procedurally unjust because of the following main factors:
(1) The mother was misled by her son into believing that the mortgage was only to secure a loan for the deposit for house, where in fact the mortgage secured a loan for the entire purchase price of the house.

(2) The mother was under a misunderstanding that her son and daughter in law would refinance the loan within 6 months, as a result of which thought there would be no risk for her.

(3) When the mother engaged a lawyer in relation to the mortgage contract, she was misled by her lawyer into believing that the mortgage was not enforceable against her until it was also signed by the father.

a. Her lawyer did not explain to her whatsoever, the financial implications of her signing the mortgage.

b. Further, the property was bought ‘as an investment property’, which meant that the Consumer Credit Code was not applicable to the loan contract or to her mortgage, which supported the loan contract. Her lawyer did not adequately explained to her that as a result of this, she would lose the benefits conferred to her under the Code, which included, more stringent disclosure requirements on the part of the lender and certain restrictions on enforcement proceedings that could be undertaken by the lender upon the event of a default under the loan.

(4) The loan was reviewed by an accountant before being approved by the lenders. The accountant was engaged to assess the viability of the loan and the financial position of the mother and the couple. McDougall J found that the accountant had not properly investigated the financial circumstances of the mother and the couple and as such certificate which he later furnished to certify the viability of the loan was both false and misleading.

Furthermore, McDougall J found that because of the following factors, the mortgage was also substantively unjust:
(1) The mother’s interest in the mortgaged property is her only substantial asset. 

(2) She had no income from which she could hope to keep up payments under the mortgage if her son and daughter in law fell into default on the loan.

(3) The amount borrowed ($270,000) for the purchase of son’s house was more than the purchase price ($240,000) and more than the value of that property ($240,000).

  (4) Thus, barring some substantial increase in property values, it was highly likely (if not inevitable) that if the son and daughter-in-law made default- particularly in the early months of the loan – then the mortgaged property would need to be sold to cover the debt. 

(5) Lastly, the mother took no interest in the house purchased by the son and the daughter in law. The house was to be purchased in their names only.
In summary, McDougall J found that the contract was improvident in the highest from the perspective of the mother.  She received no part of the loan funds, and nothing of value. However, it put at substantial risk her dwelling and only asset of significance.  It was inevitable that if she were called upon to perform her obligations, of which there is a real likelihood, she would lose her dwelling.

(c) Relief to be granted from the unjust mortgage

Although his Honour found that the lenders were innocent and ignorant of the circumstances giving rise to procedural injustice, all of which were not the product of the lender’s actions, his Honour held that the lenders were not ignorant of the factors giving rise to the substantive injustice of the mortgage. For example, the lenders were aware of the valuation of the purchased property and amount of the loan; the lenders were aware that the property was to be purchased in the names of the son and the daughter-in-law and as such the mother received no real benefits from the transaction.

2. Unconscionability of the lenders

Citing the case of Elkofairi v Permanent Trustee Co Ltd (2002) 11 BPR 20,841, McDougall J held that it may be unconscionable for a lender to lend on the basis of security only, knowing that the borrower has no means of repayment and knowing that default will cost the borrower his or her only asset.
Despite being given an Accountant’s Certificate, which certified the financial circumstances of the mother, his Honour found that it was incumbent on the lenders to check the certificate against any information which they had on file. He noted that even the most cursory check of the certificate would have shown discrepancies. The failure to check the certificate suggests that the lenders did not consider the financial circumstances of the borrowers and the mother.
As a result, his Honour held that it was unconscionable for the lender to rely on the mortgage in circumstances where they knew or should have known, were lending only on the basis that they were well secured and where they had no reason to be confident that the borrowers could service the loan.

3. Relief granted

The mortgage of the mother’s property should not be enforced because of the unfairness of the contract and the unconscionability of the lenders.

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