Certificates of Advice: not a lifesaving device

The November 2020 edition of the Australian Banking & Finance Law Bulletin featured regular contributor Lee Aitken’s analysis of the Victorian Court of Appeal’s decision in Jams 2 Pty Ltd v Stubbings.[1]

Critical to the Court of Appeal’s reasoning was the view that the existence of certificates of financial and legal advice entitled the lender to look no further into the borrower’s financial circumstances where, in the absence of certificates, it may have been unconscionable for the lender to abstain from inquiry.

The decision of the Court of Appeal might reasonably have been thought to justify the view that certificates of advice could operate as a prophylactic against a challenge to even the riskiest of transactions on the grounds of unconscionable conduct.

In Stubbings v Jams 2 Pty Ltd[2] (Stubbings), the High Court reached the opposite view. Their Honours’ analysis, however, might be thought to have left open questions that are important both as a matter of legal theory and commercial practice. Can a transaction be so improvident that it cannot be immunised from a challenge, regardless of the advice given in connection with it? If that is so, does the decision in Stubbings represent a departure from the proposition (restated by the High Court in Kakavas v Crown Melbourne Ltd[3]) that “a plaintiff who voluntarily engages in risky business has never been able to call upon equitable principles to be redeemed from the coming home of risks inherent in the business”?[4]

This article explores the court’s reasons in Stubbings, and particularly the extent of the court’s observations bear upon the important question of the efficacy of certificates of financial and legal advice.

Background

Mr Stubbings was an unemployed boat repairer. He owned two properties in Narre Warren with a combined value of $770,000, against which a borrowing of $240,000 was secured. He could not meet the rates due in respect of those properties. When no longer welcome at the rental property where he lived, he sought a loan from ANZ to buy another house. That was rejected. He was thereafter introduced to firm of solicitors, which acted as an intermediary for borrowers and lenders, with a view to obtain a loan from one of the lenders for which it acted.

Mr Stubbings found a five-acre property with two houses on it in Fingal that he wanted to buy. The purchase price was $900,000. He was advised by the consultant who introduced him to the firm of solicitor that it would be possible to borrow an amount sufficient to finance the purchase of the Fingal property, pay the first 3 months’ interest on the loan, and then sell the Narre Warren properties, apply the proceeds to the loan and refinance the balance $400,000 with a bank.

The loan was set-up as a business loan, with the apparent purpose of avoiding it falling under the Consumer Credit Code. Mr Stubbings was provided with the loan documents, naming the borrower as a company he controlled (Victorian Boat Clinic Pty Ltd) whose obligations he was to guarantee. He was also provided with certificates of independent financial and legal advice to be completed by an accountant and lawyer respectively. That advice was obtained.

Mr Stubbings was an unsophisticated individual who was — as found by the judge at first instance — incapable of performing simple calculations (such as 10% of $130,000), and therefore not in a position to comprehend in any meaningful way the risks inherent in the transactions contemplated by the loan documents.

The reasons of the majority

The majority (Kiefel CJ, Keane and Gleeson JJ) found that Mr Stubbings’ lack of commercial understanding, coupled with the inevitability of default by reason of his inability to repay the loans from his own income or other assets, were matters known to the lenders and, accordingly, the exercise of their rights under the mortgages was unconscionable.

The starting point of their Honours’ analysis was an important observation regarding the requirements necessary to establish unconscionability. That is that those well-known requirements, namely a special disadvantage of one party vis-à-vis the other, knowledge of that disadvantage on the part of the stronger party and unconscientious exploitation of that disadvantage “should not be understood as if they were to be addressed separately as if they were separate elements of a cause of action in tort”.[5]

The majority considered that the critical issue was the extent of the lender’s knowledge of Mr Stubbings’ circumstances and whether there was an exploitation of that disadvantage. On that question, their Honours found that the dangerous nature of the loans (which was apparent to the lender but not Mr Stubbings) was central to the question of whether there had been an unconscientious taking advantage of Mr Stubbings’ special disadvantage.[6]

Their Honours went on to find that unconscionability was established in the Stubbings case because the lender had a sufficient appreciation of Mr Stubbings’ vulnerability and “the disaster awaiting him under the mortgages”.[7]

On the matter of the certificates of independent financial and legal advice, the majority observed that they did not establish that Mr Stubbings had turned his mind to the high cost of the proposed borrowing vis-à-vis his existing loans or how he would service it. Nor was there any reference in them to the existence or terms of the corporate borrower’s business plan or its terms. Their Honours concluded that the certificates could not negate the lender’s “actual appreciation of the dangerous nature of the loans” and Mr Stubbings’ “vulnerability to exploitation” by the lender.[8]

Mr Stubbings’ circumstances were contrasted with those of an asset rich but income poor individual seeking finance to meet temporary liquidity difficulties, or a property speculator gambling on rising asset values, the majority concluding that the lenders conduct exploited Mr Stubbings’ lack of business acumen and modest financial resources to relieve him of his equity in the Narre Warren properties he owned.[9]

Statutory unconscionability

By reason of their Honours’ conclusions that the impugned conduct justified the intervention of equity, neither the judges forming the majority nor Steward J, considered the appellant’s alternate contention that the impugned conduct amounted to unconscionable conduct pursuant to s 12CB of the Australian Securities and Investments Commission Act 2001 (Cth). Gordon J addressed that (and only that) matter in her Honour’s reasons. While those matters will not be addressed in this article, they will, in no doubt be revisited in future cases.

Analysis

The facts in Stubbings featured an obviously unsophisticated and vulnerable borrower and an obvious example of taking advantage of that vulnerability for profit. The outcome in Stubbings was, with respect, undoubtedly the correct one.

That certificates of independent advice were not an insuperable obstacle to the intervention of equity and is not a particularly surprising outcome. The observations of Dixon CJ, McTiernan and Kitto JJ in Jenyns v Public Curator (Qld),[10] cited by the majority in Stubbings,[11] are apposite:

The jurisdiction of a court of equity [in circumstances relating to unconscionable conduct] … is governed by principles the application of which calls for a precise examination of the particular facts, a scrutiny of the exact relations established between the parties and a consideration of the mental capacities, processes and idiosyncrasies of the donor. Such cases do not depend upon legal categories susceptible of clear definition and giving rise to definite issues of fact readily formulated which, when found, automatically determine the validity of the disposition. Indeed no better illustration could be found of Lord Stowell’s generalisation concerning the administration of equity: “A court of law works its way to short issues, and confines its views to them. A court of equity takes a more comprehensive view, and looks to every connected circumstance that ought to influence its determination upon the real justice of the case” [footnotes omitted].[12]

The decision in Stubbings is a salient example of equity’s flexibility and is best viewed as such. Would the outcome have been the same if the certificates of advice had recorded specific advice given to Mr Stubbings of the particular risks that arose as a consequence of him signing the loan documents? Would proceeding with a transaction in those circumstances denote Mr Stubbings’ inability to protect his own interests, or the kind of voluntary engagement in risky business from which equity offers no sanctuary? Are there any circumstances in which it is permissible to knowingly profit from the improvident decisions of commercially unsophisticated individuals?

While we await an appropriate vehicle for the consideration of these questions, lenders (particularly those engaged in high-risk lending) would be well-advised to revisit their requirements as to the manner in which independent advice is obtained. If a proposed transaction gives rise to specific risks, the High Court’s observations in Stubbings suggest that specifically referencing those risks in the advice may offer the best protection from later challenges.

Conclusion

The degree of commercial certainty that independent advice offered has been eroded by the decision in Stubbings, even if more in perception than reality. There will be individuals for whom the decision in Stubbings offers the false hope that they may avoid their obligations notwithstanding the receipt of independent advice. This might in turn generate a greater number of disputes in an already fertile area. Moreover, lawyers from whom certificates of advice are sought should be cautious about limiting that advice (or the documentation of it) solely to the matters referred to in pro forma certificates.