Second Tier Lenders and beyond – what you need to know

Jams 2 Pty Ltd & Ors v Stubbings (No 3) [2019] VSC 150 (14 March 2019) and Jams 2 Pty Ltd v Stubbings [2020] VSCA 200 (5 August 2020)

Lenders in the unregulated credit market are not immune from typical consumer credit typeclaims, including but not limited to statutory unconscionable conduct.

This article provides a summary of the cases referred to in the heading above and the lessons learned therefrom. Accountants, Financial Advisors, Lenders and Borrowers should take note.

Background

A borrower, Mr Stubbings, found a property in Fingal on the Mornington Peninsula. He attempted to procure a loan from a financial institution. However, his application for finance from that first tier lender was declined.

Mr Stubbings was then introduced to Mr Zourkas, an introducer or referrer to Ajzensztat Jeruzalski & Co (AJ Lawyers) or its lender clients.

AJ Lawyers offered, on behalf of three (3) of its clients, to provide finance to a company owned by Mr Stubbings – the loan purpose was purportedly to enable the company to set up and expand the business. However, the true purpose of the loan was to enable Mr Stubbings to purchase a residential property in his own name.

The loan was secured by a first mortgage over the residential property, with the three (3) mortgagees being co-tenants of the mortgage in the proportions that they provided the loan moneys. Mr Stubbings also provided a guarantee which was secured with mortgages over two (2) other properties he already owned.

When things took a turn for the worst, Mr Stubbings alleged (amongst other things) that the mortgages and loans should be voided on the basis of unconscionable conduct.

Mr Stubbings was successful against AJ Lawyers at first instance and orders were made to the effect that the mortgage and the loans be voided on the condition that Mr Stubbings was not unjustly enriched.

• Mr Stubbings also succeeded at first instance against a third party accountant engaged to provide “independent” financial advice to him (but who would only be paid in the event that the loan proceeded and clearly had not properly provided any independent advice); and against Mr Zourkas on the basis that he acted unconscionably in procuring Mr Stubbings to borrow through AJ Lawyers.
• However, in terms of the “success” against the accountant and Mr Zourkas, due to the fact that the mortgage and loans having been set aside, Mr Stubbings had not suffered any loss or damage attributable to the conduct of the accountant or the introducer, Mr Zourkas, and as such the Court did not make any orders in favour of Mr Stubbings against the accountant or Mr Zourkas.
• Mr Stubbings settled his claim as against another solicitor who provided him with “independent legal advice”.

Reasons for the first instance decision against AJ Lawyers

In terms of the findings of unconscionability, his Honour Robson J held at paragraph 316:

“..Mr Jeruzalski’s behaviour constituted unconscionable conduct. Mr Jeruzalski knowingly and deliberately shut his eyes to Mr Stubbings’ circumstances. Mr Jeruzalski shut his eyes to ensure that the loans would go through and that he would earn his fees. Asset-based lending coupled with the system of conduct adopted by AJ Lawyers, leads me to conclude that AJ Lawyers must be treated as knowing of Mr Stubbings’ personal and financial circumstances.”

Appeal decision

In the appeal decision, Beach, Kyrou and Hargrave JJA, overturned the finding of unconscionability against AJ Lawyers. In doing so the Court of Appeal placed significant reliance on the certificates of independent financial and legal advice that had been provided to AJ Lawyers:

131 At the time Jeruzalski approved the loans on 19 September 2015, the matters known to Jeruzalski concerning the ability of Stubbings and the company to service the loans for between six and 12 months pending refinance following a sale of the Narre Warren properties were — putting the case at its highest for Stubbings— as follows:

(1) Jeruzalski assumed that Stubbings and the company had ‘no income’, in the sense that they did not have sufficient income to service interest under the loans for between six and 12 months.

(2) Jeruzalski knew that Stubbings and the company had paid only a token deposit under the two contracts to purchase the Fingal property — $100 under the first contract (in force when the loan offers were made) and $5,100 under the second contract (in force when the loans were approved). This supported Jeruzalski’s assumption that Stubbings and the company had insufficient income to service the loans.

(3) Jeruzalski had been informed by Zourkas that the proceeds of the two loans would be used to both settle the purchase of the Fingal property and to pay out the existing CBA mortgage loans over the two Narre Warren properties; and that Stubbings’s plan was to then sell the two Narre Warren properties and then refinance the loans with a bank. Jeruzalski gave evidence that he treated Stubbings’s equity in these properties as his deposit on the Fingal property.

(4) From the disbursement authorities prepared by his office at the time the loans were approved, Jeruzalski knew that — after settlement of the Fingal property purchase, repayment of the mortgages over the Narre Warren properties, and the payment of all costs and expenses including loan procuration fees and commissions — the net proceeds of the loans available to Stubbings and the company for any business purposes would be very small in comparison to the amount borrowed.^[197]

(5) Jeruzalski had been told by Zourkas that Stubbings and the company intended to conduct a ‘business concerned with boat repairs’ at the Fingal property.^[198]

(6) Jeruzalski knew that he, as agent of the mortgagees, had the right under conditions (y) and (z) of the letters of offer to demand that Stubbings and the company provide ‘evidence of serviceability’ or evidence of ‘proposed means of repayment of the loans’ but chose not to exercise that right before approving the loans.

132 If these were the only matters known to Jeruzalski at the time the loans were approved, they may have been sufficient to justify the serious finding that it was unconscionable for him to abstain from inquiry in all the circumstances. But they were not the only matters. Jeruzalski well knew and relied on the fact that, as part of the system of lending, the loan approvals were conditional on the company and Stubbings obtaining independent legal and accounting advice and for the two certificates he had prepared to be signed and returned before the loans were made. Signed certificates were in fact returned to him. In our view, Jeruzalski was entitled to rely on the certificates — both as evidence that Stubbings had consulted a solicitor and an accountant for advice and as to the truth of the matters stated in the certificate. On that basis, Jeruzalski should not be fixed with knowledge of Stubbings’ personal and financial circumstances such that default under the loans was inevitable, as the trial judge appears to have found.

133 We conclude that the certificates, especially the accountant’s certificate, made it reasonable for Jeruzalski to refrain from inquiry as to how the company and Stubbings intended to, or whether they could in fact, service the loans pending refinance following sale of the two Narre Warren properties. In reaching that conclusion, we have been mindful that the judge inferred that:

Mr Jeruzalski must have suspected that Mr Stubbings would be guided by Mr Zourkas as to which solicitor and accountant to approach. I see this conduct as part of the system of conduct adopted by AJ Lawyers to immunise the firm from knowledge that might threaten the enforceability of the loan. As far as Mr Jeruzalski was concerned, the accountant and the solicitor would only be paid if the loans went ahead. There was no incentive for them to withhold the certificates. If they withheld the certificates, then they would receive nothing for their services. To characterise them as independent is perhaps a bridge too far.^[199]

134 In our view, those inferential findings, and the ‘bridge too far’ comment are not supported by the evidence. No basis for the inferred suspicion is given. No basis is given for the inference that the suspected conduct was ‘part of the system’. The disbursement authorities enclosed with the two approval letters made no mention of the fees due to Kiatos and Topalides coming from the loan proceeds, and their fees were not deducted at settlement. It was only after settlement that their fees were paid from the $16,360 remaining in the AJ Lawyers trust account – after authorisation from Stubbings.

Conclusion

If there was evidence that AJ Lawyers had knowledge that the certificates of independent legal and financial advice where not truly independent, the outcome of the appeal may have been different.

The case therefore highlights the importance to any lenders operating in this area of the importance of requiring borrowers to obtain independent legal and financial advice and provide evidence that they have done so. The lender should avoid referring the borrower to any particular accountant or lawyer and the lender should not involve themselves in any payments for the advice. The borrower should attend to those matters themselves. Independence is paramount and no system should be implemented that causes even the appearance that the person providing the independent advice has any kind of loyalty to or reliance on anyone other than the borrower they are advising.

It also highlights the significance of the duty incumbent on an accountant or lawyer providing independent financial or legal advice to a borrower. There are strong indications in the reasons of the Court of Appeal that if Mr Stubbings had cross-appealed against the decision not to award damages in his favour against the accountant or the introducer, Mr Zourkas, he would have been successful. Indeed that is the only conclusion which would have been available in circumstances in which the finding of unconscionability against AJ Lawyers had been overturned but the various findings against the accountant or the introducer, Mr Zourkas, had not been.

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