Could the Respondents rely on certificates of independent advice where there was unconscientious exploitation of the Appellant's special disadvantage?

Stubbings v Jams 2 Pty Ltd [2022] HCA 6 (16 March 2022)

Intro:-

This is an appeal from the Court of Appeal of the Supreme Court of Victoria.

Facts:-

The appellant owned two houses in Narre Warren, both of which were mortgaged to Commonwealth Bank. The mortgage repayments were between $260 and $280 per week. The appellant did not live in either house; instead he lived at rental premises at Boneo, where he worked repairing boats for the owner of the property. Due to a falling out with the owner, the appellant ceased work and needed to move house. Rather than live at one of the Narre Warren properties, he sought to purchase another property on the Mornington Peninsula.

The appellant was unemployed and had no regular income. He had not filed tax returns in several years and was in arrears on rates payments in respect of the two Narre Warren properties. After a home loan application to ANZ was rejected for lack of financial records, the appellant was introduced to Mr Zourkas.

Mr Zourkas described himself as a "consultant", in the business of introducing potential borrowers to Ajzensztat Jeruzalski & Co ("AJ Lawyers"). AJ Lawyers in turn provided a service to clients, such as the respondents, to facilitate the making of secured loans by those clients. The primary judge found that Mr Zourkas played an "important and essential" role in these transactions, in that his involvement ensured that AJ Lawyers never dealt directly with the borrower or guarantor, such as the appellant.

The appellant and Mr Zourkas met on a number of occasions in 2015. At their first meeting, the appellant said that he "wanted to buy a little house" to live in, to which Mr Zourkas responded that "there would not be a problem going bigger and getting something with land". On the strength of that suggestion, the appellant found a five‑acre property with two houses on it in Fingal, available for $900,000. At another meeting, Mr Zourkas told the appellant that he could borrow a sum sufficient to pay out the existing mortgages over the Narre Warren properties, purchase the Fingal property, and have approximately $53,000 remaining to go towards the first three months' interest on the loan. Mr Zourkas advised the appellant that he could then sell the Narre Warren properties, reducing the loan to approximately $400,000, which the appellant could then refinance with a bank at a lower interest rate.

The two Narre Warren properties and the Fingal property would secure the appellant's obligations as guarantor. The existing debt to Commonwealth Bank secured on the Narre Warren properties totalled approximately $240,000. On the basis that the two properties had a market value of $770,000, the appellant's equity was thus worth about $530,000.

On 30 June 2015, the appellant signed a contract to purchase the Fingal property for $900,000. A deposit of $90,000 became payable on 7 July 2015. The appellant only ever paid $100 towards it.

In late July or early August 2015, Mr Zourkas introduced the appellant to Mr Jeruzalski, a partner at AJ Lawyers. On 10 August 2015, AJ Lawyers arranged to have the two Narre Warren properties and the Fingal property valued as security for the loan. Together, the properties were valued at $1,570,000[16]. Satisfied that this would support a loan, AJ Lawyers provided two letters of offer, on behalf of their clients, including the respondents, to provide first and second mortgage finance to the company. Each offer was conditional on the appellant acting as guarantor and with the three properties as security for his guarantee.

The first mortgage loan was for a sum of $1,059,000 at an interest rate of 10 per cent per annum and a default rate of 17 per cent per annum. The second mortgage loan was for a sum of $133,500 at an interest rate of 18 per cent per annum and a default rate of 25 per cent per annum. Two loans were necessary because, in line with AJ Lawyers' standard practice, the first was capped at two‑thirds of the combined property valuations to avoid a higher loan‑to‑security ratio that might be considered too risky for the lender. The second loan was required to pay Mr Zourkas' consultancy fees, loan procuration fees, the respondents' legal costs as mortgagees, and the costs and expenses of purchasing the Fingal property. It was also necessary to enable the appellant to pay the first month's interest, which was payable in advance.

On 19 September 2015, Mr Zourkas presented the appellant with two letters, dated 16 and 17 September 2015, which indicated that AJ Lawyers had been "instructed to approve" the two loans. The letters enclosed documents for execution by the appellant and the company. This documentation included a certificate of "Independent Financial Advice", to be signed by an accountant, and a certificate of "Independent Legal Advice", to be signed by a lawyer.

The certificates were of critical importance to the decision of the Court of Appeal and were a significant focus of argument in this Court. In the certificate of independent legal advice, under the heading "Acknowledgement by Guarantor", was the following list of questions, which the appellant was to answer by writing in the right‑hand column[:

"1. Have you received copies of the documents described under the heading 'Security Documents' below?

2. Have you been given an opportunity to read those Security Documents?

3. Have the Security Documents been fully explained to you by your solicitor?

4. Do you understand the effects of the Security Documents and the consequences to you if the Borrower defaults on its obligations to the Lender?

5. In particular, do you understand that if the Borrower fails to pay all of the moneys due to the Borrower to the Lender then the Lender will be entitled to call on you as Guarantor to recover the moneys due to it?

6. Was this Acknowledgement read and signed by you BEFORE you signed the Security Documents?

...

I confirm the accuracy of the answers to the above questions and acknowledge that the Lender will be relying on these answers in respect of giving the loan to THE VICTORIAN BOAT CLINIC PTY LTD."

The certificate of independent financial advice, meanwhile, required an independent accountant to sign and attest to the following:-

"1 I have been instructed by THE VICTORIAN BOAT CLINIC PTY LTD ACN 601 712 172 to explain the financial risks being assumed:-

(a) by executing the security documents in respect of the financial accommodation to be provided by the Lender which security documents are referred to in Item 1 of the Schedule below ('the Security');

(b) by the application of the said financial accommodation for the purposes referred to in Item 2 of the Schedule below.

2 Before the Security was executed by the Borrower, I explained the financial risk being assumed by executing the Security and by the application of the aforesaid financial accommodation in the manner stated in Item 2 of the Schedule.

3 To the best of my knowledge and belief and in my opinion the Borrower appears to understand the nature and extent of the financial risk which the Security places and the nature and extent of the financial risk which will be assumed by the application of the aforesaid financial accommodation in the manner stated in Item [2] of the Schedule.

4 I have been engaged by the Borrower in advising and have given this Certificate entirely independently of any other Borrower or Guarantor.

5 The Loan herein is required for business purposes."

The primary judge found that Mr Zourkas had presented the certificates to the appellant by handing over two sealed envelopes (one labelled "Accountant", the other labelled "Solicitor"), a business card for a solicitor, Mr Kiatos, and a phone number for an accountant, Mr Topalides. Mr Zourkas told the appellant to "take these documents, get them signed and bring them back"[26]. The Court of Appeal observed that it was clear from context that approval of the loans was conditional on the two certificates being duly signed and returned.

The appellant visited both Mr Kiatos and Mr Topalides that same day. Mr Kiatos (and not the appellant) completed and signed the certificate of independent legal advice, writing in answers to the list of questions directed to the appellant as guarantor. The appellant signed an acknowledgment on behalf of the company confirming the accuracy of those answers and that he had received independent legal advice.

With the documentation complete, the loans were settled, the mortgages were registered, and the Fingal property was purchased on 30 September 2015. Once the various fees and payments had been made, the appellant was left with a sum of $6,959. The appellant subsequently moved into the Fingal property with his son. He never carried on any boat repair business.

The first month's interest having been paid in advance by the funds received from the second loan, the appellant managed to sell some assets to pay off the second month's interest. However, on 30 December 2015, the company defaulted on the third month's interest payments[36]. The respondents commenced proceedings against the appellant, seeking to enforce the guarantee and their rights as mortgagees of the two Narre Warren properties and the Fingal property.

The primary judge

The primary judge found that the appellant laboured under circumstances of "special disadvantage". His Honour described the appellant's financial position as "bleak". Notably, in this regard, the Narre Warren properties were the appellant's only assets of any value. The primary judge also found that the appellant was "unsophisticated, naïve and had little financial nous". The primary judge observed that the appellant's demeanour at trial – at which he represented himself – indicated that he was "completely lost, totally unsophisticated, incompetent and vulnerable".

The primary judge found that Mr Jeruzalski "[did] not seek or want any further information about the guarantor or his or her personal or financial circumstances". Mr Jeruzalski's attitude in this regard conformed to the standard practice of AJ Lawyers of making no inquiries as to a borrower's capacity to repay the loan, and having no contact with borrowers save for written correspondence and documentation.

The primary judge found that Mr Jeruzalski knew that the loans were "a risky and dangerous undertaking for [the appellant]" because of the high interest rates, the risk to the appellant of the cost of forced sales, and the consequential impact of a default upon the appellant.

The primary judge did not accept that Mr Kiatos and Mr Topalides were truly independent sources of advice for the appellant.

The primary judge concluded that these findings demonstrated a "high level of moral obloquy" and "wilful blindness" as to the appellant's financial and personal circumstances

The Court of Appeal

The Court of Appeal concluded that the primary judge's reasons reflected an adverse view of asset‑based lending "as a concept" and concluded that this adverse view "overwhelmed ... his determination of the unconscionability issue"[50]. The Court of Appeal was not satisfied that Mr Jeruzalski had either actual or constructive knowledge of the appellant's desperate personal and financial circumstances.

Importantly in this regard, the Court of Appeal considered that Mr Jeruzalski was entitled to rely on the certificates of independent advice as showing that the appellant had consulted a solicitor and an accountant, and as to the truth of the matters stated therein. In their Honours' view, the certificates made it reasonable for Mr Jeruzalski to refrain from any further inquiry as to the appellant's circumstances; indeed, their Honours noted that, absent the certificates, there may have been sufficient knowledge on Mr Jeruzalski's part to "justify the serious finding that it was unconscionable for him to abstain from inquiry in all the circumstances". As to the primary judge's finding that the certificates did not reflect truly independent advice, the Court of Appeal held that there was no sufficient basis in the evidence for that inference.

The parties' contentions in this Court

In this Court, the appellant conceded that asset‑based lending is not necessarily unconscionable in itself, and focussed upon the circumstances of the system of asset‑based lending employed by the respondents and AJ Lawyers in this case.

The appellant submitted that the Court of Appeal attributed unwarranted significance to the certificates of independent advice. The appellant argued that the primary judge was entitled to infer that Mr Jeruzalski knew it was unlikely that the appellant had received truly independent advice. More broadly, the appellant argued that the Court of Appeal failed to have due regard to the findings made and inferences drawn by the primary judge as to Mr Jeruzalski's appreciation of the dangers confronting the appellant in taking the loans, particularly since the primary judge had relied on his impressions of the witnesses in making these findings.

The respondents argued that the only significant finding of the primary judge that was disregarded by the Court of Appeal was the finding to the effect that the certificates were not truly independent[59]. It was said that the Court of Appeal was justified in taking this course on the basis that there was no evidence to support the primary judge's inference.

Issues:-

a) Was the system of lending involving a law firm, acting through an intermediary, tainted by unconsciousnable conduct?

b) Whether the Respondents' agent had knowledge of Appellant's special disadvantage?

Consideration:-

Unconscionable conduct

In Kakavas v Crown Melbourne Ltd, this Court said:-

"[E]quitable intervention does not relieve a plaintiff from the consequences of improvident transactions conducted in the ordinary and undistinguished course of a lawful business. 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. The plaintiff must be able to point to conduct on the part of the defendant, beyond the ordinary conduct of the business, which makes it just to require the defendant to restore the plaintiff to his or her previous position."

In Commercial Bank of Australia Ltd v Amadio, this Court held that unconscionability involves: a relationship that places one party at a "special disadvantage" vis‑à‑vis the other; knowledge of that special disadvantage by the stronger party; and unconscientious exploitation by the stronger party of the weaker party's disadvantage. But these considerations 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. As Dixon CJ, McTiernan and Kitto JJ said in Jenyns v Public Curator (Qld)[63], in a passage approved by this Court in Kakavas and Thorne v Kennedy, the application of the equitable principles relating to unconscionable conduct:-

"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 [vulnerable party]. 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'." (citation omitted)

Special disadvantage

In this field of discourse, "special disadvantage" means something that "seriously affects the ability of the innocent party to make a judgment as to his [or her] own best interests". While the factors relevant to an assessment of special disadvantage have not been exhaustively listed, Fullagar J in Blomley v Ryan considered that special disadvantage may be inferred from "poverty or need of any kind, sickness, age, sex, infirmity of body or mind, drunkenness, illiteracy or lack of education, lack of assistance or explanation where assistance or explanation is necessary". No particular factor is decisive, and it is usually a combination of circumstances that establishes an entitlement to equitable relief.

At all times, the appellant was incapable of understanding the risks involved in the transaction. He was unable to perform simple calculations, such as 10 per cent of $130,000. The primary judge observed that the very circumstance that the appellant was disposed to enter into such a transaction was evidence of his vulnerability. To say the least, the appellant's financial circumstances were "bleak".

It could not be, and was not, disputed by the respondents that the primary judge's findings as to the appellant's circumstances established that he was at a special disadvantage vis‑à‑vis the respondents. The outcome of the appeal to this Court turns on the extent of Mr Jeruzalski's knowledge of the appellant's circumstances and whether Mr Jeruzalski exploited that disadvantage so that the respondents' attempt to enforce their rights under the loans and mortgages was unconscionable.

Knowledge and exploitation

The inevitable outcome of the transaction was, objectively speaking, that the appellant's equity in his properties would be taken by the respondents by way of interest payments, including at default interest rates. The dangerous nature of the loans, obvious to Mr Jeruzalski but not to the appellant, was central to the question whether the appellant's special disadvantage had been exploited by the respondents.

The primary judge found that Mr Jeruzalski "should have known" that the appellant was bound to lose his equity in the Narre Warren properties. It may be accepted that his Honour's findings as to Mr Jeruzalski's state of mind did not rise to an unequivocal finding of actual knowledge on the part of Mr Jeruzalski that the appellant would inevitably lose his equity in his properties by taking these loans; but a finding in such terms was not essential to the appellant's case for relief. For a court of equity, the question is whether Mr Jeruzalski's appreciation of the appellant's special disadvantage was such as to amount to an exploitation of that disadvantage.

In Kakavas, this Court approved of the emphasis laid by Mason J in Amadio on the point that:

"the disabling condition or circumstance is one which seriously affects the ability of the innocent party to make a judgment as to his [or her] own best interests, when the other party knows or ought to know of the existence of that condition or circumstance and of its effect on the innocent party."

A case for relief against an unconscionable attempt to enforce legal rights is established in this case because Mr Jeruzalski had sufficient appreciation of the appellant's vulnerability, and the disaster awaiting him under the mortgages, that his conduct in procuring the execution of the mortgages is justly described as unconscientious.

There can be no doubt that Mr Jeruzalski, on behalf of the respondents, had a lively appreciation of the likelihood that the loss of the appellant's equity in his properties would be suffered by reason of his financial naïveté and his lack of means. The findings of the primary judge pertaining to Mr Jeruzalski's state of knowledge were made after having had the benefit of hearing Mr Jeruzalski in person over several days. The primary judge's findings were "inevitably affected" by his collective impressions of Mr Jeruzalski as a witness and were not "glaringly improbable" or "contrary to compelling inferences". The Court of Appeal had no basis for disregarding those findings. Certainly the certificates were not a basis for doing so.

The certificates contained nothing to suggest that the appellant had actually turned his attention to the difference between the cost of his existing borrowings with Commonwealth Bank and the proposed loans, or to how he would service the proposed loans. The absence of even the most general reference in the certificates as to the existence and terms of the company's business plan or as to how the Fingal property zoning problem (of which Mr Jeruzalski was aware) might be resolved is eloquent of their artificiality.

In addition, given the bland boilerplate language of the certificates and the statement therein of the purpose of the loan (which Mr Jeruzalski must have known to be inaccurate), it is open to draw the inference that the certificates were mere "window dressing". A similar inference may be drawn in relation to the commercially unnecessary interposition of the company as borrower, a step calculated to prevent or impede scrutiny of the fairness of the transaction under the Code. The certificates might also be seen to have been a precautionary artifice designed to prevent an inference that the respondents were wilfully blind to the obvious danger to the appellant. But however one views the certificates, they could not negate Mr Jeruzalski's actual appreciation of the dangerous nature of the loans and the appellant's vulnerability to exploitation by the respondents[78]. Indeed, one might regard the deployment of such artifices in a context where the lender or its agent deliberately distances itself from evidence that must confirm the dangerous nature of the transaction for the borrower or its guarantor as evidence pointing to an exploitative state of mind on the part of the lender.

The primary judge found that Mr Jeruzalski suspected that the appellant did not receive truly independent advice from either Mr Kiatos or Mr Topalides. Mr Jeruzalski's evidence was that, "if [the appellant] or [the company] had no income, then, from his experience, a first‑tier bank would not have lent money to him", and further, that "his firm would not assist somebody like [the appellant] to obtain a bank loan"[80]. There was nothing in the evidence to suggest to Mr Jeruzalski that the appellant had an income that would enable him to refinance with a bank. The circumstances of Mr Jeruzalski's involvement with the appellant meant that what Mr Jeruzalski did know of the appellant's affairs made the prospect of the appellant's refinancing with a bank a forlorn hope.

Mr Jeruzalski, on behalf of the respondents, appreciated that the loans were a dangerous transaction from the appellant's point of view; but the prospect of obtaining the profit to be made by the taking of the appellant's equity by way of interest payments made the exploitation of the appellant's disadvantages good business for the respondents. The transaction in this case cannot be regarded as if it were, for example, a loan to an asset‑rich but income‑poor individual sought for the purposes of meeting a temporary liquidity problem. The transaction could not even be seen as a high‑risk loan to a person willing to gamble on the prospect of a rise in property values. Having regard to the unchallenged findings of fact by the primary judge, it is evident that Mr Jeruzalski, on behalf of the respondents, took the opportunity to exploit the appellant's lack of business acumen and meagre financial resources to deprive him of his equity in the Narre Warren properties.

Conclusion:-

Mr Jeruzalski's conduct on behalf of the respondents amounted to the unconscientious exploitation of the appellant's special disadvantage. The primary judge was right to hold that it was unconscionable for the respondents to insist upon their rights under the mortgages. That being so, it is unnecessary to consider whether the appellant was entitled to succeed pursuant to s 12CB of the ASIC Act.

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