If I could turn back time: unjust transaction from 2006 may be reopened under section 76 of the National Credit Code

The Western Australian Court of Appeal recently held that a loan agreement and mortgage were unjust under the National Credit Code as at the time they were entered into in 2006.

The decision in Shannon v Permanent Custodians Ltd ^[1] turns on the specific facts of the case, but highlights that:

• a claim under section 76 of the National Credit Code is not time-barred;
  

• the relevant circumstances at the time of entering into a contract are not limited to circumstances which are known to a party;
  

• section 76 operates notwithstanding contractual structures and indemnities historically designed to insulate a lender from directly assessing a borrower for a loan; and|
  

• the question of whether a transaction is unjust is different and separate from the issue of whether a lender complied with its responsible lending obligations (which were not in operation in 2006).
  

Background

In 2006, two borrowers applied for a loan secured by a mortgage. Their historical income was barely higher than the yearly repayments. Despite this, they genuinely believed that they could afford the loan.

The borrowers applied for a loan through a friend who worked at Yes Home Loans. Yes Home Loans was an originator for loans funded by GEL Custodians. The borrowers partially completed a loan application form and returned it to their friend. The application did not set out any information about their income, assets or liabilities.

Their friend fraudulently and dishonestly inserted financial information in the loan application and submitted it to a mortgage insurer in applying for lenders mortgage insurance. As per the applicable Operations Manual, Yes Home Loans did not provide the loan application to GEL, so that, even without the fraud, GEL had no information about the borrowers’ financial situation verified by the borrowers themselves.

The borrowers were not involved in this conduct and apparently only became aware of it 6 years later.

Based on the information provided to it, GEL agreed to lend. The borrowers purchased property which was security for their loan.

5 months later, they defaulted on making an interest only repayment. After making only intermittent payments, they ceased making payment in July 2011.

At first instance, the trial Judge held that the borrowers could not afford the loan and could not make the loan repayments without substantial hardship. ​​​

The decision

Section 76 of the National Credit Code empowers a Court to reopen a transaction if, in the circumstances at the time it was entered into, it was unjust. In determining whether a term is unjust in the circumstances relating to it at the time it was entered into, the Court must have regard to the public interest and to all the circumstances of the case. Subsection (2) sets out a non-exclusive shopping list of factors for consideration including:

1. whether at the time the contract [or] mortgage … was entered into…, the credit provider knew, or could have ascertained by reasonable inquiry at the time, that the debtor could not pay in accordance with its terms or not without substantial hardship;
   

The Court of Appeal drew the inference that the lender displayed a ‘lack of concern with the suitability of the [borrowers] and with serviceability.’ It held that the relationship between the lender and other entities heightened the risk of fraudulent conduct or lending to borrowers who could not afford repayments.

The Court of Appeal’s ultimate evaluation was that the loan agreement and mortgage were unjust in the circumstances relating to them at the time. The borrowers’ partial responsibility for the transactions did not detract from the Court of Appeal’s conclusion, but would be relevant to the exercise of discretion in relation to any relief.

Vaughan JA specifically noted that a finding of a credit contract being unjust in the circumstances relating to it at the time it was entered into is evaluative and fact sensitive. His Honour stated:

In this area of jurisprudence there is a real danger … of elevating a determination on the specific facts of a particular case to a supposed general rule of universal application to other cases. There is value in reading the authorities to see how the 'unjust' criteria has been applied in different circumstances. But having done so, it should be appreciated that each case depends on its particular facts and the circumstances in the present appeal are distinctive.

Where to from here?

The consequences of this decision are not yet settled, as the Court of Appeal referred the parties to first attend mediation. If not resolved at mediation, there will likely be further proceedings to determine the appropriate relief.

An important factor is that the borrowers made only a few loan repayments before they stopped making any payments at all, while continuing to reside in the mortgaged property for 14 years. Accordingly, the loan agreement and mortgage may not necessarily be set aside.

For lenders operating in a fast-changing and competitive environment, this case highlights the critical role of credit risk assessment over the lifetime of a loan.

[1] _{[2020] WASCA 198.}