A Sticky Situation – HCA Issues a Warning to Asset-Based Lenders in Stubbings v Jams 2 Pty Ltd & Ors

In the recent case of Stubbings v Jams 2 Pty Ltd [2022] HCA 6, the High Court confirmed that whilst asset-based lending is not in and of itself an unconscionable lending concept, specific systems or structures adopted by an asset-based lender can render the enforcement of its rights against a borrower / guarantor to be unconscionable under equity or statute.

Lenders are at high risk of acting unconscionably where they deploy pro forma certificates of independent advice as mere ‘window dressing’ or ‘artifices,’ and deliberately abstain from making necessary inquiries or providing necessary assistance or explanations, as part of a conscious design to avoid knowledge of special disadvantage or vulnerability.

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The respondents (Jams 2 Pty Ltd, Conterra Pty Ltd and Janaco Pty Ltd) were lenders in the business of asset-based lending.[1] The appellant (Stubbings) was the guarantor of high interest loans totalling $1.1M provided by the lenders to a company owned and controlled by him (VBC). Stubbings’ obligations as guarantor were secured by mortgages with the lenders over three properties (two existing properties and a third property that he purchased with the loan proceeds) valued at $1.57M. The purpose of the loans was to refinance existing indebtedness and to fund the purchase of the third property, which would become Stubbings’ home.

The loans were facilitated by a consultant (Zourkas) and lawyer (Jeruzalski) who acted as intermediaries for the lenders. Approval of the loans was undertaken by Jeruzalski and was conditional on Stubbings completing pro forma certificates of independent financial advice and independent legal advice, which had been provided to him by Zourkas, together with the contact details of a recommended accountant and lawyer. Stubbings was obliged to pay significant consultancy, procuration and other fees to Zourkas and Jeruzalski (and the accountant and lawyer) which, for the most part, were funded out of the loan proceeds.

Stubbings was effectively unemployed, had no income or savings to meet the loan obligations and the mortgaged land was his only asset of any value. VBC was a shell company which had no assets and had never traded. The lenders had no, and did not request any, evidence regarding Stubbings’ or VBC’s ability to repay the loans. Nor did they warn Stubbings about the risks and dangers of entering into the transactions.

After the loans were settled, monthly interest payments in excess of $8,000 (or in excess of $15,000 at default rates) became due and payable. Stubbings defaulted on the third month’s interest payments and the lenders commenced proceedings seeking to enforce their rights under the loans and mortgages.

At first instance, the primary judge found that the certificates did not reflect truly independent advice and that loans and mortgages were procured by unconscionable conduct, and were therefore unenforceable. This decision was overturned by the Court of Appeal of Victoria, who attributed significance to the certificates of independent advice in precluding any finding of unconscionability.

On appeal to the High Court, Stubbings conceded that asset-based lending was not in and of itself unconscionable, but contended that on the facts of the case the loans and guarantee were effected in circumstances which made the enforcement of the lenders’ rights against him unconscionable.

The High Court unanimously allowed the appeal and upheld the primary judge’s finding of unconscionability.

Majority: Kiefel, Keane and Gleeson JJ

The majority found that the lenders had acted unconscionably by reference to the equitable doctrine of unconscionability, which focussed on the concept of an exploitation of special disadvantage or vulnerability.

The lenders did not dispute that Stubbings was operating under a special disadvantage vis-à-vis the lenders, by reason of his incapability to understand the risks involved in the transaction and his bleak financial circumstances.

Therefore, the majority considered that the outcome of the appeal turned on the extent of Jeruzalski’s knowledge (on behalf of the lenders)[2] of Stubbings’ circumstances, and “whether Mr Jeruzalski’s appreciation of the appellant’s special disadvantage was such to amount to an exploitation of that disadvantage”.

On this question, the majority found that:

• Jeruzalski (and therefore the lenders) had “actual appreciation of the dangerous nature of the loans and the appellant’s vulnerability to exploitation by the respondents”.
• The certificates of independent advice could not negate Jeruzalski’s actual knowledge. It could be inferred that they were mere “window dressing” or a “precautionary artifice” designed to prevent an inference that the lenders were wilfully blind to the obvious danger to Stubbings. Further, the deployment of such artifices could be seen to evidence an “exploitative state of mind” on the part of the lenders.
• Stubbings’ lack of commercial understanding and inability to repay the loans from his own income or other assets meant that default in payment and the consequent loss of the appellant’s equity in his properties by the lenders was the inevitable outcome.
• Mr Jeruzalski, on behalf of the lenders, took the opportunity to exploit Stubbings’ lack of business acumen and meagre financial resources to deprive him of his equity in his properties. This amounted to an unconscientious exploitation of the appellant’s disadvantage.

Gordon J

Consistent with the majority, Gordon J found that the lenders’ conduct was unconscionable in equity. This was by reason of Stubbings’ vulnerability and special disadvantage, as a “man with no income who … demonstrated his inability to make any realistic assessment of the worth and consequences of the transaction,” and the lenders’ exploitation of this advantage by deliberately avoiding inquiries or providing necessary assistance or explanation to Stubbings as to the risks and consequences of the transactions.

Gordon J also found that the lenders’ system of conduct was contrary to s 12CB of the ASIC Act 2001 (Cth) (‘Unconscionability in the context of financial services’), which enforces a statutory concept of unconscionability that is broader than equitable principles.

In considering the contours of the statutory prohibition, Gordon J found that:

• Section 12CB can apply to an unconscionable system of conduct or pattern of behaviour, and special disadvantage of an individual is not necessary for a system to be unconscionable. In this way, the focus of the provision is on conduct that may be said to offend against good conscience – it is not specifically on the characteristics of any possible ‘victim’ of the conduct (although this may be relevant to the assessment of the conduct).
• In applying s 12CB the Court is tasked with evaluating whether the conduct in question is “outside societal norms of acceptable commercial behaviour [so] as to warrant condemnation as conduct that is offensive to conscience” as informed by contemporary community standards.

Gordon J concluded that the lenders’ system of lending lacked transparency, used unfair tactics, lacked good faith and improperly sought to “immunise” the lenders from knowledge of vulnerability on the part of Mr Stubbings by deliberately avoiding information as to his personal and financial circumstances that might enliven the court’s equitable or statutory jurisdiction

This system was outside the societal norms of acceptable behaviour and was unconscionable contrary to s 12 CB.

Steward J

Steward J agreed the lenders had acted unconscionably by reference to equitable principles. Stubbings suffered a special disadvantage by reason of his relative impecuniosity, lack of education and business experience, lack of understanding of the transaction and need for explanation and assistance. The lenders had exploited this disadvantage by failing to make the necessary enquiries concerning his personal and financial circumstances and by failing to warn him about the risks and dangers of the transaction. Accordingly, it was not necessary to consider the application of s 12CB of the ASIC Act or s 21 of the Australian Consumer Law (‘Unconscionable conduct in connection with goods or services’).

In reaching this conclusion, Steward J found that the factors identified above did not equate to mere inequality in bargaining power between the parties, but were instead ‘special’ circumstances of disadvantage in light of Jeruzalski’s suspicion that Stubbings had no income and his knowledge that the transaction was risky and dangerous for him.

Steward J found that but for the lenders’ system of conduct which deliberately avoided inquiries as to Stubbings’ personal and financial circumstances, Jeruzalski should have known that Stubbings was bound to lose his properties. This meant that equity would treat him as having knowledge of Stubbings’ special disadvantage. Alternatively, he was wilfully blind by reason of the deployment of the lenders’ system of conduct. Accordingly, Jeruzalski (and therefore the lenders) would be fixed with the knowledge which he had deliberately abstained from acquiring.

Steward J found that the certificates of independent advice could not operate to undo the finding of unconscionability. The provision of the certificates did not provide Jeruzalski with any comfort or assurance that Stubbings or VBC would be able to service the loans or that the transactions had ceased to be risky or dangerous for them. Instead they were part of the very system of conduct “designed to inhibit the grant of equitable relief arising from the unconscionable conduct” of Jeruzalski and his law firm.

Observations

Whilst the decision generally represents an orthodox application of principle to reasonably extreme facts, the following practicalities to a dispute involving an allegation of unconscionable conduct are worth noting:

• Findings of unconscionable conduct are highly fact sensitive and there are no pre-determined categories of unconscionable conduct.
• The focus of the inquiry under equitable principles concerns whether a party to a commercial transaction has exploited a special disadvantage or vulnerability of another party, which it knows, suspects or ought to have known.
• Relative poverty is a well-established category of special disadvantage. Special disadvantage has also been recognised where there is a need for an explanation and assistance and none has been forthcoming.
• Statutory unconscionability is broader, and concerns whether the conduct in question is outside of contemporary societal norms and standards of acceptable commercial behaviour. Unconscionability may be present in a system of conduct or a pattern of behaviour, and there need not be loss or disadvantage in order for a system of conduct to be unconscionable.
• Systems, practices or procedures adopted by a lender which are deliberately designed to avoid knowledge of a party’s vulnerabilities or disadvantages or to inhibit the court’s equitable or statutory jurisdiction are likely to be found to be unconscionable.
• Related to the above, equity may fix a lender with the knowledge which they deliberately abstain from obtaining.
• Boilerplate or artificial certificates of independent advice provide weak protection for lenders against a finding of unconscionable conduct.

[1] A type of lending whereby loans are made exclusively on the basis of the value of the assets securing the loan without regard to the ability of the borrower to repay instalments under the loan, in the knowledge that adequate security is available in the event of default.

[2] The lenders conceded that Mr Jeruzalski’s knowledge and conduct was attributable to the lenders as their agent.