In brief
A recent decision of the Victorian Court of Appeal has given a wide meaning to the Code of Banking Practice, finding that the duty of care owed by a lender in assessing the borrowers' ability to repay, extends to guarantors. Effectively the bank was responsible to guarantor/directors for funding their own bad business decision. Partner Karla Fraser, Senior Finance Counsel Diccon Loxton and Research Assistant Harry Stratton report.
The facts
A bank was a party to the 2004 Code of Banking Practice. Clause 25.1 of that Code (Clause 27 of the 2013 Code of Banking Practice) provided that the lender would 'exercise the care and skill of a diligent and prudent banker…in forming [its] opinion about your ability to repay the credit facility' before offering a borrower a loan.
In this case (Doggett v Commonwealth Bank of Australia [2015] VSCA 351), a bank advanced money to a borrower under a bill facility to purchase a business managing an apartment block. The borrower planned to conduct the business by employing an on-site resident manager (unlike the vendors who managed the block themselves). The facility was guaranteed by the borrower's directors and the guarantee expressly incorporated 'relevant provisions' of the 2004 Code.
The borrower commissioned an accountants' report and supplied it to the bank before the bank approved the facility. The report showed that the business did not generate sufficient revenue to cover profitably the cost of employing a manager. The business struggled, and the guarantors complained that the bank had given them misleading advice and an inappropriate loan. The bank threatened that unless the director/guarantors signed a letter releasing the bank from liability, the bank would enforce its security. They signed the release letter.
The borrower defaulted and the bank sued on the guarantees. The guarantors argued that the 2004 Code was incorporated into the guarantees, and they had the benefit of clause 25.1 even though it appeared to be addressed to the borrower. They argued the bank breached the clause, and that the release was ineffective because it was obtained through duress.
The decision
The bank won at first instance and on appeal. The guarantors generally succeeded on the Code issues – clause 25.1 was incorporated into the bill facility and the guarantees, and the lender had breached it. But they failed on the release point – the release of liability was effective and not obtained under economic duress.
In relation to the Code, the court said the following.
- Clause 25.1 of the Code was a 'relevant provision' in the context of the guarantee and therefore incorporated in it. Therefore, the lender owed 'you' an obligation to exercise the care and skill of a diligent and prudent banker in assessing 'your' ability to repay the facility.
- When incorporated in the guarantee, 'you' as defined included the guarantors as well as the borrower. Therefore the lender also owed the relevant duty to the guarantors in relation to the borrower's ability to repay. This was despite the fact that the guarantees warned guarantors to make their own inquiries as to the borrower's financial position.
- That assessment of the borrower's ability to repay could take account of the availability to the borrower of funds from other sources, including the guarantors. That does not mean the question is whether the combined resources of borrower and guarantors are sufficient to pay the debt – the Code refers unambiguously to the borrower's ability to repay.
- The relevant bank officer did give detailed consideration to the borrower's position but made two mistakes. He incorrectly assumed a deposit had been paid, but this mistake was materially contributed to by the guarantors. And he missed that an accountants' report on the business did not take account of the fact that the borrower, unlike the seller, of the business, would have to pay the wages of the manager and therefore could not trade profitably. Accordingly, the court found the duty of care was breached.
- The majority (Whelan JA and Garde AJA) held the breach caused the loss – that the loan would not have been made (and the liability not incurred) had the lender exercised the requisite skill and diligence. The minority (McLeish JA) thought that had not been established.
Lessons from the decision
- This case may give another weapon to guarantors where the Code of Banking Practice is incorporated in a guarantee.
- It may allow guarantors an avenue to argue that banks carried out inadequate credit checks on the ability of the borrower to repay, and thus breached their duty to the guarantors. Where the duty is found to have been breached, their liability in relation to a borrower default may be reduced or avoided.
- Note that this only applies where the terms of the Code are incorporated in the guarantee. Where the Code applies but (in breach of the Code) has not been incorporated into the guarantee, the guarantors may need to seek relief more indirectly, through a claim for misleading or deceptive conduct.