In Stubbings v James 2 Pty Ltd  HCA 6, a decision from March 2022, the High Court found a loan, guarantee and mortgages were unenforceable due to the lenders’ unconscionable conduct. The case involved a system of asset based lending whereby a law firm, as intermediary, facilitated secured loans from their clients to borrowers. Asset based lending involves loans advanced exclusively on the value of the assets securing them without regarding to the borrower’s ability to make repayments.
Of significance was the High Court’s consideration of whether certificates of independent legal and financial advice obtained from the debtors justified the lenders refraining from further inquiry as to the debtors’ personal and financial situation. The High Court found they did not.
The Respondents were lenders and included Jams 2 Pty Ltd.
The Appellant, Mr Stubbings, was the guarantor of the loan made by the Respondents to a company owned and controlled by him (Borrower). Mr Stubbings’ obligations as guarantor were secured by mortgages over two properties in Narre Warren and a third property in Fingal. The Borrower had no assets and never traded. Mr Stubbings had no income.
The subject transaction arose as follows:
- Mr Stubbings’ properties in Narre Warren were mortgaged to the Commonwealth Bank of Australia.
- Mr Stubbings did not live at the Narre Warren properties. He lived at a rental property where he also worked repairing boats.
- Mr Stubbings ceased employment and was required to leave the rental property. He decided to buy a third property to live in.
- Mr Zourkas described himself as a ‘consultant’ who introduced potential borrowers to Ajzensztat Jeruzalski & Co (AJ Lawyers) who organised secured loans from their clients.
- Mr Zourkas encouraged Mr Stubbings to buy a big house with some land. Mr Stubbings found a property in Fingal for $900,000. Mr Zourkas told Mr Stubbings he could borrow enough to pay out the existing mortgages on the Narre Warren properties and purchase the Fingal property and have approximately $53,000 remaining to pay the first three months’ interest on his new loan. Mr Zourkas advised Mr Stubbings he could sell the Narre Warren properties, reducing the loan to approximately $400,000, which Mr Stubbings could then refinance with a bank with a lower interest rate.
- Mr Zourkas introduced Mr Stubbings to Mr Jeruzalski at AJ Lawyers. AJ Lawyers provided letters of offer of finance on behalf of their clients including the Respondents, each conditional upon Mr Stubbings acting as guarantor and providing mortgages over his three properties.
- AJ Lawyers and Mr Jeruzalski were found to have acted for the Respondents in the transactions and their state of mind and conduct was ‘sheeted home’ to the Respondents (14).
- Mr Zourkas provided Mr Stubbings with loan documentation including 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.
- Mr Zourkas had presented the certificates to Mr Stubbings in two sealed envelopes, one labelled Accountant and the other Solicitor, together with a business card for a solicitor, Mr Kiatos and a phone number of an accountant, Mr Topalides. Mr Zourkas told Mr Stubbings to take the documents, get them signed, and bring them back.
Primary Judge’s findings
The Primary Judge found Mr Stubbings’ indebtedness to the Respondents had been procured by unconscionable conduct on the part of their agent which was attributable to them. The Primary Judge found:
- Mr Stubbings laboured under a special disadvantage.
- It was the standard practice of AJ Lawyers to make no inquiries as to a borrower’s capacity to repay the loan and to have no contact with borrowers save for written correspondence and documentation.
- Mr Jeruzalski’s ostensible indifference to Mr Stubbings’ financial circumstances reflected a concern on his part that proof of his knowledge of such matters ‘would in some way undermine his clients’ ability to recover their loans’.
- The advice of Mr Kiatos and Mr Topalides was not truly independent
- There was a high level of ‘moral obloquy’ and ‘wilful blindness’ such that the loans were procured by unconscionable conduct and the security was unenforceable.
The Court of Appeal
The Court of Appeal overruled the Primary Judge’s decision, concluding that the evidence could not support a finding of unconscionable conduct attributable to the Respondents. Importantly, the Court of Appeal concluded that Mr Jeruzalski was entitled to rely on the certificates of independent advice such that it was reasonable for him to refrain from further inquiry.
The High Court’s decision
The High Court allowed the appeal by Mr Stubbings, applying cases including Commercial Bank of Australia Ltd v Amadio  HCA 14. In the majority’s reasons it was concluded that:
- Unconscionable conduct involves a relationship that places one party at a special disadvantage vis-a-vis the other as well as knowledge and unconscientious exploitation of that special disadvantage by the stronger party.
- Special disadvantage means something that seriously affects the ability of the innocent party to make a judgement as to their best interests. Mr Stubbings’ lack of commercial understanding coupled with his inability to repay the loans meant that the default and consequent loss of the equity in his properties was inevitable.
- Knowledge and exploitation
- The relevant question was, did the Respondents know or ought they to have known (via their agent) of the existence of the special disadvantage and its effect on the innocent party?
- Mr Jeruzalski had sufficient appreciation of Mr Stubbings’ vulnerability and the ‘disaster awaiting him’ that his conduct in procuring the execution of the mortgages was unconscientious (46).
- Mr Jeruzalski ‘had a lively appreciation of the likelihood that the loss of Mr Stubbings’ equity in the properties would be suffered by reason of his financial naiveté and his lack of means.
- The Primary Judge’s findings pertaining to Mr Jeruzalski’s state of knowledge were made after hearing Mr Jeruzalski in person over several days. The Court of Appeal had no basis for disregarding those findings. ‘Certainly the certificates were not a basis for doing so’ (47).
The High Court took into consideration the ‘bland boilerplate language of the certificates’, finding it was open to infer the certificates were mere ‘window dressing’ (49). The High Court drew the same inference from the ‘commercially unnecessary’ interposition of the company as borrower, a step calculated to impede scrutiny of the fairness of the transaction under the National Credit Code. The High Court described the certificates as ‘a precautionary artifice designed to prevent an inference that the respondents were wilfully blind to the obvious damage to the appellant’ and went on to say, ‘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’ (49).
‘Going through the motions’ without genuine, specific consideration of a transaction is risky. Worse still, deliberately avoiding inquiry in order to adopt a ‘hear no evil, speak no evil’ stance will mostly likely amount to wilful blindness. Certificates of advice do not necessarily remedy a debtor’s special disadvantage. To avoid exploiting a special disadvantage, a certificate should specifically address the disadvantage (in the facts of this case, Mr Stubbings needed advice as to the particular risks of asset based lending which he did not appreciate, due to his lack of commercial acumen). Certificates which are ‘boilerplate’ documents will not be effective. Further, the advice must actually be independent.
The overall takeaway from this case, from our perspective, is that lenders ought be engaged in each transaction and aware that contrived attempts to avoid scrutiny are unlikely to withstand challenge. The High Court has also dispelled the long held view that a person cannot be found to be under a special disadvantage if they have the benefit of legal advice, by finding that the mere presence of a solicitor’s certificate does not amount to independent legal advice.
This article was written by Simon Crawford, Partner and Jessica Cullin, Senior Associate.