The National Credit Code protects a borrower if they are a natural person and if the loan is ‘to purchase, renovate or improve residential property’.
The protections include: responsible lending assessments, precontractual statements, hardship and default procedures, a cap on the interest rate and changes to unjust loans.
Various non-bank and private lenders choose to avoid the National Credit Code by making business loans instead of consumer loans. These loans are called ‘non-coded loans’.
When making a non-coded loan to a property owner who is a ‘natural person’ ‘to purchase, renovate or improve residential property’ a lender avoids the National Credit Code by:
- Making the borrower a company of which the ‘natural person’ is a director, as opposed to the borrower being the property owner – a ‘natural person’; and
- Having the borrower sign a business purposes declaration.
In a recent decision, the Supreme Court of NSW has considered a non-coded loan made in this way and has declared that introducing a company as a borrower was not legally effective to avoid the National Credit Code. In addition, the Court declared the loan to be ‘asset lending’ which was unconscionable conduct under the ASIC Act.
In Integrated Securities No 3 Pty Ltd v Creatrix Web Development & Online Marketing Solutions Pty Ltd [2021] NSWSC 596 (19 May 2021), his Honour Justice Rein decided that:
- a loan structured as a non-coded loan made to the borrower’s company was subject to the National Credit Code because the borrower’s director and property owner had a primary liability to repay the loan as ‘debtor’;and separately,
- the lender had engaged in unconscionable conduct by “asset lending” in breach of the Australian Securities and Investments Commission Act 2001 (ASIC Act)
As a result, Justice Rein ordered that the loan agreement and mortgage be set aside and that judgment be entered for the amount of the loan actually received together with interest at the Court rate of 4.1% per annum, instead of interest at the effective interest rate under the loan documentation which was 69.588% per annum.
This is an analysis. References [ ] are to paragraphs in the judgment.
The loan by Integrated
Ms Pejkic and Mr Valerio were building a duplex at Yowie Bay, NSW. Their plan was to live in one dwelling. Initially they planned to rent, and later decided to sell the other dwelling to repay the loan. The title to property was in the name of Ms Pejkic.
The building work was unfinished when their builder walked off the site. They needed additional funds to complete the work due to escalating costs. RAMS Home Loans, which had advanced construction finance secured by mortgage over the property, refused to lend any further amounts under the construction loan due to their failure to meet repayments due under the loan.
Ms Pejkic and Mr Valerio made a loan application to Integrated, through a mortgage broker. Integrated did not hold an Australian Credit Licence and did not offer National Credit Code compliant loans.
Integrated offered a non-coded loan to Creatrix, a company of which Mr Valerio was the sole shareholder and director. Creatrix conducted a website design and development business. It had no interest in or involvement in the property or in the building of the duplex. Integrated did not request that Creatrix make a finance application or provide any information as to its financial position.
Integrated obtained personal asset and liability statements from Ms Pejkic and Mr Valerio. It relied on Mr Valerio’s income.
Integrated also relied on a valuation of the property which showed sufficient equity to support the loan. It did not require instalment payments during the term of the loan – all of the interest payable was deducted when the loan was advanced.
Mr Valerio signed a business purpose declaration (for a loan application with another lender), that is: “the credit to be provided to the applicant by the credit provider will be applied wholly or predominantly for business or investment purposes (or for both purposes).” [29, 30] He was not required to sign and did not sign a business purpose declaration for Integrated.
On 26 February 2018, the amount of $410,384.45 was paid into the bank account of Creatrix, representing the net proceeds of a loan of $530,000 (after deductions for pre-paid interest for the loan term, establishment fees and legal fees). The loan term was 6 months.
On 24 August 2018, the amount of $30,000 was paid into the bank account of Ms Pejkic and Mr Valerio, representing the net proceeds of a variation of loan of $93,295.46 (after deductions for pre-paid interest on the loan (as varied) for the extended loan term, fees and charges). The loan term was 4 months.
The interest rate on the loan was 3.5% per month. The default rate was 4.5% per month compounding monthly (the effective rate was 69.588% per annum).
The building work was completed. One dwelling was sold for $1,900,000 in May 2019. The whole of the proceeds of sale were applied towards the RAMS loan, which reduced the loan outstanding to approximately $1,000,000.
Ms Pejkic and Mr Valerio, and their children live as a family in the other dwelling, the value of which was assumed by the Court to be the same as the one sold, that is, $1,900,000.
The debt due to Integrated was $1,061,523.48 (including interest to June 2020). Integrated sought orders for payment of the debt and for the sale of the property.
The Court observed that: “there is a strong possibility that the proceeds of sale [of the unsold dwelling] will not even be sufficient to pay out the entire debt of Integrated [after the RAMS debt is paid]”. [9]
Was the Integrated loan subject to the National Credit Code?
The first issue the Court had to determine was:
Did Ms Pejkic and Mr Valerio incur primary liabilities to pay or repay a deferred debt?
If so, the Loan Agreement (which took the form of a Mortgage) was a credit contract under the Code. To incur a primary liability, one must be a ‘debtor’.
The s 204 National Credit Code definition of ‘debtor’ is:
debtor means a person (other than a guarantor) who is liable to pay for (or to repay) credit, and includes a prospective debtor.
In the Loan Agreement, the definition of “Debtor” was “Creatrix, Mr Valerio and Ms Pejkic”; and in the Variation of Loan it was “the Borrower, the Mortgagor and the Guarantor”.
In both, the definition of “Borrower” was “Creatrix”, “Mortgagor” was “Ms Pejkic” and “Guarantor” was “Ms Pejkic and Mr Valerio”. [34, 36]
The Court found that the Loan Agreement “has expanded the definition of “Debtor” from the borrower [Creatrix] to include others who would not normally have a primary liability”. That is, it included the persons described as mortgagor and guarantor. [85(4)]
The Court concluded that “Ms Pejkic and Mr Valerio are included within the definition of “Debtor” under the Loan Agreement.” [87]
The Court rejected Integrated’s contention that Ms Pejkic and Mr Valerio could not be debtors for the purposes of s 204 because they were guarantors: “In my view, s 204 should be taken to exclude from the purview of the Code persons whose only liability is a guarantor, not persons who are also debtors”. [42(4), (5), 77, 78, 79, 85]
The Court found that: “Ms Pejkic and Mr Valerio have incurred a deferred debt and they have been made [primarily] liable [as debtors] to pay the Secured Monies as defined. It follows that the Loan Agreement was [a credit contract which was] entered into in breach of the Code and the Court has open to it the remedies set out in s 180 of the NCCP Act.” [90, 91]
The second issue the Court had to determine was:
Was the loan made to Creatrix for business purposes?
Non-coded lenders rely on business purpose declarations to raise a presumption under s 13(1) of the National Credit Code that the Code does not apply “unless the contrary is established” (see s 13(2)). However, under s 13(3) a declaration is ineffective if the credit provider knew or had reason to believe that the credit was in fact to be applied for a Code purpose.
The Court found that there was no business purposes declaration complying with regulation 68 of the NCCP Regulations. The Court also found that there was no joint venture between Creatrix and Ms Pejkic and Mr Valerio to build the duplex, and that the loan proceeds were applied to complete the building work (i.e. to ‘improve residential property’).
As a result, the Court held that the s 13(2) presumption does not apply and that Integrated “bears the onus of persuading the Court that the Loan Agreement is not a credit contract to which the Code applies”.
The Court found that the onus was not discharged because the lender knew that the loan was made ‘to purchase, renovate or improve residential property’ – a purpose which was subject to the Code see: s 5(1)(b)(ii) of the Code. [42 (1), (2), (3), (7), (8), 60 (1) to (8)]
The Court concluded that:
“Integrated has entered into a credit contract which infringes the Code.” [91]
“On my findings, the Loan Agreement should never have been entered into. Section 180 of the NCCP Act gives to the Court wide powers and there is a regulatory aspect to credit contracts caught by the Code. I do not think that it would be appropriate to deprive Integrated of the $440,384.45 actually advanced and I accept as appropriate the Defendant’s concession that interest at the Court rate should be paid. In my view, all three Defendants should be required to repay the $440,384.45 plus interest at the Court rate but no more than that.” [94]
Was the Integrated loan unconscionable conduct?
The contention that the lender had engaged in unconscionable conduct in making the loan was an alternative defence, assuming that the Code did not apply. [95]
S 12CA, s 12CB and s 12CC of the Australian Securities and Investments Commission Act 2001 (Cth) apply to prohibit unconscionable conduct in relation to the supply of financial services, and so apply to non-coded loans.
The Court said: “First, I need to determine whether “asset lending” was involved here and then to determine whether other aspects of the matter point to unconscionable conduct on the part of Integrated.” [104]
The Court adopted this definition: ““Asset lending” has been described as lending “without regard to the ability of the borrower to repay by instalments under the contract, in the knowledge that adequate security is available in the event of default”. [105]
The Court found that Integrated had engaged in “asset lending” because it “was not satisfied that Integrated had a genuine basis to conclude that Mr Valerio and Ms Pejkic could repay the loan from Integrated without sale of the whole of the asset they were borrowing to protect”. [116]
The Court then weighed up various factors relevant to unconscionable conduct:
Factors against [117] –
- Independent legal advice that by signing they were doing “a deal with the devil”;
- They did not suffer cognitive or physical impairments;
- There was no pressure applied by Integrated to sign the loan documents;
- The higher than usual interest rate reflected the risk of non-payment.
Factors in favour [118] –
- Integrated required Creatrix to become a borrower even though it had no genuine connection with the project and no proprietary interest in the property;
- Integrated required Creatrix to be involved so as to avoid the Code;
- Integrated did not obtain financial statements from Creatrix;
- Mr Valerio and Ms Pejkic were in a desperate situation and did not take into account factors such as the time needed to sell the dwelling, and the only way of avoiding sale of their home was to refinance with RAMS;
- There would be little or no equity left in the property to repay the Integrated loan;
- The interest rates were exceptionally high;
- Substantial fees were payable upfront;
- After deduction of interest and substantial fees, the net proceeds available were $440,384.45 which was less than anticipated further building costs of $500,000;
- Integrated did not require them to obtain financial advice, and they did not obtain any, in the context where their ability to refinance “would appear to be slim and unrealistic”;
- “they were, I find, in a desperate situation of their own making but nevertheless thereby vulnerable”.
“I conclude that Integrated and Mr Cacciola [its sole director] have engaged in unconscionable conduct”. [120]
Orders made
The Court made these orders:
- Pursuant to s 180 of the National Consumer and Credit Protection Act 2009 and/or s 12GM of Australian Securities and Investments Commission Act 2001:
a. the Loan Agreement and Deed of Variation be set aside; and
b. mortgage given by the Second Defendant over the Property be set aside;
- The First, Second and Third Defendants [Creatrix, Ms Pejkic and Mr Valerio] to repay to the Plaintiff the amount actually received of $440,384.45 with interest accrued as follows:
a. on the amount of $410,384.45, from 26 February 2018, interest, calculated at the rate prescribed by section 100 of the Civil Procedure Act 2005 (NSW), in the sum of $66,675.18;
b. on the amount of $30,000, from 24 August 2018, interest, calculated at the rate prescribed by section 100 of the Civil Procedure Act 2005 (NSW), in the sum of $4,065.04;
The Court rate was 5.6% pa in February 2018, and is 4.1% pa currently.
Integrated has foreshadowed an appeal.
Referral to ASIC
The Court decided to refer two matters to ASIC in the public interest. The Court said:
“It is important to bear in mind that the legislature has endeavoured to ensure that people are protected from highly disadvantageous loans.”
“It is clear that Integrated and other lenders engaged in lending on onerous terms are very much aware of the loophole that seemingly permits them to escape the operation of the Code – i.e. the ability to insist on the introduction of a company as the borrower even where … there really is no existing business or venture of the corporation for which the loan is sought.” [119]
“I think ASIC’s attention should be drawn to this potential means of avoiding the Code for consideration by its relevant officers as to whether steps should be taken to seek to have the legislation extended to cases where a company borrows for no purpose genuinely connected to its normal business. I will therefore direct the Equity Registrar to forward a copy of these reasons to ASIC.”
“An additional reason for doing so is that on my findings it may need to consider whether Mr Cacciola has by his conduct breached the s 80 ban imposed upon him by ASIC and take whatever action it deems fit should it conclude that he has done so.” [120]
Note that in 2014, ASIC banned David James Cacciola from engaging in credit activities for nine years.
Concluding Comments
The findings in Integrated v Creatrix on the National Credit Code mean that lenders who provide non-coded loans need to remove natural persons from the definition of ‘debtor’ in their loan documents, as inclusion leaves the door open to Court applying the National Credit Code to the loan. And they cannot rely on a business purposes declaration if it is inconsistent with the facts.