Supreme Court Rejects Request to Invalidate Business Loan

The claimant sought to invalidate a loan and mortgage on grounds of fiduciary obligations and consumer credit violations. The court dismissed the claim, finding the agent acted within his authority and the loan was for business purposes.

New South Wales Supreme Court

CITATION : [NAME] v [NAME] [2004] NSWSC 921 HEARING DATE(S) : 28/09/04, 29/09/04 JUDGMENT DATE : 8 October 2004

JUDGMENT OF : Gzell J DECISION : Borrowers' claims to set aside loan and mortgage dismissed. Orders for repayment of principal and interest made on lender's cross claim.

CATCHWORDS : EQUITY - Fiduciary Obligations - Whether agent of lender in short term bridging loan market implicated with sufficient knowledge of a breach of duty by the directors of the borrowing companies to justify setting aside the loan and mortgage under the second limb of [NAME] v [NAME] the loan at 72% pa with a default rate of 102% pa infringed the Consumer Credit (New South Wales) Act 1995 and the Consumer Credit (New South Wales) Code Consumer Credit (New South Wales) Act 1995 Consumer Credit (Queensland) Act 1994 (Qld) LEGISLATION CITED : Consumer Credit (New South Wales) Code Oaths Act 1900 Consumer Credit (New South Wales) Special Provisions Regulation 2002 Jones v Dunkel (1959) 101 CLR 298 [NAME] v Commonwealth (No 2) (2000) 103 FCR 1 CASES CITED : Barnes v Addy (1874) LR 9 Ch App 244 Consul Development Pty Ltd v DCP Estates Pty Ltd (1975) 132 CLR 373 NCR Australia Pty Ltd v Credit Connection Pty Ltd [2004] NSWSC 1 [COMPANY] - 1st Plaintiff/1st Cross Defendant [COMPANY] - 2nd Plaintiff/2nd Cross Defendant [COMPANY] - 3rd Plaintiff/3rd Cross Defendant PARTIES : [COMPANY] - 4th Plaintiff/4th Cross Defendant [COMPANY] - 5th Plaintiff/5th [COMPANY] - 6th Plaintiff/6th Cross Defendant [COMPANY] - 7th Plaintiff/7th Cross Defendant [NAME] - Defendant/Cross Claimant FILE NUMBER(S) : SC 3194/04 COUNSEL : [redacted] SOLICITORS : [redacted] Turner Freeman Lawyers

IN THE SUPREME COURT OF NEW SOUTH WALES EQUITY DIVISION

GZELL J

FRIDAY 8 OCTOBER 2004

3194/04 [COMPANY] & [NAME] v [NAME]

Introduction 1 [NAME] carried on business in the short term bridging loan market. In June 2003 he was approached for a short term loan to the second plaintiff, [NAME] No 7 [COMPANY] for the subdivision of a property in [ADDRESS]. [NAME] said he was acting on behalf of his sister [NAME], the defendant. Documentation for a loan of $520,000 was executed by [NAME] and [NAME] as borrowers and [NAME] as lender. That documentation was subsequently changed to substitute the first plaintiffs, [COMPANY], [NAME] No 2 [COMPANY], [NAME] No 3 [COMPANY] and [COMPANY] for [NAME]. 2 The loan was for a term of four months at an interest rate of 6% per month, or 72% per annum and a default interest rate of 8.5% per month, or 102% per annum. The documentation included a second mortgage over the [ADDRESS] property. After payment of stamp duty and fees, the loan moneys were paid by direction to [COMPANY], the directors and shareholders of which were [NAME]. A caveat was registered over the property in favour of [NAME] stating her interest as mortgagee. 3 The [NAME] sought orders that the loan transaction and the mortgage be set aside and the caveat be withdrawn. They also sought a declaration that the interest provisions were void. By cross claim, [NAME] sought an order that the [NAME] pay her $520,000 plus interest, costs and expenses.

The issues 4 The [NAME] alleged that [NAME] did not exist or that [NAME] was not her agent and, in consequence, there was no loan by or mortgage to [NAME] to be set aside. Alternatively, the [NAME] argued that [NAME] breached their duties to the companies as directors, [NAME] participated in those breaches and the loan and mortgage should be set aside. In the further alternative, the [NAME] argued that the loan was not for business or investment purposes and the interest charges should be reduced under the Consumer Credit (New South Wales) Act 1995.

Existence of [NAME] 5 [NAME] did not give evidence. [NAME] said she was resident in Bangalore. His evidence that he was her brother was challenged on the basis that it was hearsay as was his evidence that he had been constituted her agent to make investments in Australia. I allowed the evidence on the basis that his belief that she was his sister and he was instructed to act on her behalf was relevant to the actions he took. 6 In evidence was a photocopy of portion of a passport containing the stamp of the Ministry of External Affairs of the Government of India in the name of [NAME] with a photograph. Also in evidence was a photograph of [NAME] and a person he described as his sister. That photograph bears a resemblance to that on the passport. 7 [NAME] conceded that he had used the name [NAME] in the past. It was suggested that [NAME] was an alias of [NAME]. I reject that suggestion. The only appropriate inference to be drawn from the material before me is that [NAME]'s belief is correct, [NAME] exists and she is his sister.

The agency of [NAME] 8 [NAME] said it was his belief that [NAME] transferred funds into the accounts of other sisters in Australia, namely, [NAME] and [NAME] at the Sydney branch of [NAME]. [NAME] said he believed that the majority of the funds in the accounts belonged to [NAME]. 9 On 30 June 2003, [NAME] transferred $107,000 from [NAME]'s account and $392,000 from [NAME]'s account into a [NAME] branch account in his former name, [NAME]. 10 [NAME] said he had the task of investing for his extended family including [NAME]. He said he was aware that [NAME] had caused funds to be deposited to the accounts of [NAME] and [NAME]. He believed that in entering into the loan transaction with the [NAME] he was doing so on [NAME]'s behalf and that a bank cheque that he purchased by a debit of $438,319 against his [NAME] account came from her funds. 11 It was submitted that I should not accept [NAME]'s evidence in the absence of corroboration. It was submitted that [NAME] should have been called as a witness as should [NAME] and [NAME] of the firm, [NAME], the solicitors for the borrowers. It was submitted that [NAME] and [NAME] should have been called. It was submitted that I should draw the inference, in terms of Jones v Dunkel (1959) 101 CLR 298, that their evidence would not have assisted [NAME]. 12 I reject the submission. [NAME] gave evidence of his belief as to [NAME]'s instructions. As a result of that belief, moneys were transferred from the accounts of [NAME] and [NAME] to fund a loan to the [NAME]. The rule in Dunkel does not require a party to give cumulative evidence. It does not compel time to be wasted in calling unnecessary witness ([NAME] v Commonwealth (No 2) (2000) 103 FCR 1 at 120). 13 The $107,000 withdrawn from [NAME]'s account reduced it to an insignificant amount. It was submitted that the moneys could not have been entirely those of [NAME] because there had been credits to the account between April 2003 and June 2003. That submission failed to take account of the fact that there was an opening balance in April 2003 in excess of the $107,000 withdrawn. 14 While the opening balance of the account of [NAME] in April 2003 was approximately $170,000 there were deposits of approximately $11,500, $150,500 and $51,000 in addition to the regular credits of $5,000 before the $392,000 was withdrawn. 15 It is clear that the source of the funds for the loan came from someone other than [NAME]. It is clear that the funds came from the Australian accounts of two of his sisters. There is no reason to reject [NAME]'s asserted belief that the funds had originated with [NAME]. There was in evidence an investor account statement in the name of [NAME] with its [NAME] of December 2002 establishing her investment of approximately $560,000 in mortgages. 16 In June 1999, [NAME] granted a joint and several power of attorney to another brother, [NAME] under his former name [NAME] and [NAME]. That power was not relied upon in [NAME]'s case. Her case was that she instructed [NAME] individually to deal with her funds in her sisters' accounts. 17 In my view, [NAME]'s authority to act on behalf of [NAME] was not confined to the power of attorney. The evidence was that coincidentally with it he believed he was authorised to act on [NAME]'s behalf with respect to the moneys in the bank accounts in the names of the two sisters. 18 In my view, the appropriate inference to be drawn from the evidence is that [NAME]'s belief was the fact and he had been constituted the agent of [NAME] to invest funds held by her in the names of two of her sisters and his execution of the loan documentation on behalf of [NAME] was authorised. It follows that [NAME] made a loan of $520,000 to [NAME] and to [NAME] to [NAME].

Breach of directors' duties 19 The original cheque directions were that the loan fund after payment of stamp duty and fees should be paid to [NAME]. Subsequently, [NAME] was instructed by the directors and secretary of the [NAME] to pay the net loan funds to [NAME]. The bank cheque drawn on the funds in [NAME]'s account was made payable to [NAME]. 20 [NAME], the provisional liquidator and one of the joint deed voluntary administrators of the [NAME], gave evidence that there was no prior indebtedness of the [NAME] to [NAME] that was discharged by the payment of the loan funds to it. 21 [NAME] had been recorded in previous years as making donations to the account of Sydney Talmudical College Association. Subsequent journal entries in a later year purported to adjust these amounts to treat them as loans by [NAME] to Sydney Talmudical College Association and by further journal entries in that later year, the purported liability to [NAME] was transferred to the [NAME] account operated by [NAME] to [NAME]. 22 It was claimed that there was nothing to justify the journal entries and, in consequence, the directors of [NAME] to [NAME] had breached their duty by making the funds secured over the property of those companies available to [NAME]. 23 I accept the analysis of [NAME]. It was not controverted by any expert evidence. 24 The significance of a breach of duty by the directors of [NAME] to [NAME] only arises if [NAME], through her agent [NAME], was implicated in the breach of duty to an extent sufficient to enliven the second limb in Barnes v Addy (1874) LR 9 Ch App 244. For the reasons that appear below, I am not satisfied that that principle was enlivened. It is, in consequence, unnecessary for me to determine whether the actions of the directors in making the funds available to [NAME] was in breach of their duties to [NAME] to [NAME].

The participation of [NAME] in any breach of duty 25 In [NAME] v [NAME] at 251, Lord Selborne LC said that the responsibility of a trustee extended in equity to others who were not properly trustees if they were found either making themselves trustees de son tort or actually participating in any fraudulent conduct of the trustee to the injury of the cestui que trust. 26 The requisite knowledge of such a person to be liable as an accessory to the breach of trust was discussed by the High Court in Consul Development Pty Ltd v DCP Estates Pty Ltd (1975) 132 CLR 373. Stephen J, with whom Barwick CJ agreed, said at 412 of the extent of constructive notice that would enliven the principle, that if a defendant knew of facts that themselves would, to a reasonable man, tell of fraud or breach of trust, the case might well be different as it clearly would be if the defendant had consciously refrained from inquiry for fear lest he learn of fraud. But to go further was, in his Honour's view, to disregard equity's concern for the state of conscience of the defendant. 27 A useful summary of the relevant bases of liability is contained in NCR Australia Pty Ltd v Credit Connection Pty Ltd [2004] NSWSC 1 at [168]. At [169] Austin J points out that there is no liability if the defendant merely knows facts that would have been investigated by a reasonable person acting diligently, thereby discovering the truth, where the defendant had innocently but carelessly failed to make the appropriate investigations. 28 There was nothing in the circumstances leading up to the documentation with respect to a loan to [NAME] that implicated [NAME] with knowledge of a breach of director's duty. He had been approached by [NAME] for short term bridging finance on a second mortgage with low loan value ratio over the [ADDRESS] property for rezoning and development. He was asked for $800,000 and said he could possibly raise $500,000. 29 [NAME] told him that he and his parents were the directors of [NAME] and it required the moneys to do a subdivision on the [ADDRESS] property. He was told the property was worth around $17 million and would be worth more than $22 million after subdivision. He was told the company required the funds only until a refinance came through. He was told that they had an offer to purchase for $15 million and they were only looking for a loan term of one to two months. He was told that [NAME] were prepared to give personal guarantees for the loan. [NAME] said he would list them as joint borrowers. [NAME] was told there should be no problem with the first mortgagee, [COMPANY], consenting to the registration of a second mortgage. [NAME] said he preferred to have a consent from [NAME] beforehand so the second mortgage could be registered but he could proceed on the basis of an executed second mortgage, a registered caveat and a signed request for the consent of [NAME] and a deed of priority. 30 It was submitted that [NAME] should have carried out a greater degree of due diligence than he did. But any failure in that regard did not enliven the second limb of [NAME] v [NAME]. There was nothing in the information given to him and which he discovered in carrying out his due diligence that would, of itself, suggest breach of duty on the part of the directors of [NAME]. The case for the [NAME] was not based upon the initial information acquired by [NAME] but was based on his knowledge when the arrangements were varied. 31 On the morning of 30 June 2003, [NAME] conducted final searches and discovered that the [ADDRESS] property was registered to [NAME] to [NAME] and not to [NAME]. He spoke with [NAME] who said that a transfer of the property from [NAME] to [NAME] in favour of [NAME] could be registered before lodgement of the caveat. 32 About midday, [NAME] spoke with [NAME] who asked that the cheques be drawn. [NAME] said he would only draw the cheques after the caveat had been registered. [NAME] said she would send the fully executed documents to [NAME] by facsimile and she could lodge the caveat. She said that the alternative to registering a transfer in favour of [NAME] was to change the documentation to [NAME] to [NAME]. 33 That was the course ultimately adopted. [NAME] lodged the caveat early in the afternoon of 30 June 2003. There was a taxi receipt timed at 2.09 pm. [NAME] said he obtained the bank cheque in favour of [NAME] after the caveat was lodged. His [NAME] statement records the debit raised in his account at 2.12 pm. 34 [NAME] maintained that he knew nothing about [NAME] until well into the afternoon. That could not be correct if the time recorded on his bank statement was accurate. It was suggested that the time was Western Australian time and it was two hours later as Eastern Standard time. I reject that suggestion. The bank statement was one from the Sydney branch. 35 There was, at the time, a deal of publicity over an action by [NAME] calling in a $13 million loan from the [NAME]. It was submitted that [NAME] was aware that [NAME] to [NAME] were incapable of discharging their liabilities and he was party to the determination to forward the loan moneys to [NAME] and, by insisting the caveat be lodged over the property of [NAME] to [NAME] before drawing the cheques, [NAME] required the breach of duty to be perpetrated before the moneys were advanced. 36 [NAME] denied any knowledge of the [NAME] litigation until later negotiations to refinance the loan took place in July 2003. The [NAME] did not establish earlier knowledge. [NAME]'s insistence that he knew nothing about [NAME] until late in the afternoon of 30 June 2003 was clearly incorrect, the doubt it raises with respect to his testimony generally is not sufficient to establish such knowledge on his part as would put him on notice that a breach of duty was to be committed. Nor, in my opinion, would the request by the directors and secretary of the [NAME] to pay the funds to [NAME] of itself raise in the mind of a reasonable person a suspicion of breach of duty. 37 On 2 September 2003, [NAME] sent an email to [NAME]. [NAME] had not consented to the registration of the second mortgage. [NAME] was anxious to obtain registration. The email contained the following: "I confirm that we based our decision to lend the money to [NAME] based on your advice that the transfer from [NAME]-6 was taking place and that this would take this property out of the reach of the other "unrelated [NAME] action". It has always been our understanding (based on your advice) that our advance would be ranked only behind [NAME] and that the [NAME] claim had nothing whatsoever to do with the [ADDRESS] property and only related to the [ADDRESS] properties over which security was held. I would appreciate your response." 38 [NAME] said the letter was based upon his overall perception of what happened and discussions he had with [NAME] in relation to refinancing. He said the email was wrong in stating that his decision to lend to [NAME] was, as at 30 June 2003, based upon any knowledge of the [NAME] action because he had not heard about it at that stage. 39 [NAME]'s attempt to explain the email, the two accounts do not stand together. [NAME] knew about the [NAME] litigation on or before 30 June 2003 or he did not. But while that conflict gives pause as to the veracity of this portion of his evidence, it does not ground the additional assumption of complicity by [NAME] in any attempt by [NAME] to engineer an indebtedness of [NAME] to 6 to [NAME] to justify the direction that the loan funds be paid to it. 40 [NAME] was also taxed about a statement made by him in a letter of 21 July 2003 in which he said: "There was an article in the Sydney Morning Herald of the 19th July 03 relating to the legal action between [NAME] and [NAME]. Your earlier verbal advice was that this action related to other properties and had no affect on this security. Is that still the case or is there now reason for concern?" 41 The reference to a conversation earlier than 19 July 2003 did not sheet home to [NAME] knowledge of the proceedings on or before 30 June 2003. 42 It was submitted that [NAME] to [NAME] conducted a religious school and were not involved in land redevelopment. Those companies were the owners of the [ADDRESS] property. The school had been transferred to other premises and the land was ready to be redeveloped. There was no reason why [NAME] should not regard [NAME] to [NAME] as in any different position from [NAME] so far as subdivision of the [ADDRESS] property was concerned. 43 In my view, the evidence did not establish that [NAME] had actual knowledge of any design on the part of [NAME] that would have constituted a breach of duty on their part to [NAME] to [NAME]. Nor did it establish that he had deliberately shut his eyes to such a design; nor that he abstained in a calculated way from making such enquiries as an honest and reasonable person would make, where such inquiries would have led to discovery of such a design; nor that he had actual knowledge of facts that to a reasonable person would have suggested such a design. 44 In my judgment the second limb of [NAME] v [NAME] was not enlivened with respect to [NAME] and his principal, [NAME].

The Consumer Credit (New South Wales) Act 1995 . 45 The Consumer Credit (New South Wales) Act 1995, s 5 provided that the Consumer Credit Code set out in the appendix to the Consumer Credit (Queensland) Act 1994 (Qld) applied as a law of New South Wales and as such law might be referred to as the Consumer Credit (New South Wales) Code. 46 Evidence was given by affidavit that short term bridging loans were made available in the short term bridging loan market for terms of one to three months with a base interest rate between 4% and 7% per month and a higher default interest rate of 2% to 5% above the lower rate. The deponent swore that there was a significant market in Australia for clients looking for such quick finance and that lenders in the market could charge up to 10% per month depending on commercial risks including whether the loan was on second mortgage and there was a high loan to value ratio. The deponent of that affidavit was not cross examined and no evidence was called in contradiction. 47 The Consumer Credit (New South Wales) Code, s 6(1) provided that it applied to the provision of credit if, when the credit contract was entered into, the debtor was a natural person ordinarily resident in New South Wales, the credit was provided wholly or predominately for personal, domestic or household purposes, a charge was made for providing the credit and the credit was provided in the course of a business of providing credit. [NAME] were borrowing parties under the loan documentation. 48 Section 11(1) of the Consumer Credit (New South Wales) Code provided that in any proceedings in which a party claimed that a credit contract, mortgage or guarantee was one to which the Code applied, it was presumed to be such unless the contrary was established. Section 11(2) provided that credit was presumed conclusively not to be provided wholly or predominately for personal, domestic or household purposes if the debtor declared before entering into the credit contract that the credit was to be applied wholly or predominantly for business or investment purposes. Section 11(3) provided, however, that such a declaration was ineffective if the credit provider knew, or had reason to believe, at the time the declaration was made, that the credit was in fact to be applied wholly or predominantly for personal, domestic or household purposes. 49 Amongst the loan documentation was a Consumer Credit Code declaration executed by [NAME] declaring that the credit to be provided by [NAME] was to be applied wholly or predominantly for business or investment purposes. That statutory declaration was declared before [NAME] pursuant to the Oaths Act 1900. In addition, [NAME] stated the purpose of the loan was for business purposes. 50 It follows from my findings above that the Consumer Credit (New South Wales) Code s 11(3) was not enlivened. [NAME] did not know and had no reason to believe that the moneys were in fact to be applied wholly or predominantly for personal, domestic or household purposes. In those circumstances, s 11(2) applied and any relief under the Consumer Credit (New South Wales) Code was excluded. 51 The Consumer Credit (New South Wales) Act 1995, s 11(1) provided that regulations might prescribe a maximum annual percentage rate for a credit contract to which the Consumer Credit (New South Wales) Code applied. The Consumer Credit (New South Wales) Special Provisions Regulation 2002, reg 7 prescribed a maximum annual percentage rate for a credit contract to which the Code applied at 48%. Relief under that provision is not, however, available to [NAME] and was not available to the [NAME].

Conclusion 52 In my view the [NAME] have failed to establish sufficient complicity on the part of [NAME] as agent for [NAME] to entitle them to relief by way of setting aside the loan transaction or the mortgage. It follows that they are not entitled to an order that [NAME] withdraw her caveat. Nor are they entitled to an order that the interest provisions under the loan transaction are void in terms of the Consumer Credit (New South Wales) Act 1995. 53 On the other hand, I am of the view that [NAME] has established an entitlement to repayment of principal and the payment of interest at the default rate of 8.5% per month. 54 I will hear the parties on costs. I direct the parties to bring in short minutes of orders reflecting these reasons. **********

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