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Lenders beware: Independent advice certificates not a substitute for proper due diligence

20 April 2022


Published by:

Amy Pun

Lenders beware: Independent advice certificates not a substitute for proper due diligence

In the recent case of Stubbings v Jams 2 Pty Ltd [2022] HCA 6 (Stubbings), the High Court of Australia provided a helpful reminder that independent advice certificates are not a tool for lenders to bypass proper due diligence. It is crucial for lenders to remain vigilant when assessing potential borrowers and guarantors, especially where those borrowers and guarantors are not well-versed financially.

In this article, we provide an overview of the role independent advice certificates play in lending transactions and key takeaways from the Stubbings case.

Purpose of independent advice certificates

It is common practice for lenders to request borrowers and guarantors to seek independent legal and financial advice before signing a loan or security agreement and to provide a signed solicitor’s certificate of independent legal advice and/or a financial advice certificate to the lender.

For a lender, these certificates can help evidence that the borrower and/or guarantor has received appropriate independent advice and that they understand the nature of the agreements they are entering into. 

However, as reinforced by the High Court in the Stubbings case, these certificates alone will not protect a lender from a court’s ability to set aside a loan and/or security from findings of unconscionability of the lender. Whilst the certificates are an important piece of evidence should a dispute arise, it is ultimately the duty of the lender to ensure they have made appropriate enquiries and have accurate information regarding the borrower or guarantor’s personal and financial circumstances, their ability to repay the loan and their comprehension of the documentation and risks involved with the transaction.

Learnings from Stubbings

In Stubbings, an individual sought an asset-based loan from a private lender to finance the purchase of a new property. The borrower’s existing two properties were used as security for the loan. The borrower was unemployed, had very few savings, and was financially illiterate. The loan was orchestrated through a deliberate and complicated system in which the borrower never communicated with the lender directly, but instead, was dealing with an intermediary and a law firm who effectively acted on behalf of the lender.

Despite the borrower’s poor financial situation, the loan was approved. Eventually, they defaulted on the loan and commenced proceedings against the lender, arguing that it had unconscionably exploited the disadvantage of their poor financial literacy and their absence of income to service the loan.

The lender contended that as it never dealt with the borrower directly, it had no actual knowledge of their financial situation and was therefore innocent of any wrongdoing. It also sought to rely on a certificate of independent legal advice and a certificate of independent financial advice signed by the borrower, arguing that these certificates established that the borrower had sought appropriate independent advice and was therefore adequately aware of its obligations.

The High Court rejected the lender’s assertions. In its judgement, the High Court reinforced some key elements around professional due diligence and independent advice certificates that lenders must be aware of when considering prospective borrowers:

  1. knowledge of agent is attributable: Despite the effective information barrier between the borrower and lender, as the law firm was an agent to the lender (its client), its knowledge was considered one and the same
  2. wilful blindness: The Court found that despite a lack of evidence suggesting that the borrower would be able to meet their financial obligations, the firm deliberately avoided conducting further due diligence checks in an attempt to remain ignorant of the borrower’s potential vulnerabilities. The Court therefore held that, due to its wilful ignorance, it had exploited the borrower’s financial vulnerability by proceeding with the loan and it was unnecessary for the firm to have actual knowledge of this vulnerability 
  3. systems: Likewise, the Court provided a warning for lending systems and procedures. In her judgement, Gordon J left open the possibility that practices, policies and systems designed to circumvent due diligence requirements through information barriers (as was the case here) may indicate an inherent appreciation for the possibility of a borrower being vulnerable
  4. certificates are not enough: While the certificates were, on the surface, a signed statement that the borrower had received independent advice on the loan, it was found that their contents suggested the borrower failed to appreciate the nature of the agreement. This was because both certificates lacked any particulars relevant to the loan terms and were written using ‘boilerplate language’, leading the Court to label them as ‘window dressing’ on a dangerous loan to a vulnerable person.

Key takeaways

Summing up, the key takeaways for lenders are:

  1. courts will not accept wilful ignorance as a defence against unconscionable exploitation. Lenders must be vigilant in making further enquiries where they suspect a borrower is potentially vulnerable
  2. lenders should regularly review their borrower assessment procedures to adequately address any potential information gaps or barriers in their procedures
  3. whilst independent advice certificates can help prove the adequacy of a lender’s due diligence practices, it is important they are tailored to the loan such that the court can confirm that the borrower and/or guarantor has sufficiently turned their minds to the loan before signing.

How can we help?

Our national Finance team acts on loan and security transactions across Australia. We can help you review your current practices and procedures to ensure that they address the issues above. Contact us below or email us here for more information. 

Authors: William Kontaxis & Amy Pun

The information in this article is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

Published by:

Amy Pun

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