Doggett & Anor v Commonwealth Bank of Australia [2015] VSCA 351

A decision of the Court of Appeal puts a bank on the hook to guarantors following a flawed assessment of the borrower’s capacity to repay, thanks to fine print in the guarantees importing obligations from the Code of Banking Practice (but a letter of compromise saves the day)

Borrower overpays for business. Bank moves in. Guarantors take the hit. Sound familiar?

These guarantors had a Big Win at trial in proving that the lender bank owed a contractual duty to them (and not just to the borrower) to take care in assessing the borrower’s capacity to repay; and, that the bank breached that duty and caused their losses.

The bank’s biggest mishap was assessing the loan application as if the guarantors were going to work in the borrower’s business themselves (saving on salaries), when the loan officer knew they weren’t. This made a marginal loan application unviable. Had it not been for this error, the trial judge said, the bank would not have approved the loan.

How did the guarantors fare in the Court of Appeal? McLeish JA agreed with the first bit (about the contractual duty) and about the breach. But, he said, it wasn’t a given that had the bank realised the true income of the business it would have been ‘computer says no’. The bank might well have decided to approve the loan anyway. Banks do that all the time! And there was, of course, no evidence from the loan officer that the bank would have rejected the loan had it realised its mistake. There was always the guarantors’ resources to be taken into account. So the would-not-have-lent scenario was all speculative.

Fellow judges Whelan JA and Garde AJA respectfully disagreed with McLeish JA on causation (they agreed on just about everything else). To paraphrase: Of course banks don’t chuck money at dud businesses. Not only did the bank underestimate management costs, it also overlooked that that the borrower had not, in fact, paid a substantial deposit on the business (as the trial judge noted). No way was the bank going to lend if it had recognised these facts.

All the judges seemed to agree that the bank had to consider the borrower’s capacity to repay, and that it couldn’t simply add the guarantors’ resources to the borrower’s business income to work that out that capacity. McLeish JA’s causation analysis gave the bank, in effect, another way to add the guarantors’ resources back into the equation. But he was on his own on this point.

If you are not a banking law regular, you may be wondering since when did banks have an obligation to take care in assessing the borrower’s capacity to repay? Well, it is a duty set out in clause 25.1 of the Code of Banking Practice (drafted by the Australian Bankers’ Association) and contractually binding on a bank when the Code is incorporated by reference. The obligation in the Code is addressed to those to whom a bank offers credit. But the obligation is not owed only to borrowers, said the Court of Appeal.

McLeish JA comes to that significant conclusion following a methodical discursus on incorporation of terms. The journey is necessary given the woolly clause in the bank’s guarantee importing all ‘relevant’ clauses of the Code. McLeish JA finds assistance from bills of lading cases where the parties were just as casual about incorporating the terms of charterparties into their contracts of carriage without specifying exactly which terms they had in mind.

McLeish JA takes the scenic route to the conclusion that the bank’s assessment of the borrower’s capacity to repay is an obligation ‘relevant’ to the guarantee and therefore incorporated into it. And why not? Sounds reasonable. Well, said the bank, under the Code the bank has to give the guarantor information about the borrower’s financial situation. So it’s the guarantor’s duty to satisfy itself on that score, right? Nope: the guarantor can rely on the bank doing its job on assessment as well, says McLeish JA.

Finally, however, the decisive issue was a compromise with the bank which the guarantors had signed in 2010. The trial judge had found that this disposed of the guarantors’ claims against the bank, leading to the appeal. The Court of Appeal unanimously agreed.

Key takeaway for banks: Beware of incurring liability to the guarantor for a flawed assessment of the borrower’s capacity to repay.