Vendor finance is a traditional, legal method used to sell property in Australia, with no bank involved.
Both buyers and sellers benefit if vendor finance is offered on fair terms that buyers can afford; that enables buyers to refinance into the banking system.
In the Supreme Court of New South Wales decision of Gray v Latter  NSWSC 122, Justice Adamson decided that the vendor finance terms the sellers (Gray) provided were unconscionable, and ordered that the loan amount repayable by the buyers (Latter) be reduced, by applying the Contracts Review Act 1980 (NSW).
How a vendor finance arrangement came about for the house at Swan Bay
Swan Bay is a peaceful location on the NSW coast, near Port Stephens.
Gray and his partner Steinwede purchased the house at 129 Davis Road in September 2010, through a real estate agent. They paid the price of $145,000, from their savings. They moved from Cairns in north Queensland to Swan Bay for family reasons, and decided to rent out their home in Cairns.
Although the house was in very poor condition, they decided to renovate, instead of building a new house. This is how they came to meet Latter, a local handyman, whom they engaged to carry out repairs.
In late October, 2010, after working on the house for four weeks, a friendship had developed. Latter, Gray and Steinwede would chat and drink beer over lunch. Latter told them that he was interested in buying the property, if they ever wished to sell it.
In early November, Gray was told by a Council Building inspector that the septic system needed to be upgraded within the next 12 months. Gray knew that a new sewerage bio-system would cost $20,000.
A few days later, Latter told Gray that he and his partner Perkins had been served with a notice to quit their rental house and were looking for a new roof over their heads. This was proving difficult because they had two dogs.
Steinwede told Latter they may be interested in selling the house to him for $250,000, and may be willing to provide vendor finance.
The vendor finance terms for the sale of the house at Swan Bay
On 12 November, 2010, Gray and Steinwede met with Latter and Perkins, at the house. They agreed in principle on the price, the deposit and the vendor finance terms. Gray said “We will set up the loan just as a bank would. You can look at us as a really nice, friendly bank to deal with.”
The Contract for Sale and the Mortgage provided that Latter and Perkins were to: (i) purchase the house for $240,000; (ii) pay a deposit of $5,000; (iii) pay a rent of $150 per week for early occupation; (iv) have $235,000 vendor financed; (v) make repayments of $300 per week - $150 for interest, and $150 for capital reduction; and (v) pay the balance principal of $218,500, two years afterwards.
Gray and Steinwede moved back to Cairns at the end of November. Settlement took place and the title was transferred to Latter and Perkins on 7 January 2011. The vendor finance was secured by a registered first mortgage over the title. The property was not valued for loan purposes because it was a private sale.
The possession proceedings
In November, 2012, Latter and Perkins applied for finance from the ANZ Bank. The bank offered only $140,000 because the house was valued at $165,000. This came as a surprise, and only then did they discover that Gray and Steinwede had paid $145,000 for the house, two months before on-selling to them. They let the vendors know that the loan offer was insufficient to repay the amount that was due on 7 January 2013, and asked for an extension.
Gray and Steinwede were not willing to extend the time for repayment. They issued a Statement of Claim for Possession and for the purchase price outstanding. Latter and Perkins continued to make payments of $300 per week throughout, and by the hearing date, had reduced the principal to $209,800.
Latter and Perkins claimed that the vendor finance arrangement was an unjust contract, and requested the Supreme Court to apply the Contracts Review Act.
This was not a run-of-the-mill Contracts Review Act situation of a large financial institution taking advantage of borrowers and guarantors who are vulnerable or disadvantaged through lack of education, unfamiliarity with English, or disability.
Was the contract unjust?
The Court found that the asking price and the terms of the vendor finance were unjust.
As to the asking price of $240,000, Gray and Steinwede justified the $95,000 increase over what they paid by pointing to purchase costs, renovation and relocation expenditure, and the added value of ‘70% extra land’ discovered by survey. By contrast, valuation expert reports obtained for the case set the fair value at the time at $167,500.
Normally, caveat emptor (let the buyer beware) applies and a buyer cannot complain that they paid too high a price. But in this case, in setting the asking price well above fair value, the Court took the view that the sellers had ‘exploited the familiarity that had developed’, which justified the Court revising the price.
As to the terms of the vendor finance, $300 per week was affordable and so was the deposit of $5,000 (about 2% of the price). The court observed: ‘The terms of the vendor finance gave the defendants a false sense of security ... that they could afford to buy the property at the exorbitant price sought ... and that they would have some equity in the property when it came to refinancing the loan after two years.” The court concluded that “there was no real prospect either that the defendants would be able to refinance or that the debt could be recouped from the proceeds of sale of the property” within two years.
Viewed through the prism of section 9(2) of the Contracts Review Act, the specific injustices were -
- ‘The setting of a purchase price that was almost 50% higher than the true value of the property was not reasonably necessary for the protection of the plaintiff’s legitimate interests.’ (s. 9(2)(d))
- ‘No financial advice was obtained by the defendants.’ (s. 9(2)(h) & (i))
- ‘The plaintiffs used ‘unfair tactics’ in their dealings with the defendants by making it affordable to enter into the Contract, without regard to the improbability of refinancing after two years.(s. 9(2)(j))
- In general, the plaintiffs ‘exploited their trust and the associated vulnerability’. (s. 9(2)(l))
The orders made
The Court rejected two scenarios which were: (1) to transfer back the property and release the debt, because Latter & Perkins would obtain no benefit from the payments made or work done on the property; and (2) refinancing $140,000 and repaying the remainder by instalments of $250 per week, because the extra payments would create a substantial risk of default.
The Court made orders to re-write the terms in favour of the buyers as follows:
- Reduce the Contract price from $240,000 to $167,500, being the true value of the property as at the Contract Date
- Reduce the Mortgage principal by the same amount, from $235,000 to $162,500, and then credit $24,600 as paid (at the rate of $150 per week)
- Allow 90 days for the defendants to pay $137,900 ($162,500 less $24,600) in full discharge of the mortgage
- In default of payment, the plaintiffs be entitled to a judgment in possession (but pay $24,600 to the defendants)
- Require the defendants to continue to pay $300 per week (with $150 credited)
Lessons for vendor financing a property
Whether the form of vendor finance is seller carry-back finance as in this case, or a rent to buy or an instalment sale, the terms must be fair.
There are two lessons to be drawn from this decision -
- It is acceptable for the price of a vendor financed property to be set higher than the cash price for the property. But the price should not be exorbitant.
- Structure the terms of the vendor finance arrangement, especially the time period, to enable the buyers to refinance with a bank.
Disclosure Cordato Partners Lawyers represented Latter and Perkins (the buyers) in the possession proceedings. Michael Klooster of counsel appeared and Fiona Ta’akimoeaka was the instructing solicitor.