Mortgage Brokers / Finance Brokers are not often targets in loan enforcement proceedings.
The fact that the mortgage broker, not the lender, was targeted by experienced property investors facing repossession proceedings makes the decisions of the Court of Appeal of the Supreme Court of New South Wales in Carnemolla v Adelaide Bank  NSWCA 122 (McColl JA, Barrett JA, Tobias AJA), and of the single judge in Bendigo & Adelaide Bank Ltd v Carnemolla  NSWSC 1202 (Hislop J) stand out.
The loan in question was made before the National Credit Law came into effect.
The court applied a common law duty of care to the mortgage broker, which is similar to the not unsuitable loan requirement and to the responsible lending conduct obligations under the National Credit Law.
Why was the mortgage broker pursued in Carnemolla?
The property investors, Sebastian and Lucia Carnemolla, consulted a mortgage broker in November 2004 to refinance a loan. The loan was secured against their residential investment properties and their family home. The investment properties had been purchased for a residential property development.
As the loan was predominantly for investment purposes, it fell outside of the former UCCC (Uniform Consumer Credit Code).
In defending possession proceedings brought by the lender against the family home, the Carnemollas joined the mortgage broker and claimed that he should bear responsibility for the loan default. They alleged -
- They were taken advantage of because of their difficult financial situation.
- They were influenced by having a close relationship with the mortgage broker.
- The new mortgage was not in their best interests.
- They needed to obtain legal advice when signing the loan application.
- The loan application contained false information and their signatures were forged.
- The taxation returns used were false.
- They were disadvantaged through lack of education, reasoning ability and financial know-how.
- One of them had a psychiatric condition.
These allegations were questions of fact decided by the single judge. He found in favour of the mortgage broker on each, substantially on credit, after hearing oral testimony. There was a clear lack of what today would be preliminary assessment documentation.
The Court found that the Carnemollas were experienced property investors – they had experience in the purchase and financing of real estate, they understood the nature of a loan application and a loan contract, and they understood that if they defaulted the lender could take possession of the property security and sell it. And that the loan was in their best interests.
The National Credit Law – the loan must be not unsuitable
The current law on the duty of care owed by mortgage brokers for residential investment loans is found in the Responsible Lending Provisions – Chapter 3 of the National Consumer Credit Protection (NCCP) Act 2009. The law took effect on 1 July 2010.
The National Credit Law applies to mortgage brokers who arrange residential property investment loans, mortgages and guarantees by natural persons. The National Credit Law follows the common law as described in the Court of Appeal in Carnemolla in two respects:
- Mortgage brokers (being persons who provide credit assistance), must arrange not unsuitable loans or principal increases (Part 3.1).
The not unsuitable loan requirement appears to be broadly equivalent to the standard of care that the Court applied in Carnemolla – that the loan [must be] in the best interests of the borrower.
In Carnemolla, the Court found that the loan refinancing was in the best interests of the borrowers because -
The refinancing the loan ... so as to obtain additional funds after the repayment of the existing loan ... was a legitimate business decision provided the excess was sufficient to enable the mortgage to be paid for a reasonable period in which ... to sell ... [the property security].
- Mortgage brokers must make a preliminary assessment about whether the credit contract is not unsuitable for the borrower. To do so, they must –
- make reasonable enquiries about the borrower’s requirements and objectives
- make reasonable enquiries about the borrower’s financial situation
- take reasonable steps to verify that financial situation
The enquiries and steps the mortgage broker must take echo the issues raised in Carnemolla.
The preliminary assessment must be prepared and made available to the borrower (if requested). Had this written assessment been prepared and been made available, it would have provided stronger evidence in Carnemolla that the mortgage broker had satisfied their duty of care.
While the National Credit Law applies only to property investors who borrow (or refinance) or provide property security as natural persons (in their personal names), for residential property investment, renovation or improvement, the general principles the Court has laid down in Carnemolla, could have wider application.
The wider application is that the principles could apply to property investors who personally guarantee residential investment loans to their investment entities such as family trusts or SMSFs, and therefore might expose their family home which is in their personal name.
The National Credit Law - responsible lending conduct
The National Credit Law applies to property investment loans obtained for the purpose of purchasing or refinancing or improving residential property for investment purposes.
According to the guidance in the National Credit Law, the credit will be unsuitable if –
- the borrower could not pay or could only pay with substantial hardship, such as if the sale of the borrower’s principal place of residence is the only means of repayment; or
- the loan will not meet the borrower’s objectives; or
- the borrower is in default under an SACC (small amount credit contract)
The National Credit Law requires care to be taken as to unsuitability when offering loans which are not standard home loans. A standard home loan is defined as a loan where principal and interest is paid for the full term, and the interest rate is either variable or fixed on the entire balance. The duty of care is higher if the investment loan does not follow the standard home loan definition. For example, it is higher if interest is capitalised to allow time to sell because this reflects poorly on the borrower’s ability to make regular payments.
ASIC Regulatory Guide 209 sets out ASIC’s expectations for meeting the responsible lending obligations in Chapter 3 of the NCCP Act.
RG 209 provides examples of the types of information that a mortgage broker should use to verify a consumer’s financial situation, such as: PAYG employees – recent pay slips and employment confirmation; Self- employed – financial statements, business bank account statements, recent taxation returns, an accountant’s statement, BAS records; All – a credit report and credit information.
The Carnemolla decision serves as a wake-up call to mortgage brokers who arrange residential investment loans which do not fall under the National Credit Law.
With non-National Credit Law lending, Mortgage brokers / Finance brokers owe a common law duty of care to property investors to arrange loans which are in the best interests of the property investor.
The documentation used should be of a similar standard to the preliminary assessment.
Some residential investment loans are hybrid in terms of the National Credit Law. A residential investment loan which is made to a family trust or SMSF with a corporate trustee does not fall under the National Credit Law. But if the family home is in the name of a natural person and is mortgaged, then that part of the loan falls under the National Credit Law.
Therefore, many mortgage brokers adopt the practice of treating all residential investment loans as falling under the National Credit Law, and apply responsible lending conduct practices.
Footnote: The Australian Treasury’s proposals to widen the application of the National Credit Law to a wide range of investment credit contracts, has been deferred until the post 7 September 2013 parliament.