Independence and unconscionability - Lessons for lenders and solicitors in advising third party guarantors
Jul 2015 |
Executive summary
The decision in Alceon Group Pty Ltd v Rose [2015] NSWSC 868 is of relevance to lenders and solicitors advising third party guarantors, insofar as it addresses the need for independence in the provision of the advice and for lenders to turn their minds to the adequacy of that advice.
The case also has an overriding relevance for all solicitors, as it addresses the need to proceed carefully in situations where the general law may impose obligations over and above those contained in professional conduct rules.
Introduction
The New South Wales Supreme Court has set aside a personal guarantee given by an elderly third party guarantor, on that basis that to do otherwise would be unconscionable where the transaction was not adequately explained to the guarantor by a ‘competent, independent and disinterested stranger’.
Importantly, in applying the High Court’s principles as set out in Garcia v National Australia Bank Limited1 the New South Wales Supreme Court firstly reinforced the obligations on a solicitor purporting to advise a third party guarantor (and a lender which seeks to rely on such advice having been given), and secondly made clear that solicitors’ professional conduct rules do not displace obligations imposed by the general law.
The facts
A lending institution called Alceon Group Pty Ltd (Alceon) agreed to lend $23 million to property development entity Quadwest Developments Pty Ltd (Quadwest), which was in desperate need of funds to pay significant creditors and ensure completion of a large residential strata title project in Perth.
The dire state of Quadwest’s finances introduced a high level of risk to the loan, which Alceon sought to mitigate by requiring security including personal deeds of guarantee and mortgages from third parties.
At the centre of Quadwest’s organisational structure was businessman Christopher Rose, the son of elderly parents Peter (Mr Rose) and Betty Rose (Mrs Rose).
Quadwest was wholly owned by another Christopher Rose company, and Christopher Rose was a director and secretary of Quadwest. Mr Rose was a director of Quadwest from December 2005 to September 2008, and from October 2008 up to and including 2011 when the Alceon loan was negotiated. Mr Rose had worked as a builder and was involved in the construction side of the project. Mrs Rose had no involvement in Quadwest’s activities.
As a condition of the $23 million loan to Quadwest, Alceon required from Mr and Mrs Rose personal deeds of guarantee and indemnity for $2 million and a mortgage over the family home at Clontarf, New South Wales. It was not in dispute that those documents were executed by Mr and Mrs Rose, and the loan was advanced.
Quadwest defaulted on the loan and Alceon sought to enforce the personal guarantees of Mr and Mrs Rose, and its rights under the mortgage over the family home. Both Mr and Mrs Rose resisted the orders sought by Alceon on a number of grounds. This newsletter focuses on the contention of Mrs Rose that the transaction was not adequately explained to her and that to enforce the transaction against her would be unconscionable.
The law
The High Court in Garcia identified certain circumstances in which a guarantee such as that signed by Mrs Rose would not be enforced on the basis that to do so would be unconscionable.
Those circumstances were described by the majority in Garcia as being where ‘the lender took no steps itself to explain … the purport and effect [of the transaction] to her or did not reasonably believe that its purport and effect had been explained to her by a competent, independent and disinterested stranger’.2
Where that failure has occurred, according to the majority in Garcia, the following circumstances make the transaction unconscionable:
- The surety did not in fact understand the purport and effect of the transaction;
- The transaction was voluntary (in the sense that the surety obtained no benefit from the contract the performance of which was guaranteed);
- The lender is to be taken to have understood that, as a wife,3 the surety may repose trust and confidence in her husband in matters of business and therefore the lender is also taken to have understood that the husband may not fully and accurately explain the purport and effect of the transaction to his wife; and yet
- The lender did not itself take steps to explain the transaction to the wife or find out that a stranger had explained it to her.4
The circumstances surrounding Mrs Rose’s guarantee
A solicitor by the name of Thomas Lennox (solicitor) had advised Quadwest on the prospective loan from Alceon, and was actively involved in the negotiations between the solicitor’s client Quadwest, and a Mr Cronin of Alceon. The solicitor was assisted in the matter by another lawyer, Patricia Tsang.
The solicitor sent an email to Christopher Rose attaching various documents including an Acknowledgment by Guarantors, a Declaration (as to receipt of independent legal advice) and a Consent to Legal Advice (from a partisan solicitor). More about these documents is said below.
In communicating Alceon’s requirement for advice to be given to Mrs Rose, Mr Cronin wrote to the solicitor that:
‘[Alceon’s] legal advice and obligation as lender is that [Mr & Mrs Rose] have to be advised of the risks associated with their guarantee in this circumstance – we understand that this advice need only be independent of Alceon and [its solicitors], so Lennox or Tsang would suffice. We believe that this advice need only be brief but is a requirement – sorry, I know this is logistically difficult but needs to be done.’
The solicitor then had a telephone conversation with Christopher Rose, Mr Rose and Mrs Rose in which he informed them to the effect that if Quadwest did not comply with its obligations, Alceon could demand the personally guaranteed amount of $2 million, and if the loan was still not satisfied, could exercise its rights under the mortgage, including selling the family home.5
Was the solicitor’s advice adequate?
Before considering Alceon’s state of knowledge about the solicitor’s advice to Mrs Rose (in order to assess the defences raised by Mrs Rose), the court considered the adequacy of the advice in fact provided to her. Although her Honour made clear that the solicitor was not a party to the proceedings and had not had an opportunity to be heard in relation to any findings of fact against him, her Honour’s assessment of what she found to be the solicitor’s advice remains a useful guide for practitioners.
As to the solicitor’s telephone call to the three members of the Rose family about the effect of the mortgage, the court found the call to be no more than ‘a formality to meet the bare requirements of Alceon’.
Further, the solicitor himself advanced no case that he had made any attempt to explain to Mrs Rose the effect of either the Declaration (which stated that Mrs Rose had received independent legal advice regarding the transaction and freely signed the mortgage, guarantee and other documents) or the Consent to Legal Advice (which purported to constitute a consent by Mrs Rose to receiving advice from a solicitor who was advising other parties to the transaction and so (in the court’s summation of the effect of the document) was ‘hampered in giving Mrs Rose independent or even complete legal advice’).6
Moreover, the court noted that the solicitor was well aware that the Declaration was ‘simply false’7 in that he knew he had not provided Mrs Rose with the advice that, by signing the Declaration, she stated she had been given.
The Court considered that Alceon’s suggestion that the advice to Mrs Rose ‘need only be brief’ was ‘not necessarily correct’.8 Rather, what was required was advice that Mrs Rose could comprehend, and the solicitor was obliged to take steps to ensure that she understood it.
Ultimately, the court held that the solicitor’s advice was ‘wholly inadequate’. It held that he failed to act as an independent solicitor, that he made no attempt to explain clearly to Mrs Rose the purport or effect of the Guarantee or the Mortgage she was asked to sign and no attempt at all to explain the Declaration. The explanation of the effect of a mortgage was ‘cursory, superficial, perfunctory and incomplete, at best’.9
Was enforcement of the transaction unconscionable?
The court considered each of the four indicia of unconscionability identified in Garcia (and noted above), as follows.
Did Mrs Rose understand the effect of the transaction?
Over the 58 years of their marriage, Mrs Rose had deferred to her husband in respect of financial matters. As she had done previously, Mrs Rose signed the Alceon documents when requested to do so by Mr Rose, without being bothered (in her words) to know what they were.
Apart from the solicitor’s explanation in the phone call to the three Rose family members, there was, as noted above, no attempt to explain to Mrs Rose the other documents which required her signature. Although no bad faith was found on the part of either Mr Rose or Christopher Rose, the court held that neither one had explained to Mrs Rose the nature and effect of those documents.
As Mrs Rose had signed mortgages over her home on a number of previous occasions, the court considered that she understood the effect of a mortgage and generally that the property could be taken if there was a default on the loan for which the mortgage was security. However, whilst Mrs Rose was found to have a theoretical grasp on these matters, she was found to not have any appreciation of the magnitude of the risk of default given Quadwest’s dire financial position, and the consequently high risk of Alceon exercising its rights under the mortgage.
As a result, Mrs Rose was held not to have understood the transaction into which she was entering.
Was the transaction voluntary?
Mrs Rose stood to gain no personal material benefit from the transaction, and was therefore a ‘volunteer’.
Was the lender taken to understand that Mrs Rose would trust and rely on her husband in relation to entry into the transaction?
Her Honour found that not only could Alceon be taken to understand that Mrs Rose reposed trust and confidence in her husband, but it did in fact have that understanding given Alceon’s attempt to protect itself by having advice given to Mrs Rose.
Did the lender believe the transaction was adequately explained by a ‘competent, independent and disinterested stranger’?
It was clear that Alceon believed the solicitor was competent; the real issue was whether Alceon could have considered at the relevant time that he was independent and disinterested. The court found that Alceon was well aware – at the time of the transactions – that he was neither.
The court held that at that time, Alceon knew of the ‘financially severe’ terms of its offer of finance, knew of Quadwest’s ‘dire financial position’ and therefore must have known ‘the very high degree of risk associated with [the] arrangement’, but nevertheless encouraged Christopher Rose to procure the solicitor – whom it knew was Quadwest’s solicitor – to provide advice to Mrs Rose.
In doing so, the court considered that Alceon ‘entirely undermined the protection it had sought to provide for itself’.
Did compliance with the Solicitors’ Rules justify the solicitor’s conduct?
Alceon sought to advance an argument that, as the solicitor had observed the Solicitors’ Rules,10 his advice should be considered adequate, and consequently Alceon had discharged its obligation. Although not identified in the judgment, it is understood anecdotally that Alceon sought to rely on the solicitor having adopted the model ‘Declaration’ of receipt of independent legal advice referred to in rule 45.7 and appearing in Schedule 2 to the Solicitors’ Rules.
Unsurprisingly the court rejected this contention (even without the necessity of examining the particular requirements of rule 45)11 holding that professional conduct rules ‘cannot, and do not, permit avoidance of the principles of law stated by the High Court’,12 and if any inconsistencies arise, it is the rules that must give way.
Moreover, her Honour noted that it is not within the contemplation of the Solicitors’ Rules that a solicitor would ‘facilitate presentation to a proposed finance provider of a document containing patently false statements’ such as the statement that Mrs Rose had been given legal advice about the solicitor’s conflict of interest in the matter.13
Conclusion
Alceon was found not to have reasonably believed that Mrs Rose received ‘competent, independent and objective’ advice as to the purport and effect of the transaction into which she was entering. The Garcia test being satisfied, the court declared it to be unconscionable to enforce the transaction against Mrs Rose.
Analysis
This case serves as a warning to lenders and also to solicitors advising third party guarantors, and to all solicitors in relation to professional standards generally.
A lender should be aware that when obtaining personal guarantees and mortgages from third parties (particularly volunteers), it must turn its own mind to whether the third party has received and understood (or reasonably appears to have received and understood) independent advice as to the purport and effect of the transaction. In this case, the lender advanced a high risk loan and sought to protect its position by obtaining the third party guarantee, but by virtue of its own constructive and actual knowledge of the solicitor’s lack of independence at the time the ‘advice’ was purportedly given to the third party volunteer, was not able to enforce the guarantee.
Solicitors advising third party guarantors should be scrupulous in ensuring that they provide independent advice to the guarantor as to each of the documents to be signed and the effect of the transaction. The solicitor should also take steps to test and, insofar as possible, ensure the third party has understood that advice.
All solicitors should also take heed of the need to observe the highest standards of professional conduct. The court’s observation that the Solicitors’ Rules in New South Wales cannot and do not override common law principles aligns with the explicit requirements of the Australian Solicitors Conduct Rules (ASCR) (now in force in Queensland, South Australia and the Australian Capital Territory) – see for example rule 2.1 (the purpose of the ASCR being to assist solicitors to ‘act ethically and in accordance with the principles of professional conduct established by the common law and these Rules’) and rule 4.1.5 (‘a solicitor must also comply with these Rules and the law’) (emphasis added in each case). Where a solicitor perceives any inconsistency between professional conduct rules and the general law, the prudent course is to observe the higher standard of the two.
1 Garcia v National Australia Bank Ltd (1999) 194 CLR 395.
2 Ibid, per Gaudron, McHugh, Gummow and Hayne JJ [31].
3 It is worth noting that these principles are not confined to matrimonial relationships, and may include de facto and same sex relationships, according to judicial comment in Garcia (see for example, at [22] and [33]). The underlying factor is the trust and confidence reposed by one party to the relationship in the other, where the trust and confidence is, or ought to be, apparent to the proposed lender.
4 Garcia v National Australia Bank Ltd (1999) 194 CLR 395 [31].
5 Interestingly, the solicitor was believed in his account of the conversation, which Mrs Rose said she did not recall, despite the fact that he had made no file note of the conversation and gave his evidence from memory more than three years after the event. In part, this was explained by her Honour’s view that the advice as the solicitor now described it ‘was deficient to such an extent that it is unlikely that his evidence was fabricated. Fabricated evidence would be expected to have gone further in protecting him against allegations of breach of duty’ ([68]).
6 Alceon Group Pty Ltd v Rose [2015] NSWSC 868 [75].
7 Ibid [85].
8 Ibid [82].
9 Ibid [74].
10 The Law Society of New South Wales Professional Conduct and Practice Rules promulgated pursuant to the Legal Profession Act 1987 (NSW).
11 Which notably include, at the least, a requirement that the interests of the recipient of the solicitor’s advice must not conflict with those of any other client of the solicitor (rule 45.4.2).
12 Ibid [87].
13 Ibid [88].
