Finance & Markets Update - May 2009

In this edition  

• Case Note: Skalkos -v- Nicols [2009] FCA 346 (Buchanan J on 15 April 2009)
• Consumer Credit Code – When is a loan for a house not for personal, domestic or household purposes?
• Fairness Test for Bank Fees?
• Supreme Cout Gets Tough on Unfounded Defences to Possession Claims

Case Note: Skalkos -v- Nicols [2009] FCA 346 (Buchanan J on 15 April 2009)

This decision considers income contributions of a bankrupt during bankruptcy and the interpretation of ss 139J, 139K, and 139L of the Bankruptcy Act 1966.

The facts

Mr Skalkos was made a bankrupt on 25 June 2004 and discharged on 3 March 2008. Mr Steven Nicols was appointed his bankruptcy trustee.

During his bankruptcy, Mr Skalkos had been residing ‘rent free’ at 31A New South Head Road, Vaucluse (the Property), which was owned by Cunick Pty Limited (Cunick), a company of which Mr Skalkos was a director prior to his bankruptcy.

The present litigation arose because Mr Nicols had issued a re-assessment to Mr Skalkos for income contributions during his bankruptcy and also issued three further re-assessments shortly after Mr Skalkos was discharged from bankruptcy.

Included in each of the income assessments was the sum of $1,000 per week representing rent for tenancy at the Property which Mr Skaklos would otherwise have had to pay but for the generosity of Cunick.

The issue

The proceedings turn on whether or not rent otherwise payable by Mr Skalkos was income within the meaning of the Bankruptcy Act 1966 (the Act).

The findings

The Court found that Mr Skalkos had been residing rent free in the Property during his bankruptcy and that such benefit was assessable income for the purposes of the Bankruptcy Act 1966.

His Honour stated that “there is no ambiguity in the present statutory scheme”. He relied upon the Explanatory Memorandum which accompanied the amendments to s.139L of the Act which stated:

“Paragraph 139L(e) of the Act as it presently stands was thought to make the value of benefits provided to a bankrupt by a third party income, regardless of whether it is provided in an employment or work context. That was the original intention of the provision. However, the Federal Court, in the decision Bond v Ramsay [1994] FCA 1411; (1994) 125 ALR 399, given on 20 October 1994, held that any benefit had to be provided in an employment context, before it could be regarded as forming part of a bankrupt’s income. Accordingly, it is necessary to amend the provision to ensure that the original intention is carried into effect, and that the value of any benefit, whether or not provided in an employment context, whether or not in connection with the provision of work or services, and regardless of who supplies the benefit or the circumstances in which the benefit is supplied will be counted as part of a bankrupt’s income. Benefits or money provided in the nature of gifts to the bankrupt, or in the form of payments which discharge obligations of the bankrupt to third parties will be required to be included as part of the bankrupt’s income for contribution purposes.”

Implication of Decision

The decision if applied effectively by trustees will have significant ramifications on the income contributions of bankrupts who rely on family, related companies and trusts to maintain a certain lifestyle to which they are accustomed during bankruptcy.

Consumer Credit Code – When is a loan for a house not for personal, domestic or household purposes?

Section 6(1) of the Consumer Credit Code (The Code) applies to credit transactions with the following features:

• the debtor is a natural person ordinarily resident in the jurisdiction or a strata corporation formed in the jurisdiction;
• the credit is provided or intended to be provided wholly or predominantly for personal, domestic or household purposes;
• a charge is or may be made for providing the credit;
• the credit provider provides the credit in the course of a business of providing credit or as part of or incidentally to any other business of the credit provider.

Typically, it is section 6(1)(b) which attracts the most attention in disputes about the whether the Code applies. Queensland courts have applied a different test to the application of section 6(1)(b) than the courts of Victoria and New South Wales. In the recent decision of Shakespeare Haney Securities Ltd v Crawford [2009] QCA 85 (9 April 2009), the Queensland Court of Appeal has attempted to reconcile these differing approaches by articulating the test that ought applied to section 6(1)(b) of the Code.The case also provides useful guidance about the application of the Code to one off property investment transactions.

The facts

Shakespeare Haney Securities Limited was the registered mortgagee of land owned by Mrs Crawford. The mortgage secured about $6,210,000.00, loaned under a series of five transactions. Mrs Crawford fell into default and was served with a notice of exercise of power of sale, and thereafter a notice requiring the delivery of possession of the mortgaged property. When possession was not voluntarily surrendered, the mortgagee made an application for possession.

Mrs Crawford defended the application claiming that the loan and mortgage documentation did not comply with the key requirements of section 100 of the Code. She gave evidence that she was self-employed as a property developer having previously been involved in developing houses on the Gold Coast. The Shakespeare loan was a refinance of a Suncorp Metway business facility to allow her to complete the construction of her own private home (the mortgaged property). She eventually intended to sell when the right buyer was found and use the proceeds to fund a simpler life as a self funded retiree.

Shakespeare Haney Securities Limited put evidence before the Court that when applying for the loan Mrs Crawford had informed it that:

• the loan was a refinance of an existing business banking loan;
• a short-term loan was required pending the sale of the property at which time the loan would be repaid;
• the property was intended to be sold as a brand new home;
• the property was for sale; and
• she did not intend to reside at the property as this would make the home more attractive to overseas purchasers to whom she was marketing the property.

Mrs Crawford had signed five declarations (one for each advance) under section 11 of the Code and section 10 of the regulation which declared that “the credit to be provided to me/us by the credit provider is to be provided wholly or predominantly for business or investment purposes (or both).”

Mrs Crawford argued that the declaration was ineffective because the mortgagee knew or had reason to believe that the credit was in fact to be applied wholly or predominantly for personal, domestic or household purposes.

Mrs Crawford failed before the trial Judge, who was of the view that the Code did not apply because there were notions of underlying commercial purposes in the transaction. Mrs Crawford appealed that decision.

Wholly or predominantly for personal, domestic or household purposes?

The Court of Appeal considered the test to be applied to credit transactions to determine whether credit is provided or intended to be provided wholly or predominantly for personal, domestic or household purposes.

The Court had a choice between two approaches:

1. look at the intention of the borrower at the time the credit is provided; or
2. look to the substance of the transaction in the context of its performance, i.e. the actual use of the credit provided.

The first test had been applied by the District Court of Queensland, [1] whereas the second had been applied by the Victorian Supreme Court and approved by the New South Wales Supreme Court [2].

The Court of Appeal held that the preferred approach to section 6(1) of the Code is the second, which looks at the substance of the subject transaction and requires an objective assessment rather than an approach that looks at the actual intention of either the borrower or the lender.

One off property investment transactions covered by the Code?

The Court of Appeal then considered whether a one off property transaction with an intention to resell at a profit constituted the necessary commerciality required to bring Mrs Crawford’s transaction outside the scope of the Code as one of “investment” or “business” purposes. In the leading judgment, Justice Muir said:[3]

“In order to cause a borrowing for the purpose of constructing, holding and maintaining one's own house to be for a business rather than a personal or domestic purpose, there must be more than the mere enterprising realisation of an asset. To my mind, there needs to be a commercial aspect to the transaction. That commercial aspect may exist where property is acquired with the intention of resale at a profit”.

The Court then observed that the following hallmarks of Mrs Crawford’s transaction, taken in combination, established that the loan was for investment purposes[4]

• the acquisition and development of the land for resale at a profit;
• the fact that the loan was an extension of a business loan;
• the short term of the loan;
• the intention that the loan continue only until such time as the property could be sold and the purchase price be obtained;
• the fact that Mrs Crawford had no income or means of obtaining an income until such time as the proceeds of sale of the property were realised and invested;
• the fact that the duration of her proposed residence in the house was dependent on when it could be sold;
• the placing of the house on the market immediately after completion of construction;
• the likelihood that if Mrs Crawford were to purchase a replacement dwelling house it would be much more modest than the subject house because of Mrs Crawford 's plan to use the balance of proceeds of sale to provide a retirement income; and
• the magnitude of the borrowing relative to Mrs Crawford's assets and the absence of an income to service interest on and repayment of the loan.

Accordingly, the Court of Appeal dismissed Mrs Crawford’s appeal and the mortgagee was granted possession of the mortgaged property.

Issues not decided by the Court

The Court of Appeal had the opportunity to consider the effect of failing to comply with section 80 of the Code (the provision requiring the issue of Code compliant default notices). In particular, the Court had the opportunity to adjudicate on whether a failure to issue compliant default notices voided subsequent legal action (the New South Wales courts say it does, whereas Queensland courts have said it does not). The Court elected not to make a decision on that question because it would not alter the outcome of the appeal.

Conclusion

1. Dale v Nichols Constructions Pty Ltd [2003] QDC 453
2. Linkenholt Pty Ltd v Quirk (2000) ASC 155-040; Jonsson v Arkway Pty Ltd (2003) 58 NSWLR 451
3. Shakespeare Haney Securities Ltd v Crawford [2009] QCA 85, [46].
4. Shakespeare Haney Securities Ltd v Crawford [2009] QCA 85, [41], [51].

Fairness Test for Bank Fees?

Readers of our Finance & Markets Newsletter may recall in our May/June 2008 Edition an article relating to the possible application of a test of fairness of bank fees which was the subject of litigation in the United Kingdom.

In that matter the Office of Fair Trading (OFT) brought action against Abbey National PLC and seven other major UK banks [1] to determine if the OFT could conduct an enquiry under the “unfair terms” provisions of the Consumer Contracts Regulations 1999 (UK): (enacting certain EU directives as to consumer protection). Regulation 6(2) of these regulations provided that so long as the contractual term was in plain, intelligible language then the main subject matter of the contract and/or the adequacy of the price or remuneration charged for the services in question was exempt from examination to assess the fairness of the terms.

The OFT sought a ruling that terms imposing charges in circumstances of customers overdrawing their accounts without arrangements were not within the provisions of regulation 6(2) and would therefore be open to assessment as to their fairness. Obviously, the banks sought to bring themselves within the exemption provided by regulation 6(2) but also sought certain declarations clarifying the concept of unfair terms in the light of other clauses in the regulations.

As would be imagined, the banks argued that a term relating to the consequence of overdrawing an account went to the very essence of the contract between banker and customer and the charge made was part of the price or remuneration for the service of providing the customer with its banking services and therefore the charges were exempt from assessment by the OFT as to their fairness in all the circumstances. Mr Justice Andrew Smith of the High Court of Justice Queen’s Bench Division Commercial Court disagreed with the banks’ arguments and in a judgment handed down on 7 May 2008 held in essence:

• that the terms were in the main, in plain intelligible language;
• that the terms did not constitute equitable penalties against which the court would provide relief;
• that in his view, the terms in question did not form part of the main subject matter of the contract and that the charges levied against the customer for unauthorised overdrawing could not be categorised as a price or remuneration for providing a service.

The Banks appealed against the decision of Mr Justice Smith and on 26 February this year, Sir Anthony Clarke M.R. delivered the unanimous decision of the Court of Appeal (Civil Division), constituted by himself, Lord Justice Waller VP and Lord Justice Lloyd.

The Court of Appeal upheld the original decision of Mr Justice Smith on the basis that, although the terms were in plain intelligible language, they did not form part of the main subject matter of the contract and the charges could not be seen as price or remuneration charged for banking services. In these circumstances the Court of Appeal concluded that an assessment of the fairness of the relevant charges is not precluded by regulation 6(2) of the 1999 regulations and the Appeal was accordingly, dismissed.

It is now open to the Office of Fair Trading to conduct an assessment of the fairness of these charges levied by the United Kingdom Banking and Finance Industry which enquiry, we understand, is now well underway.

The outcome of that enquiry will be of considerable interest in the Australian environment and relevant to the introduction of broader concepts of fairness in National and State approaches to consumer protection given that the Federal Government intends to implement a national “Australian Consumer Law” which would, amongst other things, regulate unfair contract terms in Australia.

Under the Australian Consumer Law unfair terms in consumer contracts would be void in certain cases. The proposed legislation will include a full range of penalties, enforcement powers and consumer remedies currently available in the Trade Practices Act. It is anticipated that this legislation will be released in draft by the middle of this year and be passed by the end of the year. [2]

1. Barclays Bank PLC/Clydesdale Bank PLC/HBOS PLC/HSBC Bank PLC/Lloyds TSB Bank PLC/Nationwide Building Society and Royal Bank of Scotland Group PLC.
2. Proposals for the new legislation are outlined in a recently released discussion paper “An Australian Consumer Law: Fair Markets-Confident consumers”. The paper can be found at www.treasury.gov.au/documents/1484/PDF/An_Australian_Consumer_Law.pdf. The Federal Government has indicated it will bring forward key plans of the Australian Consumer Law and that it is intended the unfair contract terms provisions will commence in 1 January 2010.

Supreme Cout Gets Tough on Unfounded Defences to Possession Claims