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Client Update: Regulation & Compliance – 9 July 2008

Issues for financiers when providing credit to individuals for business or investment purposes

In brief: A recent New South Wales Court of Appeal decision has highlighted the need for financiers to have sophisticated systems and procedures in place when providing credit to individuals for business or investment purposes. The reason for this is to avoid having to prove that the Consumer Credit Code does not apply to such transactions. Partner John Gallimore (view CV) and Senior Associate Scott Mackay explain.

When is a credit contract entered into?

The NSW Court of Appeal held in Bahadori v Permanent Mortgages Pty Ltd1 that a credit contract was entered into when some, but not all, of the documentation intended for the transaction had been signed. A 'credit contract' was created because the acceptance of initial documentation gave rise to an arrangement, being part of a 'series or combination of contracts or contracts and arrangements' (the definition of 'contract' in the Consumer Credit Code). The date of acceptance of the contract was held to be the date of acceptance of the first arrangement in the series. Unfortunately for the financier in this case, the 'business purpose' declaration provided for in section 11(2) of the Code wasn't signed until after that date.

The presumption in s11 of the Code (that the Code applies to credit contracts with individuals unless the contrary is established) is only reversed if a 'business purpose' declaration is provided by the borrower before the credit contract is entered into.

'Business purpose' declaration must precede any credit contract

The lesson for financiers when providing credit to individuals for business purposes is that their systems and procedures must ensure that a valid 'business purpose' declaration is obtained before any documentation (sometimes merely an exchange of correspondence) amounting to a 'credit contract' is entered into. Obtaining a declaration at the same time as the customer signs such a credit contract is insufficient.

If a declaration does not precede the credit contract being entered into, the financier has to prove that the Code does not apply, should the customer subsequently raise the issue.

When might a financier have reason to believe a declaration is incorrect?

The case also contains some useful observations on when a financier may have reason to believe a 'business purpose' declaration is incorrect. The facts that:

  • the employment history and statement of assets and liabilities of the debtors did not indicate receipt of any income other than wages and, in particular, did not indicate the debtors had any income from any business or investments;
  • the statement of assets and liabilities did not indicate the debtors were proprietors of any business or had any assets in the nature of investments; and
  • the financiers knew that the bulk of the credit was to be used to refinance an existing mortgage over the debtors' home,

meant that the financiers had reason to believe the loans were in fact to be applied wholly or predominantly for personal, domestic or household purposes. Financiers need to carefully consider all the information in their possession to determine whether they have reason to believe a 'business purpose' declaration is incorrect.

Form of declaration

The court considered a submission that the relevant 'business purpose' declaration was invalid because it contained some additional wording not in the form of declaration prescribed in the regulation to the Code. This argument was rejected. The court said:

The position might well be different if any additional provisions contained in the documents signed by the appellants over and above the contents of the form required by the Regulations had had the effect of qualifying the terms of the required form or reducing or negativing the impact that it was intended to make on the consumer.

This is useful guidance, but care still needs to be exercised if any additional language is to be added to the prescribed form.

Possible legislative change

The recent consultation draft of the Consumer Credit Code Amendment Bill 2007 (Qld) also raises further concerns for financiers in relation to s11 declarations. It was proposed in that draft that the section be amended to abolish such declarations, and for the presumption that credit is governed by the Code to be rebutted only if the financier has specifically made inquiries about the purpose of the credit and those inquiries resulted in the financier receiving information that the loan was for business purposes. This proposal has been heavily criticised both by the credit industry and consumer groups. See our Focus: Regulation & Compliance – October 2007 for further comment on this proposal. The Ministerial Council on Consumer Affairs has agreed to make refinements in the areas proposed in the consultation draft, but it remains to be seen how it will decide to deal with testing purpose given the number and nature of the submissions made on this issue.

The timing and effectiveness of s11 'business purpose' declarations (should they survive) also arises in connection with s63 of the Personal Properties Securities Bill 2008 (Consultation Draft), where security cannot be taken over an individual's after-acquired property without the individual's specific approval, unless a s11 'business purpose' declaration has been made in relation to, and before, the property is acquired.

Footnotes
  1. [2008] NSWCA 150.

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