Banking & Finance

Lenders in New South Wales breathed a sigh of relief earlier this month when the Supreme Court ruled in Bank of Western Australia Ltd v. Primanzon [2010] NSWSC 862 that two part-time commercial property investors could not claim relief under the Contracts Review Act 1980 (NSW) because the loans advanced to them were entered into in the course of a trade, business or profession carried on by them.

The decision marks an important line in the sand for borrowers’ rights to relief under the Contracts Review Act. However, lenders still need to be aware of the pitfalls of lending to part-time investors.

Lending money for investment purposes

Lenders may be tempted to treat loans which are for investment purposes as unregulated because the provisions of the National Credit Code do not apply. However it is important to remember that, in some cases, the Contracts Review Act will continue to operate.

Section 6(2) of the Contracts Review Act provides that, subject to some limited qualifications, the Act will not apply where the “contract was entered into in the course of or for the purpose of a trade, business or profession carried on by the person or proposed to be carried on by the person”.

A one off

Despite this, in an earlier decision of Byrne v. Cope Street Pty Ltd [2009] NSWSC 947 the claimant who purchased two properties solely for investment purposes was still able to claim relief under the Contracts Review Act because her investment was a one off and not part of a broader property investment business.

The evidence in Cope Street was that the claimant, who had entered into a put and call option and contract in relation to two investment properties, had not previously been involved in investments. Nor was there any evidence that she intended to engage in any further acts of investment. There was every indication she always intended she would divest herself of at least one of the properties or possibly both of the properties and to utilise the expected profit to reduce her overall indebtedness. It was a one off.

The Court observed in Cope Street that there may have been a different result if the evidence showed that the claimant seeking relief under the Contracts Review Act had intended the subject transactions to be the first step in engaging in other acts of investment or in trading in real estate.

Part of a business of investing in properties

In Primanzon each of the claimants were carrying on the business of investment in property and the letting out and collection of rental income from the properties. It was clear from the facts that the agreement and mortgages were entered into by the borrowers for the purpose of the business of renting out commercial properties.

The Court said that there is no qualification in section 6(2) that the trade, business or profession of the person be their “primary” or “predominant” trade, business or profession. A person may carry on more than one trade, business or profession. Whether the trade, business or profession is profitable is also irrelevant under section 6(2).

The Court in Primanzon also suggested that, although not determinative, it was helpful to consider some of the criteria commonly used by the courts to identify the existence of a business for taxation purposes. These included:

• The claimants had repeatedly and regularly derived rental income from a growing portfolio of commercial properties for the purpose of profit and had done so in an organised and business-like manner by keeping books and records.
• That the claimants were concurrently engaged in the practice of other professions does not preclude a finding that these additional activities constituted the carrying on of a business.
• The scale of the activities, given the estimated value of their other assets/investments, may also be indicative of the existence of a business.

The effect on guarantees

Lenders should keep in mind that where a borrower cannot claim relief under the Contracts Review Act, either because they are a corporation or because they are carrying on a trade, business or profession, a guarantor may still be protected.

This is because, although the loan and the guarantee are likely to have been entered into in support of the same business, trade or profession, since only one of the parties (usually the borrower) is carrying on that business, then the other party (usually the guarantor) will still be able to claim relief.

Implications

Lenders who wish to be sure that the Contracts Review Act will not apply to their loan need to go beyond a declaration that the loan is for business or investment purposes. They should seek proof that the borrower is conducting an ongoing property investment business.

Additionally, lenders should ensure that guarantors have been given an opportunity to obtain independent legal and financial advice regardless of the purpose of the loan or how sophisticated the borrower is.

Finally, lenders should regularly review their documents and procedures to ensure they do not fall foul of the evolving requirements of the Contracts Review Act.

For more information regarding this article, please contact Graham Roberts, Partner on 07 3231 2404 or Justin Ditton on 07 3231 2984.
 

Background

Section 84 of the Property Law Act in Queensland provides that a mortgagee may not exercise the power of sale unless a notice under section 84 has been served on the mortgagor and the specified default is not remedied within 30 days from service of the notice.

Ordinarily a mortgagee will wait for its section 84 notice of exercise of power of sale to expire before taking possession or before entering into a contract of sale as mortgagee.

Is there a prohibition in Queensland on a mortgagee taking possession or entering into a contract of sale as mortgagee before the expiry of the section 84 notice?

This issue can be relevant where, for example, the mortgagee wishes to commence marketing or enter into a contract of sale so as not to lose a potential buyer. Circumstances may also occur where an earlier notice purported to be served under section 84 is invalid or has not yet expired.

Earlier authority

In Boston Peak Pty Ltd v Houghton [1999] QSC 48 the Court said, it is clear that “a mortgagee may take steps to exercise its power of sale by entering into a contract prior to the mortgagee obtaining the right to sell provided the contract is conditional upon the power of sale being exercisable at the end of requisite default period”.

It is apparent from this decision that a mortgagee in Queensland can enter into possession and carry out marketing prior to the expiry of the section 84 notice. It is also permissible for the mortgagee to enter into a contract before the expiry of the section 84 notice provided the contract is conditional upon the power of sale being exercisable at the end of the period stipulated in the section 84 notice.

A further decision

More recently in St George Bank Limited v Perpetual Nominees Limited & Anor [2010] QSC 57, there was a dispute between mortgagees regarding the validity of a land sale contract and a business sale contract entered into by the first mortgagee.

On 23 November 2009 the first mortgagee entered into the contracts of sale prior the service of the notice of exercise of power of sale. On 9 December 2009 the first mortgagee served a section 84 notice. On 23 December 2009 the seller and buyer varied the contracts of sale by inserting a clause making the contracts subject to first mortgagee’s power of sale being exercisable.

The arguments

The mortgagees all accepted that a mortgagee may take steps to exercise its power of sale by entering into a contract prior to obtaining the right to sell, provided the contract is conditional upon the power of sale being exercisable at the end of the requisite default period.

The subsequent mortgagees argued that the first mortgagee’s contracts were not subject to such a condition when the contracts were made and that the contracts could not be varied at a latter date in a way which would satisfy section 84.

The decision

The Court did not consider that there was any relevant distinction between a contract originally subject to such a condition and one that is varied so that it becomes subject to such a condition, so long as the variation takes place sufficiently in advance of the completion of the contract.

In this particular case, the date for completion of the contracts was fixed by reference to the fulfilment of a number of conditions, and it was not suggested that the variation of the contracts on 23 December 2009 was not sufficiently in advance of the date for completion to allow the 30 day period under the section 84 notice to expire.

Implications for mortgagees

A mortgagee’s contract of sale should include a condition that the contract is conditional upon the mortgagee’s power of sale becoming exercisable at the end of a section 84 notice of exercise of power of sale.

The contract should also include other conditions that provide the mortgagee with flexibility to enable the mortgagee to comply with section 84 and at the same time ensure that the mortgagee does not lose the sale.

Before taking enforcement action, a mortgagee will still need to comply with any requirements stipulated in the loan agreement or mortgage and comply with the requirements under the National Credit Code (where applicable).

For more information regarding this article, please contact Graham Roberts, Partner on 07 3231 2404 or Paul Springthorpe, Lawyer on 07 3231 2981.