Commercial 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.
 

CGU Insurance Limited v One.Tel Limited

In this case, the High Court considered whether a trustee, appointed to administer the estate of a former director of One.Tel Limited (in liquidation) (One.Tel) under a deed of arrangement under Part X of the Bankruptcy Act 1966 (Cth) (deed), could recover against that person’s directors and officers (D&O) liability policy of insurance (policy) even though the deed had expired.

Facts

The former director, Mr. John Huyshe Greaves, held the policy with CGU Insurance Limited (CGU).

On 6 September 2004, the Supreme Court of New South Wales ordered that Mr. Greaves pay compensation to One.Tel of $20 million and a payment to ASIC of $350,000. Mr. Greaves subsequently entered into the deed, which, amongst other things, purported to assign Mr. Greaves' rights under the policy to his trustee and provided that any amount recovered from CGU would be paid in satisfaction of Mr. Greaves' liabilities to One.Tel and ASIC.

CGU refused to make payment to the trustee under the policy and on 18 October 2006, the trustee commenced proceedings against CGU.

CGU's contention

CGU raised a number of fraudulent non-disclosure and misrepresentation arguments. However, the proceedings ultimately turned on the assignment of Mr. Greaves' rights under the policy to the trustee, which was challenged by CGU. CGU's principal contention was that, even if the assignment was valid at the time of the deed, the trustee's right of recovery against CGU ended when the deed expired.

CGU further contended that there had not been any "loss" as defined under the policy. It sought to rely on the combined reading of clause 9 and 11 of the deed, which provided that, until the trustee issued a certificate confirming that it had settled the claim under the policy or had decided not to pursue a claim under the policy (clause 9), neither the trustee nor any creditor could take any steps to enforce the compensation and cost order against Mr. Greaves (clause 11).

"Loss" was defined under the policy as an "amount payable in respect of a Claim made against the Directors and Officers for a Wrongful Act and shall include damages, judgments, settlements, interest, costs and Defence Costs". In arguing that there had been no loss, CGU placed significant weight on the fact that clause 11 of the deed prevented the trustee or any creditor from enforcing their orders against Mr. Greaves. CGU submitted that clause 11 survived the expiry of the deed.

Decision

The High Court rejected both of CGU's contentions. 

It found that the trustee was entitled to continue recovery against the policy notwithstanding the expiry of the deed. The High Court confirmed that, in addition to the legal assignment of Mr. Greaves' rights under the policy (pursuant to the deed), there had also been an equitable assignment of those rights that operated outside of, and survived, the expiry of the deed. 

It followed that upon expiration of the deed, the trustee continued to owe duties to Mr. Greaves beneficially as a "bare trustee". As part of those duties, the trustee was required (and able) to continue recovery against CGU under the policy. 

On the question of "loss", the High Court found that even if clause 11 of the deed survived the expiry of the deed, the definition of loss under the policy was broad enough to include the orders made in favour of One.Tel and ASIC. The High Court confirmed, amongst other things, that clause 11 of the deed did not have the effect of setting aside any orders made against Mr. Greaves and that it would create an absurd result if, on the one hand, clause 11 of the deed had the result that Mr. Greaves had suffered no loss, but on the other hand, clause 9 of the deed contemplated that the trustee could pursue a claim under the policy for loss.

The High Court favoured the view that clause 11 of the deed did not continue in effect after the expiry of the deed. Instead, on expiry of the deed, Mr. Greaves was returned to his pre-deed position (albeit as beneficiary of a bare trust). At this point, it would be open for One.Tel and ASIC to pursue Mr. Greaves for any shortfall in the amounts paid to them by the trustee. On this basis, there was still loss for the purpose of the policy. 

Take home message

The case confirms that an assignment of an insured's rights under a D&O liability policy of insurance to a trustee under the bankruptcy regime may be upheld even though the deed purporting to assign the rights has expired.

To this end, it would appear that the courts will recognise an assignment of the insured's rights in equity that exists alongside, and is unaffected by, the legal assignment and the Bankruptcy Act 1966 (Cth). 

Further, even where an insured enjoys protection under the bankruptcy regime from the enforcement proceedings of judgment creditors, the definition of loss under most D&O liability policies of insurance will be triggered. Insurers will, therefore, have to rely on other potential grounds for declinature. 
 

For more information regarding this legal alert, please contact Andrew Cheetham, Partner on 07 3231 2960 or Andrew Ward, Lawyer on 07 3231 2482.