Recently, the courts have considered the validity of loans made to a company in circumstances where the loan was guaranteed by an individual and it was argued the company was not the true borrower.
A common argument against the lender was that the individual, not the company, was the true borrower and that the loan was a ‘sham’ where the lender had sought to avoid the provisions of the National Consumer Credit Code (NCCC).
If the individual was the borrower and the purpose of the loan was wholly or predominantly for personal, domestic or household purposes, then the NCCC may have been applicable. If applicable, the borrowers may have been afforded a number of protections under the NCCC and the loans may have been unenforceable.
Devon v Thirteenth Kaysan Pty Ltd
In Devon v Thirteenth Kaysan Pty Ltd  FCA 1026 the Court considered a loan made to a company. The sole director of the company guaranteed the loan and gave a mortgage over the director’s family home.
There was some evidence that the purpose of the loan was to finance a commercial development project and some evidence that the loan was to refinance the director’s family home.
It was alleged that the NCCC should apply because the loan was a ‘sham’ that had been structured as a loan to a company, not to the individual personally, to avoid the requirements of the NCCC.
The Court accepted that, had the loan been a sham, the NCCC may have been applicable, given the evidence that the loan was used to refinance the family home.
However, the loan was clearly and unequivocally a loan to the company. The Court held that the ‘existence of an ulterior purpose’ in making the loan to the company rather than the individual, did not mean the loan transaction was not ‘a genuine transaction which was intended to have effect on its terms’.
The Court held that the loan was enforceable and was not covered under the NCCC.
Yusofzai v Andask Pty Ltd
In Yusofzai v Andask Pty Ltd  NSWSC 124, the loan to the company was secured by a guarantee and mortgage given by the director of the ‘borrower’ company.
The purpose of the loan was for the director to renovate an intended family residence located on the land owned by the director, to fund his personal day-to-day expenses and also to fund the day-to-day expenses of the business operated by the company.
When the borrower company defaulted under the loan, the lender sought to sell the property mortgaged by the director.
One of the grounds on which the mortgagee sale was resisted, was that the NCCC applied to the loan because the ‘true’ parties to the contract were the individual and the lender.
However, the Court was satisfied that there was no evidence to show that the arrangement was a ‘sham’ and, as a result, the NCCC did not apply.
Jams 2 Pty Ltd v Stubbings
In Jams 2 Pty Ltd v Stubbings (No 3)  VSC 150:
- the loan was made to a shell company controlled by the individual
- the company had no assets and had never traded
- the individual was seeking to borrow money to buy a residential property to be owned by the individual
- the loan was guaranteed by the individual and secured by mortgages over the individual’s existing properties and the new residential property being purchased
- the company defaulted under the loan and the lender sought possession of the individual’s property.
The individual defended the possession claim on the grounds that the NCCC applied to the loan and that the loan was procured by the lender’s unconscionable conduct.
The Court rejected the argument that the NCCC applied to the loan, relying on the reasoning in Devon, and held that there was no suggestion that the loan was a sham and there was no doubt that the loan was made to the company and was not covered by the NCCC.
However, the Court was satisfied that the system of conduct by which the lender had procured the loan had ensured that the lender had no knowledge of the individual’s financial and personal circumstances.
The Court found that the lender had procured the loan through a system of conduct that was unconscionable, where:
- loans would be made to companies controlled by the individuals seeking to borrow and the loans would be guaranteed by the individual and secured by a mortgage
- it engaged a firm of solicitors to organise the loans
- the solicitors used ‘consultants’ who approached potential borrowers
- the solicitors (and therefore the lenders) would be shielded from knowledge of individuals’ financial and personal circumstances by the involvement of the consultants.
It was ordered that the loan agreement be set aside (on the condition that the individual not be unjustly enriched).
The Courts in Devon, Yusofzai and Jams left open the question of what will constitute a ‘sham’ loan.
What is clear from Jams is that, if the systems or processes by which loans are procured are deemed deficient, a loan may be set aside on the grounds of unconscionability. The case serves as a reminder for lenders that if vetting processes for potential borrowers are not sufficient, loans may be at risk of being set aside.