Responsible Lending Conduct Obligations & Maladministration
The national credit reforms introduced by the National Consumer Credit Protection Act 2009 (NCCP) have given birth to a statutory concept of “responsible lending” obligations which apply to loans or increases in loans.
For some years, FOS has considered disputes regarding “maladministration in lending”. FOS continues to do so under its current Terms of Reference.
The responsible lending obligations and FOS’s approach to maladministration are closely linked. A dispute is likely to raise both issues. This article discusses FOS’s approach to:
- the financial services provider (FSP)’s responsible lending obligations under the NCCP, and
We provide some guidance on the inquiries we consider appropriate to assess a consumer’s ability to service their credit facility in accordance with their obligations in light of both the responsible lending obligations and maladministration. Specific commentary is provided about our approach to low doc lending.
FOS Terms of Reference (TOR)
The TOR allow FOS to consider a dispute raising the question of whether the FSP breached the responsible lending obligations and whether there has been maladministration.
Paragraph 5.1 of the TOR says FOS may not consider a dispute about an FSP’s assessment of the credit risk posed by a client or the security to be required for a loan – but this does not prevent FOS from considering a dispute claiming maladministration in lending, loan management or security matters. This means FOS does have jurisdiction to consider disputes about maladministration. Maladministration means:
“… an act or omission contrary to or not in accordance with a duty or obligation owed at law or pursuant to the terms (express or implied) of the contract between the Financial Services Provider and the Applicant.”
As the responsible lending obligations are a duty owed at law in lending, loan management or security matters, a dispute about whether an FSP breached those obligations is within FOS’s TOR.
FOS’s TOR also provide that, when deciding a dispute and whether a remedy such as compensation should be provided, FOS will do what in its opinion is fair in all the circumstances, having regard to:
- legal principles
- applicable industry codes or guidance as to practice
- good industry practice, and
- previous relevant decisions of FOS or a predecessor scheme (although FOS will not be bound by these).
Therefore, our approach to responsible lending disputes takes into account:
- the NCCP
- any case law on the NCCP as it is developed by the courts
- ASIC’s guidelines
- industry codes and practices, and
- our past approach to claims of maladministration in lending (see Bulletins 45, 50 and 60).
Responsible lending under the NCCP
The NCCP provides that:
- a credit assistance provider must, after making reasonable inquiries and taking reasonable steps to verify information, make a “preliminary assessment” about whether the consumer’s contract or changes to the consumer’s contract will be not “unsuitable”, and
- a credit provider must, after making reasonable inquiries and taking reasonable steps to verify information, make a “final assessment” about whether the consumer’s contract or changes to the consumer’s contract will be not “unsuitable”.
A loan will be not unsuitable if:
- it meets the consumer’s requirements and objectives, and
- the consumer has the capacity to repay the loan without experiencing substantial hardship.
Need to make “reasonable inquiries”
The responsible lending obligations require reasonable inquiries to be made about the consumer’s financial situation and their requirements and objectives. In Regulatory Guide 209 (RG 209), the Australian Securities and Investments Commission (ASIC) has provided some guidance on, and examples of, the extent of the inquiries an FSP should make when assessing a consumer’s application for credit.
Consumer’s financial situation
ASIC suggests inquiries about the following matters, to assess the consumer’s financial position, would be included in reasonable inquiries (see RG 209, page 12):
- the consumer’s amount and source of income, including the length and nature of their employment
- the consumer’s fixed expenses, such as rent, repayments to other loans/debts, child support, insurance
- the consumer’s variable expenses
- any existing debts that are to be repaid from the loan
- the consumer’s credit history
- the consumer’s age and number of dependants
- the consumer’s assets
- reasonably foreseeable changes, such as the end of a honeymoon period on a loan, impending retirement, or the end of seasonal employment, and
- geographical factors, such as remoteness (which may increase expenses).
Consumer’s requirements and objectives
ASIC has provided guidance (see RG209 page 13) about what reasonable inquiries about a consumer’s requirements and objectives could include. These are:
- the amount of credit needed or the maximum amount sought
- the timeframe for which it is required
- the purpose and benefit sought, and
- whether the consumer seeks particular product features or flexibility, and understands the costs of these features and any additional risks.
A consumer’s loan must meet their requirements and objectives. For example, a consumer who is retired and lacks the income stream required to service a loan might benefit from a reverse mortgage product which allows them access to their equity in their property. However, a line of credit for far more than the consumer requires, with the excess applied to meet the consumer’s interest payments may not be suitable as there would be a finite time before the excess funds were totally depleted, after which the loan would be fully drawn and the consumer would have no capacity to continue to service the debt.
ASIC says that an FSP’s obligations are scaleable – what is required will vary depending on the circumstances.
Base line inquiries to establish a loan was not unsuitable
As a minimum, FOS considers there should be evidence of the consumer’s capacity to repay such as:
- verification of PAYG income by reference to payslips or
- verification of self-employed income by reference to tax returns and bank statements.
This requirement, in our view, is not scaleable, but rather a mandatory consideration.
FOS approach to assessing scaleability
As ASIC has identified, FOS considers that the obligation to make reasonable inquiries is scaleable. In our view, the scale of inquiries should be established with reference to the type of consumer and the type of product. We would have regard to the circumstances of a case including the following factors:
- the potential impact on the client of entering into an unsuitable loan
- the complexity of the loan arrangements, and
- the ability of the client to understand the loan arrangements.
Use of generic data to inquire about expenditure
In relation to a consumer’s regular expenditure, FSPs in the industry segment offering high volume/low value credit facilities, such as credit cards, have customarily relied upon generic data to assess a consumer’s living expenses. In our view, this data often fails to take into account:
- particular needs such as additional medical and pharmaceutical expenses
- voluntary commitments such as school fees, and
- additional transport costs due to remote location.
Without an assessment of individual circumstances, FSPs can offer a credit limit which the consumer cannot afford. This sometimes arises when the source of the lump sum payment to a credit card account is a balance transfer to another provider but the account is not closed.
While we do not endorse the use of generic data, we may, when investigating a dispute, consider an FSP could prudently rely upon generic data, particularly if it considered the consumer had under-estimated their financial expenditure. Each case would be assessed on its own merits.
Good industry practice and industry codes as guide to appropriate inquiries
When considering a dispute regarding responsible lending under the NCCP, as well as referring to ASIC’s guidelines, we will have regard to relevant provisions of the Code of Banking Practice (CBP) and the Mutual Banking Code of Practice (MBCP). While a FOS member against whom a dispute has been lodged may not be a subscriber to the CBP or the MBCP, we consider these codes reflect good industry practice and we will therefore have regard to the practices of subscribing banks and mutuals when considering if the FOS member has, in the circumstances giving rise to the dispute, acted appropriately.
Code of Banking Practice (CBP)
Clause 25.1 of the CBP provides:
“Before we [the bank] offer or give you a credit facility (or increase an existing credit facility), we will exercise the care and skill of a diligent and prudent banker in selecting and applying our credit assessment methods and in forming our opinion about your ability to repay it.” (our emphasis added).
Mutual Banking Code of Practice (MBCP)
Clause 6 of the MBCP provides:
We [the credit union or mutual building society] will always act as a responsible lender.
We will base our lending decisions, including decisions to extend existing credit facilities, on a careful and prudent assessment of your financial position. We will periodically review our credit assessment procedures and criteria for the products we issue.
We will generally only lend amounts to you that we believe, on the information available to us, you can reasonably afford to repay. However, different criteria will apply in the case of some products, such as bridging finance arrangements and reverse mortgage loans (if we offer these).
We expect you to provide honest and accurate information to us when applying for a loan or the extension of a credit facility. However, where it is prudent to do so, we will also undertake our own independent checks.
We will promote the responsible use of credit to our members and consumers using a range of approaches.”
The respective obligations of the credit assistance provider and the credit provider
The NCCP places an obligation on a credit assistance provider to assess whether a proposed credit contract is unsuitable. The credit assistance provider must have regard to the consumer’s purpose and whether their financial circumstances may allow them to achieve their purpose.
A credit provider has an additional obligation when assessing the suitability of a proposed loan or credit facility over and above the reasonable inquiries a credit assistance provider may make. We take the view that a credit provider must assess the consumer’s capacity to service the loan or credit facility which it proposes to offer.
The obligation imposed on the credit provider to make these inquiries as part of its “final assessment” is particularly important where the preliminary information provided by the credit assistance provider on behalf of the consumer is:
- not verified
- contradictory to other information the credit provider may be aware of, or
- where the circumstances of the transaction or any information provided “ring alarm bells”.
In these situations, the credit provider should make further inquiries to verify the information and ensure that any concerns are addressed.
FOS has jurisdiction in respect of both individual and small business lending
It should be noted that FOS’s jurisdiction to consider claims of maladministration encompasses all contracts between clients and their FSPs that may be the subject of a dispute at FOS. We can consider disputes from individuals and small businesses, so long as they fall within the monetary limits specified in FOS’s TOR. Essentially, we can consider a dispute where the value of the client’s claim is less than $500,000 and we are able to award compensation to a maximum of $280,000.
Therefore, subject to our monetary limit of $500,000 and our compensation cap of $280,000, although a credit contract may not be regulated under the Uniform Consumer Credit Code (UCCC) or the National Credit Code (NCC), we will consider a client’s claim that the FSP’s decision to grant the loan or credit facility amounted to maladministration in lending.
Low doc lending
We do not consider that the UCCC of itself prevented low doc lending. In the Second Reading Speech introducing the Bill for the UCCC, the relevant Minister said of section 70(2)(l):
“One area of concern is housing lending and, in particular, the serious issue of over commitment.
The Consumer Credit Code has not been drafted with the intention of requiring credit providers to make inquiries beyond those ordinarily made by prudent lenders …
It is intended to deal with those lenders who consciously lend without making proper inquiries into the debtor’s ability to pay rather than those lenders and consumers who have gone down this path and made a conscious decision based on the best information available.”
Similarly, we consider that the provisions of the NCCP may still allow for low doc lending if adequate inquiries are made and the statutory provisions regarding responsible lending are satisfied. We anticipate no doc lending on the levels previously experienced is unlikely to be sustainable given the new obligations.
The fact that an FSP has entered into a low doc loan is not sufficient, of itself, to establish that the loan was unsuitable under the responsible lending obligations or that there has been maladministration. However, there is a significant risk with low doc lending that further investigation may mean the FSP cannot establish whether it complied with its obligations.
We recognise that there is a place for low doc loans to cater for those self-employed clients who are unable to provide more traditional evidence of their income. However, in our view, low doc loans should not as a general rule be granted to PAYG employees.
Self-certification of financial details
We do not consider a declaration from the client will protect an FSP from having the loan considered:
- maladministration or
- in breach of responsible lending obligations, or
if the circumstances were such that the FSP ought to have made inquiries but chose not to do so.
A client’s false declaration, whether it was made knowingly or inadvertently, is a relevant factor to be taken into account, but is not decisive.
This view is supported by the comments of the trial judge in Permanent Mortgages Pty Ltd v Cook  NSWSC 1104:
“I find it impossible to escape the conclusion that [the first defendant] knew he was making a false statement of a material kind when he made it and that the falsity was of some significance, apart from being detrimental to himself. However, I accept that he was probably unaware of the nature of that significance. As I have already indicated, provided the formalities were observed, the Plaintiff, in my view, was indifferent to the underlying factual situation. … In all the circumstances, while the false declaration of the Defendants and their procuring of what must have been the false statement of an accountant should be deprecated and taken into account as a relevant factor within s70 (2) (a), they are not, in my opinion, necessarily decisive of the issues before me.”
In relation to whether the loan was unjust, the trial judge made the following comments:
“Whether I should hold the mortgage unjust in this case involves a balancing exercise. On the one hand are the circumstances that the Defendants speak English as their first language; were experienced consumers; had the services of a solicitor; were extremely anxious to obtain the loan; and were prepared to sign false statements and procure false certificates. On the other hand, the beneficial nature of the Code indicates that it was intended to protect the unsophisticated and meagerly educated, such as the Defendants, from their own foolishness. Given the means of the Defendants and their credit history, the Plaintiff, in my view, was aware, or would have been aware, had it made the most perfunctory of inquiries, that the Defendants were not capable of servicing the loan even at the lower rate of interest and could only satisfy their obligations by selling the mortgaged property for a sum sufficient to cover the principal and interest.”
Based on the requirement in paragraph 8.2 of FOS’s TOR to do what is fair when deciding disputes, it may be that, in some cases where a client has made a false declaration, we will apportion liability (and reduce any compensation accordingly). We will consider (among other factors):
- Did the client knowingly provide inaccurate information?
- If not (usually because the information has been provided on their behalf by an agent or intermediary), did the client fail to protect themselves (for example, by signing a blank form trusting their representative to accurately complete it)?
- Did the FSP fail to apply its policies and procedures which, if adhered to, would have disclosed the inaccuracies?
Assessment of low doc lending
When investigating a dispute about a low doc loan, we consider the following matters:
- Did the client fully understand the process, so that it can be said that a conscious decision has been made?
- Have clear questions been asked of the client in assessing the relevant and available information? For example, gross income may be misunderstood to mean turnover, rather than income;
- Have the monthly repayments been accurately calculated and disclosed at the time of application?
- Was legal or financial advice recommended and/or required?
- Did the FSP engage in good industry practice by exercising the care and skill of a diligent and prudent lender in:
- selecting and applying credit assessment methods; and
- forming an opinion about the client’s ability to repay?
- Was there information in the application which should have led a reasonable and prudent lender to make further inquiries, but the FSP chose not to?
- Did the FSP act prudently by assessing the entire transaction contemplated by the client to see if there is capacity to repay from proven sources? For example, it is not always appropriate to rely solely on the receipt of rent from a rental property, given the vagaries of the rental market, either generally or in a particular location;
And finally, it is important to be aware that an acknowledgment by the client that the client does not rely on the FSP’s assessment of capacity to repay may not excuse the FSP if it fails to make a proper assessment.
Changes to the Corporations Act (Act) which came into effect from 1 January 2011, mean a financial services provider (FSP) that issues margin lending facilities to a retail client must comply with new responsible lending provisions.
The issue of a margin lending facility/margin loan includes:
- new margin loans, and
- increases in the credit limit of margin loans
granted on or after 1 January 2011.
For some years, FOS has considered disputes regarding “maladministration in lending”. FOS continues to do so under its current Terms of Reference including disputes about margin loans and leveraged investments – see Investment Lending Case Study.
This article provides guidance on how FOS assesses disputes between retail clients and their FSPs about the issue of a margin loan in light of these new responsible margin lending conduct obligations (Conduct Obligations).
FOS Terms of Reference (TOR)
The TOR allow FOS to consider a dispute raising the question of whether the FSP breached the Conduct Obligations.
Paragraph 5.1 of the TOR says FOS may not consider a dispute about an FSP’s assessment of the credit risk posed by a borrower or the security to be required for a loan – but this does not prevent FOS from considering a dispute claiming maladministration in lending, loan management or security matters. This means FOS does have jurisdiction to consider disputes about maladministration.
“… an act or omission contrary to or not in accordance with a duty or obligation owed at law or pursuant to the terms (express or implied) of the contract between the Financial Services Provider and the Applicant.”
As the Conduct Obligations are a duty owed at law in lending, loan management or security matters, a dispute about whether an FSP breached the Conduct Obligations is within FOS’s TOR.
The legislation prohibits an FSP from issuing margin lending facilities unless the Conduct Obligations are fulfilled (s985E(1)).
The Conduct Obligations require the FSP to:
- make reasonable inquiries about a retail client’s financial situation (s985G(1)(a));
- take reasonable steps to verify the retail client’s financial situation (s985G(1)(b)); and,
- assess whether the margin lending facility will be unsuitable for the retail client (s985E(1)(c) and s985F).
In this article, we explore FOS’s approach to each of these three aspects of the Conduct Obligations. We expect that regulations will be made to prescribe matters referred to in the Conduct Obligations and that ASIC will issue guidance on these obligations. If and when this material takes effect, we will take it into account.
1. Reasonable inquiries about a client’s financial situation
FOS takes the view that the purpose of inquiries into a client’s financial situation is to assess whether the client would be able to:
- meet all the repayments, fees, charges and transaction costs of a possible margin call, and
- service the loan and meet possible margin calls from income and liquid assets, rather than from long-term savings or from equity in a residential home, without suffering significant hardship.
Whether an FSP has made reasonable inquiries about a client’s financial situation turns on whether information has been obtained to make this assessment.
Therefore FOS takes the view the reasonable inquiries an FSP ought to make in order to assess a client’s financial situation include enquiring into:
- the client’s gross and disposable income
- the reliability of the client’s income, and
- the availability of assets to meet possible margin calls.
When the potential returns from an underlying portfolio are included in the calculation of the client’s income, FOS will look at whether those returns were treated appropriately by the FSP. While such income may be taken into account, an FSP must assess the reliability of that income and whether or not this income was the sole or main source of funds to service the margin loan.
Scalability of inquiries
In FOS’s view, the requirement on an FSP to make inquiries will be scalable having regard to the circumstances of a case including the following factors:
- the potential impact on the client of entering into an unsuitable margin loan
- the complexity of the margin loan, and
- the ability of the client to understand the margin loanfacility.
More extensive inquiries into the client’s financial situation are likely to be appropriate where the potential impact of an unsuitable margin loan is serious. For instance, in “double gearing” situations, FOS would expect the FSP to conduct more extensive inquiries into the client’s financial situation.
More extensive inquiries into the client’s financial situation are likely to be appropriate where the loan is a non-standard margin loan (as defined by s761EA(5)) that is, for example, in the nature of a securities lending agreement.
More extensive inquiries into the client’s financial situation are likely to be appropriate where the client is not well versed in financial matters and is therefore less likely to understand the effect of the margin loanfacility.
Anticipated regulations - Double gearing
The Explanatory Memorandum for the Corporations Legislation Amendment (Financial Services Modernisation) Bill 2009 (“the Explanatory Memorandum”) notes (at 1.82):
“Regulations will be made to prescribe specific matters that lenders must take into account, which are intended to include important considerations such as whether clients have taken out a second loan to finance their equity contribution for the margin loan, and whether they used their homes to secure the second loan.”
The explanatory memorandum suggests a second loan or double gearing situation may signify another variable that affects scalability.
2. Reasonable steps to verify a client’s financial situation
When assessing whether an FSP took reasonable steps to verify a client’s financial situation, FOS will have regard to:
- the normal business practices of a prudent margin lender, and
- the verification practices applied in other credit areas.
The legislation requires FSPs to take reasonable steps to verify the client’s financial situation (section 985G(2)).
Verification of income and reliability of income
Examples of the type of information an FSP may need to provide to FOS about its verification of income and reliability of income include:
- where the client is a PAYG employee:
- confirmation of employment, and
- recent income tax returns / group certificates;
- where the client is self-employed:
- recent income tax returns
- a statement from the client’s accountant, and
- business activity statements.
Verification of creditworthiness
FOS may ask an FSP to establish its verification of the creditworthiness of the client. A credit check is considered to be an action undertaken by a prudent lender in the normal course of its business.
Verification of assets
Examples of the type of information an FSP may need to provide to FOS about its verification of the client’s assets include:
- real property title search(es)
- valuation of real property(ies)
- share / securities holding statements, and
- asset and liability statements prepared by the client’s accountant.
Information which may not have to be verified
Subsection 985G(3) provides FSPs need not verify information about a client’s financial situation which isprovided in a Statement of Advice (SOA) prepared for the client by a financial services licensee who is authorised to provide financial product advice in relation to margin lending facilities.
The FSP can only rely on the unverified information in the SOA if:
- the SOA was prepared not more than 90 days prior to the date of the issue of the margin lending facility
- the SOA recommends the client acquire the margin loan facility or that its limit be increased
- the limit of the margin loan facility or the increase in the limit of the facility is not greater than that recommended in the SOA, and
- the SOA includes the information used to prepare the SOA.
The Explanatory Memorandum (at 1.94) adds:
“It is envisaged that margin lenders could make arrangements for information relevant to a margin loan to be excerpted from an SoA and presented to them in a particular format. Lenders will have to obtain appropriate confirmation that any information excerpted in this way forms part of an SoA, including the date of the SoA.”
3. Assessing whether the facility will be unsuitable
Under the legislation (sections 985E & F), the assessment of whether a facility will be unsuitable for the client must:
- be made within 90 days before the facility is issued, and
- cover the period during which the facility is issued.
The Act specifies that an assessment of whether the facility will be unsuitable need not be made for any increase in the credit limit of an existing loan because of changes in the market value of the underlying security.
The Act (see s985H(2)(a) and s985K(2)(a)) provides that a margin lending facility will be unsuitable for the client if it is likely that if the client received a margin call they:
- would not be able to comply with their financial obligations under the facility, or
- would not be able to do so without suffering substantial hardship.
Note 2 to s985H(1) provides that an FSP may assess the margin loan as being not unsuitable under s985H(2), but may still assess the facility as being unsuitable for other reasons. While the Act does not provide any further detail, FOS considers an FSP must assess a margin loan as unsuitable if, for example, the margin loan is not fit for purpose (see s12ED(1) of the Australian Securities and Investments Commission Act).
In light of these legislative requirements, FOS will consider issues including:
- whether or not the FSP’s assessment specifically addressed the ability of the client to cope with the consequences of a margin call, with a particular focus on:
- the time the client was allowed to meet the margin call, and
- the nature of the assets at the client’s disposal to meet the margin call.
- whether or not the assessment specifically addressed the ability of the client to deal with a negative equity situation.
Documenting inquiries, verification and assessment
FOS may ask FSPs to provide:
- information about the inquiries made
- documents evidencing the inquiries made
- information about verification procedures
- documents evidencing the verification procedures undertaken, and
- documents reflecting the assessment of unsuitability made.
FOS expects FSPs to establish that:
- their inquiries about the client’s financial situation were reasonable
- the information about the client’s financial situation was verified, and
- an assessment was made that the margin loan was not unsuitable by providing documents that record and reflect:
- the inquiries process
- the inquiries made into the client’s financial situation
- the verification process
- the verification process that was followed and
- the assessment of unsuitability.
An absence of these documents to establish that inquiries were made and verified and an assessment was made that the facility was not unsuitable will affect an FSP’s ability to satisfy FOS that the FSP met the Conduct Obligations.
Confidence in information
Subsections 985H(3)(b) and 985K(3)(b) make clear that when assessing whether a margin loan will be unsuitable, an FSP may only take into account:
- information it has reason to believe to be true, or
- information it would have reason to believe to be true if it had made the inquiries or verification under s985G.
When determining whether or not an FSP had reason to believe information was true, FOS will:
- take into account all of the facts of the dispute, and
- apply a reasonable, prudent margin lender test.
Calculation of compensation
If FOS concludes an FSP has failed to comply with the Conduct Obligations, FOS will consider what loss the client has suffered as a result. The aim of compensation will be to put the client in the position they would have been in had the loan not been issued, or the increase not been granted.
In the case of a new margin loan where a margin call is made, FOS will assess compensation by reference to the value of the outgoings paid by the client in relation to the margin loan. These may include:
- the amount paid by the client or the value of the underlying assets sold to restore the margin loan’s loan to valuation ratio to agreed levels;
- transaction costs (including acquisition and sale costs)
- repayments made on the margin loan, and
- interest paid on the margin loan.
The total outgoings paid by the client would be offset by any benefits the client obtained during the existence of the margin loan. These may include:
- dividends / income received from the underlying securities
- tax deductions, and
- tax credits.
The net amount would be the client’s claim.
In the case of an increase in the credit limit of an existing margin loan, FOS will seek to put the client in the position they would have been in but for the increase in the credit limit.
Further causes of action
In addition to assessing a dispute to determine whether there has been a breach of the Conduct Obligations, FOS assesses whether there has been a breach of:
- the common law requirement to exercise the due care and skill of a diligent and prudent lender
- the prohibition of misleading or deceptive conduct in relation to a the provision of a financial service (s12DA of Australian Securities and Investments Commission Act (ASIC Act)) or financial product (s1041H of the Corporations Act)
- the statutory warranty to provide a financial service with due care and skill and provide materials in relation to the service fit for the purpose for which they were provided (s12ED(1) of the ASIC Act)
- the obligation to provide the financial services the FSP is licensed to provide efficiently, fairly and honestly (s912A(1)(a) of the Corporations Act), and
- the disclosure requirements, for example to provide:
- a Product Disclosure Statement, or
- disclosure information in a Product Disclosure Statement.
Financial advisers who provide personal financial advice to retail clients to acquire or increase a margin loan may be liable to their clients for breaches of:
- the suitability rule in s945A(1) of the Corporations Act;
- the common law duty to act as a reasonable and prudent financial adviser;
- s12DA of the ASIC Act and/or s1041H of the Corporations Act where the advice to borrow to invest constitutes a representation to the client that the financial adviser considers the client to have the capacity to service the margin loan;
- the disclosure conduct rules in the Corporations Act, namely the obligation to give the client:
- a Product Disclosure Statement, and
- a Statement of Advice.
Mr and Mrs Z applied for a loan from the financial service provider (FSP) to:
- refinance an existing loan, and
- obtain additional finance of approximately $200,000 to assist them in purchasing another property.
The FSP approved their loan based on:
- their income as disclosed in their application, and
- their declaration that the loan was within their ability and capacity to service.
Mr and Mrs Z disclosed:
- partnership income of $400,000
- rental income of $40,000, and
- a parenting allowance of $20,000.
The FSP did not make any independent enquiries to verify this information.
Mr and Mrs Z subsequently claimed that the FSP’s decision to lend amounted to maladministration as they did not have the capacity to service the additional loan of $200,000.
The case manager considered a prudent and diligent lender ought to have been alerted to make further enquiries when presented with a Low Doc income declaration listing:
- pre-tax income of $440,000 and
- a parenting allowance of $20,000.
The level of income was, on the face of it, inconsistent with an entitlement to a parenting allowance of $20,000.
The case manager obtained from Mr and Mrs Z a copy of their partnership tax return prepared one month prior to their loan application. The tax return revealed a net partnership income of $45,000.
The case manager also found that Mr and Mrs Z had:
- made two previous loan applications in which they had made similar income declarations (although these loans had not proceeded), and
- two opportunities to correct their misquoted income, and failed to do so.
As the FSP had failed to make enquiries, the case manager concluded that the FSP’s approval of the loan was maladministration in lending.
However, the case manager also took into account:
- the Ombudsman’s criteria of fairness in the circumstances of the case, and
- section 12GF (1B) of the ASIC Act which deals with proportionate liability in claims of misleading conduct.
In light of these principles, the case manager did not consider that the FSP should be liable for Mr and Mrs Z’s loss in its entirety.
The case manager concluded that Mr and Mrs Z should bear two thirds of their loss and the FSP was responsible for one third of the loss.
The FSP rejected the case manager’s conclusions, and said:
- it had met its guidelines for low doc lending, and was entitled to rely on Mr and Mrs Z’s income declaration, and
- the approach had serious consequences for low doc lending for the industry and was contrary to the acceptance of low doc lending by the Australian Prudential Regulatory Authority (“APRA”).
The Ombudsman agreed with the case manager’s assessment.
In his decision, the Ombudsman noted the following:
- APRA has a supervisory role in the Australian financial market. Complying with APRA’s requirements does not provide a protection to an FSP in relation to whether or not it has engaged in maladministration in lending,
- A lender’s obligation to lend responsibly is encapsulated in
- the common law;
- to the extent the loan is regulated, section 70(2)(l) of the Uniform Consumer Credit Code (“UCCC”) (and now section 76(2)(l) of the National Credit Code);
- for subscribing FSPs, clause 25.1 of the Code of Banking Practice (“CBP”); and
- section 12DA of the ASIC Act;
- The UCCC does not, of itself, prevent low doc lending. However, the common law and the CBP require an FSP to exercise the care and skill of a diligent and prudent lender, and arguably a diligent and prudent lender would not rely solely on information provided by the customer to a loan;
- The fact that an FSP has entered into a low doc loan is not sufficient to establish maladministration. However, it is a known risk of low doc lending, and the risk is assumed by the FSP;
- There is a legitimate place for low doc loans to cater for those self-employed borrowers who are unable to provide more traditional evidence of their income. However, a customer’s self-declaration of financial details will not protect the FSP from having the loan considered maladministration or unjust if the circumstances were such that the FSP ought to have made enquiries but chose not to do so;
- Relying on the comments of the trial judge in Permanent Mortgages Pty Ltd v Cook  NSWSC 1104, a customer’s false declaration, whether knowingly or inadvertently, is a relative factor to be taken into account, but is not decisive, such that the FSP should avoid liability for maladministration in lending;
- In this case, the FSP was privy to financial information inconsistent with the customers earning $440,000, namely that they were also receiving parenting allowance. If the FSP had adopted good industry practice and sought clarification, any reasonable inquiry would have revealed that Mr and Mrs Z did not have the capacity to service the $200,000 loan.
The Ombudsman agreed with the case manager’s conclusion that there had been maladministration in lending, and that apportionment of liability as suggested by the case manager was appropriate.
A mortgage broker sourced Ms V’s details from a default listing made by the local council as a result of unpaid council rates. The broker contacted Ms V and offered to obtain finance for her to:
- consolidate her existing loans
- pay outstanding bills, and
- invest additional funds with him at a return of 10%p.a., which would be at least 3%p.a. above the interest rate payable on the loan.
The broker completed an application for finance on Ms V’s behalf applying for:
- an $80,000 home loan, and
- a $250,000 interest only investment loan.
The application disclosed Ms V earned an annual income of $60,000 as the head chef of Eat-a-Lot restaurant. Annexed to the application in support was a letter from Eat-a-Lot restaurant confirming Ms V’s employment and income.
The financial services provider (FSP) approved Ms V’s application. It made available to her $80,000 for debt consolidation and paid directly to her broker the investment loan proceeds of $250,000. Ms V granted a mortgage over her family home.
For two years, Ms V received regular returns from her broker. Then she was advised that her broker was ill and that his investments would be realised to return capital advanced by investors. Ms V subsequently could not make contact with the broker and had been unsuccessful in recovering her $250,000 investment.
Ms V said that:
- she was in receipt of Centrelink benefits
- she supplemented her pension by selling home-made preserves at the local council monthly market
- her annual income was less than $15,000
- she had never worked for a restaurant
- she had never earned $60,000
- the signature on the loan application was not her signature
- she signed the FSP’s loan offer and mortgage
- she accepted liability for the loan she had received to consolidate her debts and pay outstanding bills
- she should not be liable for the false and misleading information the broker provided to the FSP, and
- she should not be liable for the $250,000 investment loan.
The FSP’s response
The FSP said:
- the finance application had been introduced by an introducer, who was affiliated to a mortgage manager, A
- it paid commission to A for introducing successful finance applications
- it had no affiliation directly with the introducer or with the broker, and was not liable for their conduct
- Ms V’s loan application was assessed in accordance with its policies and procedures
- its procedure included a telephone call to Ms V’s employer to confirm her employment and income
- Ms V’s verified income of $60,000 was sufficient to service her $330,000 loans even without relying on the anticipated 10%p.a. return from her investment with the broker, and
- it had no liability to Ms V for her investment decisions
- it had no liability for the conduct of Ms V’s broker, and
- Ms V was liable to repay both loans.
Investigation of signature on loan application
FOS inspected Ms V’s signature on:
- a privacy consent form
- the FSP’s loan offer, and
- her original dispute lodged with FOS
On a simple inspection, there were significant inconsistencies between the signatures on these documents when compared with the signature on the loan application. In the case manager’s view, these inconsistencies supported the conclusion that Ms V did not sign the loan application before it was presented to the FSP.
Investigation of who was responsible for the broker’s acts
In response to FOS’s request for information, Ms V said:
- she had met the broker at her home
- she provided him with the information he requested about her income and financial position
- she trusted the broker
- she did not check the details completed by the broker, and
- she was not asked to sign any documents by the broker at that meeting.
FOS noted the loan application form identified:
- Ms H as agent for the introducer, not the broker
- the domain name for Ms H’s e-mail address as the broker’s business
This information suggested the broker and the introducer had a working relationship.
The case manager also noted the broker’s name was the same as the proprietor of Eat-a-Lot restaurant who had signed the letter of employment confirming Ms V’s employment and income which was cause for suspicion.
While the FSP had acknowledged it had an affiliation with A, the mortgage manager, there was no information to support a conclusion that the broker or introducer was an agent or held themselves out as representing the FSP. Therefore, there was no principal/agent relationship between the broker and the FSP that would make the FSP liable for the conduct of the broker or the introducer in submitting information supporting Ms V’s loan application.
FOS assessment of maladministration in lending
The case manager noted that Ms V’s loan application was approved via the FSP’s automated credit approval process.
While credit modelling is widely used, the case manager noted that it is good industry practice, particularly with third party introduced business, for the information relied upon to be checked and verified by the lender. Therefore, although Ms V’s application had passed the FSP’s automated test for her capacity to service the loans, the FSP was required to verify the employment and income data it had relied upon.
The FSP’s policy said:
- the preferred verification of income was by way of confirmation of regular credits to an account
- deposit details are more reliable than payslips or other documentation which can be easily forged
- new customers must produce original or verified account statements, and
- in some cases additional information, such as a letter from an employer, may be required to clarify information contained in an applicant’s account statements.
The FSP’s lending approval:
- did not show any inquiry being made about where Ms V’s stated income of $60,000 was being deposited
- did not show any statements were sighted substantiating her salary being paid into an account,
- noted the FSP spoke with the author of the letter of employment, who confirmed Ms
- V’s employment and salary
- Did not include any account statement records.
The FSP relied solely on the fraudulently raised letter of employment and then telephoned the author of the fraudulent letter to confirm its content.
The case manager noted:
- the FSP’s policy had specific procedures to address the risk of false loan applications being made in similar scenarios
- had the FSP requested copies of Ms V’s account statements, the statements would have shown her regular Centrelink receipt
- the existence of a pension benefit, when the loan applicant was allegedly working full time would have prompted a diligent and prudent lender to make further inquiries of the applicant about their income position.
The case manager concluded that if the FSP had sought Ms V’s account statements in accordance with its policy, the loans would not have been approved because, based on her existing pension and small supplemental income, serviceability was not demonstrated.
As a consequence, the FSP’s approval of loan facilities totalling $330,000 was maladministration in lending.
Was Ms V liable to repay the $250,000 invested with the broker?
While Ms V acknowledged she received the use of $80,000, she said she had received no benefit from the $250,000 loan as the funds were paid directly to the broker and she should not be liable to repay a debt for which she received no benefit.
The case manager did not accept that Ms V did not have the use of the $250,000. She was aware and agreed that those funds should be paid to her broker, whom she entrusted to invest those funds on her behalf. She had received a benefit from those funds in the form of that investment and the interest paid to her by her broker for some two years. The FSP had no liability to her for the performance or continued performance of her investment choice.
Should there be an apportionment of liability?
As Ms V had acknowledged receiving $80,000 to consolidate her existing liabilities, it was reasonable for Ms V to be liable for that amount, together with the contractual rate of interest.
Any apportionment would apply to the interest accruing on the new debt created by the advance of the investment loan of $250,000.
The case manager said it was certainly arguable that Ms V’s trust in the broker was careless and as such, she failed to act reasonably to protect her own position. However, this position was somewhat countered by her lack of knowledge of the deception and fraud being perpetrated against her and the FSP.
The case manager was satisfied that Ms V did not read, complete or sign the loan application and therefore did not have knowledge of what was contained in the loan application or what documentation was presented to the FSP in support of the loan application. In circumstances where both Ms V and the FSP were victims of a crime perpetrated against them, the case manager did not consider apportionment of liability to be appropriate as it would return profit to the FSP for a loan that, if the FSP had complied with its lending policy, would never have been advanced.
Therefore, the case manager concluded Ms V should be liable for interest on $80,000 of the debt advanced by the FSP and the remaining $250,000, which was new debt, was repayable without interest. He completed a reconstruction of Ms V’s liability to the FSP as follows.
- interest was payable on $80,000 of the debt advanced at the FSP’s prevailing variable housing interest rate from time to time
- all repayments made by Ms V to the FSP since inception of the loans was applied in reduction of the $80,000 debt repayable with interest, and
- the residual debt was repayable without interest and fees.
Ms V’s payments were sufficient to pay out the interest bearing component of her liability and left a residual non-interest bearing debt of approximately $200,000. As the original loans had been repayable over 30 years, of which only two years had elapsed, the case manager considered that, taking into account the FSP’s responsibility to work with Ms V if she was in financial difficulty, the residual debt should be repaid without interest over the remaining 28 years of the original term. This equated to a payment of approximately $750 per month. Ms V could establish her capacity to make monthly payments of $750 if she stayed in her family home. In the event that the family home was sold at any time within the ensuing 28 years, the case manager noted that Ms V’s indebtedness should not be transferrable and the indebtedness outstanding to the FSP at the time of sale should be discharged in full at settlement. The parties accepted the case manager’s recommended resolution.