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Curtis, Chris --- "The Code of Banking Practice" [2016] PrecedentAULA 36; (2016) 134 Precedent 44

THE CODE OF BANKING PRACTICE

By Chris Curtis

The Code of Banking Practice (the Code) is a voluntary code of conduct published by the Australian Bankers Association (ABA) together with a list of banks that have ‘adopted’ it.[1] Recently, the Code has become part of the legal landscape for borrowers and guarantors when considering their possible rights for relief against a lender, because of its widespread incorporation by reference into the terms and conditions of loans and guarantees between financial services providers and their customers.

The Australian Securities and Investment Commission (ASIC) generally regulates financial services licensees, such as banks, but has not approved and does not oversee the Code.

LEGAL ENFORCEABILITY OF THE CODE

There are two ways in which the Code may provide effective relief to a consumer or customer.

The first relates to the fact that the Code is largely being adopted for the purposes of out-of-court dispute resolution schemes, in particular the Financial Ombudsman Service (FOS). All financial services licensees must subscribe to an external dispute resolution scheme. Most banks use the FOS as their external dispute resolution scheme provider, which permits customers to refer certain types of disputes to the FOS. The terms of reference of the FOS expressly permit FOS to have regard to applicable industry codes. In the author’s experience, the Code is usually treated as highly persuasive in terms of establishing relevant standards for lenders within the FOS dispute resolution process.

The second way in which the Code can provide relief is in establishing legal rights against a financial institution. The Code is not enforceable under any legislation or statutory scheme. Generally speaking, it is enforceable only where it is incorporated by reference in the contractual documents comprising a loan agreement or guarantee between a financial services provider and customer, and thereby forms part of the terms and conditions of the loan.[1]

The starting point in considering whether any rights are available under the Code is therefore to review the relevant loan and guarantee terms and conditions documents or other contractual documents to determine whether there is a reference to the Code that makes it sufficiently clear that the terms of the Code were intended to be incorporated in the relevant loan or guarantee.

It is often pleaded that the fact that a bank has publicly subscribed to the Code means that the Code is automatically incorporated into loan contracts and guarantees provided by that financier. This approach, while common, appears incorrect in principle. The starting point for determining the terms of a contract is to analyse the terms agreed between the parties by reference to the manner in which they have expressed their agreement. This will usually be a signed loan agreement or letter of offer (for a loan) which may incorporate separate terms and conditions, or a signed guarantee. Terms and conditions can always be incorporated into a contract by reference, but the writer is not aware of any decision finding that the mere fact that a bank is a subscriber to the Code has established that it is contractually binding on the bank. So far as the author is aware, where the Code has been successfully established as having contractual force, it is because there is an express reference to the Code in the terms and conditions.

CONTENTS OF THE CODE

This article refers to the version of the Code as at May 2004. A revised version was published in January 2013, and took effect from February 2014. However, most existing case law considers the May 2004 version.

The Code is expressed to apply to customers who are individuals or ‘small business’ customers, being defined as a business with fewer than 100 full-time equivalent employees (if the business includes the manufacture of goods) or 20 full-time equivalent employees (in all other circumstances).

The Code contains obligations that can generally be classified into two varieties. First, there are a number of very general statements. These include expressions such as, ‘We will act fairly and reasonably towards you in a consistent and ethical manner[2] and ‘We will comply with all relevant laws relating to banking services...’.[3]

These generally worded clauses were commented on by Young JA in Sam Management Services (Aust) Pty Ltd v Bank of Western Australia Ltd,[4] where His Honour stated:

‘This appeal has been made viable because of the inclusion in the contract between the parties of the Code of Banking Practice, a document which was probably never prepared by its drafters to form part of a legal document. It is drafted as a lay person’s document to be understood in a quick reading by a person considering dealing with the bank. It thus lacks the precision that one would expect in a term to be included in a contract dealing with megadollars.’

However, despite the lack of precision in these generally worded clauses, the clauses have remained in the Code, nonetheless.

The second variety of obligations are more specific and particular, phrased in a way that are more precise, and drafted in a way that contractual terms would often be drafted. These include:

• Clause 25.1 which states that ‘Before we offer or give you a credit facility (or increase an existing credit facility), we will exercise the care and skill of a prudent and diligent banker in selecting and applying our credit assessment methods and in forming our opinion about your ability to repay it’;

• Clause 26.2 which states that ‘We will, before signing you up as a co-debtor, take all reasonable steps to ensure that you understand that you may be liable for the full amount of the debt and what your rights are under clause 26.3’; and

• Clause 28 which sets out a variety of clauses specific to guarantees. This includes promises that a warning statement containing particular terms will be given (cl 28.4), and that a guarantee document will not be accepted unless the document has been left with the proposed guarantor overnight (cl 28.5).

Two important parts of the Code are considered in more detail below: the duty imposed on a financial institution in relation to assessing serviceability under cl 25.1, and obligations in relation to guarantors in cl 28 of the Code.

The rights conferred on borrowers under clause 25.1 of the Code

Clause 25.1 of the Code is almost certainly the most significant clause in the Code in terms of changing the usual rights that borrowers have in relation to a lender.

It is not uncommon for customers experiencing financial difficulties after entering into a financed investment to seek advice on claims on the basis that they have assumed that because the bank was, after due consideration, willing to lend money for the investment, they were comforted or assured that the investment was secure or prudent.

The traditional position at common law is, however, that, generally speaking, a banker or financier has no duty of care to a borrower, in terms of ensuring that a loan is prudent or suitable for the borrower, or any duty to give any warnings or advice to a prospective borrower.[5] This is consistent with the recognised principle that a duty of care to avoid economic loss will not usually arise if the potential plaintiff had their own means of protecting themselves from the loss, and hence they were not ‘vulnerable’ in the relevant sense.[6] A customer of a bank, in ordinary circumstances, will usually have their own opportunity to seek advice about whether they should obtain a loan.

In contrast to the common law position, cl 25.1 expressly provides that before a lender will either offer or give a credit facility, it will exercise the ‘care and skill’ of a ‘prudent and diligent banker’ in selecting and applying credit assessment methods and forming an opinion about the customer’s ability to repay the loan. This clause has now often been accepted as a warranty that before establishing the relevant facility, the lender will have taken reasonable care in having appropriate credit assessment methods in place, and in applying those credit assessment methods. This is a significant reversal of the common law position.

This means that when a customer has experienced financial difficulties or losses as a result of an investment involving borrowing, then it may be worth investigating whether the decision on the part of the lender was a responsible one in the circumstances.

Some important points should be noted:

• The obligation in cl 25.1 is to exercise the reasonable care and skill of a prudent and diligent banker, but the clause does not provide any warranty or guarantee that the transaction or investment involving the loan will be successful. Whether the clause was breached involves an analysis of whether the process that was applied in deciding to lend to the customer was reasonable at the time the loan was established. It is necessary, when claiming a breach of cl 25.1, not to apply hindsight reasoning, but to assess any claim against the information that was provided or available to the bank at the time the loan was established.

• The obligation on the part of the bank is to exercise the care and skill of a prudent and diligent lender at the time of offering or providing credit. It is not expressed as an ongoing obligation to monitor or reassess the loan at any stage, or for the bank to provide any ongoing advice or assistance after the loan has been established.

• The obligation is expressed as an obligation to both exercise care when ‘selecting’ credit assessment methods, and when ‘applying’ those methods. This means the investigation about any claim under cl 25.1 should involve trying to identify with some precision what it was about the lending decision that may have been flawed. For example, whether the lender’s practices were deficient, or whether there were parts of the lender’s practices that were not followed.

If a breach of the clause is established, the next step is to ascertain what damages are available. The ordinary measure for breach of contract is an award of damages necessary to put the borrower in the position they would be in had the breach not occurred. A breach of cl 25.1 will usually involve an assessment of damages in terms of the difference between the borrower’s position as a result of entering into the loan in question, in comparison with the position they would have been in had they not entered into the loan.

The rights conferred on guarantors under clause 28

The rights conferred on guarantors are also significant. These include a range of very specific obligations that a bank will comply with before obtaining a guarantee. Some significant restrictions in relation to guarantees obtained in relation to guarantees for other individuals or small businesses are as follows:

• Clause 28.2 provides that a guarantee will be accepted only if it is limited to a specific amount, liabilities described in the guarantee, or the value of a specified security. Generally ‘all money’ guarantees in relation to other individuals are not permitted.

• Clause 28.4 sets out very specific requirements for notices to be provided to a guarantor prior to any guarantee being accepted, including a warning statement about the guarantor’s rights, information about any notices of demand or notices of dishonours by the debtor in the past two years, and copies of related credit contracts and other documents relating to the debtor.

• Clause 28.5 requires that the lender does not ask the guarantor to sign a guarantee without providing the information set out in cl 28.4 and allows the guarantor until the next day to consider the information. This will generally prevent a lender from accepting a guarantee arranged at a single meeting or ‘on the spot’.

• Clause 28.6 requires that the guarantee should not be signed in the presence of the debtor.

The consequences of a breach of one of these clauses was recently considered by the Supreme Court of Victoria in National Australia Bank v Rice.[7] This case involved an unsuccessful challenge to the guarantee in question on the basis of unconscionability, but a successful reliance on cl 28.4 of the Code.

The case involved a very successful businessman, who nonetheless was found to have signed guarantees without understanding their nature or effect. In particular, it was found that cl 28.4 of the Code was breached by the lender’s representative who failed to give the warning statements required by cl 28.4 of the Code, and failed to provide the guarantor an opportunity to consider the guarantee documents overnight, in breach of clause 28.5 of the Code.[8]

The question then became what relief was appropriate. It was found that, as a matter of fact, had the warning statement been given, then the guarantee would not have been provided and the guarantor would not have been liable under the guarantee.[9] As such, the guarantor’s losses were assessed as being equal to the amounts being claimed under the guarantee.[10] The end result was that the offsetting claim for the breach of the Code effectively ‘cancelled out’ the lender’s claim for enforcement of the guarantee.

The case highlights that a defence based on the Code, when it applies as a contractual term, will apply in the well-established ways in which contractual warranties provide relief to a customer. They involve, first, an assessment of whether the warranty was breached; then an analysis of what would have happened differently, had the warranty been fulfilled; and thirdly, an assessment of the amount or quantum of compensation that is appropriate.

CONCLUSION

Traditionally, a customer who entered into a guarantee without appreciating its significance, or who entered into a loan where there was doubt about its serviceability, would have to consider claims based on unconscionable conduct, or specific consumer protection legislation which provides relief for misleading or deceptive conduct.[11]

Despite a number of successful cases having now been brought based on the Code in recent years, it appears that financial institutions are prepared to retain the Code for the foreseeable future. In particular, cls 25.1 and 28 of the Code have been continued in cls 27 and 31 of the new version of the Code dated February 2014.

This means that practitioners with clients who have entered into loans where there is doubt that they should have been provided, having regard to their ability to repay, or clients who have entered into guarantees without understanding their effect, should now always consider whether the Code is a suitable avenue for relief.

Chris Curtis is a Brisbane-based barrister who practises in commercial law. PHONE (07) 3210 2233 EMAIL: ccurtis@qldbar.asn.au.


[1] http://www.bankers.asn.au/industry-standards/ABAs-code-of-banking-practice; The author has also seen attempts to plead that the Code should be enforced because a customer relied on a belief that the institution in question would comply with the Code when entering into the transaction in question. A reliance-based allegation would require proof that the customer was conscious of the terms of the Code and had a positive belief that the relevant clause would be complied with, which would be very difficult to prove for an ordinary consumer.

[2] Code of Banking Practice, cl 2.2.

[3] Ibid, cl 3.1.

[4] [2009] NSWCA 320

[5] Custom Credit Corporation Ltd v Lynch [1993] VicRp 86; [1993] 2 VR 469; Micarone v Perpetual Trustees Australia Ltd [1999] SASC 265; (1999) 75 SASR 1.

[6] Woolcock Street Investments Pty Ltd v CDG Pty Ltd [2004] HCA 16; (2004) 216 CLR 515 at [21]- [23].

[7] National Australia Bank Ltd v Rice [2015] VSC 10.

[8] At [223]-[239].

[9] At [282]-[295]. There was an argument made, but not accepted, that the amount should have been reduced by some benefit the guarantor received by the related transaction going ahead.

[10] At [294]-[295].

[11] For financial services, usually provided for in Part 2, Div 2 of the Australian Securities and Investments Commission Act 2001 (Cth).



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