ANTONIO AND FILIPPA MODDERNO v AUSTRALIAN AND NEW ZEALAND BANKING GROUP LIMITED [1999] NSWCA 13 | Case summary

1 HANDLEY JA: This is an appeal by mortgagors from a decision of McInerney J on 17 May 1996 in favour of the Bank. The appellants entered into a third party mortgage over their property to secure a loan by the Bank to their son Carlo and his wife Danielle. This loan was not repaid and the Bank sued for possession and to recover its debt. The appellants defended the action with a cross-claim seeking relief under the Trade Practices Act in respect of misleading and deceptive, or unconscionable conduct, declarations that the Bank was in breach of a duty of care, or had agreed with the principal debtors to vary the contract, and an order declaring the mortgage void. The appellants sold the property and the Bank's debt was paid in full on 18 September 1995, shortly before the trial, without prejudice to their claims. In a reserved judgment the Judge dismissed the cross-claims. Facts 2 The appellants owned a one acre property at Pendle Hill on which was erected their matrimonial home. Carlo and Danielle wished to build a second house on the land although it had not been subdivided. They needed a loan to finance the construction of the house and Carlo applied to the respondent's branch at Winston Hills where the appellants were customers. After considering this application, Christine Brennan, Consumer Finance Manager, Parramatta, sent a letter on 29 January 1992 to "Mr and Mrs Modderno, 22 Bega Street, Pendle Hill" with details of the loan offered by the Bank on the security of a first mortgage on the appellants' property. This letter was in the form for a loan to purchase an existing property. 3 The mistake was noticed and the Bank sent a follow-up letter on 3 February 1992 in the form for a loan to finance the construction of a house which described the method to be used in approving progress payments. A term in this letter formed the basis of the appellants' cross-claims. The Judge found that the letters were addressed to Carlo and Danielle but could not decide whether the appellants saw them because both couples were residing in the same house. However even if the appellants did see them they could not have understood them because they could not read English. 4 In the second letter the Bank approved a home loan of $142,500 "to help you to build a home for your occupancy". The term relied on by the appellants was: "Progress Payments: All claims for progress payments are to be submitted in writing to the Bank by the builder. Each claim will be verified by the Bank before payment". 5 In November 1991, when Carlo asked the appellants if he could build on their land, they said "That's alright with us". He told them in February that the Bank had approved a housing loan but they would have to mortgage their property as security. Both appellants responded, "Yes I know. That should be alright". The Judge noted with "surprise" that the appellants' affidavits were relevantly in the same terms. 6 Mr Frank Mecuri, solicitor, who was acting for Carlo and Danielle, arranged for the appellants to see Mr Agostino, an Italian-speaking solicitor, to have the mortgage documents explained to them. Mr Agostino did this on 21 February 1992. It is not clear what other documents were sent with the appellants to Mr Agostino. They said in their affidavits, again in identical terms, that Mr Agostino said, in answer to the first appellant's question "What protection do we have?": "There are two ways that you are protected. Firstly the Bank will not pay any money to the builder by way of progress payments until the builder has submitted a claim in writing and the bank will verify each claim before making any payment. Secondly if anything was to happen to Carlo and you were left with the liability of the loan you would at least have the building on your land". 7 The appellants claim they executed the mortgage relying on this advice. The Judge identified problems with this evidence. The affidavits were in identical terms and he could not accept that the appellants would remember exactly the same words. He found that the first appellant's evidence "was of little value". Mr Mercuri could not remember which letter from the Bank he had sent to Mr Agostino. He did not have the originals. If he sent the earlier letter Mr Agostino could not have given the advice. Two photocopies of the letter of 3 February in Mr Mecuri's file were tendered but both were incomplete due to poor transmission. However the copy annexed to the first appellant's affidavit of 17 February 1994, said to have been given to Mr Agostino, was complete. The appellants did not call Mr Agostino who was obviously a most material witness. 8 Mr Agostino's certificates of independent advice stated that he had independently advised the appellants about "the documents set out in the schedule below", which referred only to the mortgage and did not mention any letter from the Bank. Those certificates were typed in Mr Mecuri's office, and the appellants took them with the mortgages to Mr Agostino. The Judge was not satisfied that the letter of 3 February was sent over with the mortgage documents to Mr Agostino and explained to the appellants. 9 A home loan account in the name of Carlo and Danielle was opened on 29 January at the Bank's Winston Hills branch. Substantial funds were advanced on this account between February and August 1992, but the claims for progress payments were false, and the monies were not used for the construction of the house. On 17 February a disbursement order was signed by Carlo and Danielle for $28,340.70. This was supported by invoices, including two from Imperial Tiles, a firm with which Carlo was associated. On 21 February the mortgage was delivered to the Bank. 10 Imperial Tiles had an account at the Bank's Baulkham Hills branch. On 21 February the progress payment of $28,340.70 was authorised and paid into this account. All later disbursement orders were signed by Carlo alone. On 4 March the Bank advanced $10,000 for payment to Westdraft Pty Ltd but this amount was credited to the Imperial Tiles' account on 11 March. Carlo and Danielle separated in May but the progress payments continued. Another $10,000 was drawn down on 1 June 1992 for payment to Imperial Tiles, supposedly for construction materials, but was not paid into its account. On 15 June Carlo requested, and the Bank authorised, a further $6,765 supported by a quotation for electrical installation. This referred to a "site inspection" which was fictitious because construction work had not commenced. The funds were paid into a savings account held by Carlo and Danielle. 11 On 28 July a loan disbursement order was signed by Carlo for $21,546 supported by a quotation from an unnamed party for plasterboard, painting and carpets. The progress payment was authorised and the money disappeared. This pattern was repeated on 17 August and 21 August when further payments of $11,916 and $6,900 were authorised. The total amount lent was $108,325. 12 The Bank were advised of the real position by a phone call from Danielle on 25 August. The Lending Support Manager, Lee Croucher, and Manager Consumer Finance, Chris Brennan, then called at the property. Their diary note stated: "Mr (Carlo) Modderno was on the premises … and was questioned as to where the $108,325 had gone … Mr Modderno states that he had told the Branch Manager at the time that he would be purchasing all materials up front and then once everything was together he would commence building. Mr Modderno claims that all materials are now held and the slab will be poured 1/10/92 on his return from overseas. Claims the materials were with the builder who was supervising the building. Mr Modderno also claims that approved Council plans were sighted by the Branch Manager at the time of the interview. Phoned Branch Manager on our return to advise the above. She claims that the Council approved plans have not been sighted by her. She will phone the council to ascertain if they are held at all and will revert in early course. She is also to phone Mrs Modderno to ascertain the storage place for these materials. Further to the above we have found that a progressive valuation of the property was obtained 20/8/92 to ascertain progress on the building to date. The valuation states that the home is complete and being lived in … the valuation is for parents' house … Whilst the position is not good, it is not proposed to do anything until 1/10/92 when further funds will be needed to lay the slab. At that time we propose to call on the property again to confirm same prior to release of any further funds. Another unattractive part of the problem is that the loan was approved subject to parents' RGM as the property was being built on their land. The land will eventually be subdivided. However, at no stage of the application were we advised that the guarantors were pensioners and same was not picked up when the securities worksheet was prepared and signed off. Notwithstanding this, we do have independent advise". [sic] 13 On 2 September Abbott Tout Russell Kennedy, who were acting for Danielle, wrote to the Winston Hills branch confirming the separation, and that construction had not commenced. A diary note of 24 September stated that Carlo had telephoned to request $4,000 to pay for tiles which he had gone overseas to obtain. The note continued: "Advised customer that we had no intention of drawing any further funds on the loan until he returns and can show us the supplies he claims to have purchased. He now won't return until 14/10/92". 14 The work was never commenced, and Carlo was unable to repay the loan. 15 A house at 13 Eastwood Avenue, Culburra owned by the appellants and Carlo, which had also been mortgaged to the Bank, was sold by the Moddernos and the sale was completed in December 1993. The proceeds, after discharging another loan, were applied by the Bank in reducing the debt on Pendle Hill. The sale of Pendle Hill was completed shortly before the trial in October 1995, and the balance of the housing loan paid off from the proceeds. Was there a variation of the principal contract that discharged the appellants? 16 In its letter of offer of 3 February 1992 the Bank stipulated that claims for monies to be released under the home loan agreement would be verified by it. Carlo, and in the case of the first draw down, Danielle, submitted claims for progress payments, but evidence of delivery or actual construction was never supplied. The Bank failed to properly verify the claims before authorising payment. 17 In Ankar Pty Ltd v National Westminster Finance (Aust) Ltd (1987) 162 CLR 549, at 558-9, the majority said: "… any departure by the creditor from the suretyship contract 'which is not obviously and without inquiry quite insubstantial, will discharge the surety from liability, whether it injures him or not, for it constitutes an alteration in the surety's obligations': Halsbury's Laws of England, 4th Ed, vol 20, par 259 … the principle applies so as to discharge the surety when conduct on the part of the creditor has the effect of altering the surety's rights, unless the alteration is unsubstantial and not prejudicial to the surety. The rule does not permit the courts to inquire into the effect of the alteration. The consequence is that, to hold the surety to its bargain, the creditor must show that the nature of the alteration can be beneficial to the surety only or that by its nature it cannot in any circumstances increase the surety's risk". (emphasis supplied)

Did the bank owe a duty of care to the appellants? 24 The appellants submitted that the Bank owed them a duty not to act, or fail to act, in a way that was prejudicial to their interests. The appellants argued that the respondent's conduct in approving claims for progress payments without proper verification was a breach of this duty which entitled them to have the mortgage declared void. 25 Mr Barry spent much time in oral argument demonstrating the various ways in which the Bank had been careless in allowing funds to be drawn down under the loan. The approvals for the draw downs were also contrary to the Bank's internal procedures but this is irrelevant unless it owed a relevant duty to the guarantors. McInerney J said: "Clearly, the plaintiff has been extremely careless in the verification, or indeed lack of any verification, of the invoices submitted by the principal debtors. These actions have been contrary to the interests of the defendants as guarantors as it increased their liability under the guarantee upon default and reduced their chances of recovery against the principal debtors after payment under the guarantee. The question is, however, whether such carelessness is sufficient, in the circumstances, to discharge the guarantee given by the defendants?" 26 Mr Barry claimed that the Bank owed a general duty of care to the appellants and relied on Black v The Ottoman Bank (1862) 15 Moore PC 472 (15 ER 573) where, in a case involving a fidelity guarantee, Lord Kingsdown said at 483 (577): "… the rule at law and in equity is the same - that the mere passive inactivity of the person to whom the guarantee is given, his neglect to call the principal debtor to account in reasonable time, and to enforce payment against him, does not discharge the surety; that there must be some positive act done by him to the prejudice of the surety; or such degree of negligence as, in the language of Vice-Chancellor Wood in Dawson v Lawes ((1854) 23 LJ Ch 434); 'to imply connivance and amount to fraud'. The surety guarantees the honesty of the person employed and is not entitled to be relieved from his obligation because the employer fails to use all the means in his power to guard against the consequences of dishonesty". 27 Fraud in this context has been said to be "any conduct which is unfair to the surety": Mayor of Durham v Fowler (1889) 22 QBD 394 at 419; but this is given a narrow meaning. In that case Denman J, who also referred to the judgment of Wood VC in Dawson v Lawes (above), said at 419: "by … 'fraud' we understand unfair conduct, towards the sureties, but … [Wood VC says] 'there must be …such an act of connivance as enables the party to get the fund into his hands,' which is a somewhat different thing; but it is clear that Wood VC, draws a great distinction between affirmative and negative misconduct, and that when he deals with the latter he imposes a further condition in order to absolve the surety from liability, for he adds to the words I have last quoted the words 'or such an act of gross negligence as to amount to a wilful shutting of the person's eyes to the fraud which the party is about to commit' … the evidence in the present case fails to show that the plaintiffs had the least suspicion that Goundry was at all likely to commit the frauds". (emphasis in original) 28 It is clear from these passages that only a wilful act or neglect can absolve the surety. Indeed it was said in Mayor of Durham that not even "great negligence" by the creditor, in acquiescing in slovenly accounting, could avoid the surety's obligations. These cases have never been applied in the broad way for which Mr Barry QC contended. The gravity of the conduct by the creditor, which alone can relieve the surety, has also been emphasised in O'Day v Commercial Bank of Australia (1933) 50 CLR 200 at 223; and in Westpac Securities v Dickie [1991] 1 NZLR 657, CA at 663-5. 29 There is also modern authority that mere carelessness or irregularity on the part of the creditor will not discharge the guarantor. In Bank of India v Trans Continental Commodity Merchants Ltd [1983] 2 Lloyd's Rep 298, it was alleged that the failure of the creditor to obtain written confirmation of foreign currency transactions had increased the liability of the principal debtor and therefore of the guarantor. At 302 Robert Goff LJ approved the statement by Bingham J in the court below that "a surety is discharged if the creditor acts in bad faith towards him, or is guilty of concealment amounting to misrepresentation, or causes or connives at the default by the principal debtor in respect of which the guarantee is given, or varies the contract between him and the principal debtor in a way which could prejudice the interests of the surety". He continued: "… there is no general principle that "irregular" conduct on the part of the creditor, even if prejudicial to the interests of the surety, discharges the surety, though there are particular circumstances in which the surety may be discharged, of which the instances specified by the learned Judge provide certainly the most significant, and possibly the only, examples. I say that simply because I do not wish to be thought to be shutting the door upon any further development of the law in this field by rigidly confining the circumstances in which a surety may be discharged to the specified instances, though I am unaware at present of any others. But that merely irregular conduct on the part of the creditor, even if prejudicial to the interests of the surety, does not discharge the surety, there can in my judgment be no doubt. Here … the criticised 'irregularity' consisted of a failure on the part of the creditor … to conform strictly to procedures devised to protect himself against possible repudiation of liability by the debtor, irrespective of the interests of any surety". 30 See also China and South Sea Bank Ltd v Tan Soon Gin (1990) 1 AC 536, 543-4; and Westpac Securities Ltd v Dickie (1991) 1 NZLR 657, CA 663-5. The stipulations in the letter of 3 February, and the Bank's internal procedures, were for the Bank's own protection, and not for the protection of guarantors, least of all for the protection of the borrowers. The Bank's failures do not rise to the level identified by Goff LJ which could discharge the guarantors. This ground of appeal fails. 31 The question of constructive knowledge by the Bank was also raised but not really pursued. The submission was that the Baulkham Hills branch where the Imperial Tiles account was conducted should have known about the operation of the housing loan facility at the Winston Hills branch and vice-versa. Presumably the Lending Support Centre at Parramatta should have known about the situation at both branches. If such knowledge had existed in fact, or was deemed in law to exist, the destination of the amounts lent to Carlo would have become apparent at the outset. However such knowledge cannot in law be imputed to the Bank, or to its Winston Hills Branch. 32 Information in the possession of an agent can be imputed to the principal where the agent is the relevant actor, or where the agent has a duty to communicate the knowledge to the principal. Bowstead & Reynolds on Agency, 16th Ed, 1996 p 532. Although there appears to be no authority on the point, it may be that a similar principle applies as between agents of a common principal. 33 McInerney J was satisfied that the information available to the relevant officers in each branch did not require them to communicate with the other branch and this finding cannot be disturbed. In my judgment there is no other basis for imputing the knowledge of the relevant officers of one branch to the relevant officers in the other. It would be absurd and unjust for the legal responsibility of a Bank to be determined on a fiction that the officers in any branch had imputed to them all the knowledge of its officers having dealings with the same customer in every other branch in the world. Breach of s 52 of the Trade Practices Act 1974 (Cth) 34 Mr Barry QC did not press the Trade Practices Act claims in oral argument, but they were not formally abandoned. The submission was that the Bank breached ss 52 and 52A by its letter of offer of 3 February and the conduct which followed. It was argued that the Bank's conduct in approving the drawing down of funds, contrary to the terms of the letter of 3 February, made it a misrepresentation. He also relied on statements, based on this letter, made to them by Mr Agostino. 35 The Bank did not send the letter to the guarantors or require it to be shown to them. The letter was not, in itself, a representation to the guarantors, and it was not established that the letter reached Mr Agostino. The representations attributed to Mr Agostino, even if made, went beyond the 3 February letter because they converted terms inserted by the Bank for its own protection, which it was free to waive, into terms of the contract of guarantee for the protection of the guarantors. Such representations were not made or authorised by the Bank and in the absence of some estoppel did not constitute conduct by it for the purposes of ss 52 and 52A of the Trade Practices Act. This ground of appeal also fails. Was the transaction unconscionable under the general law? 36 This submission was made briefly in the appellant's written submissions. At trial the question of unconscionability appears to have been part of the claim that the Bank breached s 52A of the Trade Practices Act. Mr Dowdy for the Bank argued that a claim under the general law had not been made at trial and could not be made on appeal. However s 52A was pleaded and unconscionability was therefore in issue. The Bank was not prejudiced, in a procedural sense, by this issue being considered on appeal. 37 The appellants relied on Garcia v National Australia Bank Ltd (1998) 72 ALJR 1243 where the High Court explained the equitable principles referred to in Yerkey v Jones (1939) 63 CLR 649 which protect wives who voluntarily undertake liability for the debts of their husbands. Those principles have not been applied to transactions involving parents and their adult children. 38 The appellants trusted Carlo ("a good boy") but there was no evidence that he exercised coercion or undue influence over them. On their own evidence they agreed to his proposals straight away ("That's alright with us"). The evidence supports the trial Judge's conclusion that they entered into the transaction under no special disadvantage which might have made the transaction unconscionable. The Bank made a fresh advance to the principal debtors, supported by a secured guarantee from the parents of one of them, to enable them to acquire a home. There was nothing unfair about the original proposal or the transaction as documented and the appellants had independent advice. The difficulty arose because their trusted son defrauded both them and the Bank and used the proceeds of the loan for other purposes. The submission that the transaction was an unconscionable dealing must therefore fail. 39 The appellants also raised the defence of non est factum but this fails because they received independent advice from Mr Agostino about the mortgage which was not shown to be inaccurate. The Culburra mortgage 40 Another issue raised in the appeal concerned the application of the proceeds of sale of the Culburra property. The mortgage to the Bank over this property contained an "all monies" clause that secured all debts owed by Carlo to the Bank. There was no dispute that it secured Carlo's investment loan of $26,565.12, but the Bank claimed that it also secured the housing loan. 41 The appellants argued that the Bank was not entitled to apply any part of the proceeds of the sale of Culburra towards the housing loan because the borrowers under the mortgages were different. The borrower under the Culburra mortgage was Carlo and under the Bega Street mortgage the borrowers were Carlo and Danielle. 42 The "all monies" clause in the Culburra mortgage was as follows: "… the amount which shall for the time being be owing or unpaid by the Mortgagor and/or the Borrower to the Bank … for or in respect of all loans or advances … made by the Bank to or for or at the request of the Mortgagor and/or the Borrower or in respect of any indebtedness from the Mortgagor and/or the Borrower to the Bank by any means whatsoever including all sums in which the Mortgagor and/or the Borrower … may hereafter become liable … to the Bank in respect of any guarantee … given … by the Mortgagor and/or the Borrower to the Bank …". 43 The definition of "Borrower" in both mortgages included: "… when the Borrower consists of more persons than one such persons jointly and every two or more of them jointly and each of them severally …". 44 The effect of these clauses is clear. The "all monies" clause in the Culburra mortgage secured the Bega Street housing loan, and the definition of "Borrower" in the Bega Street mortgage made Carlo separately liable for the whole of that debt. Compare Re Modular Design Group Pty Ltd (1994) 35 NSWLR 96, 99-102. Carlo's misconduct did not affect the giving of the guarantee but occurred later. It follows that the Bank was entitled to appropriate the surplus proceeds from the sale of the Culburra property against the debt on the Bega Street mortgage. 45 The appellants' appeal therefore fails on all grounds and must be dismissed with costs. 46 STEIN JA: I agree with Handley JA and with the additional remarks of Fitzgerald AJA. 47 FITZGERALD AJA: The circumstances giving rise to this appeal are set out in the reasons for judgment of Handley JA, which I have had the advantage of reading in draft. While I perceive no reason to disagree with any part of what his Honour has stated, it is sufficient for me to base my agreement with the orders proposed upon his Honour's conclusions with respect to the appellants' mortgage over their Culburra property. I have not found it necessary to decide whether the bank's mortgage over their Pendle Hill property was also enforceable against the appellants. 48 Both the Culburra and Pendle Hill properties had been sold prior to the trial, and the bank had been paid in full. The appellants' cross-claim remained for determination and was dismissed by the trial judge. It is unnecessary for present purposes to discuss the detail of that cross-claim or the orders sought by the appellants on this appeal beyond noting that, in practical terms, the substantive relief which the appellants seek is a payment to them by the bank. The fundamental premises underlying their claim are that the bank was not entitled to rely upon the Pendle Hill mortgage against the appellants and that that mortgage provided the sole material basis of the appellants' liability to the bank in respect of advances relating to the Pendle Hill property which the bank made to the appellant's son, Carlo Modderno, and his then wife. 49 As Handley JA has pointed out that is not correct. Prior to the appellants mortgaging the Pendle Hill property to the bank, they and their son Carlo, who was also a part-owner of the property at Culburra, had mortgaged that property to the bank. All three mortgagors were liable as principal debtors for all money secured by the Culburra mortgage. I agree with Handley JA, for the reasons given by his Honour, that that mortgage secured debts which became owing to the bank by Carlo or by Carlo and his then wife. It is not in dispute that Carlo and his then wife, became indebted to the bank for the money which it advanced to them in respect of the Pendle Hill property, and it was not argued that those advances constituted a breach by the bank of its obligations to the appellants under or in respect of the Culburra mortgage. 50 Any claim by the appellants against the bank on some wider basis must, in the circumstances, depend upon their reliance to their detriment upon a statement made by the bank and/or some breach by the bank of a duty which it owed the appellants which caused them loss additional to their liability under the Culburra mortgage. 51 The only statement by the bank relied upon by the appellants was the provision with respect to progress payments made by the bank in its letter of 3 February 1992 to the appellants' son Carlo and his then wife. I agree with what Handley JA has written on that subject, which is sufficient to dispose of the appellants' contention that they are assisted by that statement in this litigation. 52 Neither that statement nor any other identified circumstance constituted a breach by the bank of any obligation which it had to the appellants which materially worsened their position. In particular, any breach of the bank's obligation to the appellants under or in respect of the Pendle Hill mortgage did not cause them any damage since the bank's entire claim was provided for by the Culburra mortgage. 53 As earlier stated, I agree that the appeal should be dismissed with costs.

ANTONIO AND FILIPPA MODDERNO v AUSTRALIAN AND NEW ZEALAND BANKING GROUP LIMITED

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