Perpetual Trustee Australia Limited v Romeo

A good (arguable) defence 7The requirement to establish the existence of a good defence raises issues of greater complexity. Mr and Mrs Romeo contend that they have a defence by way of cross-claim for relief pursuant to the Contracts Review Act 1980 and, alternatively, for unconscionable conduct within the meaning of the Competition and Consumer Act 2010 (first articulated as a claim under the Trade Practices Act 1974). A proposed form of cross-claim pleading both causes of action was provided to Court at the hearing of the application. However, the principal focus of the argument on the motion was the contention that the loan agreement and the mortgage were unjust within the meaning of the Contracts Review Act .

Circumstances in which the proposed defence is sought to be litigated 8Mr and Mrs Romeo mortgaged the property to the plaintiffs as security for an advance of $3,578,435.31. Those funds were advanced pursuant to the terms of a deed of loan dated 25 October 2006 and a supplementary agreement dated 8 May 2009. The mortgage was granted on 26 October 2009 and was also subsequently varied. 9The gist of the proposed cross-claim is that the contracts in question were unjust because they amounted to "asset lending" of the kind criticised by the Court of Appeal in Perpetual Trustee Company Ltd v Khoshaba [2006] NSWCA 41 at [82] per Spigelman CJ; Handley JA agreeing at [104] and at [128] per Basten J. As will be seen, the circumstances of the loans made in the present case were very different from the circumstances of the loan made to Mr and Mrs Khoshaba. 10Mr and Mrs Romeo own a restaurant called the Pasadena with a bottle shop and other shops at Church Point, together with the Church Point General Store, which contains a post office and a cafeteria. 11Those businesses were acquired in about 1989 with loan funds from the St George Bank in the sum of $4.8 million. At that time, Mr and Mrs Romeo owned two properties at Mona Vale as well as the security property, which is five acres of land with a four-bedroom house built by Mr and Mrs Romeo. 12In about 2002 or 2003, the Romeos evidently fell into default of their facilities with St George and receivers were appointed to some of those properties. Mrs Romeo states that she and her husband subsequently employed a mortgage broker, Mr Tony Murray, to source a loan for them to buy back those properties. The proposed cross-claim pleads that he was paid a salary of approximately $1100 per week by Mr and Mrs Romeo. According to Mrs Romeo's affidavit, in order to repurchase those properties, the Romeos obtained loans totalling about $5.5 million. 13It was submitted on behalf of Mrs Romeo that, over the following years, the evidence reveals a pattern of "debt-churning" in which Mr Murray would approach "third tier" lenders and even individuals to obtain further loan funds with which to pay the interest on prior loans or refinance such loans, taking substantial fees along the way. 14In July 2006, an approach was made to the plaintiffs to refinance the defendants' borrowings. The approach was made by Mr Goldberg of Ashe Morgan Commercial, a firm of finance brokers. It was submitted on behalf of the defendants that, in due course, they would seek to make good the proposition that Mr Goldberg was acting together with Mr Murray, at least as a "joint introducer". 15The loan application to the plaintiffs was considered by Mr John Thomas. It included at least the following documents: (a) a statement of assets and liabilities dated 4 July 2006 for Mr and Mrs Romeo. The statement identified total assets of $36.4 million against total liabilities of $18.4 million; (b) a profit and loss statement for the period ending June 2006 for "Pasadena on Pittwater". The statement did not identify the legal entity to which it related. It reported a net profit of around $250,000 for that year; (c) a profit and loss statement for the same period for "Church Point Cellars", again with no identification as to the legal entity to which it related. That statement reported an operating profit of around $200,000; (d) a letter from Challenger to Mr Romeo dated 11 July 2006 confirming his "account status" in the following terms: "All interest instalments have been made in an excellent manner in accordance with the mortgage agreement". 16Mr Thomas stated in an affidavit read on the application that, after considering the submission he received from Mr Goldberg, he was "favourably impressed" but was concerned as to the Romeos' ability to service the financial obligations of the proposed borrowings. He requested some independent verification of their ability to service the loan. 17In response to that request, Mr Thomas received a letter dated 1 September 2006 from Arapidis and Partners Pty Limited Chartered Accountants. The letter stated: I understand that Mr and Mrs Romeo are proposing to borrow the sum of $3.3 m. Based on their income and expenditure and on my knowledge and understanding of their financial position, I am of the opinion that they are able to pay the interest on the loan in accordance with its terms and can do so without financial hardship. I am not aware of any factors which may affect their ability to make the repayments of some $25,000 per month which may cause substantial hardship to them. 18Mr Thomas states that, after receiving that letter, he was satisfied of Mr and Mrs Romeo's ability to service the proposed loan. He nonetheless made a phone call to his counterpart at Challenger (the outgoing lender) noting that the proposal was for a substantial loan and asking why Challenger had decided not to increase their loan. Mr Thomas states that he was told that the last valuation had come in "very low" and that the loan to value ratio was accordingly too tight. Mr Thomas says that he was told that the Romeos were good borrowers who had "never missed a beat". 19A letter of offer was subsequently issued. The accountant's letter 20The accountant's letter assumed some importance at the hearing before me. On the first day of hearing, it was contended on behalf of Mr and Mrs Romeo that the letter was not true and that Mr Arapidis had not acted as their accountant (T17 of 3.3.11). 21On the application of the plaintiffs, the proceedings were then stood over part heard to enable them to obtain instructions after I allowed the defendants to rely upon a late affidavit sworn by Mrs Romeo. At the adjourned hearing, the defendants read further affidavits sworn by Mrs Romeo and the plaintiffs read an affidavit sworn by Mr Arapidis. Each of those witnesses was then cross-examined as to the circumstances in which Mr Arapidis wrote the letter (among other things). 22Mrs Romeo acknowledged that she had met Mr Aripidis a few times in 2003 but maintained that he had not worked as her accountant. She stated that, on the last occasion when she met him (in 2003), Mr Aripidis said that he did not want to do her work. In cross examination, however, I understood Mrs Romeo effectively to have acknowledged that she did not know what work Mr Aripidis might have done at the request of Mr Murray, who she acknowledged was employed to do "whatever needed to be done in all normal course of running the business" (T21 of 25.3.11). 23Mr Arapidis stated that he wrote the letter at the request of Mr Murray. Extraordinarily, he conceded that, contrary to what was asserted in the letter, he had not in fact done any work as the accountant for the Romeos personally (as opposed to doing work for their companies at the request of Mr Murray). He conceded that he had no knowledge or understanding of their financial position (as opposed to that of their companies) as at September 2006, the date of the letter (T30-31). 24Accordingly, it is clear enough that the letter was not in fact the product of a considered assessment based on adequate information as to the serviceability of the loan, notwithstanding its terms. What is less clear is what flows from that fact so far as the parties to this litigation are concerned. Is there an arguable defence to be litigated? 25It was submitted on behalf of the defendants that the circumstances in which the loan and mortgage were entered into disclose a triable issue as to the existence of an entitlement to relief under the Contracts Review Act , principally on the basis that the loan could be characterised as unjust for the reasons discussed in Khoshaba. Mr Dubler, who appeared for the defendants, submitted that there were three areas of debate as to which it was necessary to consider whether a triable issue exists. 26The first was described by Mr Dubler as the "measure" of the defendants. He submitted that the evidence disclosed an issue as to whether they were savvy property developers, as contended by the plaintiffs, or rather "elderly Italian people...who were fruit shop owners in the main, with one failed property development". 27The second triable issue identified was the standard of enquiry undertaken by the plaintiffs, which informs the question whether the plaintiffs were indifferent to the serviceability of the loan. In that respect, Mr Dubler submitted that the cross-claim raised the issue of the practices of lenders and noted that it was not yet known what lending guidelines were applicable or whether the plaintiffs complied with any such guidelines. 28Finally, Mr Dubler pointed to the role of Mr Murray, whom the defendants accuse of embroiling them in "debt-churning" in his own self-interest, generating huge fees for himself whilst exposing the Romeos to increasingly unsustainable borrowings. It was submitted that there was sufficient indication within the material presently available to indicate the existence of a cosy relationship between Mr Murray and Mr Goldsmith of Ashe Morgan, who introduced the loan to the plaintiffs. 29The evidence pointed to on that issue was not overwhelming, but was at least capable of raising the possibility of some connection between those men. It is pertinent in that context to note, as I was reminded by Mr Dubler, that although the hearing took the unusual course of entailing relatively extensive cross-examination, I should not be misled into thinking that I am in a position to find facts and "be comfortable about things". 30In Khoshaba, it was noted that a case under the Contracts Review Act involves a three stage process: the making of findings of fact (where the facts are disputed); the formation of an evaluative judgment as to whether or not the contract is unjust and, finally, the exercise of the court's discretionary power to grant relief and determine its extent: at [99] per Handley JA; at [106]-[109] per Basten JA. 31As submitted by Mr Walsh on behalf of the plaintiffs, the critical consideration which prompted the Court of Appeal to dismiss the lender's appeal in that case was "the indifference, suggesting that [Perpetual] was content to proceed on the basis of enforcing the security": at [92] per Spigelman CJ; Handley JA agreeing at [104]. 32The significance of indifference on the issue of unjustness of the contract was stark in the circumstances of that case. Mr and Mrs Khoshaba were pensioners. Mr Khoshaba had not worked for 31 years. The Khoshabas were members of the Sydney Assyrian community in which there had evidently developed a degree of enthusiasm for an investment scheme operated by Mr Karl Suleman. The scheme was in fact a pyramid selling scheme and inevitably failed. 33Mr Khoshaba was approached by an old friend and prevailed upon to borrow funds to invest in the scheme. Unbeknownst to Mr Khoshaba, the loan application falsely asserted that he was employed and earning a salary of $43,000 per annum. The loan was secured against Mr and Mrs Khoshaba's only asset, their home. They had no prospect of servicing it if the investment scheme failed, having regard to their true financial position. 34It was submitted on behalf of the plaintiffs that, having regard to the terms of the judgment of the Chief Justice in Khoshaba at [92], it may be concluded that the lender's appeal would have been allowed had it taken the steps that were in fact taken by the plaintiffs in the present case (of obtaining further evidence as to the serviceability of the loan). That may well be so, but it does not follow that there is no triable issue on that question in the present case. 35The authorities establish that so-called "asset lending" is not to be considered unjust in itself. The significance of exclusive reliance upon the security for the loan and indifference to the borrower's capacity to repay is critically dependent upon the context in which that approach is adopted to the assessment of the loan. Thus in Kowalczuk v Accom Finance [2008] NSWCA 343, Campbell JA (with whom Hodgson and McColl JJA agreed at [1] and [2] respectively) said at [99]: I would accept that in some circumstances knowledge of a high degree of risk that there might be a default in payment of interest or principal so that a mortgagee sale would result, could be unjust lending, even though it could not be said that the lender knows that there will be default. However I do not accept that a lender is always bound to carry out a detailed investigation of the practicality of an intending borrower actually being able to carry through the plan the borrower says he or she has for repayment of the loan. In the present case, Kowalczuk stated to Accom that he proposed to pay the Berowra loan out through bank refinance, and the Haberfield loan through refinancing with FirstLoan (the same brokers through whom Kowalczuk was able successfully to refinance the Berowra loan) and there was no occasion for Accom to doubt that he would be able to do so. Thus, even if Mr Conti is right in saying that there can be pure asset lending if the lender knew that there was a high risk that the intended means of repayment might fail, in the present case Accom did not have knowledge of that type. 36The decision in Khoshaba should accordingly not be understood as equating a failure to make inquiry with "indifference" of the kind disapproved by the Court in that case. 37The submissions put on behalf of the defendant on that issue were compelling. However, I have ultimately come to the conclusion that it is not possible to rule out the prospect of the defence succeeding on the strength of the necessarily limited material before the Court on the present application. It is clear enough on the evidence that the Romeos circumstances are very different from those of the Khoshabas, or indeed Mrs Elkofairi (see Elkofairi v Perpetual Trustee Co Ltd [2002] NSWCA 413; (2003) 11 BPR 20,841). Nonetheless, I do not think it is possible to conclude at this point of the proceedings that their contentions are unarguable. 38Two considerations in particular have led me to that view. First, as noted by Mr Dubler, it is not yet known what lending guidelines were applicable to the loan application or whether any such guidelines were complied with. Thus although it may readily be concluded that the Court of Appeal may have come to a different conclusion in Khoshaba had that "Lo-Doc" loan been the subject of further inquiries as seen in the present case, the present facility was of a wholly different kind and could not properly have been processed as a Lo-Doc loan. 39Whether there was an absence of reliable evidence as to serviceability, and if so whether that was due to the adoption of a "tick-a-box" approach to the loan approval process are among the issues of fact that could properly be litigated, in my view. It would not be appropriate to jump to any conclusion as to whether the contract was capable of being regarded as unjust before making findings as to all of the (contested) circumstances in which the agreements were entered into. Interests of justice 40Finally, it is necessary to consider whether it is in the interests of justice to allow the proposed defence to be litigated. I have ultimately concluded, with some reluctance and hesitation, that it would be wrong to shut the defendants out of litigating the issues raised in the cross-claim. It will be clear from my reasons set out above that I entertain considerable doubt as to the strength of the contention that the loan falls within the principles considered in Khoshaba , but I must heed the caution sounded by Mr Dubler as to the risk of mistaking the present task for a fact-finding process. Assuming the Romeos can prove their contentions, I think it has to be acknowledged that the cross-claim is arguable, and I am satisfied that those contentions are made in good faith. 41I think, however, that interests of justice require that the setting aside of the judgment should be on terms apt to give some protection to the interests of the plaintiffs. 42At the hearing, an offer was made on behalf of the defendants in open court to pay $1.6 million into court and to maintain interest payments on that amount at 7.75 percent as an average of advertised standard mortgage rates (T41-42 of 25.3.11). Mr Dubler explained the offer as reflecting a recognition of the broad range of remedies available under the Contracts Review Act and the fact that the proposed cross-claim does not impugn the St George mortgage, which was in approximately that sum. It was suggested that the amount should be paid into court rather than to the plaintiff, since it is not one of the "big four" banks. 43In my view, an appropriate balance between the competing interests of the parties can be achieved if the defendants are required to pay that amount into court as a term of obtaining the relief sought. Further, I would propose that the amount be paid out to the plaintiffs, to be applied in reduction of the loan, upon their undertaking to the court to disgorge the payments made in the event that there is a final determination in this Court (including any appeal) that the sum so paid was not payable by reason of the success of the Contracts Review Act claim. 44In my view, the plaintiffs should also be protected as to costs. The application was entirely discrete and separable from the substantive issues in the proceedings. Further, although the defendants have explained the default by reference to the conduct of their former solicitor, it is nonetheless an event for which they should bear responsibility so far as costs are concerned. Finally, it will plainly be some time until the proceedings are finally determined. For those reasons, in my view the Romeos should pay the plaintiffs' costs of the notice of motion and those costs should be payable forthwith. 45Accordingly, the orders I propose are:

1. That, upon payment into Court by the defendants of the sum of $1.6 million within 28 days of the date of these orders, and further upon their undertaking to the court to maintain interest payments on that amount at 7.75 percent per annum, the default judgment entered on 14 September 2011 be set aside.
2. That, upon the plaintiffs' undertaking to the Court to disgorge any payments received in the event that there is a final determination in this Court (including any appeal) that the sum so paid was not payable by reason of the success of the Contracts Review Act claim, the amounts paid into court in accordance with order 1 be paid out to the plaintiffs.
3. That the defendants pay the plaintiffs' costs of the application, as agreed or assessed, forthwith.

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