Plaintiffs v Defendants

EQUITY - Unconscionable conduct - Whether asset based lending unconscionable - Loan by clients of solicitor's mortgage practice - Arguable defence of unconscionability established - Default judgment set aside on conditions -Elkofairi v Permanent Trustee Co Ltd [2002] NSWCA 413; Kowalczuk v Accom Finance Pty Ltd [2008] NSWCA 343; Perpetual Trustees Australia Limited v Schmidt & Anor [2010] VSC 67; Perpetual Trustee Company Limited v Khoshaba [2006] NSWCA 41 considered.

1 The plaintiffs are clients of a legal firm which conducts a solicitor's mortgage practice. The solicitors arranged for the plaintiffs to lend the sum of $400,000 to the defendants on the security of the defendants' home. The loan was secured by a mortgage dated 18 November 2009 and registered on the title as a first mortgage.

2 The mortgage soon fell into default. In October 2010, the plaintiffs commenced this proceeding, seeking judgment for possession of the property.

3 A default judgment was obtained on 11 February 2011. The plaintiffs issued a warrant of possession and it was executed by the Sheriff on 23 May 2011. Accordingly, the defendants were forced to leave their home at this time.

4 About four weeks later, the defendants' daughter agreed with the plaintiffs to purchase the property from them and, pending settlement of that sale, entered into a licence agreement to occupy the property. This allowed the defendants to move back into their home.

5 The defendants' daughter was unable to complete the contract of sale. Following her default, separate proceedings were issued by the plaintiffs seeking possession of the property from the defendants and their daughter. Judgment for possession was ordered by an associate justice on 9 November 2011. The application for judgment was not opposed.

6 The plaintiffs issued a second warrant of possession, which was executed on 4 April 2012. The defendants were evicted from their home a second time.

7 By summonses in each of the proceedings, the defendants seek to set aside the judgments for possession. They also seek an injunction restraining the plaintiffs from proceeding with a mortgagee's sale of the property, currently fixed for 19 May 2012.

8 In order to obtain an order setting aside the judgments, the defendants require the Court to exercise its discretions under rr 21.07 and 49.02(2) in their favour. In each case, although the discretion to set aside a judgment is discretionary, the authorities establish that relevant considerations to be considered on such an application include: (1) the reason why an appearance was not filed or the defendant failed to appear at the hearing when judgment was obtained; (2) whether there has been delay in applying to set aside the judgment; (3) whether the defendant has established an arguable issue to be tried; and (4) whether the plaintiff would be prejudiced by the judgment being set aside and the proceeding going to trial, which prejudice could not be adequately compensated for by a suitable award of costs and the giving of security when appropriate.[1]

9 Before considering each of the relevant issues, it is necessary to set out the facts deposed to by the defendants in support of their application.

10 In summary, the defendants deposed to the following facts:

(1) They are elderly pensioners, aged 74 and 75 years respectively.

(2) Mr Vavladelis is in reasonable health. Mrs Vavladelis is in poor health.

(3) They are Greek migrants. Neither has any formal education in the English language. Mr Vavladelis can speak some English for everyday activities and can make out some words written in English. Mrs Vavladelis speaks a little English only. She requires an interpreter for English language documents.

(5) They have two children - a daughter, Androniki Halvadakis ('Niki'), and a son, Simon Vavladelis. There is much evidence about Niki but none about Simon.

(6) As at 2007, their home was unencumbered. They had the duplicate certificate of title in safe keeping with their bank. In circumstances of which they know nothing, their duplicate certificate of title was cancelled and a new certificate issued in 2007 at the request of a law firm. They have had no dealings with that law firm.

(7) Apart from savings of approximately $10,000, which they have set aside for their funerals, they have no assets apart from their interest in the property. They have no income and live on their pensions.

(8) Mr Vavladelis recalls legal papers being served in connection with the proceedings. He says that he did not understand them until they were recently explained to him by his solicitors. He believed that the legal papers related to a document he and Mrs Vavladelis signed between six and eight years ago in respect of a loan of $15,000 to meet a tax bill for their daughter, Niki. Mr Vavladelis obtained this understanding from discussions with his daughter Niki. He gave her all of the legal documents served on him relating to the proceedings. Niki said to him words to the effect that 'she would sort it out'. Mr and Mrs Vavladelis trusted their daughter completely and relied upon her.

(9) After they were evicted from their home on the first occasion, Niki, with the assistance of another firm of solicitors, negotiated for her parents to move back into the family home. Niki told Mr Vavladelis that the solicitors then informed her 'that it was now "guaranteed" that the family home was safe'.

(10) At about the time Niki negotiated to purchase the property from the plaintiffs, Mr and Mrs Vavladelis borrowed $59,000 from friends and family. They gave this money to Niki to enable her to arrange for them to re-enter the home. That money was used by Niki to pay a deposit on her purchase of the home. As appears above, Niki could not proceed with that purchase. The $59,000 deposit was forfeited to the plaintiffs and has been applied towards the mortgage debt.

(11) Mr Vavladelis has positively sworn that his purported signature on the mortgage document is a forgery; notwithstanding the existence of a certificate signed by a legal practitioner that he explained the terms of the loan and the effect of the mortgage documents to Mr and Mrs Vavladelis before they signed the documents. Mr Vavladelis denies the effect of the certificate. If his evidence is accepted at trial, the certificate is false.

(12) They have not received any of the moneys advanced by the plaintiffs at settlement of the loan.

11 Mr Vavladelis exhibited a historic title search to his affidavit. That search discloses many prior registered dealings and caveats since 2007; in particular, two prior mortgages which were discharged at the time of settlement of the plaintiffs' mortgage. [A settlement statement produced by the plaintiffs' solicitors states that approximately $355,000 was paid to discharge these mortgages from the $400,000 advanced at settlement.] Mr Vavladelis denies that he or his wife obtained any benefit from these prior mortgages, as they were also the result of fraud. However, they have not positively sworn that they had no knowledge of and received no benefit from a significant number of other prior dealings and caveats registered on the title to the property. Nor have they explained the circumstances of two of three subsequent dealings which appear on title.

12 Reading the material as a whole, it is clear that Mr and Mrs Vavladelis believe that their daughter Niki, and perhaps a person or persons associated with her, have been involved in defrauding them since the duplicate certificate of title was re-issued. I was informed by counsel for Mr and Mrs Vavladelis, from the bar table, that Niki is separately represented and has declined to swear an affidavit in the proceeding.

13 In her affidavit, Mrs Vavladelis deposed to her and her husband, in the company of their solicitor and an interpreter, attending at the Fawkner Police Station on 3 May 2012. Following discussions with a detective, she said that their solicitor 'explained what had happened to us'. The detective advised Mr and Mrs Vavladelis how to make a formal complaint, and they apparently intend to make a complaint as soon as possible. However, given the family circumstances, there is obvious reluctance by Mr and Mrs Vavladelis to give details of the fraud practiced upon them by a family member or their associates. The fact remains, however, that Mr and Mrs Vavladelis seek the beneficial exercise of the Court's discretion. They ought to have disclosed all of their knowledge concerning the frauds they alleged were committed against them. The Court will refer this matter independently to the Victoria Police, to ensure that it is properly investigated.

14 In my opinion, the failure of the defendants to file an appearance in the first proceeding, and to appear at the hearing of the second proceeding, is sufficiently explained. That conduct should not bar them from obtaining the relief they seek if they are able to satisfy the Court that they have an arguable defence and that there is no relevant prejudice to the plaintiffs. Taking the facts as a whole, I am satisfied that, if their evidence is accepted at trial, they have been deceived by their daughter, and perhaps others, into a belief that they had no reason to be concerned about the proceedings against them. The fact that their daughter was able to negotiate for them to return to their home after the first eviction provided them with objective evidence to support their belief. Whether their belief is ultimately accepted is, however, a matter for determination at trial. After the second eviction, Mr and Mrs Vavladelis acted promptly in bringing their applications.

15 Against this background, it was submitted on behalf of Mr and Mrs Vavladelis that they have an arguable defence based on two grounds. First, because their signatures are forgeries. Second, because the plaintiffs, through their solicitors and agents, engaged in unconscionable conduct in connection with the mortgage - by engaging in 'asset based lending'.

16 I will deal first with the forgery defence. In my opinion, it is not an arguable defence. Mr and Mrs Vavladelis have put forward no evidence to demonstrate any possibility that the plaintiffs or their solicitors were a party to any forgery. That is fatal to this aspect of their case, as the mortgage must be taken as indefeasible unless the mortgagees or their agent were party to or privy to the forgery.[2]

17 The second postulated defence stands in a different position. In my opinion, based on the evidence presently available, it is clearly arguable. Asset based lending by mortgagees may, depending upon the circumstances of the particular case, constitute unconscionable conduct entitling the mortgagor to set aside the mortgage instrument. However, as appears below, relief setting aside a mortgage in such circumstances will usually be granted only on condition that the mortgagor do equity by paying or securing to the mortgagee the amount of any benefit obtained by the mortgagor from the relevant mortgage advance.

18 In Elkofairi v Permanent Trustee Co Ltd,[3] the lender knew that Mrs Elkofairi had no income and that the loan amount was a large borrowing secured over her only asset. This was apparent to the lender from the loan application form. The lender made no enquiries about the purpose of the loan, other than to note that a proportion of it was to be used for business or investment purposes. The lender made no enquiries about Mrs Elkofairi's income, or what income the business or investment was likely to generate. The lender also knew that Mrs Elokfairi did not receive legal advice. In these circumstances, Beazley JA (with whom Santow JA and Campbell AJA agreed) held that these facts should have 'sounded a warning bell' to the lender,[4] and continued:

1. In my opinion, notwithstanding that the respondent did not have knowledge of the appellant's lack of education and her language and domestic difficulties, her lack of income, in the circumstances of this transaction - that is a large borrowing secured over her only asset, in circumstances where the application form failed to disclose any income for either husband or wife - placed her in a special position of disadvantage. Though the full extent of that special position of disadvantage was not known to the respondent, nonetheless the absence of any relevant financial information was sufficient to put the respondent on notice of the appellant's lack of capacity to meet the repayment obligations under the mortgage. That left as the only source of repayment the selling of her only asset, as again the respondent must be taken to have known.
2. Counsel for the respondent submitted that the respondent did not need to be concerned with the fact that the borrowers, or the appellant at least, had no income. It was sufficient for its purposes that the loan was amply secured. That was a position, according to the respondent, which the respondent was entitled to take. I do not agree. In fact, it demonstrates the unconscientious nature of the transaction and the advantage the respondent took of the appellant's disadvantageous position. On its own submission, the respondent was only concerned with its ability to recoup any amount outstanding on the loan in circumstances where it must be taken to have known, because on the only information the respondent had, the appellant had no income, that the appellant, who was exposed to liability for the whole of the loan, had no ability to make even the first payment. The unconscientious nature of the transaction was that she was thereby at risk of losing her only asset. That risk was both immediate and real.
3. It is no answer that the respondent was content with the transaction because the loan was well secured. Nor is it an answer that the respondent had assurances from Mr Elkofairi's accountants of his ability to repay. Even if it could be said that the respondent was entitled to assume that the husband would bear the liability for the repayments (an assumption which I do not consider is available), the vagueness and unparticularised nature of the accountant's letters were not sufficient, in this case, to entitle the respondent to make the assumption that the lending to the appellant was not unconscientious.
4. In my opinion, therefore, it was unconscientious for the respondent to lend a large sum of money to a person with no income with full knowledge that if the repayments under the loan were not met, it could sell that person's only asset.[5]

19 In Kowalczuk v Accom Finance Pty Ltd,[6] the New South Wales Court of Appeal accepted that 'pure asset lending' may in some circumstances constitute unconscionable conduct,[7] but went on to say that whether pure asset lending is unconscionable 'depends on other matters as well'.[8] In Perpetual Trustees Australia Limited v Schmidt & Anor,[9] J Forrest J interpreted the above statement in Kowalczuk in the following way:

In other words, the mere fact that the loan is asset based is not, of itself, sufficient to make it unconscionable. There must be some other factor that makes the conduct of the lender morally repugnant.[10]

Whether or not that interpretation is correct need not be determined in this application as, for the reasons appearing below, there is an arguable case that the solicitor's conduct on behalf of the plaintiff lenders was morally repugnant.

20 In Small v Gray,[11] the mortgagor had no interest in the loan transaction, which was wholly for the benefit of her son and daughter-in-law. The lender knew this. Further, the lender knew that the financial information available as to the capacity of the mortgagor to pay the loan was scant. McDougall J said that the loan was made in unconscionable circumstances. In particular, the circumstance that the lender did not consider or make enquiries as to significant discrepancies in the financial information provided was held to make the loan unconscionable.

21 In Perpetual Trustee Company Limited v Khoshaba,[12] the failure of the lender to make relevant enquiries about the purpose of the loan and the circumstances of the mortgagor, in particular as to whether the mortgagor had the financial capacity to make the payments due under the mortgage, were held to be determinative. In a finely balanced case, Spilgelman CJ concluded:

1. The conflicting considerations are finely balanced. Had the Appellant or its representatives made any inquiries about the purpose of the loan I would have allowed the appeal. I do not mean to suggest that the Appellant had to determine that the proposed investment was reasonable and capable of servicing the loan. It is the indifference, suggesting that the Appellant was content to proceed on the basis of enforcing the security, which I find determinative.[13]

22 In this case, it is clearly arguable that the plaintiff lenders, through the solicitors as their agents, engaged in pure asset based lending. As the evidence presently stands, the solicitors were contacted by a finance broker 'looking to find an amount of $400,000 on the security of a first mortgage over a property'. At the time, the solicitors had a number of clients who were interested in lending moneys on first mortgage security, up to a maximum of two-thirds of a sworn valuation. In these circumstances, the solicitors advised the finance broker that they may be able to assist, and requested him to forward a fee to enable the solicitors to engage a valuer to value the property. On the basis of the valuation, the solicitors arranged for the plaintiffs to lend an amount not exceeding two-thirds of the sworn valuation. There is no evidence of the solicitors making any enquiries as to the circumstances of Mr and Mrs Vavladelis; in particular as to their age, ability to understand the English language, health, the purpose of the mortgage loan, their income or their ability to repay the amounts due from time to time under the proposed mortgage. There is no evidence that the solicitors asked the finance broker as to whether the broker had made enquiries as to these relevant circumstances. From the affidavit material filed, it would appear that the solicitors adopted the position that all they needed to do in the circumstances was: (1) ensure their clients were adequately secured; and (2) obtain a certificate from an independent solicitor, to the effect that Mr and Mrs Vavladelis had read and understood the mortgage documents and the effect of them if default was made in payment.

23 In my opinion, it is arguable that the failure of the plaintiffs or their solicitors to make any relevant enquiries as to the circumstances of Mr and Mrs Vavladelis, as described above, may have been morally repugnant. As the evidence presently stands, an arguable case of unconscionable conduct has been made out. This does not, however, mean that the judgment for possession of the property should necessarily be set aside, or that the mortgagee's sale fixed for 19 May should be restrained.

24 It was submitted on behalf of the plaintiff mortgagees that equitable relief setting-aside the mortgage in these circumstances would necessarily be accompanied by a condition that Mr and Mrs Vavladelis do equity themselves by paying or securing the amount of any benefit they received from the amount of the mortgage advance. In Elkofairi, Beazley JA considered this issue. The amount of the benefit to the relevant mortgagor who succeeded in establishing unconscionable conduct in connection with the mortgage, was half of the mortgage sum. The order setting aside the mortgage against that mortgagor was made conditional upon her paying that amount to the mortgagee, plus a 'reduced and reasonable rate of interest' fixed by the Court.[14] In formulating this condition of relief, Beazley JA relied upon the principles summarised by the High Court in Maguire v Makaronis.[15] Santow JA agreed with Beazley JA on this issue, and gave further reasons to the same effect.[16]

25 In this case, the historical title search in evidence discloses that the $400,000 loan funds were principally advanced to repay the two prior mortgages. A disbursement authority and supporting evidence was produced by the plaintiffs during the course of the hearing. The supporting evidence includes copies of records of the bank cheques paid at settlement and solicitors' letters from the two mortgagees, stating the amounts owing. The letters and bank cheque records correspond. On that basis, approximately $355,000 of the mortgage advance was applied to the pre-existing first and second mortgages. In these circumstances, the mortgagees contend that Mr and Mrs Vavladelis received the benefit of having the prior mortgages discharged by moneys advanced by the plaintiffs; and a condition of any final relief setting aside the plaintiffs' mortgage would necessarily be to require Mr and Mrs Vavladelis to pay or secure the sum of at least $355,000 to the plaintiffs.

26 On behalf of Mr and Mrs Vavladelis, reliance was placed upon the evidence that they did not know about the two prior mortgages; and it was contended that those mortgages may also have been subject to equitable defences if the prior mortgagees had endeavoured to enforce them. In substance, even if not precisely articulated, it was contended that the unconscionable conduct caused Mr and Mrs Vavladelis to lose the opportunity to discover the fraudulent use of their property as security for loans of no benefit to them, and resist any enforcement action by the two prior mortgagees.

27 Further, the evidence discloses that subsequent encumbrances have been registered over the property since registration of the plaintiffs' mortgage. There is a second mortgage registered 26 February 2010 and two caveats lodged by chargees who, from their names, appear to be mortgage lenders. There is presently no evidence of the amounts secured. Mrs Vavladelis has sworn that she has no knowledge of the facts relevant to one of the two subsequent caveats. However, neither Mr nor Mrs Vavladelis has given any evidence about their knowledge or involvement in the facts underlying the other caveat, or about the subsequent mortgage. Given the nature and timing of their applications, they ought to have done so.

28 Taking their affidavits as a whole, however, I infer that they will contend the subsequent securities also represent unauthorised transactions, and are accordingly infected by unconscionable dealing or other equitable claims. In this context also, unconscionable conduct by the plaintiffs may have caused Mr and Mrs Vavladelis to lose the opportunity to prevent these unauthorised dealings.

29 On the evidence as it presently stands, there is an arguable case that any unconscionable conduct by the plaintiffs has caused Mr and Mrs Vavladelis to lose the opportunity to resist demands for payment of the amounts secured by the prior mortgages, and to avoid the imposition of the subsequent encumbrances. If those cases are established, it will not necessarily follow that conditions will be imposed on equitable relief setting aside the plaintiffs' mortgage. Accordingly, there may be real utility in setting the judgment aside.

Can any prejudice to the plaintiffs be compensated for?

30 In my opinion, any prejudice to the plaintiffs consequent on setting aside the judgments cannot be compensated for by mere orders for costs, for the following reasons:

(1) The amount presently owing to the plaintiffs under the mortgage is approximately $475,000, with interest accruing at approximately $4,100 per month.

(2) The only valuation evidence before the Court is that obtained in October 2009 for the purposes of the plaintiffs' mortgage. At that time, the property was valued at $615,000 in a market which was said to be 'rising slightly'.

(3) Assuming that the property is now worth approximately $625,000 after selling expenses, there is approximately $150,000 difference between the present debt owing to the plaintiffs and the likely net sale proceeds.

(4) If the judgments are to be set aside, the ensuing multi-party litigation (as described below) will take some time to reach trial and for a judgment to be delivered. In the meantime, interest will continue to accrue and the plaintiffs will incur significant legal costs. Given the allegations of unconscionable conduct, they will likely need to engage new legal representation; as their present solicitors may be in a position of conflict of interest.

(5) In all the circumstances, any order setting aside the judgments would need to be on condition that some further security be provided by the defendants. This issue is developed below.

31 In my opinion, the just course is to set aside the judgments for possession, and restrain the proposed mortgagee's sale, but only on conditions as to further security being provided. My reasons follow.

32 First, for the reasons given above, I am satisfied that the failure to appear and delay in applying to set aside the judgments is sufficiently explained.

33 Second, for the reasons given above, I am satisfied that there is an arguable case of unconscionable conduct by the plaintiffs and their lawyers in connection with the mortgage. If that defence is made good at trial, it may be that the defendants will only be able to obtain equitable relief setting-aside the mortgage if they pay the amount of approximately $355,000 paid by the plaintiffs to discharge the two prior mortgages, and perhaps other amounts secured by caveats. However, that may not necessarily be the result. If unconscionable conduct is established at trial, the Court's statutory jurisdiction to award damages and other relief under ss 158 and 159 of the Fair Trading Act 1999 (as in force as at the date of the mortgage) may result in one or more of the following orders:

(1) An order for damages for loss of opportunity. It may be contended at trial that, in the absence of unconscionable conduct by the plaintiffs and their lawyers, the defendants would have been alerted to the fact that the property was encumbered by the two prior mortgages and other interests protected by caveats. On this factual scenario, the defendants would likely have refused the proposed loan from the plaintiffs and sought legal advice. They may have had good grounds to set-aside the pre-existing securities over the property, in whole or in part, and to avoid the subsequent encumbrances being placed on their property. If so, they may have a personal claim against the plaintiffs and their solicitors for damages equal to or exceeding the amount of the mortgage debt.

(2) Orders in the Court's statutory jurisdiction to make other orders under s 158 of the Fair Trading Act. For example, an order declaring the mortgage to have been void ab initio, an order varying the terms of the mortgage or an order refusing to enforce any or all of the provisions of the mortgage.

34 Third, for the reasons given above, I would make orders setting aside the judgments conditional on the defendants giving the plaintiffs further security to that provided by the mortgage. I will hear the parties as to the amount of security. However, the security should include an amount equal to approximately 12 months interest and a generous allowance for the plaintiffs' likely costs of the proceeding on a solicitor and client basis. The security should be provided within 30 days of this day, or the applications will stand dismissed. In the meantime, I would restrain the sale of the property for a period of 30 days.

35 I will hear the parties as to the form of orders, as to directions and as to the further conduct of the proceeding. In that regard, there was mention at the hearing of other claims which may be available to Mr and Mrs Vavladelis against third parties, including claims against:

(2) prior and subsequent security holders who have been or are registered on the title to the property;

(4) other solicitors: for example, the solicitors who were involved in obtaining the issue of a replacement duplicate certificate of title, the solicitor who signed the certificate acknowledging that he explained the terms and effect of the plaintiffs' mortgage to the defendants, and any solicitor who may have purported to act for the defendants in connection with the granting of the mortgage;

(6) the Registrar of Titles pursuant to s 110 of the Transfer of Land Act 1958.

36 If the defendants do not proceed against all or some of these parties, it is likely that the plaintiffs or other parties will. Thus, the reference to multi-party litigation and the need to order further security.

37 The defendants' lawyers need to give careful consideration to all available claims. They must also consider the most practical and cost-efficient order and manner of proceeding against the various possible wrongdoers who, on the defendants' version of events if accepted at trial, have caused the property to be encumbered without the defendants' consent.

[1] Kostokanellis v Allen [1974] VicRp 71; [1974] VR 596; Rosing v Ben Shemesh [1960) VR 173.

[2] Pyramid Building Society (in liq) v Scorpion Hotels Pty Ltd [1998] 1 VR 188.

[3] [2002] NSWCA 413 ('Elkofairi ').

[5] Ibid, [56]-[59] (emphasis added).

[6] [2008] NSWCA 343; (2008) 252 ALR 55 ('Kowalczuk').

[9] [2010] VSC 67.

[11] [2004] NSWSC 97.

[12] [2006] NSWCA 41.

[15] [1997] HCA 23; (1997) 188 CLR 449, 475-8.