Doggett v Commonwealth Bank of Australia: What does it take to be a diligent and prudent banker?
The Victorian Court of Appeal last week handed down its judgment in Doggett v Commonwealth Bank of Australia.[1] In a case bearing significant implications for the lending industry, Whelan and McLeish JJA and Garde AJA in separate decisions considered the issues in dispute. Although their Honours differed in their reasons, and in some instances disagreed in their conclusions, they were unanimous in dismissing the appeal.
The case is important because it confirms that the requirements of the Code can apply to loan guarantees, and provides guidance — albeit unsettled — about circumstances in which breach of the Code can be said to result in a guarantor’s loss.
The facts
The appellants purchased a number of apartments on the Gold Coast as investment properties between 2004 and 2007, funded by borrowings from the Commonwealth Bank of Australia. The borrowings were ultimately consolidated into a single facility.
In 2008, an opportunity arose for the appellants to purchase the management rights to the apartment complex. The appellants did so by setting up a company to borrow the full amount of the purchase price, and executing guarantees of the company’s obligations in respect of the facility. The appellants intended to fund the facility through income from the apartment management business.
When the global financial crisis struck in the second half of 2008, the appellants struggled to meet their obligations under the facility. The Bank took steps to assist the appellants, including by increasing the limit of the appellants’ overdraft and by extending the facility’s expiry date. The appellants made numerous complaints about the Bank’s conduct, culminating in a letter of compromise in April 2010. The appellants later claimed they had signed the letter under economic duress.
The apartment management business never flourished, and in time the Bank appointed receivers and managers to the appellants’ company. A shortfall of over $3 million remained after sale of the appellants’ secured assets.
The Bank commenced proceedings in the Supreme Court in 2011, alleging amongst other things that the appellants were liable as guarantors in relation to the facility. The appellants counterclaimed that the Bank owed them a contractual obligation, pursuant to cl 25.1 of the Code of Banking Practice (as existed at the time), to exercise and care and skill of a diligent and prudent banker in assessing the company’s loan application and forming an opinion about its ability to repay under the facility.
At trial, the judge held that cl 25.1 created a contractual obligation for the Bank, that the Bank breached this obligation, and that said breach resulted in the appellants’ loss. However, the trial judge held that the letter of compromise, not tainted by duress, wholly defeated the appellants’ claim.
On appeal
On appeal, it was not controversial that the provisions of the Code were incorporated by reference into the facility agreement. Because the appellants were not parties to the facility agreement (the company was), the real issue was whether the terms of the Code, and particularly cl 25.1, formed part of the guarantees. The guarantees anticipated that only ‘relevant’ terms of the Code would be incorporated.
Did the Code apply to the guarantees?
Clause 25.1 of the version of the Code which existed at the time of the transaction read:
‘Before we offer or give you a credit facility (or increase an existing credit facility), we will exercise the care and skill of a diligent and prudent banker in selecting and applying our credit assessment methods and in forming our opinion about your ability to repay it’.[2]
McLeish JA, with whom Whelan JA and Garde AJA agreed, held that cl 25.1 was a ‘relevant’ provision and so formed an obligation under the guarantees, noting that:
‘Critical to the potential liability of the guarantor, as one would expect, is the failure of the borrower to meet its obligation to pay. The capacity of the borrower to do so is plainly relevant to the transactions and obligations for which the guarantee provides’.[3]
The Court having found that cl 25.1 constituted a term of the guarantees, the question arose whether the Bank had breached that term.
Did the Bank breach the Code?
In the course of applying for the facility, the appellants had obtained an independent financial analysis which they submitted to the Bank. An employee at the Bank assessed and approved the appellants’ application for the facility, but not before making a number of errors. The errors were such that, in the trial judge’s view, the Bank had failed to exercise the care and skill of a diligent and prudent banker in accordance with cl 25.1 of the Code.
McLeish JA, with whom Whelan JA and Garde AJA agreed, also arrived at this conclusion.
Did the breach cause the appellants’ loss?
Turning to the issue of causation, McLeish JA first considered what the exercise of the care and skill of a diligent and prudent banker required. His Honour held:
‘Clause 25.1 does not presuppose or require that a bank must form an opinion that a borrower will be able to repay the loan. Rather, cl 25.1 requires care in the formation of an opinion as to whether a borrower will be able to repay the loan. The bank may take due care in forming an opinion as to whether a borrower can repay a loan and decide that, although it is possible that the borrower may not be able to repay the loan, it will offer the loan in any event’.[4]
It followed that any failure to comply with cl 25.1 did not inform the Bank’s ultimate decision to offer the facility; instead, it went to the manner in which the Bank applied its credit assessment methods and formed its opinion about the company’s financial position.[5] Because cl 25.1 did not have the effect of creating a precondition to the granting of the facility that the Bank should form an opinion that the borrower be able to repay the facility, simply proving that the borrower could not have complied with the facility did not mean that the Bank’s decision to offer the facility was necessarily a result of breach of that clause.
These were matters with which Whelan JA agreed.[6] What the Court became divided on, then, was its treatment of the trial evidence. In considering the causal nexus, McLeish JA was not satisfied that, in the absence of breach, the Bank would not have agreed to lend to the company; his Honour held that the evidence ‘demonstrate[d] that, even if the Bank had ascertained the appellants’ true financial situation, the evidence still does not establish that it would have refused the loan’.[7] In his Honour’s view, to argue in the absence of evidence what the Bank might have done had it not made the errors was purely speculative, such was the challenge the appellants faced. His Honour considered that, at best, matters would have pointed to ‘no more than a possibility’.[8]
On the other hand, Whelan JA (with whom Garde AJA agreed) appeared to hold a more pragmatic view about the realities of lending, stating that:
‘McLeish JA’s observations upon the effect of cl 25.1, and upon other potential sources of funding and the level of security are valid considerations but, in my view, they should be tempered by the consideration that whatever recourse there might be to other sources of funds (by compulsion under guarantees or subject to the agreement of others) or to security, the capacity of a borrower to service a loan must remain a fundamental consideration. A conclusion that a loan would not have been made to a borrower who had a demonstrated incapacity to meet the required repayments by a significant margin is not one which would be ordinarily in doubt, notwithstanding potential recourse to guarantors, other parties or security’.[9]
Whelan JA held that, on the facts, ‘as a matter of probability’ the Bank would have refused the loan application had it not made the errors it did.[10] His Honour considered a scenario in which a facility application had been made in knowledge of the Bank’s errors, holding that such an application would not have been approved. His Honour stated that ‘[i]f the misconception [about the financial analysis which the appellants supplied] had been revealed, as it ought to have been, it seems most unlikely any relevantly similar advance would have been made’.[11]
Garde AJA agreed with Whelan JA’s reasons, finding that:
‘But for the Bank’s misunderstanding of the [financial analysis] — this misunderstanding being a breach of cl 25.1 — it is unlikely that the already marginal loan application would have been approved in either its original or a reworked form’.[12]
However, the difference in view about the issue of causation was of no consequence for the appellants — the Court was unanimous in the view that the letter of compromise had the effect of releasing the Bank from claims for breach of the Code.
Conclusion
The decision in Doggett demonstrates that the terms of the Code of Banking Practice are capable of being incorporated by reference into guarantees. Notwithstanding the significance of this, the further elements of causation and proof of loss and damage — although ultimately rendered moot due to conclusions about the effect of the letter of compromise — were not matters agreed upon by the members of the Bench.
Inherent in both judicial approaches was a degree of conjecture. For Whelan JA and Garde AJA, it was enough to satisfy the element of causation that it was unlikely that a bank, in breach of cl 25.1 of the Code, would still have agreed to lend. For McLeish JA, the evidence at its highest suggested a (mere) possibility. This was not, in his Honour’s view, sufficient to hold together the chain of causation.
The title to this case note poses the question, ‘What does it take to be a diligent and prudent banker?’ Another question which Doggett encountered, and which through a difference of opinion the Court of Appeal has left open, is, ‘When will it make a difference?’
[1]: [2015] VSCA 351.
[2]: Clause 27 of the current version of the Code, which came into operation on 1 February 2014, is similarly worded.
[3]: [2015] VSCA 351 [138].
[4]: Ibid [163] (emphasis added).
[5]: Ibid [164].
[6]: Ibid [8].
[7]: Ibid [187].
[8]: Ibid.
[9]: Ibid [12] (emphasis added).
[10]: Ibid [26].
[11]: Ibid.
[12]: Ibid [219].