Circumventing the Credit Code – Private lenders and unconscionable conduct

What are ASIC’s concerns?

Private lenders in Australia range from large privately owned mortgage funds lending millions in large property developments and equity loans, to sophisticated investor individuals who provide SME loans for working capital and ad hoc purposes. A percentage of these lenders elect to provide exclusively unregulated business loans that do not fall under the National Credit Code (the Code) and thus do not hold an Australian Credit Licence or membership with the Australian Financial Complaints Authority (AFCA).

The Code does not apply to any manner of credit to corporations and, in the absence of the Code, lenders are not required to follow any specific rules regarding serviceability assessments. This can lead lenders to either knowingly or unknowingly engage in practices that could be unconscionable conduct in a financial business, particularly where loans involve:

1.  approval on the basis of security value only, when serviceability is clearly lacking; and

2. loans to companies that are intended to be used by the individual owners for consumer purposes.

These practices are not only fraught with risk from a commercial stand point, but also from a regulatory stand point, and lenders could risk prosecution by ASIC if not careful, as is evident from ASIC commencing legal action against Oak Capital in October 2024.

ASIC v Oak Capital

It is important to note before we begin to consider ASIC’s action against Oak Capital, that this case has not yet been decided and Oak Capital refutes ASIC’s allegations. The scope of this publication is to consider ASIC’s allegations against Oak Capital as informative to other lenders.

ASIC has commenced proceedings against Oak Capital Management Fund Pty Ltd and Oak Capital Wholesale Fund Pty Ltd (the two funds comprising Oak Capital) on the basis of unconscionable conduct under section 12CB of the ASIC Act.

Section 12CB of the ASIC Act states that a person must not, in trade or commerce, in connection with the supply, acquisition or possible supply or acquisition of a financial service, engage in conduct that is unconscionable. A financial service includes dealing in financial products such as credit facilities of any kind (not only Code loans). Section 12CC of the Act lists a number of matters which the Court may have regard to for the purpose of determining unconscionable conduct, including, among other matters:

(a) the relative strength and bargaining power of the parties; 

(b) whether the conduct by the credit supplier was reasonably necessary for the protection of the legitimate interests of the supplier or otherwise; 

(c) whether the borrower or person liable was able to understand any loan documents used; and

(d) whether there was undue influence or pressure exerted on, or any unfair tactics used by, the lender or any person on behalf of the lender.

In its action against Oak Capital, ASIC alleges that:

1. Oak Capital engaged in a business model of making loans to companies where the true purpose of the loan was for the individual guarantor to utilise the loan proceeds for personal or residential property purposes of the guarantor, such that had the loan been made to the guarantor directly, it would have been a Code loan.

2. In these loans, the company borrower was either not trading, had no assets or was not otherwise expected to benefit from the loan.

3. Oak Capital either knew the above or wilfully turned a blind eye to it by relying on brokers who submitted limited application data.

4. The loans were made on the basis of the asset based model of lending, with primary assessment being the security and little or no regard for the guarantor’s ability to service the loan.

5. The loans were high fees, high interest and typically short term interest only loans.

6. Oak Capital required the borrowers to acknowledge and agree by declaration at various stages of the loan that the loan was wholly or predominantly for business or investment purposes only.

7. By engaging in this practice, Oak Capital was able to circumvent the application of the Code and in this way denied borrowers and guarantors important protections including responsible lending protections and maximum fee protections.

8. This practice was unconscionable within the meaning of section 12BD of the ASIC Act.

Lenders should note that ASIC’s action against Oak Capital is not the first time a Court has been asked to consider unconscionable conduct in the context of asset based lending. In the decision of Stubbings v Jams 2 Pty Ltd & Ors [2022] HCA 6, the High Court of Australia considered facts very similar to those alleged by ASIC (being facts that were substantiated in that case) and found that such a practice was indeed unconscionable. It also found that having pro-forma certificates of legal advice and declarations of business purpose did not affect the culpability of the lenders.

Indicators of unconscionable conduct 

Based on the material available to date, we can identify a number of indicators that could lead to a finding of unconscionable conduct in non-Coded loans. Lenders should be particularly careful of approving loan transactions involving any of the following circumstances:

1. The customer is an individual in financial strife or desperate for finance. For example, due to contractual obligations to a property seller or another creditor.

2. The customer is seeking finance for a personal or consumer purpose, including in connection with residential property investment by the individual.

3. The borrower under the loan contract is a company that has no assets, is not trading, or will not otherwise benefit from the loan. For example, it is financing an asset it does not reasonably require or which will be in the name of the individual and not the company.

4. The individual is a guarantor, and the guarantor’s personal property is the primary security, whether it is the guarantor’s home, an investment property or other personal asset.

5. The lender’s approval of the loan is based almost exclusively on the equity in the security property, with little or no consideration for the customer’s ability to repay the loan.

6. The customer is seeking a business loan in circumstances where obtaining a consumer loan would not otherwise be possible. For example, because of poor credit or failure to meet serviceability assessments based on Code standards.

7. The lender either knew of the circumstances of the loan and engages in a practice of offering this type of credit, or is otherwise in the practice of turning a blind eye to the circumstances of loan offers in order to be in position to service these customers.

8. The loan is the subject of high fees and interest beyond those reasonable to amortise the lender’s risk and may suggest profiteering on the part of the lender. 

If a loan scenario contains one or more of these elements, a lender should pay particular attention and conduct a more in-depth assessment as to whether the loan offer could place the lender at risk of unconscionable conduct.

What is the consequence of a finding of unconscionable conduct?

The obvious risk of a finding of unconscionable conduct, either under the unwritten law or under section 12CB of the Act, is that the Court may make the loan void and unrecoverable as well as possibly award damages.

However, the ASIC Act extends beyond those reliefs. In ASIC v Oak Capital, ASIC is seeking pecuniary penalties (fines), relinquishing of profits and a publicity order (naming and shaming) requiring Oak Capital to publicise the outcome of the decision in The Australian and the Australian Financial Review and by individual communication to all borrowers.

Recommendations for lenders concerned about possible unconscionable conduct

Lenders who engage in the practice of lending to companies in order to provide consumer loans outside of the Code need to be very careful of continuing this practice in future.

Lenders should only fund unlicensed unregulated loans in genuine business loan facilities for genuine business purposes and always with a degree of serviceability assessment. Lenders need to be aware that they could be asked to show cause as to the basis of approval of a credit which is ultimately used for consumer purposes or in circumstances where the borrower would not have met a Coded serviceability assessment.

It is recommended that private lenders operating in the space of non-Code finance:

1. Take steps to ensure brokers are aware of the lender’s market offering and provide full and frank disclosure of all matters pertaining to the credit sought by the customer.

2. Require the customer to include in the application an explanation of the purpose of the credit and collect information to verify the same. For example, check that contracts of sale or invoices being financed are made out to the borrower and not the guarantor.

3. Verify the business case for repayment, particularly for short term loans. For example, requesting evidence of the contract or arrangement the borrower intends to rely on to repay the loan on time. 

4. Ensure advancing of the funds is made consistent with the loan purpose. For example, to the bank account of the borrower and not the guarantor.

5. Do not rely on declarations of business purpose, legal or financial advice certificates as 'get out of jail free' cards. They will not have this effect.

6. Ensure letters of offer reserve the lender’s right to withdraw in case of concerns, and withdraw when it becomes apparent that the loan is not in the customer’s interest.

Brokers need to be cautious of offering unregulated finance in order to assist customers who would not otherwise qualify for consumer credit finance. An unregulated loan can place the customer in a worse off position than the customer might have been in void of any finance, given it may result in the customer becoming insolvent quicker, owing more and being denied access to AFCA dispute resolution and other important protections under the Code.