Can a loan to a company be regulated under the National Credit Code?

The National Credit Code (the “Code”) is designed to provide protection to borrowers, but it states that it only applies where the borrower is a natural person or a ‘strata corporation’.  Even when the borrower is a natural person, there is also a purpose test which limits the application of the law to lending for personal, domestic or household purposes, or for residential investment purposes.

Several cases have considered the question whether the Code could nonetheless apply to a loan made to a company.

In any proceedings (whether brought under the Code or not) in which a party claims that a credit contract, mortgage or guarantee is one to which the Code applies, it is presumed to be subject to the Code unless the contrary is established. Therefore if a company borrower claims that the Code applies to their loan, the lender has the burden of disproving that claim.

Equitrust v SLJM [2010] NSWSC 1059

This case involved an individual who was a guarantor of a loan to a company which he controlled. The guarantor argued that the Code should apply to the loan because he was the real borrower, and the use of the company as the borrower was a sham.

The Judge rejected this argument, noting well-understood legal meaning of a sham. A sham refers to steps which take the form of a legally effective transaction but where the parties’ intent has no apparent or any legal consequences: Equuscorp Pty Ltd v Glengallan Investments Pty Ltd (2004) 218 CLR 471.

In Raftland Pty Ltd v Cmr of Taxation (2008) 238 CLR 516, Kirby J identified the key requirement to finding a sham as the “demonstration, by evidence or available evidence, of a disparity between the transaction evidenced in the documentation (and related conduct of the parties) and the reality disclosed elsewhere in the evidence.” On this basis, a sham will be found where the evidence displays a discord between parties’ legal rights or obligations as described in the documents and the actual intentions that the parties are shown to have. The test of the parties’ intentions is subjective. Ultimately, they must have intended to create rights and obligations which differed to those described in their documents, and the documents must have been intended to mislead third parties about such rights and obligations.

Applying these principles, the Judge said it was quite clear that the lender in this case intended the transaction to have exactly the legal consequences which the documents had on their face, and found that the Code did not apply.

Devon v Thirteenth Kaysan Pty Ltd [2016] FCA 1026

The Court in this case considered a loan to a company where the sole director guaranteed the loan by way of mortgage over the family home. It was claimed that the Code should apply as the loan was a sham that had been structured as a loan to a company to avoid application of the Code.

Although there was evidence that the purpose of the loan was to both refinance the family home and finance a commercial development project, the Court held that the loan was clearly and unequivocally an enforceable loan to the company and not subject to the Code. The Court stated that the existence of an ulterior purpose in making the loan to the company rather than the individual was not sufficient to make the loan transaction not a genuine transaction. The Court accepted that if the loan had been a sham, then the Code may have been applicable.

Yusofzai v Andask Pty Ltd [2019] NSWSC 124

In this case, a loan to a company was secured by a guarantee and mortgage provided by the director of the debtor company. Here the purpose of the loan was for renovations to the director’s family residence, to fund his personal daily expenses and to fund the daily expenses of the business operated by the company. The debtor defaulted on the loan and the lender sought to sell the mortgaged property. It was argued by the director that the Code applied to the loan because the true parties to the contract were the director and the lender. However, the Court was satisfied that there was no evidence to show the arrangement was a sham, and it found that the Code did not apply.

Jams 2 Pty Ltd v Stubbings (No 3) [2019] VSC 150

This case concerned a loan to a shell company controlled by an individual, Stubbings. The company had no assets and had never traded. Stubbings sought to borrow money to buy residential property, which was to be owned by him. He guaranteed the loan, with security over his existing properties and the new residential property being purchased. The company borrower defaulted under the loan and the lender sought possession of Stubbings’ property. Stubbings claimed that the Code should apply to the loan, and that the loan was procured by the lender’s unconscionable conduct.

The Court rejected the argument that the Code applied to the loan. Relying on the reasoning in Devon v Thirteenth Kaysan Pty Ltd, the Court held that there was no suggestion that the loan was a sham and that there was no doubt the loan was made to the company and was not covered by the Code. However the Court was satisfied that the lender acted unconscionably because it had no knowledge of Stubbings’ finances and personal circumstances when procuring the loan. For that reason, the Court ordered that the loan be set aside.

The decision was appealed to the Court of Appeal of the Supreme Court of Victoria on the finding of unconscionability by the lender. The Court of Appeal allowed the appeal and ordered the trial judge’s orders be set aside. However, special leave to the High Court was granted and the High Court is expected to hand down its judgment soon.   

Brackenridge v Bendigo and Adelaide Bank Limited [2021] SASCA 129

Brackenridge v Bendigo and Adelaide Bank Limited was a case on appeal involving loans to a company, Apex Property Solutions Pty Ltd (Apex), guaranteed by the appellant, Mr Brackenridge, and secured by a mortgage over the property of Brackenridge, who was the sole director and shareholder of Apex. The purpose of the loans was to construct a home on the secured property, but the home was never completed and the defendant defaulted on the loans.

Brackenridge alleged among other claims that the loans in question were subject to the Code and that the lender did not comply with various provisions of the Code. The definition of a debtor in the Code includes a ‘prospective debtor’ and the appellant submitted that he may have been a prospective debtor as the person who was expected or likely to have to repay the loans; in other words, that he was the debtor as a matter of substance.

The Court held that the loans were not subject to the Code as Apex was the debtor and Brackenridge was not a debtor for Code purposes.

Integrated Securities No 3 Pty Ltd v Creatrix Web Development & Online Marketing Solutions Pty Ltd [2021] NSWSC 596

This case concerned multiple loans from a lender (Integrated) which did not hold an Australian credit licence and did not offer Code compliant loans. Integrated made the loans to a company (Creatrix). The purpose of the loans was for a proposed demolition and new construction of a duplex on a property owned by one of the defendants, Ms Pejkic. Creatrix had no interest in or involvement in the property or in building the duplex.

Integrated did not request any financial information from Creatrix and rather relied on the income of the sole director and shareholder of Creatrix, Mr Valerio, and a valuation of the property.

Pejkic and Valerio argued that they were seeking the loans for themselves and not for the business and that Integrated made the loans to Creatrix to avoid the Code.

The Court found that there was no obvious reason for Creatrix to be involved in the transaction other than as a means of avoiding the application of the Code.

The loan agreements specified that Creatrix was the borrower but provided that Pejkic and Valerio were not only guarantors, but also ‘debtors.’ The Court decided that the loans were subject to the Code because there was no reason not to regard Pejkic and Valerio as having undertaken a primary liability to repay the debt. The credit contracts entered into infringed the Code.

It also ruled that Integrated had engaged in unconscionable conduct. The introduction of a company as a borrower under circumstances where there was no existing business or venture of the business for which the loan was sought, and to avoid the operation of the Code, were factors which supported this finding.

The Judge in this case called on ASIC to consider taking steps to have the legislation amended to prevent such lending activity. He commented that “It is clear that Integrated and other lenders engaged in lending on onerous terms are very much aware of the loophole that seemingly permits them to escape the operations of the code by insisting on the introduction of a company as the borrowers even when there is no existing business or venture of the business for which the loan is sought.” The Judge directed the Registrar to send his judgment to ASIC.

Discussion and conclusion

Courts are reluctant to find a sham on the basis that a loan to a company was for all intents and purposes a loan to an individual, even when the parties had clear ulterior intentions for the purpose of the loan.

However, the Integrated Securities case has opened the possibility of a loan to a company being subject to the Code when individual guarantors of the loan are found to have primary liability as debtors under the credit contract.

Patrick Dwyer and Kathleen Harris

Legal Directors

Thanks to Danielle Hodgson for her assistance in preparing this article.