The elephant in the court room

On 4 September 2018, ASIC announced that it had agreed with Westpac to settle its court action against Westpac for alleged breaches of responsible lending obligations.

The proposed settlement included a record civil penalty of $35 million to be paid by Westpac.

ASIC and Westpac then asked the court to award this penalty. They prepared and filed a detailed joint submission called a Statement of Agreed Facts.

But last week the judge hearing the case, Justice Perram of the Federal Court, refused to award the penalty that the parties had agreed.

Chalk and cheese

ASIC commenced its action in March 2017. The case involves more than 260,000 home loans written by Westpac between December 2011 and March 2015.  A key plank of ASIC’s action is the claim that Westpac breached its responsible lending obligations in relation to these loans by using a benchmark figure (the HEM Benchmark) and not taking into account the consumer’s declared expenses when assessing whether the loan would be unsuitable for the consumer.

The responsible lending obligations require a credit provider to make reasonable inquiries about the consumer’s requirements and objectives and financial situation, and then to take reasonable steps to verify the consumer’s financial situation. The credit provider must then assess if the loan would be unsuitable for the consumer. The loan will be unsuitable if, at the time of assessment, it is likely that either the consumer will be unable to comply with their financial obligations under the contract (or only comply with substantial hardship) or the contract will not meet the consumer’s requirements and objectives.

ASIC argues that the responsible lending obligations require that the assessment take into account the applicant’s declared living expenses.

Obviously, Westpac didn’t think so at the time. The Statement of Agreed Facts says that Westpac’s policies and procedures were approved and authorised by its senior management, and that they believed those policies and procedures were sufficient.

Justice Perram described the differing views of ASIC and Westpac as “chalk and cheese.”

Where’s the breach?

As it turned out, for most of the Westpac home loans, the HEM Benchmark was actually higher than the consumer’s declared expenses, which means that Westpac was using possibly a more prudent test of capacity to repay than if declared expenses were used. And for most of the other home loans where declared expenses were higher than the HEM Benchmark, the use of declared expenses would have had no impact on the serviceability calculation.

Only a tiny portion of the loans in the case (5,041 - about 2%) had declared expenses above the benchmark where this would have led to a different result if declared expenses were used – namely, a manual assessment. But as Justice Perram said in his judgment:

What would have happened after that manual assessment the parties have not told me. Nor have they told me whether any of these 5,041 loans were, or were not, unsuitable for the borrowers. This also undermines the ability of the Court to assess the reasonableness of the agreed penalty. Were the contraventions technical and harmless because the loans were suitable? Or, has significant harm been done to some or all of the 5,041 borrowers by the making of unsuitable loans? How can the Court expected to assess the reasonableness of the proposed penalty if it be left in the dark about what the actual problem is? The Statement of Agreed Facts discloses that of these 5,041 home loans, 21 were in hardship (0.42%) and 19 were 90 days plus in arrears (0.38%). It’s not disclosed if these rates are higher than the average, but overall, loans that were conditionally approved by the automated decision system (which used the HEM Benchmark) had a lower rate of hardship applications than manually approved home loans during the same period, and a similar rate of 60 plus days delinquency.

The rate of hardship applications and delinquency surely has some bearing on whether a loan might be unsuitable – although it must ultimately depend on the facts of each loan. If the other 99% of the 5,041 loans were all performing, why would they be “unsuitable”?

The elephant in the court room

The judge was also concerned that the Statement of Agreed Facts did not explain why Westpac used the HEM Benchmark rather than declared living expenses. Not knowing this makes it very difficult to assesses how serious the conduct is and hence how appropriate a civil penalty of $35 million might be … the Court should not be expected to approve a (record) penalty without being told why the HEM Benchmark was used by the Respondent in preference to declared living expenses. That missing fact is, with respect, the elephant in the court room. A simple explanation would be that Westpac used the HEM Benchmark because it believed that this practice was both lawful and prudent.

After all, the Explanatory Memorandum for the responsible lending legislation says: Credit providers are not expected to take action going beyond prudent business practice in verifying the information they receive …  Prudent lenders and credit brokers/advisers would ordinarily make inquiries along similar lines as of their normal business operations, in order to assess the customers’ capacity to repay. Clearly the original intent of the legislation was not to create a new artificial standard of inquiry or evaluation above what a prudent lender would ordinarily do when conducting a credit assessment.

Implications for responsible lending

The decision by the judge not to approve the orders sought by ASIC and Westpac does not give a green light to using benchmark amounts for expenses when a responsible lending assessment is being made: Westpac has accepted that it should have had regard to declared expenses when they were higher than the HEM Benchmark. Rather, the judge is asking the parties to explain why the use of a benchmark was a breach of the responsible lending obligations, and why Westpac chose to use that method.

Many lenders would welcome some guidance from the Court on the use of benchmarks and responsible lending.

Patrick Dwyer and Kathleen Harris

Legal Directors