4. Reforming the law

Updates and background for this project (Digest)

• Introduction
• Policy objectives
• Inadequacies of the present law
• Ruling out some reform options
• How to achieve reform

INTRODUCTION

4.1 This chapter considers whether the law of New South Wales on third party guarantees is in need of reform and, if so, how this is achievable. It identifies:

• The policy objectives underlying this area of law;
• The extent to which the current law fails to achieve these objectives;
• Reform options that are incompatible with the realisation of these objectives; and
• The most effective means of achieving reform.

Protecting third party guarantors from unfairness

4.2 An important goal of credit law is to provide a necessary measure of protection for consumers. Implicit in this goal is acceptance of the fact that the parties to the transaction may not be on an equal footing and able to bargain with each other from a position of comparable strength. Financial institutions, for example, are generally in a much stronger bargaining position than their customers (particularly individuals as distinguished from institutional clients) due to the superior information and resources they possess.

4.3 When financial institutions offer their products and services, there is usually very little or no effective bargaining with customers about terms and conditions. Instead, they provide these products (such as loan facilities including supporting transactions like guarantees) on the basis of standard, non-negotiable contracts. It is common for guarantee contracts to be drafted by the financial institution and given on a take-it-or-leave-it basis or with little opportunity for the guarantor to bargain or alter the provisions. There is, therefore, a real risk that the terms and conditions of these contracts will be materially biased towards the financial institution.

4.4 There is also an imbalance as regards information. While banks possess vital information about a proposed transaction, for example, the credit standing of the borrower and (if applicable) the viability of the business for which a loan is sought, a guarantor may not. Hence, a guarantor may not be in a position properly to assess the risks of the transaction.

4.5 The disadvantaged position of guarantors, in relation to lenders, may be aggravated by their personal characteristics, such as age, sex, literacy, level of income, and ethnic background.¹ The guarantor’s relationship with the borrower and his or her motives for agreeing to the guarantee are also relevant.

Characteristics of guarantors in Australia

4.6 The empirical research study undertaken by the Commission and the University of Sydney (“Lovric and Millbank”) has revealed some of the characteristics of guarantors in Australia, as well as their motives for entering into such transactions.²

4.7 Family relationships. Close family members sign the vast majority of guarantees or joint loans: mostly female spouses, followed by parents of borrowers. Many of them are elderly. A large number of them are also from non-English speaking backgrounds. While many had obtained good education and were confident about their literacy, a substantial number found it difficult to understand the guarantee documents they signed.

4.8 Gender. About two-thirds of guarantors are women, who mostly guarantee loans for borrowers with whom they are in a close personal relationship, usually their husband. Some of the women were likely to be influenced in their decision-making by their economic dependence on their husband, particularly where they perform unpaid housework or their spouse has more highly paid work. An overwhelming majority of guarantors said that one of the reasons they signed the guarantee was because they trusted the borrower. Women place a high value on trust in their relationships, with many believing that their relationship with the borrower obliges them to help him obtain credit. Many of the female guarantors said they did not feel they had a choice about signing the guarantee documents. The absence of choice sometimes arose from the women’s strong sense of obligation, and fear that their relationship with the borrower would be irreparably damaged if they refused. At other times, it meant that they experienced pressure or duress to sign. A few even received threats of violence from the borrower.³

4.9 Age. Older people were disproportionately represented in the study. Sixty-five per cent of respondents were over the age of 50. More than one third (37%) were 60 years old and over. This highlights the other relationship that is prevalent in guarantees – parent and child. The statistics on litigated guarantor cases pointed to a high proportion of parents guaranteeing loans for their children (29%). Many parents who assisted their children with loans did so out of a sense of moral obligation, that they would do anything for their children or that it was the right thing to do for the family. There is potential for pressure to be brought to bear on elderly parents, especially by someone they trust. Older people are particularly liable to be asked to guarantee adult children’s debts because they are more likely to have a valuable asset that can be used as security for a loan: an unencumbered residential home.⁴

4.10 Language background. A substantial number of guarantors were born overseas and/or did not speak English as their first language. Around 40% of those who participated in the guarantor survey were born outside Australia (this is around double the proportion of overseas-born residents in the general Australian population) and, of those, 85% were from non-English speaking countries. Of those who indicated that English was their second language, the majority said their level of spoken and written English was weak or fair. The over-representation of people from non-English speaking backgrounds is reflected in litigated cases. Forty-two per cent of litigated guarantee cases involved guarantors from non-English speaking backgrounds.⁵ For some people from non-English speaking backgrounds, the concept of credit transactions, particularly those attracting interest charges, is an alien one.

4.11 Literacy. Twenty-seven per cent of guarantors in the study reported that they could not read or did not understand the documents they had signed. This is despite the fact that most guarantors had secondary education and a technical or university qualification, and were confident about their literacy. A generally good level of education and confidence about their literacy did not translate into a high degree of comprehension of legal documents.⁶

4.12 The empirical evidence demonstrates that the vast majority of guarantors belong to categories of people who are traditionally considered vulnerable: the elderly, women, migrants, members of minority groups and those who find it difficult to understand legal documents and transactions. Because of their personal relationship with the borrower, guarantors generally enter guarantees for emotional rather than financial reasons. This hampers their ability to make an objective assessment. All these factors further weaken their already unequal position in relation to financial institutions. There is, therefore, a need for the law to give special protection to guarantors to make sure they are treated fairly.

Promoting commercial certainty for lenders

4.13 The law must also consider the interests of lenders. Financial institutions are engaged in a commercial profit-based enterprise. When they offer credit facilities, they want to be certain the loan, including interest and other charges, will be repaid. The contract of guarantee is a device they use to minimise their risk by ensuring that, if the borrower is unable to pay the loan, someone else will. Any regulatory regime must take this into account. Moreover, the regime must give lenders confidence that, if they comply with it, the guarantee will be enforced and not be the subject of unnecessary and unpredictable litigation. It is only in these ways that finance for personal consumption and business purposes will remain reasonably accessible.

Accommodating the interests of guarantors and lenders

4.14 In the Commission’s view, it is obviously in the interests of guarantors, lenders and the efficiency of any regulatory regime, that such a regime is certain in its application; workable in practice; and does not unduly increase the cost of finance by transferring to borrowers unjustifiably high compliance costs. Further, striking the optimum balance between the need to protect guarantors from unfairness and the need to provide commercial certainty for lenders, requires a regime that is, in substance, aimed principally at preventing disputes from arising, rather than simply reacting to their occurrence. Additionally, the regime should be as comprehensive as necessary: it should cover consumer and small business loans; and it should cover the entire span of the transaction – the formation stage of the contract, its operation, right up to the time of its enforcement or termination.

INADEQUACIES OF THE PRESENT LAW

4.15 In the Commission’s view, the current law of New South Wales fails to achieve the policy objectives that we have identified. In particular:

• the numerous sources regulating contracts of guarantee create unnecessary complexity and inefficiency;
• the focus of regulation is reactive: it is not aimed at attempting to prescribe standards or conduct that will prevent problems from arising (a “preventive regime”);
• the primary focus of regulation on unjustness and unconscionability creates uncertainty in the law;
• the Consumer Credit (New South Wales) Code (“Consumer Credit Code”), the only preventive regime, does not apply to loans for small businesses; and
• the law fails to endorse industry standards that are certain and, presumably, cost effective.

4.16 Legal regulation of guarantees occurs at common law, in equity and by statute.⁷ The statutory regimes overlap with the general law.⁸ The doctrines developed at common law and in equity overlap,⁹ as do the equitable doctrines themselves.¹⁰ In short, the legal categories are not mutually exclusive,¹¹ and may be constantly shifting.¹² Moreover, the exact content and boundaries of each doctrine are often unclear, since, as the Expert Group on Family Financial Vulnerability put it, the doctrines are highly technical and complex.¹³ Thus, the law is often difficult to understand – not only for guarantors and financial institutions, but also for their lawyers.

4.17 Lovric and Millbank found that guarantors commonly plead from three to six different claims or defences.¹⁴ This means that litigation is “often a complex maze of claims and cross claims”.¹⁵ Obviously, this impacts adversely on the efficiency of litigation, suggesting the need for at least some consolidation of the sources dealing with the law of guarantees.

Reactive regulation

4.18 Lovric and Millbank found that the most common defences or cross claims used by guarantors who dispute a guarantee are the statutory ground of unjustness under the Contracts Review Act 1980 (NSW) and the equitable ground of unconscionability, including the “special wives’ equity” in Garcia.¹⁶ These areas of law deal mainly with providing a remedy after the event. They do not prescribe standards that aim to prevent problems and disputes relating to guarantees from arising in the first place. The decision of the House of Lords in Royal Bank of Scotland plc v Etridge (No 2)¹⁷ shows that it is possible for the general law to develop in this direction. However, it is unlikely that the common law of Australia will follow such a course.¹⁸

4.19 It is no doubt true that important court decisions, such as Amadio,¹⁹ Yerkey v Jones,²⁰ and Garcia,²¹ as well as the provisions of the Contracts Review Act 1980 (NSW), have influenced legislation and industry practice to adopt measures which promote procedural fairness when financial institutions enter into contracts with guarantors, for example, by providing pre-contractual information that may assist the guarantor in deciding whether or not to agree to the contract.²² This effect is, however, indirect. The law on unfair or unconscionable contracts does not, and is not intended to, provide comprehensive regulation of guarantees. Moreover, its usefulness is limited to guarantors who have the resources to litigate.

Uncertainty

4.20 The statutory ground of unjustness under the Contracts Review Act 1980 (NSW) and the general law doctrines relevant to the protection of guarantors are, necessarily, very much concerned with the facts and circumstances of each individual case. Writing extra-curially of the list of factors that courts are directed to take into account when deciding whether or not a contract is unjust under the Contracts Review Act, Justice Michael McHugh has pointed out that:

[t]he difficulties in applying such vague criteria mean that parties to contracts have difficulty in knowing what their rights are. Litigation is forced upon them. When courts have to apply vague standards, consistency of decision-making – which is one of the primary benefits of the rule of law – is difficult to achieve. Moreover, the decision of a court applying such vague criteria often seems arbitrary. Dissatisfaction with the decision maker in particular cases is often the result. In time, confidence in the judicial system is undermined.²³

4.22 A comprehensive regulatory regime focusing on specific preventive strategies is required. This is not to say that the broad general law and statutory principles dealing with unjustness and unconscionability should be abandoned. Their proper place is, however, to deal with the circumstances of individual cases that may fall outside the comprehensive regulatory regime, but that nevertheless indicate unjustness or unconscionability in the circumstances. It is appropriate, therefore, that the broader doctrines of general and statutory law should remain in the background to apply, where necessary, in the circumstances of individual cases.

Inapplicability of preventive regulation to business loans

4.23 The Consumer Credit Code provides a comprehensive regime to regulate the provision of credit wholly or predominately for personal, domestic or household purposes. It does not cover credit contracts and related guarantees that are undertaken for business purposes.²⁵ Yet Lovric and Millbank found that the vast majority of third party guarantees are undertaken to support small business borrowing, primarily by family businesses.²⁶ They found that 94% of litigated cases involving guarantees related to business loans. Ninety eight percent of solicitors and 70% of barristers who participated in the study reported that the last guarantee matter they handled had involved a business loan. About half of the guarantors who participated in the study said they guaranteed small business loans.²⁷ Hence, a very significant number of guarantees relate to small business loans, which fall outside the regulatory framework of the Consumer Credit Code.

4.24 The policy behind regulating transactions that relate to personal consumption more strictly than those involving business seems to be based on the premise that people engaged in business are in a better bargaining position when dealing with financial institutions than individual consumers. The empirical evidence does not support this assumption as far as guarantors are concerned.

4.25 Lovric and Millbank found that a vast majority of guarantors, regardless of whether they guaranteed personal or business loans, belong to vulnerable groups of people whose personal relationship with the borrower and their emotional motives for agreeing to the guarantee prevent them from making an objective assessment of the transaction. In particular, about half of those who guaranteed business loans described themselves as having no role in the business for which the loan was secured. A further 20% said they were “silent” directors, that is, they were nominal directors with no real power or involvement in the business. They were, therefore, unlikely to have possessed information about the business that would have been necessary to assess the risks properly. Even if they had such information, many would have found it difficult to refuse to sign the guarantee in light of their relationship with the borrower. Consequently, Lovric and Millbank concluded:

The presumption that people entering into guarantees for businesses are more sophisticated, more empowered or on a more equal bargaining footing than those guaranteeing personal loans was not borne out in our research.²⁸

Failure to endorse industry standards

4.27 The Code of Banking Practice (“Banking Code”), which is partly based on the provisions of the Consumer Credit Code, regulates, in a preventive manner, various stages in the life of a guarantee. Since 2003, its provisions extend to small business loans.²⁹ The general law and statutes lag behind this industry standard in recognising the desirability of a preventive regulatory regime that extends to small business loans. From a banker’s point of view, the substance of the Banking Code obviously represents an acceptable accommodation of the interests of guarantors. From a guarantor’s point of view, the Commission has received no information that the application of the Banking Code has resulted in the prohibitive cost of finance.

4.28 Unfortunately, it is not only the general law and statutes that fail to live up to the standards prescribed in the Banking Code. So too does most of the finance industry. The Banking Code is of limited force: not all banks have subscribed to the 2003 or 2004 version, and there is no other Code of Practice that is so comprehensive in its coverage. Indeed, most of the finance industry operates without codes of practice. The proliferation of non-bank lenders in recent years, and particularly those involved in low document loan transactions, means that most lenders in the finance industry fall outside the protections that codes of practice can offer to guarantors.

RULING OUT SOME REFORM OPTIONS

4.29 It is implicit in what we regard as the policy objectives underlying this area of the law that the Commission rejects a number of reform options, namely:

• the prohibition of third party guarantees;
• the imposition of restrictions on the use of the family home as security for loans; and
• leaving reform solely to industry self-regulation.

4.30 In the past, some legal systems have prohibited personal guarantees, at least in certain circumstances.³⁰ In the early 1990s, the National Consumer Affairs Advisory Council and the Australian Financial Counselling and Credit Reform Association recommended that all guarantees be prohibited.³¹

4.31 The Commission raised this matter in Issues Paper 17 to test current community attitudes.³²

Views in submissions

4.32 Most submissions oppose a ban on the use of guarantees.³³ These are the reasons that were given:

• It would prevent people from giving financial assistance to their family members.³⁴
• Without third party guarantees, lenders might address the risk of borrowers’ default by raising interest rates.³⁵ In other words, lenders may increase the cost of finance.³⁶
• It would restrict borrowing³⁷ and, in particular, hinder the ability of small businesses to obtain finance.³⁸ This may create social harms. A tightening of financial opportunities may prevent social mobility for some people.³⁹

The Commission’s view

4.34 The Commission agrees with those who oppose a ban on the use of guarantees. Such a ban is likely to force lenders to find other ways to minimise and deal with loan defaults. Lenders may, for example, use co-borrower arrangements where a third person (who would otherwise have been the third party guarantor) becomes a co-borrower with the main borrower. Alternatively, lenders might use contracts of indemnity more frequently. Co-borrower and indemnity contracts are more onerous because, unlike a guarantee where the guarantor is only secondarily liable, a person who becomes party to a co-borrower or indemnity agreement is primarily liable, even when he or she gains no benefit from the loan.⁴¹

4.35 If guarantees were prohibited, lenders might also impose higher interest rates and/or use more stringent credit standards. An increase in interest rates and charges would place greater financial pressure on the borrower’s business, due to higher repayment obligations – assuming, of course, that the borrower is able to obtain the loan. Lenders may make it more difficult for some borrowers to obtain credit by imposing more stringent credit criteria. Borrowers who have no collateral and first time borrowers seeking to establish new businesses but who have no credit history may find it harder to get approval.

4.36 A ban on the use of guarantees may, therefore, limit access to finance and prevent potentially worthwhile businesses from taking off or developing. It would be an unnecessarily severe reaction to the problems associated with guarantees. Instead of prohibiting the use of guarantees, the focus should be on formulating an effective, consistent and comprehensive regulatory regime, which addresses the problems identified in this Report and in the Lovric and Millbank study.

Restricting the use of the family home

4.37 Using the equity in the family home is a common way of raising capital to start up or expand a business.⁴² It is common for loans to be secured by a guarantee and mortgage over the family home. If the lender seeks to enforce the guarantee and the guarantor does not have the money to pay the debtor’s debt, the guarantor risks losing his or her family home. Concerns have been raised in Australia about the use of the family home in this manner.⁴³ One possible reform option is to prohibit or limit the use of the family home as security for finance.

4.38 In some overseas jurisdictions, “homestead laws” impose limits on the extent to which residential property can be used as security for loans.⁴⁴ In essence, these laws exempt all or part of the home of the borrower from being used to satisfy claims by lenders. Their main purpose is to promote and preserve home ownership by protecting the family home from lenders’ claims.

4.39 Should the family home continue to be used as security for business loans or should its use be limited?

Views in submissions

4.40 Most submissions opposed the restriction on the use of the family home as a loan security for the following reasons:

• Such a restriction would be too limiting for business and investment.⁴⁵
• The use of the family home as security is often the only way that some people can commence business and be financially successful.⁴⁶ Preventing the use of the family home as security would unnecessarily restrict economic and social opportunities for some people, particularly those who are relatively disadvantaged.⁴⁷
• Many small businesses are undercapitalised and, because the family home represents many people’s major capital investment, the only option available to many small businesses would be to sell the family home and use the proceeds to provide the necessary capital.⁴⁸
• Countless small businesses would either pay higher interest or not receive credit at all if they could not use the family home as security.⁴⁹
• In some cases, the family home has been funded as the result of small business activities.⁵⁰

4.41 The Commission agrees with these submissions. The family home is the main and, quite often, the only asset available for borrowers and their guarantors to secure finance. A ban or restriction on the use of the family home as security may severely limit access to finance. This may, in turn, result in decreased business investments. There is also evidence in the United States showing that homestead exemption laws increase the cost of credit, particularly for the poor.⁵¹ The Commission favours the present position that allows people (especially those who do not have ready access to funds) to use their homes to achieve financial security.

Leaving regulation solely to the financial industry

4.42 History and comparative law demonstrate a clear need for the statutory regulation of contracts of guarantee. A possible alternative is self-regulation, where relevant sections of the financial industry create, monitor and enforce rules against their own members. For example, banks and credit unions could incorporate the reforms proposed in this Report into their existing codes of practice. Other financial institutions could adopt their own codes with the appropriate rules on guarantees. Alternatively, all financial institutions might get together and adopt a uniform code of practice.

Views in submissions

4.43 The majority of submissions to this reference did not favour reliance on self-regulation alone.⁵² These are some of the reasons given:

• Given the variety of legislation, common law doctrines, and industry codes that impact upon third party guarantees, a single piece of legislation would simplify regulation. Industry codes of practice may still have a significant role, but they have to be consistent with the legislation.⁵³
• Legislation would ensure comprehensive and consistent regulation of the financial industry. It avoids the problem of inconsistency between the various industry codes of practice. It also ensures the regulation of those who are not covered by, or prepared to accede to, such codes.⁵⁴
• Public regulation avoids perceptions of bias and lack of objectivity that arise in relation to the self-regulatory schemes.⁵⁵
• Self-regulation is inappropriate in an industry that provides a service to vulnerable groups and where inadequate regulation may have serious consequences for guarantors.⁵⁶
• There are doubts about the financial industry’s capacity and willingness to develop successfully the appropriate rules in a controversial and contentious area such as guarantees.⁵⁷

4..44 The Commission is swayed by the lessons of history and the majority of submissions. Industry codes of practice, while commendable, have inherent limitations over legislation. They obviously depend on industry members individually agreeing to be bound by the codes’ conditions. Even where the law makes it mandatory for lenders to adopt a code of practice and there are several codes available, some might opt for the one that is least onerous to them and least beneficial to their clients. Fringe operators may emerge who are unprepared to adopt a relevant code, and who use that opportunity to acquire a share of the market that is attractive to the most vulnerable borrowers and guarantors.

4.45 Further, enforcement of industry codes of practice is problematic. Self-monitoring and the sanctions that the industry associations are able to impose on their members could prove, or at least be perceived to be, inadequate. Legislation, on the other hand, is able to ensure better enforcement mechanisms. It can provide a central agency to monitor the implementation of its provisions and to which consumers can go for complaints. It can also deliver a more comprehensive range of sanctions, including administrative, civil and criminal penalties.

4.46 Finally, self-regulatory regimes find it difficult to avoid perceptions of bias. People may not trust self-regulatory bodies to apply rules in the interests of consumers and the general public. Further, as indicated in submissions, the public demands government responsibility in this area of finance because it involves vulnerable consumers.

4.47 The Commission does, however, support industry regulation in this area of the law as a supplement to, and check on, current legislative standards. Industry codes can strengthen and advance government regulation. They can be useful in influencing the behaviour of lenders. Codes that reflect requirements in the legislation will reinforce to industry members the need to comply with the law. They may also communicate better the legislative requirements by using language that is more meaningful to industry members. Further, they may, like the Banking Code, expand and improve the standards set by legislation.⁵⁸ Finally, they are useful in providing industry-based mechanisms for resolving complaints to supplement the dispute resolution measures provided by law.⁵⁹

HOW TO ACHIEVE REFORM

4.48 The Consumer Credit Code is the sole legislative instrument in New South Wales that contains specific provisions expressly regulating guarantees.⁶⁰ These provisions only protect guarantors of consumer loans.⁶¹ Notwithstanding their limited operation, they largely give effect to the policy objectives that the Commission has identified as underlying this area of law. Moreover, their provisions are substantially reflected in the Banking Code, which applies more widely to guarantors of small business loans.

4.49 For these reasons, the Commission has taken the provisions of the Consumer Credit Code as the starting point for a comprehensive regulatory regime dealing with guarantees. At base, we would regard such a regime as at least extending the provisions of the Consumer Credit Code to business loans. We have, however, gone further and analysed each of the relevant provisions in the Consumer Credit Code to determine its adequacy in light of the submissions, the findings of the Lovric and Millbank study and other recent developments, including the 2003 and 2004 iterations of the Banking Code. We have also identified areas not covered in the Consumer Credit Code in respect of which we think it is appropriate to make recommendations.

4.50 At least potentially, therefore, our recommendations duplicate, overlap, revise, extend or differ from various provisions of the Consumer Credit Code. This makes it essential to consider the relationship between our recommendations and the Consumer Credit Code, in particular how our recommendations should be implemented in the light of the existence of the Consumer Credit Code. Consideration of this issue reveals that the most obvious course of recommending the embodiment of our proposed regulatory regime in a single consolidating legislative instrument of the New South Wales Parliament is not free from difficulty. The Uniform Consumer Credit Laws Agreement 1993, the executive agreement that underpins the uniform credit legislation, provides that a State or Territory cannot:⁶²

• introduce any amending legislation to the Consumer Credit Code unless approved by at least two thirds of the members of the Ministerial Council for Uniform Credit Laws (“MCUCL”);⁶³ nor
• submit legislation to its Parliament which will conflict with or negate the operation of the Consumer Credit Code.⁶⁴

• amendment of the Consumer Credit Code;
• enactment of legislation to exist alongside the Consumer Credit Code; or
• enactment of legislation as part of a uniform law initiative with other Australian jurisdictions.

4.52 An obvious way to implement the Commission’s recommendations is, seemingly, to amend the Consumer Credit Code. This is not, however, a simple matter. There are procedural and substantive hurdles to overcome.

Procedural requirements

4.53 As pointed out above, any amending legislation to the Consumer Credit Code must be approved by at least two thirds of the members of the MCUCL.⁶⁵ The MCUCL consists of the Commonwealth, State, and Territory Ministers responsible for fair trading, consumer protection laws and credit laws. It receives reports from the Standing Committee of Officials of Consumer Affairs (“SCOCA”), which in turn receives reports from the Uniform Consumer Credit Code Management Committee. This Committee monitors all activities relating to the Consumer Credit Code to ensure consistency in its implementation across jurisdictions. It examines proposed amendments to the Consumer Credit Code before they are presented to the SCOCA and MCUCL. Hence, the amendment of the Consumer Credit Code to implement the recommendations in this Report would entail a complex process that needs the approval of other States and Territories.

Extending the scope of the Consumer Credit Code

4.54 Substantially, and more significantly, the extension of the protections of the Consumer Credit Code to small business loans needs to be compatible with the objectives of the Consumer Credit Code. The main aim of the Consumer Credit Code is to regulate consumer credit contracts, which the Consumer Credit Code defines as those provided by credit providers “for personal, domestic or household purposes”.⁶⁶ Examples of credit contracts that may be covered by this definition include personal loans, housing loans, bank term loans, overdraft facilities, and credit card facilities. The Consumer Credit Code contains a broad range of requirements in relation to consumer credit contracts, such as: the form of the contract, pre-contractual disclosure, matters that must be in the contract, interest charges, other fees and charges, the debtor’s monetary obligations, and the credit provider’s obligation to account.

4.55 To regulate all aspects of credit contracts within its ambit, the Consumer Credit Code also has provisions, particularly in Part 3 Division 2, on mortgages and guarantees that relate to such contracts. Leaving aside other recommendations in this Report, the implementation of our recommendation that any legislative regulation of contracts of guarantee should cover small business guarantees⁶⁷ would require that the definition in the Consumer Credit Code of “credit contract” be amended, at least as it applies to Part 3 Division 2 and any other provisions on guarantees. It may be argued that it would be odd to have one definition of “credit contract” for purposes of the general provisions of the Consumer Credit Code, and yet another that applies only to its provisions on guarantees. On the other hand, the regulation of guarantees could be seen as ancillary to the central function of Consumer Credit Code of regulating consumer credit contracts. Moreover, it could be argued that the definition of “consumer” should be broadened for the general purposes of the Consumer Credit Code in the light of the trend in traditional consumer protection statutes towards extending protection to small businesses.⁶⁸

4.56 These issues are beyond the Commission’s terms of reference. We express no opinion on them. It took many years to reach agreement on the uniform consumer credit legislation and the specialist expertise that has evolved in its development and administration means that the Standing Committee of Officials of Consumer Affairs is the appropriate body to initiate and consider any proposed amendment to the Consumer Credit Code.

Enacting a NSW statute to exist alongside the Consumer Credit Code

4.57 A New South Wales statute could seek either to regulate guarantees generally or only to regulate guarantees that specifically relate to small business lending.

4.58 In the Commission’s view, the enactment of a statute relating to guarantees generally would breach NSW’s obligations under the Intergovernmental Agreement of 1993, in particular cl 13(1) of the Uniform Consumer Credit Laws Agreement 1993. At least to the extent that the statute’s provisions are more favourable to guarantors than those found in the Consumer Credit Code, the statute would “negate” (in the sense of render ineffective) the operation of the Consumer Credit Code, since guarantors would obviously rely on the provisions of the legislation most beneficial to them. There is little doubt that such legislation would also breach the spirit of the Agreement.

4.59 This leaves the possibility of enacting legislation that deals only with guarantees of small business loans. Such legislation would neither conflict with nor negate the Consumer Credit Code. It would, however, put a premium on the distinction between “small business” and other loans. More importantly, it would, in the Commission’s view, be highly undesirable because it would add a further layer of regulation in an area already subject to various sources of law and practice, thereby increasing the complexity of the overall regulatory regime, with implications for the cost of finance and the efficiency of dispute resolution. In particular, as the recommendations in this Report do not accord in all respects with the provisions of the Consumer Credit Code, a stand-alone statute on small business guarantees would result in two different sets of rules, one for small business guarantees and another for consumer guarantees. Guarantors of business loans would then have greater protection than guarantors of consumer loans, and the creation of two sets of rules located in separate statutes would detract from the aim of simplifying regulation. Further, the costs of complying with two separate regulatory regimes, substantially passed on from finance providers to borrowers, would result in an overall increase in the cost of finance in New South Wales, and probably in Australia.⁶⁹ More generally, to enact legislation in New South Wales dealing specifically with small business lending would be to ignore the need for uniformity in credit law in Australia.

Pursuing a uniform law initiative

4.60 In response to the Lovric and Millbank study, the Australian Bankers’ Association noted that:

Banks and other credit providers operate on a national basis. The Uniformity Agreement between the States and Territories that underpins the uniform Consumer Credit Code reflects the legitimate needs of industry and consumers for national uniformity on matters of credit policy and law. Such an approach enhances the efficiency of the financial system and certainty for consumers and industry alike.⁷⁰

4.62 In making this recommendation, we stress one matter and raise one other:

• First, we expressly leave open the relationship between the Model Law and the Consumer Credit Code. In all respects that relationship needs careful study, analysis and definition so as not to compromise the uniformity already achieved in credit law in Australia.
• Secondly, we draw attention to the fact that our terms of reference are restricted to contracts that guarantee the loans of another.⁷¹ It will be necessary to investigate further whether or not the Model Law should be restricted to such contracts. An alternative is a Model Law that is broader and incorporates, for example, all aspects of indemnities and performance bonds.⁷²

New South Wales should initiate discussions with other Australian jurisdictions to develop and enact a uniform law (the “Model Law”) relating to contracts guaranteeing another’s debt. The Model Law should implement the recommendations in this Report.

4.63 The achievement of a uniform law is likely to be a lengthy and complicated process. Pending the completion of such a process, some of the recommendations in this Report are capable of being adopted into applicable finance industry codes. For example, the recommendations dealing with entry into a guarantee would be amenable to inclusion in codes of practice, whereas the recommendations dealing with unjust contracts are not. Ideally, all relevant members of the finance industry could adopt the provisions to ensure uniform coverage across the finance industry.

4.64 Notwithstanding the problems inherent in sole reliance upon industry self-regulation, there are many positive outcomes to be achieved through industry codes of practice.⁷³ The Commission further considers that the adoption of our proposals by all, or even some, relevant sectors of the finance industry will help make legislative implementation easier. This is because financial institutions will already be complying with our proposals and their experience will influence the final form of the legislation. This would follow in the steps of the Banking Code, which has been in the vanguard of developing protections for guarantors over the past decade. Optimal regulation, often achievable only through the use of a variety of actors and techniques, would, we believe, be the result.⁷⁴

RECOMMENDATION 4.2

Sectors of the finance industry that use guarantees should adopt codes of practice that are consistent with applicable recommendations in this Report.

4.65 The Model Law should apply against the background of the general doctrines of the common law and of more generally applicable statutory norms. This will ensure the availability of a body of law to cover the circumstances of individual cases that fall outside the Model Law’s preventive regime.⁷⁵ The Commission does not propose that the Model Law be a Code.

RECOMMENDATION 4.3

The Model Law should not derogate from rights and remedies that exist apart from the Model Law.

1. Some studies have identified women, older people and those who belong to minority groups as disadvantaged when negotiating transactions: see, for example, I Ayres, “Fair Driving: Gender and Race Discrimination in Retail Car Negotiations” (1991) 104 Harvard Law Review 817; I Ayres, “Further Evidence of Discrimination in New Car Negotiations and Estimates of its Cause” (1994) 94 Michigan Law Review 112; H Douglas, “Mixed-Gender Negotiation: Does Gender Need to Matter?” (1997) 8 Australian Dispute Resolution Journal 295; R Smith, “Fraud and Financial Abuse of Older Persons” (2000) 11 Current Issues in Criminal Justice 273; C Lowe, “Why it still cost more to be a woman…” (2001) 87 Consuming Interest 13.

2. J Lovric and J Millbank, Darling, please sign this form: a report on the practice of third party guarantees in New South Wales (NSW Law Reform Commission, Research Report 11, 2003) ch 3.

3. Lovric and Millbank at para 3.6, 3.38, 3.42, 3.43, 3.51, 3.52.

4. Lovric and Millbank at para 3.9-3.12.

5. Lovric and Millbank at para 3.14-3.17.

6. Lovric and Millbank at para 3.21, 3.24.

7. See Chapter 2.

8. See para 2.19-2.20. See also D Harland, “Unconscionable and Unfair Contracts: An Australian Perspective” in R Brownswood, N Hird and G Howells, Good Faith in Contract: Concept and Content (Ashgate Publishing, Aldershot UK 1999) 241 at 257-62.

9. For example, duress and undue influence (see NSW Law Reform Commission, Guaranteeing Someone Else’s Debt (Issues Paper 17, 2000) at para 2.37); unconscionability and misrepresentation (see Commercial Bank of Australia v Amadio (1983) 151 CLR 447 (comparing the decision of Gibbs CJ with those of the other members of the court)); unconscionability and common law duress: consider Australian Competition and Consumer Commission v C G Barbitis Holdings Pty Ltd (2003) 214 CLR 51 at para 45.

10. For example, unconscionability and undue influence: see para 2.5-2.11.

11. Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447 at 461 (equitable doctrines as species of unconscionable conduct).

12. See Australian Competition and Consumer Commission v CG Berbatis Holdings Pty Ltd (No 2) (2000) 96 FCR 491 at 501-502 (French J); on appeal Australian Competition and Consumer Commission v C G Berbatis Holdings Pty Ltd (2003) 214 CLR 51 at para 44-45 (Gummow and Hayne JJ).

13. Report of the Expert Group on Family Financial Vulnerability, Good Relations, High Risks: Financial Transactions Within Families and Between Friends (1996) at 36-37. Consider also C Rickett, “Unconscionability and Commercial Law” (2005) 24 The University of Queensland Law Journal 73 (discussing the varying content of unconscionability).

14. Lovric and Millbank at para 7.10.

15. Lovric and Millbank at para 7.9.

16. Lovric and Millbank at para 7.10.

17. [2002] 2 AC 773 at para 50-80 (Lord Nicholls, indicating the steps that a bank must follow once it is put on inquiry).

18. See R P Meagher, J D Heydon and M J Leeming, Meagher, Gummow and Lehane’s Equity Doctrine and Remedies (4th ed, Butterworths, Chatswood, NSW, 2002) para 15-150 (describing the “judicial legislation” in the Etridge case as “deeply flawed”).

19. Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447.

20. (1939) 63 CLR 649.

21. Garcia v National Australia Bank (1998) 194 CLR 395.

22. See, for example, Code of Banking Practice (2004) cl 28.4(d), responding to the general law rule that the creditor has no general duty of disclosure to prospective guarantors: see para 2.44.

23. M McHugh, “The Growth of Legislation and Litigation” (1995) 69 The Australian Law Journal 37 at 43.

24. See para 4.8-4.9.

25. Consumer Credit (New South Wales) Code and Regulations 1995 (NSW) s 6, and note the presumptions in s 11. See Permanent Mortgages Pty Ltd v Cook [2006] NSWSC 1104.

26. Lovric and Millbank at xiii.

27. Lovric and Millbank at para 2.19.

28. Lovric and Millbank at para 2.17-2.18.

29. See para 2.42-2.45.

30. See para 3.2-3.10.

31. See Australia, Trade Practices Commission, Guarantors: Problems and Perspectives (Discussion Paper, 1992) at 19-20; E Clark, Young People and Consumer Credit: Summary (National Clearinghouse for Youth Studies, Hobart, 1991) at 4. For a similar suggestion in the context of American law, see R Hasson, “Darkness at Noon: A Comment on the Consumer Guarantee Law in Ontario” (1995) 11 Banking and Finance Law Review 141 at 149-150.

32. NSWLRC IP 17 at 107 Question 33.

33. St George Bank, Submission at 5; Australian Finance Conference, Submission at 22; Women Lawyers’ Association of NSW, Submission at 10; Commonwealth Bank, Submission at 14; NSW Legal Aid Commission, Submission at 19; NSW Young Lawyers, Submission at 11; University of Western Sydney, Centre for Elder Law, Submission at 33; Australian Credit Forum, Submission at 3.

34. Commonwealth Bank, Submission at 14.

35. NSW Department of Fair Trading, Submission at 3.

36. Commonwealth Bank, Submission at 14.

37. St George Bank, Submission at 5.

38. Commonwealth Bank, Submission at 14; University of Western Sydney, Centre for Elder Law, Submission at 33; Country Women’s Association, Submission at 3.

39. NSW Legal Aid Commission, Submission at 20.

40. Women’s Legal Resources Centre, Submission at 12.

41. Australia, Trade Practice Commission, Guarantors: Problems and Perspectives (Discussion Paper, March 1992) at 19.

42. Lovric and Millbank at para 2.27.

43. See Australia, House of Representatives Standing Committee on Finance and Public Administration, A Pocket Full of Change: Banking and Deregulation (AGPS, Canberra, 1991) at 414.

44. See para 3.28-3.48.

45. St George Bank, Submission at 5; Australian Credit Forum, Submission at 3.

46. Country Women’s Association of NSW, Submission at 3.

47. NSW Legal Aid Commission, Submission at 19.

48. Commonwealth Bank, Submission at 13-14.

49. NSW Department of Fair Trading, Submission at 7.

50. Australian Finance Conference, Submission at 21.

51. R Gropp, J K Scholz and J White, “Personal Bankruptcy and Credit Supply and Demand” (1997) 112 Quarterly Journal of Economics 217.

52. NSW Legal Aid Commission, Submission at 6, 17; NSW Department of Fair Trading, Submission at 3; St George Bank, Submission at 2, 4; Australian Finance Conference, Submission at 10, 11, 18; Women Lawyers Association of NSW, Submission at 3, 8; Women’s Legal Resources Centre, Submission at 4; Ryde-Eastwood Financial Counselling Service, Submission at 6; J L Goldring, Submission at 2; NSW Young Lawyers, Submission at 2; Financial Counsellors’ Association of NSW, Submission at 2.

53. St George Bank, Submission at 2 and 3; Australian Finance Conference, Submission at 18.

54. Australian Finance Conference, Submission at 18; NSW Legal Aid Commission, Submission at 5; Women’s Legal Resources Centre, Submission at 4 and 5; St George Bank, Submission at 4; NSW Young Lawyers, Submission at 7.

55. Financial Counsellors’ Association of NSW, Submission at 4.

56. NSW Department of Fair Trading, Submission at 3.

57. NSW Legal Aid Commission, Submission at 5-6.

58. See para 2.42-2.44.

59. For example, banks have established a Banking and Financial Services Ombudsman. See also para 12.34-12.40.

60. For a summary, see para 2.35.

61. See para 4.23.

62. The text of the agreement is at <http://www.creditcode.gov.au/display.asp?file=/content/original_credit_code.htm> (at 1 September 2006).

63. Australian Uniform Credit Laws Agreement 1993 cl 10.

64. Australian Uniform Credit Laws Agreement 1993 cl 13.

65. Australian Uniform Credit Laws Agreement 1993 cl 10.

66. Consumer Credit (New South Wales) Code s 6(1)(b).

67. See Recommendation 5.3.

68. For example, Trade Practices Act 1974 (Cth) s 51AC. See also para 5.11-5.16.

69. Australian Bankers’ Association, Submission at 2 (noting the substantial costs involved in compliance programs to meet the requirements of the 2003 version of the Banking Code).

70. Australian Bankers’ Association, Submission at 2.

71. See also Recommendation 5.1.

72. See generally G Andrews and R Millett, Law of Guarantees (4th ed, Sweet & Maxwell, London, 2005) at para 1-004-1-006, 1-012 – 1-015.

73. See para 4.47.

74. A realisation that, amongst other matters, has promoted a “decentred” approach to the study of regulation: see especially J Black, “Decentring Regulation: Understanding the Role of Regulation and Self-Regulation in a ‘Post-Regulatory’ World” (2001) 54 Current Legal Problems 103; J Black, Mapping the Contours of Contemporary Financial Services Regulation (Economic and Social Research Council Centre for Analysis of Risk and Regulation, Discussion Paper 17, October 2003); I Ramsay, “Consumer Law, Regulatory Capitalism and the ‘New Learning’ in Regulation” (2006) 28 Sydney Law Review 9.

75. See para 4.22.