4.2 The Commission has been awarded a research grant with the University of Sydney’s Faculty of Law as part of the Australian Research Council’s Strategic Partnership with Industry for Research and Training (SPIRT) scheme.¹ The grant will be used to support a detailed empirical study that will include surveying lenders, solicitors, borrowers and guarantors, as well as observing relevant court and tribunal hearings.

4.3 The Commission is interested in hearing from members of the public as well as from relevant organisations (including legal, social welfare and finance industry groups) about their experiences with the use of third party guarantees. Submissions are sought on any of the matters raised by the terms of reference (these are set out at page vi of this Issues Paper). This chapter lists a number of issues that have been raised in the preceding chapters in addition to those matters upon which the Commission is seeking further information. This list can be used by those interested in participating in this reference to guide their responses. The issues are grouped loosely into categories, though there is considerable overlap between some of them.

THE NEED FOR MORE INFORMATION

How prevalent is the use of third party guarantees?

4.4 As the Australian Banking Industry Ombudsman pointed out in its recent report on relationship debt, there is a lack of information about:

• The number of third-party guarantees given to financial institutions;
• The proportion of guarantees given which are actually called upon; and
• What amounts guarantors, on average, have to pay.²

Q1 What proportion of guarantees are provided in the context of family and other close relationships?

Q2 What proportion of guarantees are provided in support of a business loan?

4.5 It has been suggested to the Commission that the use of third party guarantees has increased since the mid 1980s, along with changes in banking and credit provision practices, and the Commission will be attempting to ascertain from lenders a clear sense of the circumstances in which third party security is used. There has also been particular concern expressed about the continued use of “all moneys” clauses.

Q3 What is the current prevalence of the use of “all moneys” or “all accounts” clauses in contracts of guarantee?

Q4 Has the increase in competition arising from deregulation of the financial sector led to a greater use of guarantees?

Q5 How effective are the lending practices of creditors in the assessment of risk? Does the widespread use of third party guarantees move the emphasis away from effective risk assessment by lenders?

4.6 As the previous two chapters make clear, with minor exceptions, transactions in the course of business are excluded from the scheme of regulation that governs consumer transactions (for example, the uniform Consumer Credit Code).

4.7 A key question is:

Q6 Should third party guarantees for small business lending continue to be regulated separately from guarantees for consumer loans?

Encouraged by this widespread concern for the consumer faced by harsh or unjust contracts, the Government has decided that the Contracts Review Bill before this House will be confined to consumer and unincorporated farming transactions. In effect, the only persons having access will be the commonly-termed traditional consumer, that is, a consumer of goods, services or land for personal, domestic or household use only, and the unincorporated farmer.⁶

Q7 The Contracts Review Act 1980 (NSW) was hailed as “revolutionary legislation whose evident purpose is to overcome the common law’s failure to provide a comprehensive doctrinal framework to deal with ‘unjust’ contracts.”⁷ Has it achieved this aim? If not, why has it not done so?

Q8 Do the provisions of the Contracts Review Act 1980 (NSW) sufficiently cover third party guarantees? Should the Act be amended so that it applies expressly to all situations where a third party provides a personal guarantee for a loan?

Q9 Should the unconscionable conduct provisions in s 43 of the Fair Trading Act 1987 (NSW) be amended so that they apply expressly to all contracts of guarantee provided by third parties and not just those given with respect to loans for “personal, domestic or household use or consumption”?

Q10 Is it appropriate to maintain the clear regulatory distinction between consumer guarantors and those who provide personal guarantees for small business loans?

Q11 Are the 1998 small business amendments to the Trade Practices Act 1974 (Cth) effective in dealing with guarantees of small business loans? Should similar provisions be included in the Fair Trading Act 1987 (NSW)?

Q12 Should self-regulation (via the industry codes of practice) be the main way of regulating small business lending?

Q13 Should there be a uniform credit industry code of practice (and should any such code also apply to finance companies)?

Q14 What information should lenders be required to disclose to prospective guarantors in relation to the financial situation of the borrower?

Q15 Should the limited common law duty to disclose only “unusual” facts be modified and supplemented by rules that require a third party guarantor to be provided with all information about the circumstances of the borrower (including why a guarantee has been sought) that will enable her/him to evaluate the risks involved in giving the guarantee?

Q16 In what circumstances should prospective guarantors be required to seek independent legal advice? Should lenders be required to ensure that this has occurred before being able to finalise a guarantee? If so, what form should that advice take? What issues must the guarantor be advised about? Should additional requirements be imposed where the relationship between guarantor and borrower is a close personal relationship? Should proof that a person has received independent legal advice ever be a precondition of a guarantee’s enforceability?

Q17 Are there any circumstances in which a prospective guarantor should be required to seek independent financial advice on the commercial aspects of the transaction being guaranteed?

Q18 Is the information that must be provided to the guarantor during the life of a contract of guarantee clear to all parties, and sufficient? What information should be provided to a guarantor during the life of a loan?

Q19 Should the industry codes of practice require, so far as practicable, the same pre-contractual information to be provided as does the Consumer Credit Code?

Q20 Are vulnerable members of the community such as women guaranteeing partners’ loans and people of non-English speaking background, effectively targeted by community education programs about guarantees?

4.9 Assuming guarantees continue to be used, are there technical or formal matters that should be regulated to minimise some of the risks of guarantors failing to understand the nature of the obligation they are entering into? The Commission is interested in submissions on the following matters:

Q21 Should the law regulate the manner in which guarantees are entered into? For example, should there be specified formalities for entering into all guarantees (including guarantees of business loans) so that failure to comply with those formalities (such as not signing in the presence of the borrower) renders the agreement unenforceable? If so, what other formalities or processes should be required?

Q22 Should all guarantees, including those for business loans, be subject to technical specifications such as minimum font size etc, and be required to be comprehensible, clear and concise?

Q23 What steps should be required to ensure that people from non-English speaking backgrounds are fully informed about the nature of the obligation they are undertaking?

Q24 Should there be a cooling off period during which a person who has signed a personal guarantee can change his or her mind? If so, how long should this period be?

Q25 Should these kinds of regulation be a matter of statute law, or should they be left to the industry organisations to regulate by way of their voluntary codes of practice?

Q26 Are the processes followed by lenders when borrowers default on their loans adequate?

Q27 Should a lender be required to notify a guarantor about a default by the borrower as soon as the default occurs?

Q28 Are there effective processes for resolving disputes involving guarantors?

4.10 As noted in Chapter 3, one of the key difficulties in this area of law is that normal contractual principles designed to operate upon arms length commercial transactions are being imposed upon factual situations that may have more in common with what is traditionally considered to be “family” law than “commercial” law. How can the law best respond to this intertwining of family and commercial considerations?

Q29 What effect, if any, should be given to the fact that a guarantee is provided in the context of a close personal relationship, rather than by way of an arms length contractual arrangement? Have common law attempts to take that relationship into account, such as the “special rule” for wives (Yerkey v Jones⁸ and Garcia v National Australia Bank Ltd⁹ ), been successful? Should there continue to be such a “special rule” and if so, should its application be broadened to those in a wider range of relationships?

Q30 What obligations, if any, should a lender owe to a third party guarantor in a close personal relationship with the borrower?

Q31 Should the family home continue to be used as security for business loans or should its use be limited?¹¹

Q32 How effective is independent legal advice in offsetting emotional/family/other pressures on a guarantor to enter a guarantee? Should other pre-contractual advice (such as independent financial advice) also be required?

4.12 There have also been some suggestions that personal guarantees should not be permitted in any circumstances. For example, the Martin Committee on Banking and Finance questioned “the appropriateness of guarantees as commonly used financial instruments”.¹² Similarly, the Australian Trade Practices Commission (now the Australian Competition and Consumer Commission) in its 1992 discussion paper Guarantors: Problems and Perspectives refers to suggestions by the National Consumer Affairs Consultative Council and the Australian Financial Counselling and Credit Reform Association that all guarantees be prohibited.¹³ The Trade Practices Commission, while not agreeing that all guarantees should be banned, did support the Martin Committee’s recommendation that unlimited consumer guarantees should be proscribed.

Q33 Should all third party guarantees be prohibited?

Q34 Should legislation and industry codes of practice generally prohibit particular provisions such as “all moneys” or “all accounts” clauses from all contracts of guarantees?

4.13 It has been suggested that other forms of joint debts such as credit cards are equally problematic.¹⁴ This is a particular issue for women separating from partners whose debts they have secured. The Commission is interested in receiving submissions about difficulties experienced by third parties in other types of debt and about some of the broader aspects of “relationship debt” that come within the terms of reference.

1. The research team is Ms Jenni Millbank, Professor David Harland (both from the Faculty of Law) and from the New South Wales Law Reform Commission, Professor Reg Graycar, the Commissoner in charge of this reference.

2. Australian Banking Industry Ombudsman Ltd, Report on Relationship Debt (Bulletin No 22, 1999) at 3. The report noted that without that information, it is difficult to assess whether the complaints received by the Ombudsman about guarantees are representative of the experience of guarantors.

3. In a preliminary submission it has been suggested that while no statistics have been kept, it is estimated that approximately 75% of files documented at the bank would include third party securities and that approximately 30% of home loan files are secured by supported guarantees: L E Taylor, Submission.

4. In 1992 the Trade Practices Commission noted that its survey had disclosed that parents are most frequently used as consumer guarantors in Australia, whereas according to a US Federal Trade Commission report (1984), spouses and parents are most commonly used, with other relatives, friends and employers also figuring: Australia, Trade Practices Commission, Guarantors: Problems and Perspectives (Discussion Paper, 1992) at 13.

5. J R Peden, Harsh and Unconscionable Contracts (Report to the Minister for Consumer Affairs and Co-operative Societies and the Attorney General for New South Wales, 1976).

6. New South Wales, Parliamentary Debates (Hansard) Legislative Assembly, 19 March 1980 at 5533.

7. West v AGC (Advances) Ltd (1986) 5 NSWLR 610 at 621 (McHugh JA).

8. (1939) 63 CLR 649.

9. (1998) 194 CLR 395.

10. Examples of the different types of homestead laws are – in the United States: General Laws of Massachusetts Chap 188, Arizona Revised Statutes s 33-1101, and Texas Property Code Chap 41; in Canada: The Homesteads Act, CCSM, c H80 (Manitoba), and Homestead Act, RSBC 1996, c 197 (British Columbia); and in New Zealand: Joint Family Home Act 1964 (NZ). See also B Fehlberg, Sexually Transmitted Debt: Surety Experience and English Law (Clarendon Press, Oxford, 1997) at 273-274.

11. See the concerns of the Martin Committee Enquiry concerning the family home: Australia, House of Representatives Standing Committee on Finance and Public Administration, A Pocket Full of Change: Banking and Deregulation (AGPS, Canberra, 1991) at 414.

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

13. Australia, Trade Practices Commission, Guarantors: Problems and Perspectives (Discussion Paper, 1992) at 19-20. For a similar suggestion by a Canadian law professor, 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.