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Where am I now? Lawlink > Law Reform Commission > Publications > Guaranteeing someone else's debts: summary of Issues Paper 17
Guaranteeing someone else's debts: summary of Issues Paper 17
1 Introduction 4 Issues to consider Submissions The Commission invites submissions on the issues relevant to this review, including but not limited to the issues raised in this Issues Paper. All submissions and enquiries should be directed to: Mr Peter Hennessy email nsw_lrc@agd.nsw.gov.au telephone (02) 9228 8230 facsimile (02) 9228 8225 [Current contact details for the Law Reform Commission] There is no special form required for submissions. If it is inconvenient or impractical to make a written submission you may telephone the Commission and either direct your comments to a Legal Officer over the telephone, or else arrange to make your submission in person. The closing date for submissions is 31 August 2000. Use of submissions and confidentiality If you would like your submission to be treated as confidential, please indicate this in your submission. Submissions made to the Commission may be used in two ways:
1 INTRODUCTION [1] On 2 March 1999, the Attorney General asked the Law Reform Commission to undertake a review of the law relating to third party guarantees. The terms of reference for this review are set out at page 20 of this summary. Why this review? [2] For some years, there has been growing concern about the consequences of the widespread use of third party guarantees to secure loan transactions. In cases where a lender will only provide money if the loan is secured, and a borrower has no acceptable security, the lender may agree to lend the money if it is secured against some property or other interest of a third party. These “third parties” are often spouses, close family members or friends who may not otherwise be involved in, or receive any benefit from, the loan transaction. It is not uncommon for the guarantees to be enforced against such people, often with serious consequences such as the loss of their home. This is a particular problem in the context of guarantees to secure loans for the purpose of financing small businesses. Other reviews [3] In recent years, a number of organisations have undertaken a range of inquiries and research as increasing awareness of, and discussion about, this problem has emerged. These include bodies such as the Trade Practices Commission (1992), the Martin Committee (a 1991 federal parliamentary committee on banking) and a variety of community organisations such as consumer credit services and legal centres. The Australian Law Reform Commission and a number of credit advice bodies and legal services focussed particular attention on what came to be widely known as “sexually transmitted debt”. Following the 1994 report of the Access to Justice Advisory Committee, a national Expert Group on Family Financial Vulnerability was established and its report, Good Relations, High Risks: Financial Transactions within Families and Between Friends, released in February 1996, pointed out that the range of relationships affected by these issues extends beyond spouses. There is evidence to suggest that the problem particularly affects borrowers and guarantors from non-English speaking backgrounds. Increasing awareness of issue [4] Over the same period, there has been unprecedented academic as well as community interest in these issues, while at the same time, some litigated cases (such as Garcia v National Australia Bank in 1998) have received considerable media attention. The legal issues are by no means new ones, involving the common law doctrines of unconscionability and the separate rule in Yerkey v Jones (1936) as well as a range of statutory regimes. Yet what is new is the increasing awareness of the fact that every year, numbers of friends and family members fall victim to failed loans they have guaranteed. [5] There are a number of possible reasons for this heightened awareness. The 1983 decision of the High Court in Commercial Bank of Australia v Amadio brought to light the vulnerability of elderly parents who want to assist their children, and in particular, people whose first language is not English. Increasing awareness of the legal disadvantages experienced by women, particularly as spouses of borrowers, led community groups and the emerging women’s legal services to draw attention to “sexually” or “emotionally transmitted debt” (or, as it has recently come to be known, “relationship debt”). There have also been changes to the economic landscape, including major restructuring and changes in the banking and finance industry. Specifically, a small number of long established banks have been supplemented by foreign banks, building societies, credit unions, finance companies and other forms of financial institution that provide credit (for example, home mortgage providers and insurance companies). Consumer protection [6] With these developments, there has also been increasing recognition of the vulnerability of consumers when borrowing from large financial institutions. A national network of consumer credit organisations (including financial counselling services and specialist community legal centres) has been established. As long ago as 1980, New South Wales broke new ground in Australia by enacting the Contracts Review Act, which remains unique to this State. The Act gives courts a broad power to vary contracts that are unjust as well as allowing for a measure of “abstract control” by prescribing or otherwise restricting “the terms upon which [a] person may enter into contracts of a specified class”. While the Contracts Review Act was described as “revolutionary” when enacted nearly 20 years ago, there has been no research into its operation or effectiveness. Other consumer protection legislation, such as the Fair Trading Act 1987 (NSW) has also been enacted, and in 1996 new national consumer credit legislation (the Consumer Credit Code) came into force as a cooperative arrangement involving all States and Territories. Small business [7] While these developments show increasing recognition of the rights and interests of consumers, a widening gulf has developed between consumer laws and those laws that regulate the financing of small business, as the new credit laws apply only to consumers. For example, relief under the Contracts Review Act 1980 (NSW) is not available to corporations, leading to a situation where “the small family company may not be granted relief whereas the wealthy individual may be”. Nor does that Act deal with contracts that “are entered into or in the course of or for the purpose of a trade, business or profession”. Similarly, until July 1998, the unconscionable conduct provisions of the Trade Practices Act 1974 (Cth) were limited and applied only to consumers, though these have been extended by s 51AC to apply to some small business dealings. [8] The policy behind regulating transactions involving consumers more strictly than those involving business seems based on the premise that consumers have less power in their dealings with, say, finance providers than do business people. But rather than being two diametrically opposed categories, the categories “consumer” and “business” operate along a continuum. That is, some individual consumers might be financially secure, wealthy and well informed professionals, while “business” includes all kinds of small family undertakings such as the corner shop and the newspaper or milk run. The transactions at issue in well known cases such as Amadio and the more recent Garcia v National Australia Bank involved borrowing for business purposes. Situations involving guarantees for business loans, which are increasingly common, have just as much capacity to cause personal as well as business losses. It is therefore timely to review the maintenance of this distinction in the regulatory systems. OUTLINE OF ISSUES PAPER 17 AND SUMMARY [9] Issues Paper 17 has four chapters. After an introduction, Chapter 2 outlines the current law, both common law and statute. It discusses the variety of legal doctrines that operate on these issues thereby illustrating the uncertainty that surrounds the legal framework. Chapter 2 also outlines some alternative approaches to regulation from other jurisdictions. Chapter 3 addresses current practices in the finance industry after considering the social context in which many guarantees or sureties are sought, as well as looking at industry-based forms of regulation (such as the Code of Banking Practice and analogous codes adopted by Credit Unions and Building Societies). The Chapter also considers the legal profession’s involvement in the provision of independent legal advice, and the role of such advice in the use of guarantees. Chapter 4 summarises the issues raised and outlines a list of matters on which further research will be undertaken and on which the Commission is keen to receive submissions. [10] This summary follows the same structure as the Issues Paper. It is also divided into four parts. The summary of chapter 2 is a brief outline of the legal framework, while the summary of chapter 3 sketches some of the practice issues that surround the day-to-day operation of guarantees. Chapter 4 of the summary contains the same questions that are included in the Issues Paper. [11] The Commission is interested in information or views on any of the matters raised in this paper. Chapter 4 is designed to make it easier for people wanting to make submissions by providing a brief list of questions. The Commission welcomes responses to any one or more of these questions or on any other related issue. The deadline for the receipt of submissions is 31 August 2000. [12] The law that regulates third party guarantees is largely common law, that is, judge-made law developed by the courts in cases where guarantors have argued that the guarantee they have signed is unjust. There are also various statutory laws that apply. [13] Who are the three parties? A lender, creditor or credit provider is someone who lends money. This can be a bank, finance company, credit union or building society, but it needn’t be an institution that is in the business of providing credit: it can also be any individual who lends money. A borrower or debtor is the person to whom a loan is made. A third party guarantor is a person who promises to pay the loan if the borrower cannot (or will not) repay it, but who is generally not otherwise involved. They are a “third party” because they are not a party to the actual loan contract which is between the borrower and the lender. Sometimes, the guarantor will provide some kind of mortgage over their property as further security for the loan. [14] Grounds for setting aside (or varying) contracts of guarantee: At common law, there are a number of different defences that can be raised when a lender tries to enforce a guarantee that the guarantor considers unjust. While there is some degree of overlap between them, each of these has different technical criteria that govern when they can be used and what remedies are available (for example, setting aside the contract or limiting the amount owed). These categories include unconscionability (or unconscionable conduct), mistake, misrepresentation, undue influence and duress. [15] A “special rule” for wives? Another ground for setting aside guarantees applies only to cases where wives guarantee the debts of their husbands. This category was established by the High Court of Australia in 1936 in a case called Yerkey v Jones. It came to be considered obsolete by a number of courts and commentators (including the New South Wales Court of Appeal). However, in 1998, the High Court applied it in a case involving a wife (Garcia v National Australia Bank), and left open the possibility that the rule might be extended to a broader category of cases that involve a relationship of trust and confidence between the borrower and the guarantor. [16] Statutory law: There are a number of statutes (acts) that can be used by people seeking to have a guarantee set aside or varied. Some of these provide alternatives to the common law; some extend the law; while others fill gaps in the existing common law. Each statute is limited in some way. For example, there are various time limits in each of the acts, and they generally distinguish between business loans and consumer loans. [17] The Contracts Review Act 1980 (NSW) gives courts power to set aside or vary contracts that are found to be unjust on one or more of the grounds specified in the Act. It excludes contracts entered into “in the course of or for the purpose of a trade, business or profession” other than a “farming undertaking”. Even so, it has occasionally been used successfully in cases involving a personal guarantee of a business loan. [18] The Fair Trading Act 1987 (NSW) and the Trade Practices Act 1974 (Cth) both prohibit certain kinds of unconscionable conduct and misleading and deceptive conduct. These generally don’t apply to business transactions. A new section of the Trade Practices Act 1974 (Cth), which was added in July 1998, extends some of its provisions to transactions involving “business consumers” and “small business suppliers” where the amount at issue is $1,000,000 or less. [19] The Consumer Credit (New South Wales) Code is the full name of national uniform credit legislation that applies in New South Wales. The “Consumer Credit Code” (sometimes called the “uniform Consumer Credit Code”) has been adopted by all the Australian States and Territories. The Code contains a set of general provisions about unjust contracts similar to those in the Contracts Review Act 1980 (NSW) and the trade practices legislation. Importantly, it also includes a number of specific requirements that must be met if a guarantee is to be enforced. However, the Code only applies to consumer credit and therefore doesn’t apply to guarantees that secure business loans. [20] An alternative approach? Challenging individual guarantees through the courts, often many years after they have been entered into, may not necessarily be the best means of achieving justice. Not only is the process of taking matters to court costly and time consuming, but only the parties to that particular case are bound by the result. Therefore even where the guarantor “wins”, this may not affect day-to-day practices. An alternative approach to the problem of unfair guarantees is “abstract control”, that is, preventing lenders from using guarantees that have unfair terms. The focus is on ensuring the contract is fair from the outset. Chapter 2 of Issues Paper 17 includes examples of abstract control, such as the European Community Directive on Unfair Terms in Consumer Contracts (EC Directive 93/13) which applies in England and s 10 of the Contracts Review Act 1980 (NSW) which has not been used much in this State. [21] There are a number of day-to-day practice issues that affect the use of guarantees. These are considered against the background of the social context in which guarantees are used. [22] The social context: “relationship debt”: Unlike most commercial decisions, the decision to be a guarantor is often not made out of financial self-interest but for other non-commercial reasons. Many guarantors get no financial benefit at all from the loan. Recently, there has been considerable attention given to “relationship debt” and to the social and economic context in which this occurs. In a 1999 report, the Australian Banking Industry Ombudsman described “relationship debt” as “a shorthand expression for the assumption by one person of responsibility for a debt owed by another person to whom they are related in some way”. [23] There is a clear contrast between the emotional underpinnings of many transactions secured by third parties and the imperatives of commercial stability and certainty. Lenders are engaging in a commercial profit-based enterprise and they need to be able to operate within a defined legal and commercial framework. Yet the legal and commercial framework – the common law, statutory law and the voluntary industry codes of practice – reveals a lack of clarity and certainty in relation to guarantees. [24] Advice and information issues: There is only a limited legal obligation on lenders to disclose information to guarantors before they sign guarantees. It is now relatively common for people to be urged to obtain “independent legal advice”, although there is no formal legal requirement that they do so. It is sometimes, though less commonly, suggested that borrowers might also obtain independent financial advice. The New South Wales rules about the provision of legal advice changed early in 2000 following concerns by the Law Society that lenders have tended to use independent legal advice as a means of shifting responsibility from themselves to solicitors. [25] The “fine print”: There are also a number of practical issues that surround the signing of a guarantee, such as who is present when the guarantee is being signed, the location where it is signed, and the readability of the documents. Guarantees are sometimes hard to read and can be written in very complex language. There are only limited situations (mostly to do with consumer credit lending) where the law requires that they be in clear, simple English. This may cause particular difficulty for people whose first language is not English. [26] “All moneys” clauses: Sometimes called “all accounts” clauses, these have the potential to create an open-ended liability for a guarantor who is, in effect, agreeing to secure any future loans that the borrower may enter into. There is nothing to prevent the use of such clauses at common law, although the courts sometimes limit their operation in disputed cases. [27] Ongoing information: At common law, there is no general obligation on a lender to supply a guarantor with ongoing information about the status of a loan, such as whether the repayments are being regularly made by the borrower. In these circumstances, guarantors have no way of knowing how vulnerable they are, unless they are being kept informed by the person whose loan they have guaranteed. [28] Enforcement: A lender need not inform the guarantor that the borrower has defaulted under the principal loan before commencing proceedings to enforce the guarantee. And, a lender doesn’t have to sue the borrower first, unless the contract expressly says so. Some informal dispute resolution processes have been established by the industry groups as part of their codes of practice, for example, the scheme administered by the Australian Banking Industry Ombudsman. [29] Although there is a detailed (if complex) legal framework and various other forms of regulation (such as the voluntary industry codes of practice) concerning third party guarantees, most of the many transactions that take place on a daily basis do not come before courts for scrutiny, nor do they come to the attention of bodies such as the Australian Banking Industry Ombudsman. As part of this reference, the Commission will be undertaking empirical research to assist in developing a clearer picture of the use of guarantees, particularly those given to secure small business lending. [30] 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. 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. [31] 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 20 of this Summary). The following paragraphs list a number of issues, some of which have already been raised, 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? [32] As the Australian Banking Industry Ombudsman pointed out in its recent report on relationship debt, there is a lack of information about: 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? In what circumstances are guarantees required by lenders? [33] 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 get 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? THE BUSINESS/CONSUMER DISTINCTION [34] 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). [35] A key question is: Q6 Should third party guarantees for small business lending continue to be regulated separately from guarantees for consumer loans? [36] This distinction has always been a matter of some contention. At the time of the introduction of the Contracts Review Act 1980 (NSW), implementing the 1976 Peden Report on Harsh and Unconscionable Contracts, the then Minister for Consumer Affairs, the Hon Syd Einfeld, noted that an earlier version, not limited to consumer transactions, had received a strongly negative response – in some cases (in his words) one that “bordered on the hysterical” and the Bill was subsequently limited in its application. He noted: 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.2 [37] Other questions to consider include: 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.” 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)? INFORMATION AND ADVICE 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? FORMALITIES [38] 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? ENFORCEMENT ISSUES 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? RELATIONSHIPS: CONTRACT LAW AND RELATIONSHIP DEBT [39] 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 Jones; Garcia v National Australia Bank Ltd), 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? [40] In some overseas jurisdictions, there are laws known as “homestead” laws that impose limits on the extent to which residential property can be used as security for debts. These laws vary from place to place. Some protect all or part of the value of the property; some apply to sole owners while others only apply where family members or spouses also live in the property; and some are limited to situations where the security over the property has been entered without the consent of the other spouse. Some of these laws apply automatically; others require some form of written notification. Q31 Should the family home continue to be used as security for business loans or should its use be limited? 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? LIMITING THE USE OF GUARANTEES? [41] 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”. 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. 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? OTHER ISSUES [42] It has been suggested that other forms of joint debts, such as credit cards, are equally problematic.3 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. FOOTNOTES 1. Australian Banking Industry Ombudsman Ltd, Report on Relationship Debt (Bulletin No 22, 1999) at 3. 2. New South Wales, Parliamentary Debates (Hansard) Legislative Assembly, 19 March 1980 at 5533. 3. New South Wales, Department for Women and Department of Fair Trading, Separating Joint Finances: An Opportunity for Reform (Background Paper, 1999). Appendix A: Terms of Reference On 2 March 1999, the Attorney General, the Honourable Jeff Shaw QC MLC, asked the Law Reform Commission to inquire into and report on the legal framework for the protection of guarantors of small business and other loans and in particular, to consider: (i) whether the present legal framework adequately protects the interests of personal guarantors of small business and other loans; (ii) whether there is a reasonable level of satisfaction in the community with the operation and application of the existing laws protecting guarantors of small business and other loans, in particular, whether those guarantors, financiers and principal borrowers are satisfied with the present legal framework; (iii) whether there are more practical and effective strategies for the provision of personal guarantees of small business and other loans that would enhance the development of conscientious lending practices while not placing undue constraints on small business lending; and (iv) any related matters. In carrying out its review, the Commission is to have regard to:
Appendix B: Participants Pursuant to s 12A of the Law Reform Commission Act 1967 (NSW) the Chairperson of the Commission constituted a Division for the purpose of conducting the reference. The members of the Division are: Justice Michael Adams Officers of the Commission Executive Director Legal Research and Writing Librarian Desktop Publishing Administrative Assistance Reference Group |
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