8.1 This report has collected empirical evidence on the practice of third party guarantees. This chapter outlines some of the implications of this research in two areas: first, pre-transaction conduct, and secondly, dispute resolution after a guarantee has been called upon and is disputed.
8.2 The objectives of law and policy reform in this area involve a tension between the need to protect guarantors, secure finance for small business, and provide some measure of certainty in procedure, practice and outcome for all parties concerned. This report does not suggest particular reform measures. Rather, it highlights key findings of our research and suggests how these findings need to be considered by, and may impact upon, future developments in law and policy.
A. SIGNING
1. Guarantors in positions of vulnerability
8.3 The evidence from this report clearly shows that women, elderly people and those from non-English speaking backgrounds are disproportionately affected by third party guarantees.
8.4 These findings highlight the need to consider these groups as the prime demographic of guarantors and to target them specifically in any reform or education measures.
8.5 This research found that many guarantors were in positions of vulnerability, either because of their emotional connection with the borrower or because of structural factors such as age, economic dependence or language skills. These findings suggest that there are significant issues of power imbalance in guarantor/borrower and guarantor/lender relationships that may not necessarily be resolved by the provision of more or better information. These findings suggest that the guarantor relationship is one that is infused with inequity, and that third party guarantees may therefore be regarded as inherently suspect transactions.
2. Guarantor relationships and gender
8.6 While women are mostly involved as guarantors of their male partner’s borrowing, the smaller number of men who are involved as guarantors tend to be the parent of the primary borrower. Women and men noted many of the same reasons for entering into the transaction, such as trust and optimism, but there were very marked differences in key areas. Women were far more likely to report that they entered the guarantee because they were pressured, scared or felt that they had no choice. Women also appear far more likely to be economically dependent upon the borrower, such that their choices are constrained.
8.7 Men and women’s experiences of guarantee transactions therefore appear to be quite different, and any reform and education measures need to be careful to identify guarantor needs and experiences by gender.
3. Informational disparity
8.8 It appears common for guarantors to sign in situations where they have little information or are misinformed about key aspects of the transaction. Guarantors rarely have any information about the borrower’s loan or about the health of the business they are supporting and so are unable to assess the risk they are taking. Such information is clearly necessary to enable even the possibility of an informed choice about the transaction.
8.9 Guarantee documentation is lengthy, complex and on occasion incomprehensible even to the legally trained. While plain language documentation may not prevent guarantors from entering into improvident transactions, it would, like the provision of other information and advice, assist in giving at least the opportunity for some real choice to be exercised.
8.10 The inclusion of “All Moneys” clauses is still apparently occurring in guarantee transactions despite moves from the Australian Banker’s Association in 1993 to prohibit them in at least some circumstances through the Code of Banking Practice. These clauses are very widely regarded as problematic, as they extend liability to future as well as past and present loans. A significant proportion of guarantors in our study did not discover that they had even signed an “all moneys” guarantee until it was called upon. Such clauses in and of themselves enhance the likelihood that guarantors will be placed in an ill-informed and disadvantaged position in the guarantee process.
4. The circumstances of signing
8.11 It appears disturbingly common that guarantee transactions are carried out in informal surroundings and/or in the presence of the borrower. It was very common for guarantors to have little time to consider the terms of the agreement. The guarantee transactions in our study almost always took place in the absence of adequate legal or financial advice. These factors contributed to guarantors’ poor understanding of their obligations and to depriving them of an opportunity of informed choice.
8.12 These findings openly contradict what is understood as good practice – and commonly assumed to be typical practice – in this area. Good lender practice, as set out in lenders’ own policy manuals, requires guarantors to sign at the lenders’ premises in formal circumstances, in the absence of the borrower and following the receipt of independent legal advice.
8.13 These findings suggest that more attention must be given to compliance with good practice in the taking of guarantees at both an industry and regulatory level. If self regulation measures do not have sufficient industry coverage or are ineffective, increased regulation should be considered.
5. Legal advice
8.14 In addition to a generally low number of guarantors receiving legal advice, guarantors of non-English speaking background appear particularly likely to enter guarantee transactions unadvised. These findings suggest that greater efforts need to be taken to make guarantors, especially those of non-English speaking background, aware of the need for such advice. Measures may also need to address the accessibility of legal advice avenues that are unrelated to the borrower or lender.
8.15 The research found that, of those guarantors who did receive advice prior to entering into the transaction, there was often a short time between such advice and signing. This means that there was no real chance to consider any advice and act upon it. This finding, in addition to those above in paragraphs 5.28-5.46 above, suggest that a “cooling off” period may assist in giving guarantors the opportunity to consider what information they do have in relation to the transaction. Such a “cooling off” period could relate to the period between being advised and signing, or between signing and the commencement of the legal effect of the guarantee, or both.
8.16 There were also very serious concerns about the content of legal advice. Our guarantors reported advice that was scant, hurried and in two instances, partisan for another party and plainly not independent. Lawyers saw their role as very limited. There appears to be a sharp disparity between what courts, lenders and policy-makers understand to be the scope and content of independent legal advice and what is delivered in practice. “Independent legal advice” is in practice merely a “basic explanation” of the content of legal documents and does not extend to advising on the wisdom of entering into the transaction, the likely results or risks faced, or any alternative forms of transaction.
8.17 These findings have serious implications in terms of the development of guarantor protections, which until now, have contained a heavy focus upon independent legal advice as a cure for unfair dealing, a source of information or empowerment for the guarantor, and as a protection against lender liability. While the presence of legal advice may protect a lender from an action to set aside the transaction, such advice as it is currently typically provided does not appear to offer the guarantor very much in terms of information on the loan, advice on the transaction, or empowerment to refuse or renegotiate the terms of the transaction.
6. Lack of regulation
8.18 Despite protections such as the Consumer Credit Code (in operation since 1996) and voluntary self-regulation mechanisms such as the Code of Banking Practice (in place since 1993), guarantors continue to enter into transactions with a very poor understanding of what their obligations are. Lenders also continue to provide funds to borrowers supported by guarantees when neither the borrower nor the guarantor, upon a careful assessment, is able to repay the amount. The pre-transaction conduct of the taking of guarantees still appears largely unregulated and shows little evidence of what either the finance industry or consumer advocates would regard as best, or even adequate, practice.
8.19 Some of the problematic areas relating to guarantee practice may be assisted by the new provisions of the Code of Banking Practice. From August 2003 the Code of Banking Practice has greater coverage and enhanced guarantor protections. It now covers guarantees for small business transactions in addition to consumer transactions, and has enhanced requirements for the provision of pre-transaction information to guarantors. However the Code of Banking Practice will continue to be a voluntary source of regulation so it remains to be seen what impact it will have upon the pre-transaction conduct of bank lenders. Further, the fact that if the Code of Banking Practice is breached by a bank and a complaint is made under it, the jurisdiction of the dispute resolution body is limited and easily ousted, may limit its effectiveness in acting as a deterrent (dispute resolution is discussed further below). Further, the proliferation of non-bank lenders and mortgage and loan brokers means that there are increasing numbers of lenders who fall outside of the Code.
8.20 There appears to be a need for clear and consistent standards of conduct across the entire finance industry.
B. LATER DISPUTES
8.21 If there is any dispute over the guarantee transaction, the available avenues for redress are painfully inadequate. Informal and accessible dispute resolution mechanisms that currently exist are very limited in their scope of operation and utility of application. Litigation, with its associated expense and complexity, still remains the principal focus of dispute resolution in this area.
1. Litigation is inadequate
8.22 Litigation is complex, protracted, expensive and often poorly conducted. Litigation is fiercely and desperately fought in many matters, and may often add considerably to the final costs even when settlement is achieved at some stage in the process prior to judgment.
8.23 The comparative resources available to some parties to a litigated dispute about a guarantee are overwhelmingly disproportionate and it appears that many guarantors are proceeding with inadequate preparation, sometimes on a self-represented basis.
8.24 It appears that the complex and multiple factors that lead guarantors to enter into disadvantageous transactions are not readily translatable into existing legal categories of wrong. Courts have struggled to recognise experiences of disadvantage without resort to categories which stereotype the participants. Likewise existing law tends to assume forms of simplified power in which one party is empowered/advantaged and the other victimised, such that any degree of choice or empowerment by a claimant disentitles them to relief. In this respect the more flexible application of the Contracts Review Act 1980 (NSW) has offered more scope to weigh the competing conduct of all parties to determine a fair result.
8.25 Yet the application of flexible and discretionary legal principles in decided cases – particularly the Contracts Review Act and the “special equity” for wives in Garcia – has been inconsistent and contributed to uncertainty. It appears that there are too many legal principles that are too uncertain in their application for any degree of predictability in this area.
2. Need for certainty
8.26 The current array of common law and legislative avenues to challenge unfair transactions has contributed to the complexity of litigation.
8.27 Greater certainty in the operative law in this area could reduce litigation and provide both lenders and guarantors with a better sense of what conduct and factors will render a transaction unenforceable.
8.28 Enhanced regulation of pre-transaction conduct in taking guarantees, and greater uniformity in the regulation of the entire finance industry would also contribute to greater certainty.
3. The costs of dispute resolution
8.29 Dispute resolution is costly and such costs appear to be increasing with time. This expense is in part due to a high reliance upon litigation to resolve disputes. There are issues with both the overall cost of dispute resolution and where the burden of those costs falls.
8.30 The inclusion of “all reasonable costs of recovery” clauses is very common in guarantee transactions. These costs are in addition to the principal sum and interest, and include legal costs and the costs of pursing the borrower and the guarantor. They can amount to many tens of thousands of dollars before litigation has even commenced. These clauses transfer a significant portion of the risk of lending – the transaction costs of recovery – from lenders to guarantors.
8.31 While costs usually follow the result in litigation, the fact that most cases settle prior to or during litigation means that even guarantors who have strong claims or are only partially successful in their claims typically bear the costs of the dispute.
8.32 Considering that it is lenders who profit from the interest from the loan, that guarantors are volunteers who do not gain by the loan, and that lenders have already transferred the risk of lending to the guarantor, this seems an unfair additional burden. Such clauses act as a powerful disincentive for lenders to negotiate, to settle claims or engage in lower cost forms of dispute resolution, as their legal costs and costs of recovery are contractually borne by the guarantor and can be automatically deducted from secured assets.
8.33 These findings suggest the need to consider both how to lower or control the costs of dispute resolution in this area and the impact of costs clauses in dispute resolution processes and outcomes.
4. The need for accessible dispute resolution
8.34 While many matters settle in negotiation between lawyers, there are very few structured avenues of accessible or informal dispute resolution in this area.
8.35 The industry and tribunal level dispute resolution processes that do exist are very little used. This under-use appears to be principally caused by jurisdictional limits. Jurisdictional limits such as low monetary limits on the value of the dispute ($150,000 for the Australian Banking Industry Ombudsman) almost entirely excludes guarantees secured by residential properties. Jurisdictional limits on “consumer” rather than “business” transactions (such as the Consumer, Tenancy and Trading Tribunal) exclude guarantees that were given for the purposes of supporting business borrowing.
8.36 As a large portion of guarantees are secured by residential properties and are undertaken to support small business borrowing, the jurisdictional limits of current avenues render them virtually unusable as dispute resolution mechanisms for third party guarantee matters.
8.37 In addition, the voluntary nature of bank participation in the Australian Banking Industry Ombudsman scheme and the fact that any dispute before it can be ousted by commencing litigation means that even a higher monetary limit would not necessarily enhance its coverage of the field if lenders were unwilling to use it.
8.38 The utility of informal dispute resolution processes may be limited if they are seen as merely a prelude to litigation, or if they do not offer parties a real opportunity to air their case. There is also the risk that informal mechanisms can exacerbate rather than reduce existing power and information imbalances between parties.
8.39 There is a clear need for a relatively even playing field in which disputed transactions can be heard and adjudicated in a structured yet accessible forum. Such forums are in addition to other avenues such as formally or informally mediated or negotiated settlements.
