26 Aug 2004

Mortgagee unable to enforce an unconscionable mortgage

by Ron Schaffer, Alastair Young

It may be unconscionable for a mortgagee to enforce the terms of a mortgage against a mortgagor if the mortgagee only agreed to the mortgage because adequate security was provided in circumstances where the mortgagor entered into the mortgage for reasons other than their own benefit; and the mortgagee failed to have sufficient regard to the mortgagor's ability to repay the loan.

Small v Gray [2004] NSWSC 97, decided by Justice McDougall, involved an attempt by the plaintiff mortgagee to enforce its legal rights under a registered mortgage over a residential property that was the subject of the mortgage.

There were four defendants referred to by their first names in the judgment: Jarrod, Katrina, Rodney and Kristine.

The two mortgages

On 2 November 2001 Jarrod and his wife Katrina settled the purchase of a residential property with money lent by the plaintiffs and secured by a registered mortgage. As Jarrod and Katrina had no money of their own they were forced to borrow all the purchase price of $239,500, as well as a further $30,500 for stamp duty, legal fees and commissions.

In order to get a loan for more money than the value of the property, the plaintiffs required further security. So, Jarrod and Katrina asked Kristine (Jarrod's mother) and Kristine's de facto partner Rodney to grant the plaintiff a mortgage over their home, which they held as joint tenants. A mortgage over Kristine and Rodney's house was granted and registered, however, it was accepted that Rodney's signature on the mortgage was forged by an unknown person. It was further accepted that the plaintiffs were innocent of the forgery.

Jarrod and Katrina defaulted on their loan almost immediately and after exercising its right of sale over their property the plaintiffs sought to exercise their legal rights under the mortgage in respect of Kristine and Rodney's property.

Kristine's defence was twofold. Firstly, she claimed that the plaintiffs should not succeed because it would be unconscionable for them to enforce the mortgage. Secondly, she claimed that the mortgage was "unjust" as that term is understood by section 9 of the Contracts Review Act 1980 (NSW).

Evidence adduced by Kristine in support of her defence and accepted in its entirety by Justice McDougall, was as follows:

  1. When Jarrod approached Kristine to grant a mortgage to the plaintiff, he said that she would only need to put up her house, which was her only substantial asset, for the deposit rather than as security for the entire loan.
  2. Jarrod and his wife caused Kristine to believe that the loan would be refinanced in six months which would result in Kristine's mortgage being discharged, then relieving Kristine of any risk.
  3. Kristine was not given the appropriate advice in respect of the application of the Consumer Credit Code to the loan by a solicitor acting for the Jarrod and Katrina. Further, the solicitor forwarded to the plaintiff's solicitors a declaration of purpose that certified that Rodney had received legal advice in respect of the loan. This was done despite that fact that Rodney had never received such advice and that his signature on the declaration of purpose was forged.
  4. Kristine was asked to sign the mortgage by the solicitor, however, she told the solicitor that because Rodney was not there she did not want to sign it until Rodney said that it was "OK". The solicitor then told Kristine that it was alright for her to sign it as Kristine and Rodney were joint tenants and that the mortgage was "not legal until Rod signs them… [i]f he does not sign them then that is the end of it". The solicitor did not sign the mortgage as witness to Kristine's signature.
  5. The solicitor then told Kristine that he would send the mortgage to Rodney by express post so that he could sign it, but instead the mortgage was given to Jarrod for him to arrange for Rodney to sign it. Rodney never received the mortgage which was returned with Rodney's forged signature on it.
  6. Kristine never received an adequate explanation of the financial implications of entering into the mortgage from her accountant. Indeed the accountant furnished the plaintiff a certificate indicting that Kristine was able to repay the loan without adequately satisfying himself of the truth of that statement, despite the fact that Kristine was unemployed and had no income.
  7. Kristine received no part of the loan nor did she receive any other benefit from it.

His Honour noted that Jarrod and Katrina both became bankrupt on 15 August 1995 and were discharged, by operation of law, on 16 August 1998, suggesting, it seems, that they were not the best credit risks.

Issues for the court

The issues in this case were:

  • Was there a contract between Kristine and the plaintiff for the purposes of the Act?
  • If so, was the contract "unjust" for the purposes of the Act?
  • If so, was this an appropriate case for the court to exercise its discretion conferred by section 7 of the Act to grant Kristine relief?
  • Was it unconscionable for the plaintiffs to enforce the contract?

Was there a contract?

The plaintiffs argued that there was no common law contract between Kristine and the plaintiffs that could be reviewed under the Act because the parties contemplated that a condition precedent to contract was the offer of mortgage from both Kristine and Rodney. Consequently, it was argued that, as Rodney's signature was forged, no contract existed. The plaintiffs argued that by virtue of section 42 of the Real Property Act 1900 ("RPA"), the mortgage was valid as a charge. In support of this argument the plaintiff relied on Katsaitis v Commonwealth Bank of Australia (1987) 5 BPR 12,049 at 12,051:

"where a document is expressed to be one to be make by more than one person of the one part, such document is subject to a precondition that it will not come into operation until all have signed, if the effect of it coming into operation earlier would be to impose on those who have signed a greater liability than it was ever intended that they should bear" [emphasis supplied]

His Honour in following Katsaitis rejected this argument, stating that as the mortgagors were jointly and severally liable to perform the obligations in the mortgage, Kristine was not, as a consequence of Rodney's failure to sign the mortgage, liable for greater obligations than she contemplated.

Further, his Honour found the existence of a contract on another basis. Section 36(11) of the RPA provides that a registered dealing has "the effect of a deed duly executed by the parties who signed it". His Honour found that the terms of that deed included Kristine's personal covenant in respect of the mortgage and the covenant is a contract for the purposes of the Act.

Was the contract "unjust" for the purposes of section 9 of the Act?

In following the judgment of Justice McHugh in West v AGC (Advances) Ltd (1986) 5 NSWLR 610 at 620, where Justice McHugh identified two kinds of injustice "substantive" and "procedural", Justice McDougall found that the contract contained in the mortgage was both procedurally and substantively unjust.

Procedural injustice

His Honour found that the contract was procedurally unjust. Having regard to the above facts, it was held that:

"Kristine's signature to the mortgage was procured by a representation that turned out to be inaccurate; the document became binding upon her as the result of a fraud that could and should have been prevented; and settlement of the transaction (so that it became binding upon her) would not have occurred but for a separate and fundamental misrepresentation."

Substantive injustice

In finding that the contract was substantively unjust, his Honour followed the reasoning of Justice Beazley in Elkofairi v Permanent Trustee Co Ltd (2003) 11 BPR 20,841, in which Justice McDougall found the proposition that:

"In considering whether a contract is unjust, the court may look not only at the terms of the contract to see whether they are unjust, but also at the circumstances in which the contract was made, and at the effect that performance of the contract would have, having regard to those circumstances."

He found that substantive injustice was made out because the effect of the procedural injustice inflicted on Kristine was that she did not have the opportunity to confer with Rodney in respect of the wisdom of the mortgage.

It was found that the contract was "improvident in the highest" in respect of Kristine given the fact that she received no benefit from the loan while putting at risk her only real asset.

Should the court grant Kristine relief?

It does not necessarily follow that a contract that is unjust under section 9 of the Act will be remedied by operation of section 7 of the Act:

"Where a contract has been found to be unjust, it would in general be unsound to grant relief under s 7 where the party against whom relief is claimed was both innocent and ignorant of the circumstances giving rise to that injustice".

Justice McDougall pointed out that the plaintiffs did not know, nor ought they to have known, of the procedural injustice inflicted on Kristine. Nevertheless, the position is different in respect of substantive injustice. It is this point which is of most relevance to an understanding of mortgagees' legal responsibilities to mortgagors in respect of the accepting the grant of a mortgage.

It was found that notwithstanding that the plaintiffs did not have "actual knowledge" of the personal circumstances of Kristine which led to the above finding of substantive injustice, they had the "means of knowledge".

His Honour found that the plaintiffs agreed to lend the money solely on the basis that the loan was sufficiently secured, rather than satisfying themselves that the borrowers were in a position to repay the loan.

In summary, Justice McDougall found that given the improvidence of the mortgage and the fact that Kristine was really a guarantor of a loan that was provided to persons who borrowed more than the value of the property they purchased and who were discharged bankrupts, the plaintiffs should have not entered into the mortgage agreement with the Kristine and Rodney.

Was the contract unconscionable?

Justice McDougall found that it was unconscionable for the plaintiff to enforce the mortgage, and as Kristine did not benefit from the mortgage there was no need for her to comply with the equitable maxim: "he who seeks equity must do equity" by, for instance, paying all money owed under the mortgage to prevent the plaintiff exercising its legal right of sale.

In finding unconscionability, his Honour followed the decision of Elkofairi in which it was held that unconscionability will, of course, be determined on the facts of an individual case and that unconscionability can be made out notwithstanding that the party attempting to enforce the contract did not have knowledge of particular circumstances of the claimant that made the contract unconscionable.

His Honour found that it was unconscionable of the plaintiffs to rely on the accountant's certification of the ability of Kristine to repay the loan without conducting further analysis themselves.


It is incumbent upon mortgagees to have regard to the totality of a proposed mortgage agreement, especially the mortgagor's ability to repay the loan, regardless of the adequacy of the security for the loan.

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