Complying With the New Code of Banking Practice: The Next Chapter

Article by Mr John McKenna and Ms Sylvia van der Heyden.

The new Code released by the Australian Bankers Association on 1 August 2003 replaces and extensively revises the existing Code of Banking Practice 1993. Although banks may choose whether to subscribe to the new Code, most banks are expected to publicly adopt the new Code over the coming months.

The new Code applies to:

• all financial products or services provided by a bank in Australia for any purpose to an actual or potential customer who is an individual or small business at the time the financial product or service is provided
• certain guarantors who are individuals at the time the guarantee is taken and whose guarantee secures any financial product or service provided by a bank in Australia to any individual or small business customer for any purpose.

A customer will still have the benefit of the new Code when acquiring a bank's financial product or service through an intermediary. A bank will also need to comply with its new Code obligations concerning the distribution and supply of products when selling products provided by other parts of its corporate group or by other organisations.

In determining whether a business can take the benefit of the new Code, a bank will need to put procedures in place so that it can determine whether the business customer is in fact a small business. The draft version of the new Code picked up the definition of 'small business' in the Corporations Act. Small business was therefore defined to mean a business employing fewer than 100 full-time employees (if the business included the manufacture of goods), or in any other case, fewer than 20 full-time employees.

The recently released new Code, however, amends the concept of small business in two ways. First, the definition now speaks in terms of 'people' rather than 'employees'. Contractors and consultants working for the business customer are now to be included when determining the head count for the purposes of the definition. Second, if the banking service acquired by a business is ultimately to be provided for use in connection with a large business, then the business acquiring the banking service will not be categorised as a 'small business'. This means that a banking service, such as a credit facility that is acquired by a small business that is a special purpose financing vehicle for on-lending within a larger group, will not take the benefit of the new Code, as the service is in reality being provided to the broader corporate group.

Banks will also need to determine whether an individual customer can take the benefit of the new Code. Where the individual is applying for or acquiring a financial product or service that is not governed by Chapter 7 of the Corporations Act, the customer will have the benefit of the new Code. However, where the financial product or service is governed by Chapter 7 of the Corporations Act, an individual will only take the benefit of the new Code if he or she is also a 'retail client' under that Act. This means that some people (for example, a high net worth individual, whose assets or income take them out of the scope of the retail client protection under the Corporations Act) will not have the protection of the Code where they open a deposit account (a financial product that is regulated by Chapter 7), but will have the protection of the new Code when signing up for a new credit card product (a financial product that is not caught by Chapter 7).

The situation may also become more complicated where a small business acquires a banking service that is a financial product or financial service for the purposes of Chapter 7 of the Corporations Act. In these circumstances, the definition of 'small business' in the Corporations Act will apply, rather than the amended definition in the new Code. So, for example, when a bank determines whether a business is entitled to the protection of the Code in relation to a credit card or overdraft facility, then it must apply the narrower definition of small business set out in the new Code (which determines whether a business is a small business by looking at the number of people working at the business and not just the number of people employed by the business), but when deciding whether the same business has the protection under the new Code when acquiring a term deposit product, the broader definition of small business in the Corporations Act will be the relevant test to apply.

A bank will need to determine the extent to which it wishes to precisely identify customers who will take the benefit of the Code. It will be better to put identification systems in place that err on the side of caution and give individuals and businesses the benefit of the Code unless they can be clearly identified as falling outside its scope.

Banks need to train their staff and authorised representatives in a number of aspects under the new Code. For example, staff must be trained to ensure that they can competently and efficiently discharge their functions when providing banking services, and have an adequate knowledge of the provisions of the new Code. They must also be able to explain the contents of brochures and other written information about banking services and provide advice or referrals to customers and potential customers.

While the training obligations under the financial services reform (FSR) provisions of the Corporations Act should pick up a large part of the training requirements under the new Code, all training programs will need to cover off issues that are not caught by FSR training, such as knowledge of the requirements of the new Code itself and those financial products and services that are covered by the new Code but that are not caught by the Corporations Act, such as loan products and guarantees.

While the new Code does not specifically require that intermediaries be trained, to the extent that an intermediary undertakes an obligation of the bank under the new Code, the intermediary will also need to be trained to ensure that they understand the new Code's requirements. For example, intermediaries should understand those banking products that they are selling and be able to explain these products to actual and potential customers. Otherwise, the bank may be liable for any loss suffered by a customer where the new Code's provisions are breached by the intermediary.

Myriad information must be provided by the bank to the potential guarantor prior to a guarantee being taken. This information includes documentation relating to the credit facility to be guaranteed, and any current credit related insurance contract, as well as documents concerning the debtor's financial position.

The obligation to provide this information and documentations will not apply where a guarantee is to be taken to support a commercial asset financing facility provided to a company where the guarantor is a director of that company, or where the guarantee is given by a sole director of a company that is being provided with the facility being guaranteed.

The recently released new Code amends a number of the provisions relating to the giving of information and documentation to potential guarantors. For example, the obligation on a bank to provide notices of demand on the debtor or notice of any excess or overdrawing under any facility that the debtor has or had with the bank will now not commence until 1 June 2004. Amendments have also been made to the new Code to give banks greater time to get their systems in place to collate relevant information to be provided to a potential guarantor.

Part 3A of the Privacy Act states that a credit provider can only disclose a report relating to an actual or potential debtor's creditworthiness to a potential guarantor with the debtor's specific consent. This means that banks cannot take a guarantee falling under the new Code's protection unless the debtor has expressly consented to the bank providing their relevant personal information to the guarantor.

The Credit Reporting Code of Conduct includes a sample consent form to be signed by an actual or potential debtor, allowing the credit provider to disclose a report containing consumer credit information to a potential guarantor in accordance with the Privacy Act. Banks may wish to extend this consent to cover any information required to be disclosed under the new Code and ensure that it is completed by the debtor before any personal information is provided to a guarantor.

The new Code states that a future credit contract offered to a debtor under an existing guarantee will not be covered by that guarantee unless:

• it is within a limit previously agreed to by the guarantor and the notice of the guarantor's right to limit liability, given to the guarantor before the guarantee was taken, included a prominent statement that the guarantee could cover a future credit contract, or
• the guarantor has been provided with a copy of the future credit contract and the bank has subsequently obtained the guarantor's written acceptance of the extension of the guarantee.

It is important to note that where the guarantee is covered by the provisions of the Uniform Consumer Credit Code (UCCC), only the latter of these options will be available to the bank.

Where there is no future credit contract, but an increase to a credit limit under an existing credit contract, the guarantor would not appear to be given any additional protection by the new Code. The new Code provisions outlined above relate specifically to future credit contracts and not to amendments to an existing credit contract. However, guarantees will be limited to a specific amount or the value of specified property and guarantors still have a general right to limit their liability under a guarantee that is governed by the new Code. If the guarantor has the protection of the UCCC, any increase in the guarantor's liabilities under the terms of an existing credit contract will also need to comply with the provisions of section 56 of the UCCC.

While the 1993 Code provisions will continue to apply to a guarantee subject to that Code, from the time that a bank adopts the new Code, a guarantor:

• will be able to limit the amount of guaranteed liabilities in accordance with the new Code
• will be able to withdraw from his or her guarantee before credit is first provided to the debtor
• will not be liable under the guarantee in relation to indebtedness under a future credit contract unless the provisions of the new Code are complied with.

By this stage, banks should have reviewed documentation, procedures, computer systems, policies and staff training to ensure that all guarantees and all other documents that fall within the scope of the new Code have been identified and captured by the bank's processes and procedures, pro-forma bank documentation is modified going forward and that all relevant guarantors will receive the necessary information concerning the debtor's financial position.

Banks will need to ensure that all staff, authorised representatives and intermediaries taking guarantees are trained to provide the correct documentation to potential guarantors and ensure that guarantees are validly and correctly signed in accordance with the new Code's provisions.

A bank cannot accept a co-debtor under a credit facility if it is clear on the facts known to the bank that the debtor will not receive any direct benefit under the facility. It is not clear what a direct benefit would include. Although a joint debtor receiving a life tenancy in relation to a property purchased by the other debtor, but financed under a joint home loan would probably qualify as a direct benefit, signing up a co-debtor to a home loan whose name does not appear on title as a co-owner should probably be structured as a guarantee.

Although banks are not under any specific obligation to ensure that a co-debtor will receive a direct benefit by entering into the credit contract, as a result of the general overriding obligation of a bank to act fairly and reasonably and in an ethical manner, banks will probably need to make some basic enquiries of a potential co-debtor as to the direct benefit the co-debtor will receive by entering into the loan contract. It may not be sufficient for a bank to 'close its eyes' and not investigate whether any direct benefit will actually be obtained by a co-debtor.

It will be important for banks to ensure that mortgage originators are trained to properly assess whether a co-debtor is receiving a direct benefit under a credit facility, or else put procedures in place to ensure that banks can make this decision themselves.

Banks must also take reasonable steps to ensure that potential co-debtors understand that they may be liable for the full amount of the debt. It will probably be sufficient for a bank to explain this consequences of these provisions in plain English, rather than requiring that co-debtors receive independent legal advice in relation to their liabilities.

The Code Compliance Monitoring Committee (CCMC) will monitor compliance under the new Code. There is a possibility of being named in a CCMC report in connection with serious, systematic or other behaviour demonstrating that the bank does not take its obligations under the new Code seriously. A bank subscribing to the new Code will need to monitor and address breaches and ensure that systems are in place so that dealings with the CCMC are give priority.

As any written terms and conditions of a banking service must include a statement that the new Code applies to that service, a customer has an action for breach of contract if the bank fails to comply with the new Code. The new Code also states that banks must comply with all relevant laws relating to banking services, giving a customer another action for breach of contract if the bank fails to comply with such a law. For example, a bank disclosing information concerning a debtor's financial situation to a potential guarantor without gaining the debtor's prior consent as required by the Privacy Act will be liable to the debtor for breach of contract.

The Australian Banking Industry Ombudsman (ABIO) has indicated that the new Code will assist in determining whether a financial institution has followed good banking practice in a customer dispute situation. This means that a bank that subscribes to the ABIO scheme could be effectively bound by the new Code, even without making a public announcement that the new Code will apply to it.

The new Code has been approved by the Australian Securities and Investments Commission (ASIC) under the Corporations Act. Although ASIC will not be able to take direct legal action against a bank unless a relevant law is breached, ASIC will be able to monitor compliance with the new Code and use its influence in a breach situation by generating adverse publicity. ASIC has also indicated that, in the light of financial services reform, approved Codes such as the new Code have a role to play in establishing best practice standards in areas not directly covered by the Corporations Act.