This week's TGIF considers whether banks owe
guarantors a duty to exercise the care and skill of a diligent and
prudent banker in selecting and applying their credit assessment
methods and forming an opinion about a customer's ability to
In the decision of Doggett & Anor v Commonwealth Bank of
Australia  VSCA 351, the Victorian Court of Appeal
confirmed that provisions of the Banking Code of Practice (the
Code) may be incorporated into guarantees and a
bank, in discharging its obligations under the Code, is required to
take into account the ability of a borrower to repay from the
resources available to it.
The appellants, Mr Doggett and Mr Sullivan, were guarantors for
their company under a commercial loan agreement with the respondent
(the Bank). Following the global financial crisis,
the company defaulted on its loan repayments and the Bank appointed
receivers. After the sale of the secured assets, the Bank commenced
proceedings against the guarantors to recoup a shortfall owing
under the loan.
At trial, the guarantors alleged that the Bank owed them a
contractual obligation to exercise the care and skill of a diligent
and prudent banker in assessing the company's loan application
and forming an opinion about its ability to repay the loan and that
the Bank had breached that obligation. That obligation was said to
arise by virtue of clause 25.1 of the Code, which was incorporated
into the appellants' guarantee by reference.
At first instance, the Court found that clause 25.1 of the Code
applied to the guarantee and that the Bank had failed to exercise
the care and skill of a diligent and prudent banker when assessing
the company's ability to repay the loan. This failure was
attributed to mistakes made by the Bank when applying its credit
risk analysis. For instance, the Bank officer had failed to take
into account the cost of additional wages for an on site
The Court found that, had the Bank not breached the Code, the
Loan application would likely have been refused and the guarantee
would not have been given. Accordingly, the appellants were
entitled to be put in the position they would have been in had
clause 25.1 not been breached.
However, the Court also held that a compromise letter defeated
the guarantor's claims pursuant to clause 25 of the Code and
ultimately found in favour of the Bank. The Court of Appeal agreed
that the letter of compromise extinguished the claims.
THE DUTY TO EXERCISE THE CARE AND SKILL OF A DILIGENT AND
In dismissing the appeal, the Court of Appeal helpfully
clarified the scope of the duty to exercise the care and skill of a
diligent and prudent banker.
The Court of Appeal found that, when forming an opinion about a
customer's ability to repay the loan:
clause 25.1 of the Code does not presuppose or require that a
bank must form an opinion that a borrower will be able to repay the
rather, clause 25.1 requires care in the formation of an
opinion as to whether a borrower will be able to repay the
The Court of Appeal explained that "a bank may take due
care in forming an opinion as to whether a borrower can repay a
loan and decide that, although it is possible that the borrower may
not be able to repay the loan, it will offer the loan in any event.
That may be, for example, because additional resources can be
obtained by the borrower before the loan proceeds or during its
term. Or it may be because other financial resources, not
immediately available to the borrower, would in the event of
default be available to the bank (in particular by way of security
or guarantee arrangements)" [para 163].
Ultimately, the failure of the Bank to exercise due care and
skill went to the manner in which it applied its credit assessment
methods and formed its opinion in evaluating the company's
financial position, but not necessarily to the decision to advance
the loan. Clause 25.1 of the Code is concerned with the processes
and forming the opinion.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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