Australia: Bank's breach of the Code of Banking Practice made its guarantees unenforceable

A recent Court of Appeal decision provides a firm reminder to the banking industry that the obligations in the Code of Banking Practice impose strict legal obligations that lenders must adhere to in dealings with guarantors.

In National Australia Bank Ltd v John Albert Rose [2016] VSCA 169, the Victorian Court of Appeal dismissed an appeal by the National Australia Bank (NAB), ruling that the bank had breached the Code in the course of taking guarantees from its customer, Mr Rose.

Original Court decision

In the court decision that was appealed by NAB, Mr Rose successfully avoided liability under five separate guarantees for some $6 million as a result of NAB's failure to give a 'prominent notice' under clause 28.4 (now clause 31.4(a)) of the Code.

Clause 31.4(a) provides that, before a bank takes a guarantee, it must give the potential guarantor a prominent notice outlining that:

  • they should seek independent legal and financial advice on the effect of the guarantee;
  • they can refuse to enter into the guarantee;
  • there are financial risks involved;
  • they have a right to limit their liability in accordance with the Code and as allowed by law; and
  • they can request information about the transaction or facility to be guaranteed, including any facility that is being refinanced.

In Rose, the guarantee documents were only given to the guarantor for the first time at a meeting with NAB's bank manager when the documents were signed. At this meeting the bank manager did not properly explain the effect or financial risks of any of the guarantees, never told Mr Rose to obtain independent legal advice and did not inform him that he could refuse to sign the guarantees (or at least limit his level of liability).

It was accepted by the Court that, if Mr Rose had been made aware of his guarantee obligations and potential liability, he would have never have signed the documents.

For more information on the facts of the case and the original court decision, see here.

Appeal decision

The Court of Appeal upheld the original court decision. Both parties had a poor recollection and limited documentation regarding the meeting in which Mr Rose signed the guarantees. As a result, the Court focused on the matrix of circumstances that surrounded the meeting that suggested that a prominent notice had not been given. These circumstances included:

  • the short time in which the meeting took place (15-30 minutes);
  • the volume of material that needed to be perused and considered in that short time;
  • the guarantee was only one document in each set of multiple documents and the written warning as to the nature and effect of the guarantee was only a small part of those documents;
  • the summary of the guarantees given by the bank manager was incomplete;
  • the documents were not given to Mr Rose to consider before the meeting or provided for overnight review before signing; and
  • the bank manager was aware that Mr Rose had not had a chance to read the documents before he signed them.

As a consequence, the Court of Appeal decided that NAB failed to give a sufficiently prominent notice to Mr Rose before he signed the guarantees.

Further, it was held that, although no direct link could be drawn between the breach of the Code and the loss incurred by Mr Rose, NAB's breach did lead to his misunderstanding of the effect of the guarantees.

Critically, if Mr Rose had been made aware of his guarantee obligations and potential liability, he would not have signed the documents. As a consequence the guarantees were unenforceable.

Comment

The Code imposes strict legal obligations that banks must closely observe.

There is a danger in bank representatives witnessing the execution of guarantees and having loose procedures regarding the explanations and warnings to be given to a proposed guarantor to comply with the Code.

Banks should review their standard practices to make sure that each requirement imposed by the Code is carefully followed.

However a bank's internal documents, such as a record of interview or checklist, may be of little assistance to the bank if there are gaps or errors in the document or if they are inconsistent with what actually occurred.

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