In the recent Supreme Court of NSW case, Permanent Trustee Company Limited v O'Donnell [2009] NSWSC 902, the financial burden of a fraud on three mortgagors was passed on to their mortgagee. The mortgagors were able to avoid their obligations under their mortgage by utilising s7 of the Contracts Review Act 1980 (NSW).

The fraud involved a mortgage broker falsely recording income and asset details in loan application forms so that the mortgagors could obtain LoDoc mortgages to invest in a property development joint venture with the broker. Two of the three mortgages litigated were for approximately $500,000 each and the other was for approximately $400,000. The mortgagors' family homes were provided as security for each mortgage. The property development joint ventures were unsuccessful, with the fraud perpetrator taking all of the funds and the mortgagors having no interest in any development property.

In each case, the mortgagee was completely unaware of the fraud and the mortgagors admitted they were careless in signing blank or partially completed loan application forms.

Nevertheless, the court held that the mortgagees should bear the burden of the fraud. The three key factors in the court's decision were:

  1. the fraud perpetrator in its capacity as mortgage broker was appointed as the agent of the mortgagee;
  2. the loans were approved but without all relevant internal approval procedures and guidelines being followed; and
  3. the loans amounted to asset lending, as the mortgagors did not have the capacity to repay the loans.

In the circumstances, the court held that the mortgages were unjust and that relief should be granted to the mortgagors under s7 of the Contracts Review Act. The relief entailed the mortgages being declared void, which means that the mortgagees could not seek to enforce the mortgages to recover the funds loaned and that the mortgagees could not recover the funds loaned as a debt.

This case sends a clear warning to mortgagees to ensure that internal policies and procedures are followed in completing loan applications and to conduct due diligence into the character of any appointed mortgage broker.

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