Court of Appeal confirms Banking Code obligation to exercise care skill and diligence
Doggett v Commonwealth Bank of Australia  VSCA 351
The decision of the Victorian Court of Appeal confirms that the Banking Code obligation to exercise care skill and diligence in assessing credit can (and will often) be incorporated as a contractual term into guarantees. This finding is likely to affect lenders’ risk assessments when considering ‘riskier’ loans
The appellants, Mr Doggett and Mr Sullivan, initially had a single loan facility with the Commonwealth Bank of Australia (’CBA’) for the purpose of buying investment properties on the Gold Coast. They incorporated the company (‘Dogvan’). The CBA extended a bill facility to Dogvan, supported by guarantees from both appellants.
The global financial crisis hit and created turmoil for the appellants’ financial situation. Dogvan defaulted under the bill facility and CBA eventually appointed receivers and managers.
In 2011 the CBA issued proceedings against both guarantors for recovery of more than $3,000,000. The guarantors brought a counter-claim to the effect that the Banking Code of Practice (‘Code’) subjected the CBA to a contractual obligation to exercise the care and skill of a diligent and prudent banker in assessing Dogvan’s loan application and forming an opinion about its ability to repay the loan (‘cl 25.1’). The Code obligation was argued to be incorporated into each guarantee.
The CBA conceded relevance in relation to Dogvan’s bill facility. In applying cl 25.1, the VSCA considered that as part of its credit assessment of a borrower’s ability to repay, it was natural and proper for the bank to consider the financial position of those standing behind or financing the entity (especially where a special purpose vehicle was concerned).
The guarantees both stated that “[r]elevant provisions of the Code of Banking Practice apply to this guarantee“. The VSCA noted that the drafting of the guarantees did not provide much guidance. The Court then conducted a survey of Code provisions applicable to guarantors and English and New South Welsh authorities. The VSCA agreed with the guarantors that cl 25.1 was a relevant provision and therefore formed part of each guarantee. At the fore of the VSCA’s reasoning was the fact that Dogvan’s failure to pay was “critical to the potential liability of the guarantor […]. This being the context in which the words of incorporation appear, provisions of the Code bearing on these transactions and obligations are properly seen as “relevant”.”
It followed from this finding that in respect of the guarantees and the Dogvan bill facility, the Bank’s obligation of prudence in cl 25.1 required the Bank to form an opinion as to whether Dogvan had the ability to repay from the resources available to it.
The Bank was found to have breached cl 25.1 but different views were expressed by the VSCA with respect to whether the breach caused the guarantors loss and damage, i.e. that the amount of their indebtedness as guarantors was a loss flowing from the Bank’s breach of cl 25.1.
To succeed, the guarantors needed to show that, had cl 25.1 not been breached, the Dogvan bill facility would not have been advanced; specifically that, had the Bank had realised that managers would need to be appointed to Dogvan, contrary to what was assumed in particular material it relied upon, it would have declined the loan.
Whelan JA and Garde AJA both agreed with the trial judge that the breach of the Code caused loss to Dogvan. McLeish JA held that it did not. However, all three Judges held that the appeal should be dismissed because a compromise letter released the Bank from a claim for a breach of cl 25.1 and the compromise was not tainted by duress.
While the case provides a clarification about the application of cl 25.1 of the Code to guarantees, it also provides an illustration of the difficulty of proving causation in complex circumstances, which may provide comfort to lenders who may be reassessing their lending procedures in light of this decision.
The decision provides a helpful analysis of the extent of the Code’s ‘relevance’ where the lender’s agreement is silent on the extent of the Code’s application (in this case to guarantees).