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Jenni Millbank and Jenny Lovric[*]
Third party guarantees are undertaken when a credit provider will not lend money, or will not extend a loan, unless the loan is secured by a guarantee provided by a person other than the borrower. This third person may not be involved in, or benefit from, the loan transaction itself. Numerous major recent reports have referred to the problem of relationship debt as concern about guarantee transactions has grown. This article outlines the major findings of the first comprehensive Australian empirical research into the practice of third party guarantees.[1] The legal and regulatory framework is discussed elsewhere.[2]
In the early 1990s Belinda Fehlberg conducted the first empirical research into the issue of third party guarantees, undertaking a small-scale qualititative study in the United Kingdom.[3] A major theme that emerged was that the guarantors felt they had no real choice about providing security for the borrower's debt. Reasons ranged from emotional pressure to threats and physical violence, and Fehlberg noted that economic dependence on the borrower was a key aspect in constraining the guarantors' choice. We were particularly interested to see whether the Australian experience was similar and whether Fehlberg's key findings would be repeated in a larger and more broadly recruited sample.
The research was undertaken by researchers from the University of Sydney in conjunction with the New South Wales Law Reform Commission between 2000 and 2003. This project sought both qualitative and quantitative data from guarantors, lenders, solicitors, barristers and judges. The data collected from guarantors and their advisers was compared with data collated from court judgments (including those in published reports and unreported cases available through Internet sources) to determine whether there was significant variation between the demographics and experiences of litigants and non-litigants.
We found that the vast majority of third party guarantees are undertaken to support small business borrowing, primarily by family businesses. When we examined business loans specifically, we found that guarantors were typically supporting the borrowing of a business over which they had little control. Thirty-eight per cent of guarantors surveyed had 'no role' in the business whose loans they guaranteed; another 9% had 'no formal role' in the business. A further 20% of our guaran.tor respondents were 'silent' directors. Only 16% were active directors of the business whose loan they had guaranteed. The data reveals that the largest group of guarantors were women with no formal role in the business for which they provided a guarantee, according with Fehlberg's study where half of the guarantors described themselves as having no role in the business for which they secured a loan.
The survey of guarantors revealed almost two-thirds of those who guaranteed loans were women.
This research did not explicitly seek guarantors who had signed guarantees in the context of close personal relationships. The results revealed that family members signed the vast majority of guarantees: mostly spouses, or parents of borrowers.
According to the guarantor survey, 83% of guarantors were in a close personal relationship with the borrower. Of these, 39% of loans were guaranteed by a partner or spouse of the primary borrower; 26% were parents who had signed as a guarantor for their adult child, and 18% had signed for another relative. The review of litigated cases and data from solicitors and barristers revealed very similar results.
When the relationship figures are broken down by gender it was clear that women principally undertake guarantees as the wives or de facto partners of male borrowers. Very few men guarantee the debts of a spouse. Those men who were guarantors typically guaranteed the loan of an adult child.
The respondents to the guarantor survey were generally older, with 65% of respondents over the age of 50, suggesting that older people are disproportionately represented in problematic third party guarantee transactions. Commentators have noted that older people are particularly liable to be asked to guarantee adult children's debts because they often possess valuable security in the form of an unencumbered residential home.
Around 40% of our guarantor survey respondents were born outside Australia - double the level of overseas-born residents in the general Australian population. Twenty per cent spoke a language other than English as their first language. This proportion was reflected in the other data collected. The majority of these respondents indicated that their spoken English was weak or fair, while half reported their understanding of written English was weak.
Significantly, solicitors reported that the last time they gave advice to a guarantor prior to signing the guarantee, only 5% of such clients were from a non-English speaking background. This suggests that guarantors from non-English speaking backgrounds are not receiving advice prior to signing guarantees: a time where advice is critical.
Some women who act as guarantors for the business enterprise of their husbands are influenced in their decision-making by their economic dependence, particularly where they primarily perform unpaid work and the spouse performs more or better paid work. While we did not ask guarantors whether they were economically dependent on the borrower, or whether the borrower controlled family finances, it was clear from several responses, discussed below, that this was the case. Almost one-third of respondents to the guarantor survey reported that they signed because the borrower made the financial decisions in their relationship and they did as they were told. A further 17% reported that they were partners and it seemed right to share -of these the great majority were women.
The factors below reflect the categories of reasons for entering the transaction, which respondents were invited to choose between. While focusing on these specific responses, we do not mean to suggest that structural inequalities are not present. Indeed, they inform many of the comments made by guarantors.
My role was a housewife. I had to trust my husband and I did. I trusted my husband and the bank officer to do the right thing.
The decision to enter into a guarantee to secure a family member's loan is undertaken without any assessment of risk. Three-quarters of guarantor respondents reported one of the reasons they signed the guarantee was because they trusted the borrower. Many guarantors reported that they wouldn't think of openly questioning the request to act as guarantor because this would indicate a lack of trust.
Optimism about the borrower's ability to repay the debt is often informed by the desire to help another family member get ahead, a high degree of trust or a desire to affirm a developing relationship. In our survey of guarantors the respondents were not asked specifically whether they were optimistic about the transaction. However, 44% said they did not think signing involved any serious risk and the same portion thought the transaction was for the family's financial benefit. Eighty-two per cent reported that when they found out there was a problem with the debt, it came as a big shock for them.
I felt I was in a trap. I felt I had no choice. Finally I reluctantly agreed to provide a mortgage to secure the loan.
Over one-third of respondents said they did not feel that they had a choice about signing; of these the great majority of these were women.
The absence of choice must be broken down to better understand what people meant when they say they didn't feel they had a choice. Sometimes it meant that they were under pressure or duress to sign, including threats of physical violence. Sometimes it referred to an overbearing sense of obligation, and the fear that the relationship would be irreparably damaged if they refused.
In some instances, there was no option but to sign if the guarantor wished to remain in the relationship. One barrister commented:
For the sake of domestic harmony there is usually irresistible pressure on the guaranteeing spouse to sign.
Dependency, vulnerability and absence of real choice do not always fall into the neat legal category of 'undue influence', nor do they necessarily fall within the parameters of unconscionability. Several respondents felt that they were under an emotional or moral obligation to help family or repay assistance from other family members. Many parents who assisted their children with loans did so out of a sense of moral obligation. Comments included:
It was for my daughter and I would do anything for my children. We are family. It is the right thing to do for your family.
The issue of choice was also connected to pressure and threats of violence. Vulnerability to pressure was implicit in many of the responses from guarantors in our surveys.
I was too scared not to sign- he'd leave or kill me.
In Fehlberg's UK study, she found that pressure ranged from actual physical violence to more subtle forms of emotional pressure. Our observations were consistent with these findings; many guarantors reported they signed because of pressure of various kinds.
Guarantors reported substantial emotional pressure.
I felt embarrassed and foolish. I was on my own at the time and probably vulnerable trying to do things on my own. Very emotionally drained, under pressure from the other person who harassed me for a further guarantee for funds. I felt bullied.
My husband and I worked our whole life ... my husband died and almost immediately my son began pestering me for a loan ... my son was putting highly intense pressure on me ...
Guarantors also reported harassment or direct threats.
I had one week to sign but I was hassled every day. Even the neighbours knew what was going on we were yelling so much. What could I do? I had 2 small children and he'd leave if I didn’t sign.
I was really harassed. Fearful of physical threats, and !lost sight of perspective. He [the borrower] was aggro -out of control.
Of 16 respondents who reported that they were 'too scared not to sign', 14 were women. Several women but only one man reported threats, harassment or pressure to sign.
Cultural factors concerning the way people perceive their role and responsibilities within their community and family are significant. Previous reports have identified cultural attitudes and immigration as further complications in guarantee transactions.[4] Cultural obligations and responsibilities mean that a guarantor may feel obliged to provide assistance to family members and community members.
These issues were clearly borne out in responses from guarantors. For example, Mr V, a 74-year old pensioner with a university education in Vietnam, reported that he mortgaged his home to assist his son-in-law develop a shopping centre. When the son-in-law did not make his repayments, the bank claimed possession of Mr V's home. The son-in-law had sponsored Mr V to Australia many years ago. Because of this Mr V felt 'indebted to him and felt obliged to help him' to repay this 'debt' of sponsorship. Even though the son-in-law subsequently left his daughter and became a successful businessman, Mr V said that he would do the same again 'because of the family situation and especially the sponsoring'.
Our research confirmed earlier findings that many guarantors sign without understanding the nature of the transaction. Guarantors experience both factual and legal misunderstandings as a result of misrepresentations, failure to read or understand the documents, lack of competent legal and financial advice, lack of business experience and different cultural expectations.
The litigated cases and survey results point to an alarming level of guarantor misunderstanding about many elements of the transaction. In many cases there appeared to be a fundamental misunderstanding about the way a mortgage operates. Consumer advocates consulted expressed the view that there is a low level of understanding about basic concepts such as liability (joint, several or secondary) in the general community and that some people do not understand what a guarantee is. There is also confusion about the obligations of co-guarantors.
The research found that no simple line that could be drawn between understanding and misunderstanding the transaction; rather there was a wide range of misunderstandings, assumptions, deceptions and half mistakes that formed a continuum of error. Such errors cover a range of issues: the period of liability, the amount of the potential liability, the actual role in the transaction (being guarantor or borrower) and whether the loan was secured. Many believed that they were signing a guarantee for a limited period of time.
We found that guarantee documentation is very poorly understood by guarantors. Guarantors surveyed were asked whether they understood or could read the documents that they signed and 27% of respondents stated that they could not. Problems identified by guarantors include the use of legal jargon and small print in contract documents and the large volume of paper.
Throughout our consultations and surveys, guarantors expressed a need for better documentation and more information. Over half of respondents said that more written and spoken information would have assisted them when they signed the guarantee.
Provisions commonly known as 'All Moneys' or 'All Accounts' clauses are used in mortgage and guarantee documents to extend the liability of a guarantor to future advances by the lender to the borrower. They are open ended and complex and their construction may depend on reading several documents, such as a personal guarantee and a mortgage document, together. The 'All Moneys' clause is often in the memorandum of common provisions; a separate document to the mortgage and the guarantee, also executed by a guarantor. Such clauses are a major concern because guarantors may not be aware when they enter a transaction that they are guaranteeing all money owed presently and all money loaned in the future.
Lenders report that such clauses are rarely used, but project data revealed a disturbing number of guarantees for unlimited amounts. Eighteen per cent of guarantors reported guaranteeing an unlimited or indefinite amount of money. Furthermore, 27% of guarantors reported they discovered they had given a mortgage over their home containing an 'All Moneys' clause only after problems arose. Our review of litigated cases found that over half involved an 'All Moneys' mortgage.
It appears that guarantors who receive legal advice may be more, rather than less, likely to be entering such transactions. Nearly half of solicitors and over 80% of barristers reported that on the last occasion they advised a guarantor the documents contained an 'All Moneys' clause.
Guarantors often had little or no knowledge of the financial situation of the business or the person borrowing the money prior to signing, and received inadequate information from the lender about the debt after signing. Few people obtained a copy of the documents they signed, or a copy of the borrower's contract. It is as if the borrower takes the money and 'disappears'.
Third party guarantors are rarely in the position of a business partner who has an understanding of the business prospects and risks. Of respondents who guaranteed a business loan, nearly half had little or no knowledge of the financial situation of the business when the loan was taken out. Likewise, 43% reported little or no knowledge of the borrower's personal financial situation.
Many respondents reported that they were presented with documentation in a transaction in which their only role was understood to be signing. This had a clear impact on several issues discussed below, including whether the guarantor had time to consider the contract, ability to negotiate the terms of the contract, or the opportunity to receive independent advice.
Our research indicates that it is fairly common for mortgage and guarantee documents to be signed in relatively informal surroundings such as the family home. Twenty-two per cent of survey respondents signed the security documents at home. One guarantor said she signed the documents in her garage, while the 'witness' had signed the document prior to her signature. In one instance, a guarantee was signed in hospital, and in another 'at the greengrocer's down the road from the bank'.
Despite the inherent risks associated with presence of the borrower when the documents are signed, the data indicates that the borrower was frequently present when the guarantor signed. Forty-seven per cent of survey respondents stated the borrower was present when they signed. Twenty-three per cent of guarantors reported that both the borrower and the lender were present. Similarly, our review of litigated cases revealed that the borrower was often present at the crucial time. In 60% of cases the borrower and others (such as the lender, or another guarantor) were present while in 14% of the cases the borrower alone was present with the guarantor at the time of signing.
The broker just put reams of paper in front of me and said sign here etc, it was all done in a hurry.
Our data indicates that many people enter guarantor transactions in a hurry and with little or poor preparation. One guarantor stated that she signed a guarantee for her husband after being taken to the bank by him without prior notice or discussion. As she did not expect to sign any papers, she did not have her glasses with her and could not read the documents.
We found strong guarantor support for the introduction of a cooling off period to allow time to reconsider guarantee transactions before they take effect. Fifty-two per cent of respondents said that a cooling off period would have helped them.
The presence of legal advice is one factor listed in the Contracts Review Act 1980 (NSW) as a consideration in determining whether a contract is unfair. Recommending independent legal advice may relieve a lender of responsibility for unfairness under the High Court decision Garcia v National Australia Bank.[5] It is commonly thought that many lenders now insist that guarantors obtain independent legal advice. Our research indicates that many guarantors do not obtain independent legal advice and that when it was given it was often of very limited utility.
Most guarantors who responded to our survey, and many of those in our review of the litigated cases, did not receive any legal advice prior to entering the transaction. Only 14% of the surveyed guarantors reported that they obtained independent legal advice. In only 29% of the litigated cases had the guarantor obtained legal advice prior to signing. Our survey data revealed that those from non-English speaking backgrounds were particularly unlikely to receive independent legal advice. Disturbingly, only 20% of guarantors reported that anyone -including the lender - suggested that they obtain independent legal advice.
Of guarantors who had received legal advice prior to signing, many were of the view that it had not greatly assisted them. There was little opportunity for guarantors to reflect on the advice received; of the 10 guarantors in our survey who received advice and could recall when they signed the contract, five reported that they signed the same day, while another two signed within two days.
In two instances, our guarantors reported advice that was openly partisan to the borrower. In one, only the 'positive' aspects of the loan were explained, while in another the lawyer pressured the guarantor to sign during the interview by saying that if they didn't sign quickly the loan would be reduced and the project would falter. In these instances, and one additional case, the lawyer was also acting for the borrower.
Some guarantors indicated that the advice was perfunctory, with one guarantor noting that it took less than 15 minutes. Another guarantor reported that the documents were only partly explained. Only one guarantor reported that the advice clarified their thoughts on the document. This was consistent with Fehlberg's finding that solicitors restricted themselves to a brief explanation of the effects of the document, and did not offer advice in the sense of indicating whether consenting to the transaction was wise or improvident. As a consequence guarantors did not feel adequately advised. Fehlberg argues that the term 'independent legal advice' as it is understood in legal regulation of guarantees is a misnomer; she states that 'basic explanation' is a more accurate description of what takes place in practice.
The independence of legal advice may be affected by the solicitor's or the guarantor's perception of their role if their advice has been arranged by the lender, if they are acting for another party in the transaction, or if they provide advice in the presence of other parties to the transaction.
Of the 11 guarantors from our survey who had received legal advice, three reported that they were advised by solicitors acting for the borrower, and one by a solicitor acting for the lender. The independence and utility of legal advice may also be compromised if the guarantor does not meet with the solicitor alone. While the majority of solicitors we surveyed reported to us that on the last occasion they gave advice, only the guarantor was present, this may not be an accurate representation. While we did not specifically ask guarantors whether anyone else was present when they received legal advice, of 11 guarantors who had received advice, it was clear in four cases that the borrower had been present.
It appears that further attention and deeper analysis needs to be directed to the provision and utility of independent legal advice.
There was a high level of dissatisfaction with legal processes from guarantors. This was reflected in the responses of solicitors and barristers, regardless of whether they acted for guarantors or lenders. While a range of common law and statutory remedies may be available to guarantors who seek to challenge the enforcement of a guarantee, these remedies are discretionary and open to a range of interpretation by the courts. Our research confirms that there is a lack of uniformity in the decided cases and that litigation in this area is expensive and complex. Delay and the high costs of litigation and enforcement of guarantees emerged as issues of concern.
Many lawyers and judges expressed the view that litigation was expensive, complex and inefficient for the resolution of guarantee disputes and expressed a preference for more accessible dispute resolution mechanisms such as mediation, industry resolution or tribunal processes. Yet the few such processes in existence -such as the Australian Banking Industry Ombudsman or the Consumer, Trader and Tenancy Tribunal -were very little used.
We found strong support for increased involvement by lower cost tribunals in cases involving third party guarantees to overcome problems associated with the high cost of litigation, but this is clearly not possible under the current jurisdictional restrictions.
The objectives of law and policy reform in this area involve a tension between the need to protect guarantors, secure finance for small business, and provide some measure of certainty in procedure, practice and outcome for borrowers, guarantors, lenders and legal advisers.
Implications of this research are divided into two areas: first, pre-transaction conduct, and second, dispute resolution after a guarantee is disputed.
Our research indicates that women, elderly people and those from non-English speaking backgrounds are disproportionately affected by third party guarantees. This highlights the need to consider these groups as the prime demographic of guarantors, and to specifically target them in any reform or education measures.
Many guarantors surveyed were in positions of vulnerability, either because of their emotional connection with the borrower or because of structural factors, suggesting significant issues of power imbalance in guarantor/borrower and guarantor/lender relationships that may not be resolved by the provision of more or better information.
While women are mostly involved as guarantors of their male partner's borrowing, the smaller number of men who are involved as guarantors tend to be the parent of the primary borrower. Women and men noted many of the same reasons for entering into the transaction, such as trust and optimism, but there were very marked differences in key areas. Women were far more likely to report that they entered the guarantee because they were pressured, scared or felt that they had no choice. Women also appear far more likely to be economically dependent upon the borrower, constraining their choices. Men and women's experiences of guarantee transactions appear to be quite different, and any reform and education measures need to be careful to identify guarantor needs and experiences by gender.
Guarantors often sign in situations where they have little information or are misinformed about key aspects of the transaction. Guarantors rarely have any information about the borrower's loan or about the health of the business they are supporting and so are unable to assess the risk they are taking. Such information is essential for an informed choice about the transaction.
Guarantee documentation is lengthy, complex and on occasion incomprehensible even to the legally trained. While plain language documentation may not prevent guarantors from entering into improvident transactions, it would, like the provision of other information and advice, assist in giving an opportunity for some real choice.
The inclusion of 'All Moneys' clauses in guarantee transactions persists. Such clauses enhance the likelihood that guarantors will be placed in an ill-informed and disadvantaged position in the guarantee process.
It appears disturbingly common that guarantee transactions are carried out in informal surroundings and/or in the presence of the borrower. It was common for our surveyed guarantors to have little time to consider the terms of the agreement. The guarantee transactions almost always took place in the absence of adequate legal or financial advice. These factors contributed to guarantors' poor understanding of their obligations and deprived them of an opportunity to exercise informed choice.
These findings contradict what is understood as good practice-and commonly assumed to be typical practice in this area. Good lender practice, as set out in lenders' own policy manuals, requires guarantors to sign at the lender's premises in formal circumstances, in the absence of the borrower and following the receipt of independent legal advice.
These findings suggest that more attention must be given to compliance with good practice in the taking of guarantees at both an industry and regulatory level. If self-regulation is ineffective, increased regulation should be considered.
There is a sharp disparity between what courts, lenders and policy-makers understand to be the scope and content of independent legal advice and what is delivered in practice. 'Independent legal advice' is in practice merely a 'basic explanation' of the content of legal documents.
These findings have serious implications in terms of the development of guarantor protections, which until now, have contained a heavy focus on independent legal advice as a cure for unfair dealing, a source of information or empowerment for the guarantor, and as a protection against lender liability. While legal advice may protect a lender from an action to set aside the transaction, the advice currently provided does not appear to offer the guarantor adequate information about the loan, advice on the transaction, or empowerment to refuse or renegotiate its terms.
The pre-transaction conduct in obtaining guarantees remains largely unregulated and shows little evidence of what either the finance industry or consumer advocates would regard as best, or even adequate, practice. There appears to be a need for clear and consistent standards of conduct across the entire lender industry.
If there is any dispute over the guarantee transaction, the available avenues for redress are inadequate. Informal and accessible dispute resolution mechanisms that currently exist are very limited in their operation and utility. Litigation, with its associated expense and complexity, still remains the principal focus of dispute resolution in this area.
Litigation is complex, protracted, expensive and often poorly conducted. Litigation is fiercely and desperately fought in many matters, and may often add considerably to the final costs even when settlement is achieved.
Existing legal principles are too uncertain in their application for any predictability. Greater certainty would reduce litigation and provide both lenders and guarantors with a better sense of what conduct and factors will render a transaction unenforceable.
While many matters settle in negotiation between lawyers, there are very few structured avenues of accessible or informal dispute resolution in this area.
The existing industry and tribunal level dispute resolution processes that do exist are very little used. This under-use results from jurisdictional limits: monetary limits on the value of the dispute and limited application to 'consumer' rather than 'business' transactions. As many guarantees are secured by residential properties and undertaken to support small business borrowing, the jurisdictional limits render these processes virtually useless.
There is a clear need for a relatively even playing field in which disputed transactions can be heard and adjudicated, in addition to avenues for mediated or negotiated settlements.
Despite protections such as the Consumer Credit Code (since 1996) and voluntary self-regulation mechanisms such as the widely adopted Code of Banking Practice (1993), guarantors continue to enter into transactions with a very poor understanding of their obligations. Lenders also continue to provide funds supported by guarantees when neither the borrower nor the guarantor has the capacity to repay. The pre-transaction conduct appears largely unregulated and shows little evidence of best, or even adequate, practice.
Some of the problematic areas may be assisted by new provisions in the Code of Banking Practice. From August 2003 the Code of Banking Practice has broader coverage and enhanced guarantor protections. The Code now covers guarantees for small business transactions in addition to consumer transactions, and has enhanced requirements for the provision of pre-transaction information to guarantors. However the Code will continue to be a voluntary source of regulation so it remains to be seen what impact it will have upon the pre-transaction conduct of bank lenders.
Although many steps have been taken to improve policy and best practice in this area, our research demonstrates that much remains to be done at all levels: legal regulation, self-regulation, professional practice in both finance and legal arenas, and in dispute resolution.
[*] Jenni Mil/bank teaches law at the University of Sydney. Jenny Lovric is Project Officer at the National Pro Bono Resource Centre.
Thanks to Tiffany Hambley for her research assistance and to the reviewer of this journal for their invaluable comments.
email (Lovric): jenny@nationalprobono.org.au
© 2003 Jenni Millbank and Jenny Lovric (text)
© 2003 John Lynch (cartoon)
[1] A copy of the full length report (Research Report 11) can be found on the website of the New South Wales Law Reform Commission <http://www.lawlinknsw.gov.au/> .
[2] See Reg Graycar, Robyn Johansson and Jenny Lovric, 'Guaranteeing Someone Else's Debts' (2001) 12 Journal of Banking and Finance Law and Practice 181; New South Wales Law Reform Commission, Guaranteeing Someone Else s Debts (Issues Paper 17, 2000) <http:// www.lawlink.nsw.gov.au/lrc.nsf/pages/ip I7toc> .
[3] Belinda Fehlberg, Sexually Transmitted Debt: Surety Experience and English Law (1997).
[4] Commonwealth Attorney-General, Expert Group on Family Financial Vulnerability, Good Relations, High Risks-Financial Transactions Within Families and Between Friends (1996); Australian Law Reform Commission, Multiculturalism and the Law, Report 57 (1992).
[5] Garcia v National Australia Bank (1998) I94 CLR 395.
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