Federal Court dismisses ASIC’s test case against Westpac on Responsible Lending
In early August 2019, Justice Perram of the Federal Court dealt ASIC a significant blow by dismissing its case that Westpac had breached responsible lending laws.
In some ways, the decision was not a surprise. It was clear that ASIC might strike obstacles when, in late 2018, Justice Perram refused to accept a $35 million civil penalty settlement struck by the parties. His reasons were simple: amongst all the legal speak in the proposed settlement, no actual breach of the law was articulated.
This forced the parties into a contested hearing which has now resulted in the most significant decision since the National Consumer Credit Protection Act 2009 was enacted. The much-needed judicial guidance this decision brings extends beyond banks and home loans. It applies to all types of credit providers and intermediaries that conduct unsuitability assessments for consumer loans.
What did ASIC allege that Westpac breached?
Before considering the reasons for the Court’s decision, it’s worth remembering what ASIC alleged Westpac had breached.
When ASIC commenced proceedings in March 2017, its case centred on Westpac not complying with the responsible lending laws because of the way its computer operated loan approval system operated.
In relation to Westpac’s principal and interest home loans, this computer system assessed the suitability of loans by relying on the Household Expenditure Measure for expenses rather than the borrower’s declared living expenses.
When it came to Westpac’s interest-only loans, this computer system assessed the suitability of loans on the basis that the loans were principal and interest loans for the duration of the entire loan and thus, did not have regard to (higher) repayments required at the end of the interest-only period.
By relying on its computer operated loan approval system in the above way, ASIC alleged that Westpac had failed to conduct an unsuitability assessment in compliance with the law for the almost 262,000 loans it had approved using this system.
What did the Court decide?
The Court dismissed ASIC’s case both on the facts and on the law. This meant that not only did ASIC fail to prove its case, the Court also rejected ASIC’s interpretation of the responsible lending requirements.
Case dismissed on the facts
The finding that ASIC failed on the facts means that ASIC failed to prove its central allegation – that Westpac did not take into account the borrower’s declared living expenses when assessing whether a loan was unsuitable.
Instead, the Court found that Westpac’s computer operated loan approval system (a system of over 200 rules) did take into account a borrower’s declared living expenses. Specifically, Westpac’s 70 Per Cent Ratio Rule took these expenses into account.
In Westpac’s computer operated loan approval system, the 70 per cent Ratio Rule was a rule that was triggered when a borrower’s declared living expenses exceeded 70 per cent of their verified income.
Because of the risk of borrowers defaulting when living expenses were greater than 70 per cent of income, Westpac required the application to be manually assessed.
ASIC argued that Westpac’s 70 Per Cent Ratio Rule assessed a borrower’s credit risk which was not the same as assessing whether a borrower could service the loan. It said that, because the responsible lending laws distinguished between these risks, merely assessing credit risk was not sufficient to comply with these laws.
The Court rejected this argument and accepted that a rule whose purpose is to gauge the risk of default can also be a rule about a borrower’s ability to meet their financial obligations under the loan.
Case dismissed on the law
Most critically for ASIC is that the Court also rejected ASIC’s interpretation about what the obligation to make an unsuitability assessment requires.
ASIC alleged that the proper interpretation of this obligation requires a credit provider to base its assessment on information about a borrower’s financial situation which it has gathered through enquiries and which it has verified. This includes a borrower’s declared living expenses.
The Court rejected this interpretation on the basis that it “telescopes substantial obligations” into how a credit provider goes about assessing unsuitability which “appear altogether unnecessary”. Instead, it found that “a credit provider may do what it wants in the assessment process.” What it cannot do is make unsuitable loans.
Justice Perram’s rejection of ASIC’s approach was based on the premise that knowing what a person actually spends (that is, their declared living expenses) tells one nothing about a borrower’s capacity to meet repayments under the loan or doing so without causing substantial hardship. This is because it conveys nothing about the expenses a borrower is willing to forgo to be able to make those repayments.
So, while ASIC’s interpretation centred on actual household expenditure as a way to measure whether servicing the loan would cause substantial hardship, the Court suggested that such an approach was potentially “quite misconceived”. This is because, while the information may tell us that a borrower will have to “trim their sails”, there is arguably a conceptual gulf between trimming one’s sails and poverty.
In relation to Westpac interest-only loans, the Court also rejected ASIC’s approach that lenders are required to assess repayments at the end of the interest-only period. The Court held that such repayments are not mandatory considerations when assessing unsuitability.
What did the Court say about HEM?
Despite ASIC’s case originally hinging on Westpac’s use of the HEM instead of relying on a borrower’s declared living expenses, the Court ultimately did not need to decide whether such an approach was lawful. This is because ASIC’s case ultimately turned on whether Westpac had used borrowers’ declared living expenses when conducting unsuitability assessments. Whether the bank used the HEM was irrelevant to this question.
So, while the Court did not need to consider the extent to which the HEM can be relied on to assess unsuitability, it did observe that (despite its limitations) the benchmark attempts to assess hardship.
As the case did not turn on this aspect, these comments by the Court are not binding on other Courts. However, they are still of interest to other Courts and give an indication of how Courts are likely to view the HEM in future.
Implications of the Court’s decision
While we wait to see whether ASIC will appeal the decision, there are some important implications we can draw.
Firstly, not all of a borrower’s declared living expenses must be taken into account when assessing unsuitability. However, some of these expenses may be relevant to the extent that they identify expenses that cannot be forgone or reduced.
Secondly, while the HEM is an attempt to assess when a borrower may experience hardship, it is not necessarily a good proxy for what substantial hardship might be for a borrower.
Finally, and most importantly, while the law leaves it to credit providers (and credit assistance providers) to determine what steps they take and what information they consider when assessing unsuitability, their written procedures should demonstrate how their processes ensure that loan repayments can be met without causing substantial hardship.
Where to next?
ASIC may appeal the case. (See update below.)
It may also consider the comment made by Commissioner Hayne in the Final Report of the Royal Commission:
“If the court processes were to reveal some deficiency in the law’s requirements to make reasonable inquiries about, and verify, the consumer’s financial situation, amending legislation to fill in that gap should be enacted as soon as reasonably practicable.”
In other words, ASIC might choose to lobby the Government to amend the law in this area.
ASIC has since filed an appeal with the Full Federal Court of Australia against the decision of Justice Perram. A Court hearing date is yet to be determined.
For more insights into this case, you can watch our webinar which was recorded not long after the judgment was released.
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Author: Jesse Vermiglio (Partner)