Low-doc loan declared unjust

In Permanent Mortgages Pty Ltd v Michael Robert Cook and Karen Cook [2006]  NSWSC 1104 the NSW Supreme Court declared a loan contract and mortgage unjust, following the decision in Khoshaba.

The borrowers (defendants) executed a mortgage over their home. They were substantially in arrears and the mortgagee (plaintiff) sought possession.

The following quotes set out the distinguishing features of the case:

"78 The public interest is one of the
matters that the court must have regard to under s70. On this issue
over the objection of the Plaintiff, I admitted evidence by Dr Steve
Keen, Associate Professor of Economics and Finance at the University of
Western Sydney.

79 After reviewing the Defendants’
borrowings, for reasons which he gave in a lengthy and detailed report,
he categorised the subject mortgage as evidencing a “Ponzi” loan,
namely one which “can only be repaid by either taking out a larger
subsequent loan, or by selling the asset that was financed using the
loan”. He also described it as a “low doc” loan, that is one where
borrowers self verify their income in the application process. He said
that such loans are:

          “designed mainly for the self-employed
          or those with irregular income who do not have the documentation
          required to obtain a conventional housing loan.”

80 As to the public interest involved in “low doc” and “Ponzi” loans, Professor Keen said:

          “(a) Standard home loans are limited
          in size by the need for the borrower to establish that he/she can repay
          the loan out of income.

          (b) Legitimate “Low “Doc Loans” are a
          necessary development of income-based loans i

          (c) Ponzi Loans are loans that can
          only be repaid by either taking out a larger subsequent loan, or by
          selling the asset that was financed using the loan.

          (d) Ponzi Lending can occur in Low Doc
          Loans because the loosening of income-verification standards enables
          loans to substantially exceed the size that could be met out of
          borrower’s actual income.

          (e) The Subject Loan to the Cooks was a Ponzi Loan.


          (g) Were the practice of Ponzi Lending
          to become widespread, it would substantially increase the tendency of
          the Australian financial system to asset bubbles and subsequent
          financial crises, by:

              i accelerating the accumulation of excessive debt during the up-swing to an asset bubble;

              ii accelerating the rate of decline during the bursting of the bubble; and

          iii causing the recovery to take much longer.

          (h) Ponzi Loans thus have adverse economic consequences that extend well beyond the immediate parties to the loan agreement.


    85 Against any public interest in
    discouraging loans of the type identified by Professor Keen and Mr
    Carraill, there is, of course, a public interest in the enforcement of
    contractual obligations freely entered into. In the result, I do not
    regard the public interest as of much significance in resolving this
    case. Rather, I think the greater focus should be upon factors personal
    to the Defendants, or more directly concerned with the particular

    88 Whether I should hold the mortgage
    unjust in this case involves a balancing exercise. On the one hand are
    the circumstances that the Defendants speak English as their first
    language; were experienced borrowers; had the services of a solicitor;
    were extremely anxious to obtain the loan; and were prepared to sign
    false statements and procure false certificates. On the other hand, the
    beneficial nature of the Code indicates that it was intended to protect
    the unsophisticated and meagrely educated, such as the Defendants, from
    their own foolishness. Given the means of the Defendants and their
    credit history, the Plaintiff, in my view, was aware, or would have
    been aware, had it made the most perfunctory of enquiries, that the
    Defendants were not capable of servicing the loan even at the lower
    rate of interest and could only satisfy their obligations by selling
    the mortgaged property for a sum sufficient to cover the principal and
    interest. It was likely that they would thus become obligated to pay
    interest on the amount of the credit, not at 8.8% p.a., but at the much
    higher rate of 13.8%….

    92 Undoubtedly, the Defendants were
    foolish but, in my opinion, the circumstances of this case constitute
    the “something more” contemplated by Basten JA [in Khoshaba], in that the Plaintiff
    or its agents who were, or should have been, aware of the foolishness
    had, in effect, encouraged it. I am of the opinion that the subject
    mortgage and the credit contract, pursuant to which it was given,
    should be held to be unjust within s70 of the Code."

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