Responsible lending case note: ASIC v Westpac

In the first contested decision on the specific obligations of responsible lending, in Australian Securities and Investments Commission v Westpac Banking Corporation (Liability Trial) [2019] FCA 1244 Justice Perram of the Federal Court dismissed ASIC’s claims that firstly Westpac’s computer-operated loan approval system failed to have regard to any of the living expenses declared by consumers on their loan application forms and secondly that Westpac’s loans having an initial interest only period before payment of principal was required contravened the National Credit Act. Background.

UPDATE: ASIC has appealed the decision.

UPDATE July 2020: ASIC’s appeal dismissed.

Although Westpac (and other lenders) have changed their assessment procedures since the period under review the decision makes important observations about the discretion lenders have in their assessment process and what is and is not, mandatory.

ASIC’s case focussed on the meaning of Section 131(2)(a) of the National Credit Act which deals with when a credit contract must be assessed as unsuitable.

Justice Perram rejected ASIC’s case on the facts. He found that Westpac did have regard to borrowers’ declared living expenses and therefore made a valid assessment.

He concluded that by means of its 70% Ratio Rule Westpac did take into account the consumer’s declared living expenses from Westpac’s Form PFI001 as part of a process leading to an answer to the section 131(2)(a) requirements.

The 70% Ratio Rule was triggered if a consumer’s declared living expenses, as recorded on the Form PFI001, exceeded 70% of their verified monthly income. Once triggered, an application was referred for manual processing by a credit officer.

In the course of the action, ASIC amended its claim to focus on the general obligation to assess unsuitability under the National Credit Act rather than to examine whether particular loans should have been assessed as unsuitable.

ASIC alleged that Westpac breached the Act for every one of the 261,987 Westpac-branded home loans it made in the period 12 December 2011 to March 2015 (after which it changed its procedures).

But ASIC did not allege that the alleged defects in the automated decision system (‘the ADS’) resulted in Westpac extending loans in the case of any of the 261,987 loans to any consumers who it ought to have found would be unable to meet their financial obligations under the credit contracts or who would be able to do so only in circumstances of substantial hardship.

Interpretation of Section 131(2)(a) of the National Credit Act
Justice Perram said:

“… so far as the consumer’s financial position is concerned, the Act requires a credit provider to ask itself only whether ‘the consumer will be unable to comply with the consumer’s financial obligations under the contract’ or, alternatively, whether the consumer ‘could only comply with substantial hardship’: s 131(2)(a)….
Whilst I accept that the Act requires a credit provider to ask the consumer about their financial situation (s 130(1)(b)) and, in turn, to ask itself—and to answer—the s 131(2)(a) Questions, I do not accept that this has the further consequence that the credit provider must use the consumer’s declared living expenses in doing so.
In fact, the Act is silent on how a credit provider is to answer the s 131(2)(a) Questions. Division 3 of the Act contains neither an express statement that a credit provider must use the consumer’s declared living expenses in doing so nor, in my opinion, can such a requirement be discerned from its terms as a matter of necessary intendment. “

ASIC argued that Westpac’s assessments did not comply because they did not follow 3 required steps:
1. in conducting an assessment under s 129 a credit provider must take account of information about the particular consumer’s financial situation obtained under s 130.
2. across the whole of its home loan approvals that were not referred for manual assessment for the period 12 December 2011 to March 2015 Westpac failed to take account of the consumer’s declared living expenses in purportedly assessing whether a credit contract was unsuitable and therefore failed to take into account information about each consumer’s financial position.
3. Westpac’s failure to take account of the consumer’s declared living expenses in purporting to carry out an assessment under s 129 meant that it had not carried out an assessment as required. It then followed that Westpac contravened s 128 which required it to conduct an assessment under s 129 before extending a loan to a consumer.

Justice Perram rejected each of those three steps.

In respect of ASIC’s First Step, Justice Perram said that section 129 does not say that a credit provider must take account of the consumer’s financial information obtained by it under s 130(1)(b) in performing an assessment under s 129.

“Rather, it says that the assessment must have two qualities. It must ‘specify’ the period to which it relates and it must ‘assess’ whether the credit contract ‘will be unsuitable for the consumer’. If a credit provider performs an assessment which does both of these things then it will have made an assessment in accordance with s 129.”

He agreed with ASIC that the inquiries required by s 130 must take place before the assessment is carried out and the only purpose for which these inquiries are made is for the purpose of carrying out the assessment.

He rejected ASIC’s arguments as to the nature of the assessment which is required and that declared living expenses are mandatory.

He said that the assessment is to be an assessment of whether the proposed credit contract would be unsuitable for the borrower:

“the mandatory matter which must be taken into account is the consumer’s financial situation viewed overall and not any particular integer of which it consists. Whether that financial situation has been taken into account and how it has been taken into account will therefore be a question of fact and degree…

“The only statutory purpose for which the information is collected is, in my opinion, to answer the s 131(2)(a) Questions (or, in a case where they were relevant, the s 131(2)(b) or (c) questions). They are precise questions: is it possible for the consumer to service the loan at all and, if it is, can it nevertheless only be serviced by the making of repayments which would put the consumer in circumstances of substantial hardship? I accept that, in principle, whatever must as a matter of necessity be considered to answer those two questions is a mandatory matter which a credit provider must take into account.”.

“I do not, however, accept ASIC’s contention that all of the financial circumstances of the consumer can be such a mandatory matter. Many of the consumer’s financial circumstances are not relevant to either question. For example, the fact that a consumer had superannuation could have no relevance to the s 131(2)(a) Questions of whether the consumer could in absolute terms afford the repayments; so too, the fact that the consumer takes an annual first class holiday to the United States is not relevant to assessing whether the repayments will put the consumer into circumstances of substantial hardship. Thus, the mandatory matters flowing from the terms of the s 131(2)(a) Questions cannot include as a single mandatory matter all of the financial circumstances of the consumer. And, because they do not include all of those circumstances, it cannot be said that this argument has the consequence that the subset of all of the financial circumstances of the consumer comprising the consumer’s declared living expenses must be a mandatory consideration either.”

“I am unable to discern why, as a matter of principle, the consumer’s declared living expenses must be considered in answering the s 131(2)(a) Questions. The first of those questions concerns the absolute ability of the consumer to make the repayments on the loan. This inquiry is only concerned with the consumer’s ability to service the loan and not with any issues as to whether doing so will put the consumer in circumstances of substantial hardship. I am unable to perceive why, in answering that question, one must know what the declared living expenses of the consumer are. ASIC’s submissions did not seek demonstrate why this might be so.”

The problem for ASIC’s argument is that the mere fact that there are living expenses is not necessarily relevant to whether a consumer will be unable to comply with their loan obligations because it is always possible that some of the living expenses might be foregone by the consumer in order to meet the repayments.

In fact, the only way that one or more declared living expenses can be shown to be necessarily relevant to the issue of whether the consumer can afford to make the repayments is by identifying some living expenses which simply cannot be foregone or reduced beyond a certain point. For example, everyone has to eat so there must be an amount for food which is the minimum which can conceivably be spent. But that minimum is an entirely different concept to the declared living expense of what the consumer actually spends on food. Indeed, knowing how much the consumer actually spends on food does not tell one anything about that conceptual minimum.”

“The situation is no better in relation to the second of the s 131(2)(a) Questions (i.e. whether the consumer, whilst able to afford the repayments, will not be able to do so without being placed in circumstances of substantial hardship). Largely the problem is the same as that described in the preceding paragraph although it is now more acute. Here the issue is not whether some or all of the declared living expenses can be done without but the even more complex question of whether, if done without, this would give rise to circumstances of substantial hardship. Again, one cannot say that as a matter of necessity this can be discerned from the declared living expenses by themselves. “.

“It follows that as a matter of analysis, declared living expenses by themselves do not necessarily have to be relevant to the s 131(2)(a) Questions. If they do not necessarily have to be relevant to the answering of those questions, one cannot say that s 129 requires that the declared living expenses be taken into account in performing an assessment of unsuitability. I therefore reject the first step in ASIC’s argument.

That conclusion is consistent with what seems to me a more likely operation for ss 128 and 129. To grasp this it is first necessary to know that Div 3 is very concerned to ensure that the assessment which the credit provider carries out is correct. The credit provider is obliged by s 129 to carry out an assessment of the suitability of the loan for the consumer (strictly, unsuitability) and is prohibited, on pain of civil penalty, by s 128 from entry into a credit contract unless it has performed such an assessment. ASIC’s argument effectively telescopes substantial obligations into ss 128 and 129 relating to how a credit provider goes about this process. But this appears to me to be pointless because of ss 131 and 133. Section 131 requires certain credit contracts to be assessed as unsuitable and s 133 prohibits entry by a credit provider into a credit contract which is unsuitable.

The policy of the statute that unsuitable loans should not be made is explicitly and directly given force by ss 131 and 133. Given that statutory fact, what purpose can be served by prescribing how a credit provider goes about the assessment process? Sections 131 and 133 make that the problem of the credit provider. A credit provider may do what it wants in the assessment process, so far as I can see; what it cannot do is make unsuitable loans. ASIC’s argument creates a whole new range of implied rules which appear altogether unnecessary in light of ss 131 and 133.

Justice Perram concluded that ASIC’s second step failed on the facts: Westpac did not fail to take into account the consumer’s declared living expenses. It took them into account in applying the 70% Ratio Rule as part of its process of assessment under the ADS in conjunction with other rules.

In respect of ASIC’s third step he concluded that even if Westpac had been obliged to take into account all declared living expenses (which it was not) and if it had failed to do so (which it did not), then it had not failed to carry out the assessment called for by s 129.

He said that the word ‘assessment’ as used in section 132 refers to the thing which results from the process of assessment.

The HEM benchmark
ASIC did not submit that s 129(b) prohibits a credit provider from using the HEM benchmark. It argued that because the HEM benchmark is not about a particular consumer or a particular credit contract, a credit provider who assessed a loan’s suitability based only on the HEM benchmark would not have carried out the assessment required by s 129(b). It argued that in using the HEM benchmark a lender must take into account the individual financial position of the consumer in doing so and that the HEM benchmark, by itself, will not satisfy that requirement.

ASIC’s case was that Westpac had not used the consumer’s declared living expenses and had, rather, relied solely on the HEM benchmark.

But Justice Perram found that Westpac did use the declared living expenses.

He did not decide whether the HEM benchmark was a good proxy for what substantial hardship might be. He said:

“Assuming … that the HEM benchmark is imperfect, this does not prevent me drawing the conclusion that Westpac understood the HEM benchmark to be a measure to assess hardship and that it used it in the ADS, in good faith, for that purpose.

I reject Westpac’s … submission that the use of the HEM benchmark did involve an assessment of the borrower’s actual expenses and accept instead its contention … that the use of the HEM benchmark is not an estimate of the borrower’s actual living expenses but ‘an estimate of the level of household expenditure that the consumer could reasonably be expected to spend to participate fully in society with a reasonable standard of living.’”

Initial interest only period loans
ASIC alleged that Westpac contravened the National Credit Act in respect of initial interest only period loans on 154,351 occasions across the same period as its first allegation (these loans are a subset of the 261,987 loans in ASIC’s primary case).

He said Westpac’s legal obligation was to ask and answer the s 131(2)(a) Questions. The fact that it did so as if the loan did not involve an initial interest only period did not mean that it did not ask and answer those questions.

ASIC did not allege that where Westpac calculated the monthly repayments on a variable interest rate loan using the rate prevailing at the inception of the loan that it infringed the Act if the interest rate subsequently shifted.

Justice Perram concluded:

“This part of ASIC’s case may be readily dispatched. What it submits is impossible. Because the interest is variable it is not possible to know what the repayments will be at the end of the only interest only period. In the case of these loans the choice is between assessing the monthly repayments as the repayments of interest due at the inception of the loan or doing as Westpac did which is to amortise the principal across the life of the loan on the assumption that the initial interest rate applies across the life of the loan. ASIC’s contentions about these loans can be rescued from incoherence only by adding an additional assumption that the repayments at the end of the initial period should be estimated at the initial interest rate. …

The burden of ASIC’s submission is that the repayments due at the end of the initial interest only period is a mandatory matter which must be taken into account in answering the s 131(2)(a) Questions. I do not see how that can be. As I have explained above, the consumer’s entire financial position is not a mandatory consideration for the purpose of answering the s 131(2)(a) Questions. One cannot reason therefore that the repayments due at the end of the interest only period is mandatory through the fact that they make up part of the consumer’s financial position.

What is in fact mandatory are those matters which must be known before the s 131(2)(a) Questions can be answered. Since the manner of answering those questions is not itself regulated by s 131 it may be difficult to identify such matters in advance although I would not at this stage exclude the possibility. But in any event it certainly cannot remotely be said that those questions cannot be answered without knowing the repayments which will be due at the end of the initial interest only period.

I am unable to discern how Div 3 can be construed in such a way that the numerical figures used in process of assessment can result in there having been no assessment at all. Indeed, ASIC accepted in its closing written submissions that it was not a contravention of s 128 ‘for a licensee to make a wrong assessment’ and this was because ‘s 128 is not about being right or wrong’. I would accept that an invalid assessment would result if a credit provider failed to ask itself the s 131(2)(a) Questions and asked itself some other question. But once it is accepted that Westpac did in fact ask itself the s 131(2)(a) Questions, how it went about answering those questions was, …, legitimately a matter for it. In that regard, ASIC’s position on its primary case (where it accepted that what the credit provider did with the information it gathered was a matter for it) was inconsistent with its secondary case about loans with initial interest only periods (where it said that the credit provider has to calculate the repayments in a particular way). “

Where to now?
ASIC may appeal the decision but the judge’s findings on the facts may preclude that.

A class action continues against Westpac on behalf of persons who entered into unsuitable loans secured by residential property with Westpac from January 2011 and who have suffered, or are likely to, suffer loss.

ASIC is still consulting on changes to its Regulatory Guide 209 but RG 209 is only guidance, not the law.

ASIC may request the Government to amend the National Credit Act. But that may create further uncertainty.

The Financial Services Royal Commission Final Report when discussing benchmarks noted that ASIC v Westpac was in process and said that “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.” (page 57, violume 1).

But there is nothing in the decision that suggests there is a deficiency in the law. Justice Perram decided that ASIC’s interpretation of the law was wrong in this case.

AFCA may still take a different view of a matter based on its fairness approach.

What is clear is that lenders need to satisfy themselves that their assessments meet the minimum statutory requirements as interpreted by Justice Perram.

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