The typical Australian banker’s obsession with bricks and mortar and distrust of cash-flow have been the bane of small business borrowers for decades.
However, as a recent court case shows, the obsession with property as collateral can sometimes cloud a banker’s judgement and lead to severe consequences for the borrower, as a striking court ruling has demonstrated.
Anthony Bellairs and Alan Pike are small business owners who learnt the hard way that a bank determined to protect itself from default can abuse its power and then blame the customer for any subsequent default.
Bellairs and Pike borrowed $535,000 from Suncorp-Metway to purchase a business called Valleyview Nursery on the NSW north coast near Lismore for $675,000.
The buyers told the bank they needed an interest-only loan for five years, and this was included in their loan application.
In assessing the loan application, a Suncorp credit officer assessed the cashflow from the nursery, but stipulated that the valuation of the property be “land and buildings”.
At no stage before obtaining finance were Bellairs and Pike told that the valuation would be confined to land and buildings and no reliance placed on the nursery business or any of the associated fittings and fixtures.
The bank proceeded to calculate the security by excluding the nursery business, which led to a shortfall in security. To remedy this, the bank jacked up the monthly repayments to include principal and interest. The loan-to-value ratio was 72%.
This sudden change in conditions naturally caused Bellairs and Pike concern. They thought they would be unable to meet the principal repayments and that the effect on their cashflow would cripple the business.
But Bellairs told the NSW Supreme Court he had no choice but to proceed because he had already exchanged contracts and would forfeit the deposit. But he was an optimist and hoped he could survive the additional interest charges.
Bellairs and Pike were never told that the valuation shortfall was, in part at least, because the land was valued without the business.
The loan was made on 21 October 2003 and the first three automatic debits were dishonoured because of cashflow problems in the business. The dishonours caused the interest rate to jump from 2% over the bank bill rate to 3%.
Nevertheless, in the first year of the loan, Bellairs and Pike repaid $70,756 in principal and interest and in the second year of the loan they repaid $24,000. However, they were hit with a series of fees related to dishonouring cheques and automatic deductions.
If the loan had been interest only, Bellairs and Pike would have paid all interest owed plus some principal. At the end of two years no more than the original loan of $535,000 would have been owed to the bank.
When Pike tried to refinance the loan through the Commonwealth Bank in 2005 he needed an extra $11,654. He asked Suncorp for approval to put this on a Visa card but the bank refused. As a result Pike did not sell his shares in the business and the CBA refinancing did not occur.
Judge Stephen Rothman of the NSW Supreme Court found that Suncorp imposed conditions on the borrowers that were impossible to fulfil.
The terms of the loan agreement were dramatically different to the original offer of finance, which was for an interest-only loan. This change was not negotiated and Rothman said this reflected the material inequality of the relative bargaining power of Suncorp.
Suncorp knew that the exclusion of the $100,000 value of the business from the security valuation meant that a key condition it had set in its second offer of finance could not be satisfied.
Rothman found that the change in payment terms from interest-only to principal and interest was not reasonably necessary to protect Suncorp’s position.
The bottom line is that the contract was found to be unjust because of its terms and circumstances in which it was made.
The judge ordered that the defendants be compensated for additional cost or burden caused. All higher rates of interest or penalty interest payments must be remitted to Bellairs and Pike from the inception of the loan to 9 March 2009.
All fees and charges imposed for non-compliance with the loan conditions must be excluded from any money owed by Bellairs and Pike.
Suncorp will still get possession of the property, but that will be delayed for six months to give the owners a chance to refinance it or sell it.
Court victories against banks in favour of the man in the street provide a rare opportunity to gain insights into how easy it is to get bushwhacked by a banker. This case is no exception.
The broader issue is the unequal power relationship between a borrower and a banker. Suncorp-Metway v Bellairs and Pike shows how easy it is for a bank to abuse that power.
Suncorp is probably no worse than any other bank. In fact, the latest financial accounts would show that its credit protection measures failed horribly at the big end of town. It failed to use its power where it counted.
There is anecdotal evidence that the obsession with holding property as security is as strong as it ever was. There is plenty of evidence that the current tough economic conditions have been used as an excuse to tighten lending standards.
The Reserve Bank’s latest review of the financial system, which included industry liaison, found that banks are increasing their risk margins and strengthening non-price conditions such as collateral requirements and loan covenants. The RBA said this was more pronounced for larger-value loans than for smaller business loans.
As a small business borrower, all you can hope is that the financial institution you choose adheres to ethical values and abides by principles of fairness.
This article first appeared on Business Spectator
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