Lender Beware: The importance of mandating Independent Legal Advice requirements on individual guarantors

Written by: Lily Chang Jiang

Lenders often require individual guarantors to obtain Independent Legal Advice. However, the importance of Independent Legal Advice is seldom explored and a mere request for an individual guarantor to obtain independent legal advice which fails the requirements of the law could cause significant issues to the validity of a loan facility.

What is Independent Legal Advice?

Independent Legal Advice is provided by a qualified and independent third-party solicitor who does not act for the lender or the borrower and is not a beneficiary of the transaction. The advising solicitor acts in the sole interest of the individual guarantor receiving the advice.

Provision of Independent Legal Advice generally involves the advising solicitor setting out the risks and obligations involved with entering into the transaction as a guarantor to the individual. Once Independent Legal Advice is provided, the advising solicitor will usually provide (or at the request of the lender) a certificate of Independent Legal Advice which satisfies the requirements of the applicable state laws. For example, in NSW, the advising solicitor will provide a Schedule 2 Declaration as prescribed by rule 11 of the Legal Profession Uniform Legal Practice (Solicitors) Rules 2015 (NSW). However, a lender must not require the advising solicitor to provide evidence on the provision of independent legal advice to the individual guarantor.

Why require Independent Legal Advice?

Whilst it is not a legal requirement for guarantors to obtain Independent Legal Advice, there are strict legislative and common law requirements which places the burden of proof on the lender if the validity of the guarantee (or guarantee and indemnity) is being challenged. This may include arguments on the basis of:

1. capacity of the guarantor;
2. undue influence; and
3. unconscionable conduct.

Capacity

It is essential that lenders satisfy itself that the individual has the capacity to enter into the guarantee and the loan transaction. An individual guarantor must have the capacity to legally bind him or herself to the transaction and is capable of understanding the nature of the contractual obligations under the loan facility documents or a standalone guarantee.

For example, an individual who is under 18 years of age or has a mental disorder would be considered incapable of entering into a contract and as such the validity of the transaction is void. While the party relying on an incapacity argument generally bears the burden of proof, the lender may utilise a certificate of Independent Legal Advice to rebut the grounds of incapacity.

Undue Influence

Unlike the argument on capacity above, the Lender bears the burden of proof if the validity of the loan is challenged on the basis of undue influence. As per the case of Allcard v Skinner [1886-90] All ER Rep 90, the equitable doctrine of undue influence aims to protect individuals from the use of dominance by the benefiting party to force the individual to enter into contractual obligations which he or she may not have otherwise entered into but for the close personal relationship between the parties.

Lenders should be alerted if the guarantor and the borrower holds a close personal relationship such as spouse, immediate family member or where one party holds significant trust and confidence in the benefiting party. Incorporating compulsory Independent Legal Advice requirements on an individual guarantor may be an effective mean of minimising challenges on validity of the transaction in this regard.

Unconscionable Conduct

The lender may be challenged for engaging in an unconscionable dealing or involved in unconscionable conduct when requesting the individual to be a guarantor under a loan. Unconscionable conduct is a legal doctrine whereby the stronger party exerts its power to make the transaction unfair and exploits the weaker party by persuading it to enter into the transaction.

In the case of Greentown Bellambi Pty Ltd v Wong [2017] NSWSC 872, the individual guarantor, Mrs Wong, argued that the lender had been involved in unconscionable conduct because the lender requested for her to be a guarantor to the loan for which her husband, Mr Wong, was a party to. The individual guarantor claimed that the lender insisted for her to provide a guarantee despite her explanation that she holds no asset. The guarantor also held that the lender said that a guarantee was required from her because there was a risk that assets could be transferred from her husband into her name.

However, in the case above, the guarantor’s claim on unconscionable conduct did not succeed because the lender was held to have taken “adequate steps” to satisfy itself that the obligations under the guarantee was effectively explained to the individual guarantor. The lender was able to provide evidence that it had insisted on Independent Legal Advice be obtained by the guarantor and set out this requirement clearly in writing numerous times via email and in the settlement deed.

Accordingly, when placing Independent Legal Advice requirements on individual guarantors, lenders should seek to set clear instructions and take all steps required to mandate the individual to perform this mandatory condition in accordance with the relevant laws prior to the advance of a loan.

What about Variations to an Existing Loan?

Existing loan facilities may be varied by the parties because of changes to the circumstances or financial needs of the parties from when the loan was first entered into. A lender may feel that a variation to the existing loan will not trigger a need for an individual guarantor to obtain Independent Legal Advice on the variation – especially if Independent Legal Advice was obtained at the initial advance.

The Ankar principle from Ankar Pty Ltd & Arnick Holdings Ltd v National Westminster Finance (Australia) Ltd (1987) 70 ALR 641 sets out that where the variation is substantial and capable of prejudicing the individual guarantor, the individual guarantor will be released from its obligations if he or she has not consented to the variation expressly in writing. However, even if an individual guarantor signs the variation or agrees to the variation in written form, the validity of the variation remains open to challenge if Independent Legal Advice was not satisfactorily obtained for reasons set out above. Lenders may face the risk of involuntarily releasing a guarantor from its obligations if it is unable to support the claim that the variation was duly entered into in accordance with the legal requirements.

Where possible, lenders should ensure that the requirement of Independent Legal Advice be incorporated as a precondition to the facility and be satisfied by each individual guarantor prior to the loan advance.

Further Information

If you would like advice on your obligations as a lender in relation to Independent Legal Advice, please get in touch with JHK Legal on 02 8239 9600 or book an appointment through our website Contact.