Supreme Court ‘joint loans’ ruling clarifies duties facing banks

Mike Hawthorne, who specialises in financial services dispute resolution at Pinsent Masons, was commenting after the Supreme Court gave judgment (25-page / 322KB PDF) in the case of Waller-Edwards v Once Savings Bank Plc (Once Savings Bank) on Wednesday.

Catherine Waller-Edwards was left with unserviceable mortgage debts, a home she was prohibited from occupying and diminished savings after her relationship with her former partner, Nicholas Bishop, ended.

Waller-Edwards and Bishop had taken out a £440,000 joint debt secured on a property and told Once Savings Bank that the loan would be used for three purposes: to repay the existing debt on that property; to buy another property; and to repay £39,500 of Bishop’s personal debts. The loan fell into arears and Once Savings Bank sought to exercise its security over the property. Waller-Edwards defended the possession proceedings on the basis that she had been forced to enter into the loan by Bishop through undue influence, that the lender had notice of the risk of undue influence because some of the loan was being applied for Bishop’s benefit only, and that the security should not therefore be enforceable against her.

Three cases in the early 1990s and early 2000s established the “O’Brien” and “Etridge” principles. Where a couple takes out a secured loan and the lender knows that the loan will be used for the benefit of one borrower – typically, to fund a business run by that borrower only – there is a presumption that the loan has been procured by undue influence. In these circumstances the lender must ensure that the party who is not receiving the benefit of the loan receives independent legal advice on the terms and consequences of the transaction. If the affected party receives independent legal advice and decides to go ahead with the transaction, then the presumption of undue influence is rebutted, and the lender’s security is not at risk even if it later turns out that there was undue influence.

The policy consideration behind these cases was that the law needed to strike a balance between protecting vulnerable borrowers on the one hand, and on the other hand not creating obstacles to legitimate joint borrowing. None of the previous cases directly dealt with the scenario in which a joint loan secured on joint property is intended to be partly used for the benefit of both borrowers and partly used for benefit of one borrower only. Instead, they treated joint loans as falling into two categories: surety-type loans, where one borrower in effect stands as guarantor for the other for no personal benefit; and joint lending. In this case, Once Savings Bank took the view that the arrangements with Waller-Edward and Bishop constituted a joint loan because, apart from £39,500, the proceeds were said to be intended for joint purposes.

Previously in the case, the Court of Appeal held that loans can be surety-type even when the benefit of those loans is not wholly for one of the joint borrowers over the other. It held that, where the loan is used for hybrid purposes, the question of whether it is a surety-type transaction or joint loan is fact-dependent. That required an analysis of whether the loan is being made for the purposes of one borrower only as distinct from joint purposes. The Court of Appeal’s ruling left an open question about what degree of disparate benefit it would take for a joint loan not to be categorised as such but to rather constitute a surety-type transaction.

The Supreme Court rejected the Court of Appeal’s approach, which it considered would place lenders in difficulty because of the boundary issues in deciding if a loan was in substance a joint loan or surety-type transaction. Instead, it held that a non-commercial hybrid loan does raise a presumption of undue influence, unless the excess benefit to one borrower is de minimis. From the perspective of banks, the court’s ruling means non-commercial hybrid loans are therefore to be treated as surety-type transactions.

Lady Simler, who gave the leading judgment on behalf of the Supreme Court, said: “The existence of any exclusive benefit for one borrower (not being de minimis) moves the case out of the joint loan category and into the surety category, engaging the need for a bank to take the simple steps identified in the Etridge protocol. It satisfies the need … for simplicity of operation by the banks who are more likely to wish to play safe by issuing an Etridge protocol letter to remove possible risk, than to litigate about the need for one subsequently. This bright line approach should encourage banks to prevent future litigation by taking the modest, reasonable step of issuing Etridge protocol letters, rather than encouraging controversial or finely balanced judgments to be formed by underwriting staff about whether there is, or is not, an appearance of suretyship.”

Mike Hawthorne of Pinsent Masons said: “This decision will require lenders to identify joint loans where the purpose of the loan includes making money available for the use or benefit of one borrower only. In those cases, the other borrower should be asked to take independent legal advice. The lender will need confirmation from the lawyer who gave the advice in the same way that lenders already seek that confirmation for surety-type transactions and personal guarantees.”

“I would not recommend lenders to include the de minimis carve out in their processes because we do not have a percentage or other non-judgmental test for what de minimis means. If a borrower objects to paying for independent legal advice, then there could occasionally be cases where lenders want to consider whether the surety part of the transaction is de minimis in the interests of avoiding the need for independent advice, but the risk-free decision will be to insist on independent legal advice for all non-commercial hybrid loans,” he said.

Raam Hargun, also of Pinsent Masons, added: “Banks and lenders will need to be acutely aware of the risks involved with joint loans – such as in a transaction between a lender and a husband and wife – that involve an element of the loan being used to discharge one of the party’s debts. In this situation the joint security is at risk if one of the borrowers is exercising undue influence over the other. Lenders do not have to investigate whether there actually is undue influence. All they have to do for the purpose of taking effective security is identify the issue and ensure that the affected borrower receives independent legal advice.”