In Doggett v Commonwealth Bank of Australia [2015] VSCA 351 the Supreme Court of Victoria – Court of Appeal dismissed an appeal by a guarantor against the trial judge’s decision that a compromise letter between the CBA, the borrower company and the guarantor released their claims against the Bank for the breach of clause 25.1 of the Code of Banking Practice and that the guarantors’ agreement to the compromise was not vitiated by duress.

However the Court of Appeal agreed with the trial judge’s conclusions that clause 25.1 of the Code was a term of the guarantees, that in both the guarantees and the borrower’s bill facility clause 25.1 required the Bank to exercise the care and skill of a diligent and prudent banker in assessing and forming an opinion about the borrower’s ability to repay from the resources available to it, that the Bank breached clause 25.1.

The trial judge construed cl 25.1, operating as a term of the guarantees, as containing a promise to the guarantors as follows:

“25.1 Before we offer or give [the customer/Dogvan] a credit facility (or increase an existing credit facility), we will exercise the care and skill of a diligent and prudent banker in selecting and applying our credit assessment methods and in forming our opinion about [the customer’s/Dogvan’s] ability to repay it.”

The guarantors formed a company to buy the management rights of a Gold Coast apartment complex. The investment was unsuccessful because they had not budgeted for an on-site manager’s salary.

After extensive complaints by the guarantor’s about the Bank’s conduct the guarantors signed a letter compromising their claims against the Bank in return for the Bank making various payments and reducing charges and their financial obligations. But ultimately the borrower company defaulted in its loan. CBA sued the guarantors for the shortfall.

The trial judge concluded that, had an allowance been included for managers’ wages, the business was going to make losses from the commencement of the contract and that a prudent banker exercising diligence, skill and care would probably have formed the opinion that the borrower could not meet its payment obligations to the Bank from the cash flow of its proposed management rights business — and thus did not have the ability to service or repay the loan.

The trial judge therefore found that the Bank breached clause 25.1 of the Code of Banking Practice when it applied its credit assessment methods and formed its opinion that the borrower had the ability to repay the loan.

In the appeal the Bank challenged the finding of breach. It submitted that it made a proper assessment of the borrower’s ability to repay the bill facility having regard to the resources of both the borrower and the guarantors. The Court of Appeal rejected the Bank’s contention that it did not breach clause 25.1 of the Code, incorporated into the guarantees.

The Court of Appeal made the following analysis of the scope of clause 25.1:

“Clause 25.1 does not presuppose or require that a bank must form an opinion that a borrower will be able to repay the loan. Rather, cl 25.1 requires care in the formation of an opinion as to whether a borrower will be able to repay the loan. The bank may take due care in forming an opinion as to whether a borrower can repay a loan and decide that, although it is possible that the borrower may not be able to repay the loan, it will offer the loan in any event. That may be, for example, because additional resources can be obtained by the borrower before the loan proceeds or during its term. Or it may be because other financial resources, not immediately available to the borrower, would in the event of default be available to the bank (in particular by way of security or guarantee arrangements). There is nothing inconsistent with clause 25.1 in a bank discharging its obligation in that way. It is inherent in the assessment process that it may reveal the need for steps to be taken to ensure that the overall proposal is acceptable to the bank before the loan proceeds.

In other words, the failure of the Bank to exercise due care and skill, which the judge identified, went to the manner in which it applied its credit assessment methods and formed its opinion in evaluating Dogvan’s financial position, but not necessarily to the decision to advance the loan. Clause 25.1 is concerned with those processes and the forming of that opinion. It does not prescribe a precondition to the advancing of a loan, or the content of the opinion which must be formed before that is done, only the level of care and skill with which the exercise must be undertaken.

It therefore does not necessarily follow that, if the Bank had complied with clause 25.1, it would not have offered Dogvan the bill facility.”