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Finance & Banking Update -  July 2003

In this issue: Read about the latest developments in the world of banking and finance.

Cases

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All moneys clause — rectification, mistake (Iarriccio v Lai Investments Pty Ltd [2003] SASC 54) Supreme Court of South Australia Full Court
Mind your p's and q's in correspondence regarding mortgage. Some all moneys clauses given judicial liposuction by rectification to reflect "common intention", others left alone to have wide effect.

Background

A vendor provided the purchaser company with vendor financing. The purchaser company also entered into two leases with the vendor for the lease of goods and of land. As security for vendor finance, the purchaser company granted two mortgages, a deed of charge and a deed of guarantee securing "the moneys hereby secured" widely defined.

When the vendor finance was repaid, vendor discharged the two mortgages.

The vendor subsequently claimed that the mortgages were discharged by mistake and that the mortgages, the charge and the guarantee should secure all moneys owed by the purchaser company, which included the leases. The purchaser company disputed the claim of mistake and counter-claimed rectification.

First Instance Decision

At first instance the vendor's claim that the discharge of the mortgage was a mistake was dismissed. In regard to the counter-claim, it was found that the mortgages and the guarantee were not intended by the parties to secure any other payments apart from the loan amount. However, the charge was not thought through by the parties and in the absence of cogent evidence to indicate a specific understanding as to the charge, the charge secured all money including debts under the lease. It was ordered that the mortgages and the guarantee only be rectified. Both parties appealed.

Appeal

They both lost. The Full bench of the Supreme Court dismissed both appeals. The definition of "monies hereby secured" in the mortgages, the guarantee and the charge were discussed and it was held that the clause could be considered an "all moneys" clause and would secure all present and future debts of a debtor. However, in cases where contrary intentions of the parties can be shown, the unintended parts of an "all moneys" clause can be deleted and the relevant instrument rectified to reflect the true intentions of the parties. In this case, the circumstances leading up to the signing of the mortgages, the guarantee and the charge did not show that the requisite contrary intention existed.

For more, see a copy of the case.

Mortgages — Mortgagee Duties — Accounting for Proceeds of Sale — Allocation of Proceeds of Joint Sale — No Agreement of Common Mortgagor (Commonwealth Bank of Australia v Duggan [2003] FCAFC 64) Full Federal Court

Adjoining Point Piper waterfront properties sold in "one line" by mortgagees with pre-agreed split of sales proceeds. Mortgagee still obliged to account for sales proceeds despite agreed split.

Background

The mortgagor company gave separate mortgages to a bank and a financier over adjoined properties; a freehold property and a leased property respectively. When the mortgagor became bankrupt, a sales agreement was created by the mortgagees regarding how the proceeds of sale would be distributed. The sales agreement stated that the properties would be sold in "one-line" and the proceeds split at a ratio of 60:40 in favour of the bank. This left the mortgagor still indebted to the bank by a substantial amount. A bankrupt guarantor of the mortgagor's debt to the bank (who also guaranteed the debt to the finance company) claimed that the bank owed him and the mortgagor a duty not to act recklessly in selling the property. At first instance the court held the proceeds should have been split 82.5:17.5.

A mortgagee exercising a power of sale owes the same equitable duty to a surety as to a mortgagor. Hence, where such a duty is breached the mortgagor may rely on that breach as a defence to a claim by the mortgagee. The mortgagee also holds a duty to the mortgagor under s 420A of the Corporations Act. Section 423(1)(b) allows a person (like the guarantor) to complain to the court and for the court to make orders. The result is that the mortgagor's liability is reduced to the extent that the value of the security has been diminished.

Appeal

The guarantor won. The Full Federal Court dismissed the appeal.

The sales agreement did not constitute an agreement as to the respective real values of the properties and led to the bank not accounting for the true proceeds of sale. It did not matter that the sales agreement was entered into in good faith.

The entry into a joint sales agreement for the property to be sold in "one-line" did not of itself breach the bank's statutory duty. However, in the absence of the mortgagor's consent to the sales agreement, it could not operate at the expense of the mortgagor. Therefore, the bank breached its duty by failing to account for 82.5% of the net proceeds of sale in the sales agreement, which prevented the mortgagor's debt being discharged.

Note this applied despite the fact that the 60:40 split benefited the guarantor in relation to the finance company debt.

For more, see a copy of the case.

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Equity — Guarantee and Mortgage — Unconscionability (Watt v State Bank of New South Wales Ltd (trading as State Bank of New South Wales) [2003] ACTCA 7

A fair cop for banks. Ex-senior policeman and ex-typist husband and wife, stuck with mortgage securing children's newsagency business in which they were directors and had an interest.

Background

A husband and wife applied to have both a mortgage and guarantee set aside on the grounds that they had been induced to enter into these transactions due to the unconscionable conduct of the relevant bank. They sought to rely on the principles in Yerkey v Jones and Garcia v National Australia Bank. The wife claimed she left all business arrangements to her husband and although she understood that the assistance was by means of a mortgage she did not know exactly what that involved. Before retiring the husband had been an Assistant Commissioner of the Australian Federal Police and the wife had been employed as a typist with numerous companies including a debt collection agency.

The husband and wife agreed to assist their daughter and son-in-law to acquire a newsagency business. They lent them a sum on money and entered a mortgage with a bank over their principal residence. They then became directors of the business and held fifteen percent shares. The son-in-law then arranged the re-finance of the business. This involved the husband and wife entering into a new mortgage and as directors of the company they also had to give guarantees. The re-finance also involved discharging the existing mortgage to the first bank. At the time these arrangements were entered into the husband and wife were on holiday in Europe. The son-in-law took the documents to them and they claim they signed the documents without reading them and they were unaware that they contained a mortgage over their property or personal guarantees in respect of the business. A few years later the husband and wife signed an offer by the second bank to extend the loan facilities conditional on unlimited joint and several guarantees and a third party mortgage over their property. The business was not doing very well. It defaulted on the facilities and the second bank made a claim for possession of the husband and wife's property.

First Instance

At first instance it was found that both husband and wife had been aware at least of the general effect of the mortgage and guarantee. Although they were unaware of the "particulars" of the documents they understood that their effect was to transfer their existing liability from the first bank to the second bank. Hence, the mortgage and guarantee could not be set aside. The husband and wife appealed that decision.

Appeal

The husband and wife lost. Although their situation was unfortunate their was no unconscionability on behalf of the second bank. Their vulnerability stemmed from the "love of their children". It did not stem from an inability to understand the nature of the transactions in which they had been asked to participate or insufficient information regarding the consequences of these transactions. They were not mere volunteers. They had a substantial shareholding in the business which appeared to be doing well at the time of the relevant transaction and they obtained a benefit from the transaction, namely, that they were relieved of their liability to the first bank. The evidence did not show that either the husband or the wife were mistaken about the effect of the transaction. Whilst the wife may have left business dealings to her husband it was "inherently implausible" that a person employed at a debt collection agency (although as a typist) would not at least in a general sense understand that the bank if not paid may take steps to recover monies owed by enforcing guarantees. Her claim that she did not know that the house could be sold if the debts were not paid was "equally implausible". Furthermore, the husband and wife had undertaken a number of mortgages and the fact that there were numerous transactions with the second bank supported the inference that they were aware of the essential nature of their liability under these transactions.

For more, see a copy of the case

Other Cases of Interest

Registration of Notice of Charge — Application for Extension (Re Ace Funding Ltd [2003] FCA 59)

A special purpose vehicle company made an application for an order that the time to lodge a notice in respect of a registerable charge be extended. When a company enters into a charge they must lodge notice of the charge in the prescribed form with ASIC within 45 days. The extension was granted by the court. It was found to be just and equitable to grant the extension for the following reasons: the omission was mere inadvertence; the company was only two days out of time; the extension would not prejudice the position of the creditors or shareholders of the company; the company had not granted any subsequent charges over the property, or choses, or part thereof which was secured by the charge so there was no question of priority; and their was no evidence to show present or foreseeable possibility of the winding up of the company.

For more, see a copy of the case.

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Media releases / websites

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APRA Issues Transition Guidelines for Basel II Implementation (APRA Media Release No. 03/54, 23/6/03)

The Australian Prudential Regulation Authority (APRA) recently released its preliminary requirements for local banks, building societies and credit unions under Basel II (the Basel Committee on Banking Supervision's new Basel Capital Accord). This release provides guidance on the choices for institutions in calculating their regulatory capital under the new Accord. Basel II is scheduled for implementation in 2007.

For more, see the media release.

APRA Introduces Licence Fees (APRA Media Release, No. 03/52, 4/6/03)

APRA has announced the imposition of fees for licence applications for general insurance companies, authorised deposit-taking institutions and life insurance companies, including friendly societies. These fees had in the past been covered by the annual supervisory levy paid by established institutions. The statutory instrument imposing the fees was published in the 3 June special issue of the Commonwealth Government Notices Gazette.

For more, see the media release.

APRA Statistics Highlight Concentration of Superannuation in Life Sector (APRA Media Release No. 03/49, 29/5/03)

APRA recently released statistics on life office assets and accounts.

For more, see the media release.

APRA Urges Attention to Legacy Issues (APRA Media Release, No. 03_48, 20/5/03)

APRA has recently highlighted the need for legacy issues to be reviewed by financial institutions as part of their normal planning cycle, advising that strategies should be developed to deal with superseded products and systems, particularly for life insurers and superannuation funds. APRA's General Manager, Mr Ramani Venkatramani recognised that ongoing changes to products, technology and legislation had caused some existing devices for managing legacy issues to become inadequate. Mr Venkatramani recommended greater focus by trustees in ensuring equivalent rights for superannuation members following the implementation of successor fund transfers.

For more, see the media release.

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Asian Bond Fund (Reserve Bank of Australia Media Release No. 2003-06, 2/6/03)

The Asian Bond Fund was recently launched by the EMEAP group of central banks and monetary authorities and the Bank for International Settlements.

Financial Stability Standards (Reserve Bank of Australia Media Release No. 2003-04, 30/5/03)

The Reserve Bank of Australia (RBA) has recently resolved financial stability standards under Part 7.3 of the Corporations Act 2001. These follow a decision of the Payments System Board and will apply to licensees of clearing and settlement facilities in Australia. The purpose of the standards is to make sure these licensees identify and properly control the risks associated with their operations.

Banking (Foreign Exchange) Regulations 1959 Sanctions Against Iraq (Reserve Bank of Australia Media Release No. 2003-03, 29/5/03)

Following the United Nations Security Council Resolution 1483, the Reserve Bank of Australia has taken steps under the Banking (Foreign Exchange) Regulations 1959 to remove the financial sanctions against Iraq. This is effective from 29 May 2003. Australia's obligations under Resolution 1483 will now be implemented under the Iraq (Reconstruction and Repeal of Sanctions) Regulations which commence 29 May 2003.

Chief Executive of Australian Reinsurance Pool Corporation (Treasurer Media Release No. 050, 11/6/03)

Mr Neil Weeks has been appointed as the Chief Executive of the Australian Reinsurance Pool Corporation (ARPC) by the Federal Government. The ARPC is being created under the Terrorism Insurance Bill 2003 to manage the Government's terrorism risk insurance scheme. The Bill was introduced following community concerns that there has been a market failure for insurance against terrorism, with commercial insurers refusing to provide insurance. The Senate will reconsider the bill shortly.

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Entry Into Force of the Protocol Amending the Australia and United States Double Tax Treaty (The Treasurer of the Commonwealth of Australia Media Release No. 028, 13/5/03)

On 12 May 2003 Australia and the United States exchanged instruments of ratification for the Protocol amending the Australia-United States Double Tax Convention, bringing the Protocol into force. The Protocol includes changes to withholding tax on certain dividends, exemptions from withholding tax on interest paid to financial institutions and an updated list of taxes covered and a new provision dealing with interposed trusts in relation to permanent establishments. The withholding tax charges will have effect in relation to payments made on or after 1 July 2003. For other taxes the protocol will have effect in regard to years of income beginning on or after 1 July 2004.

Taxation of Capital Protected Products (The Minister for Revenue and Assistant Treasurer No. 046/03, 30/5/03)

The Minister for Revenue and Assistant Treasurer, Senator Helen Coonan, recently announced that interim measures would be enacted to ensure the smooth operation of the market in capital protected products. This follows the announcement from the Federal Treasurer that amendments would be made to the Income Tax Assessment Act 1997 to ensure that part of the expense on a capital protected product is attributed to the cost of its capital protection component, is not interest, and is not deductible where this cost is capital in nature. These amendments were to apply from 16 April 2003. Details of the interim approach are contained in Appendix A to the media release.

Minister Releases Draft Superannuation Regulations (The Minister for Revenue and the Assistant Treasurer Media Release No. 043/03, 27/5/03)

The Minister for Revenue and Assistant Treasurer, Senator Helen Coonan, announced that the draft portability regulations for superannuation have been made public.

Australia Joins OECD to Protect Consumers Against International Scams (The Parliamentary Secretary to the Treasurer Media Release No. 032, 18/6/03)

Australia has joined with OECD countries to combat cross-border scams and fraud, particularly that occurring on the internet. OECD guidelines have been released aimed at increasing cooperation among member countries.

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Avoid Corporate Governance Quick Fix Says Leading Scholar (CPA Media Release, 17/6/03)

Leading international accounting scholar, Professor Jere Francis, has cautioned Australia to be careful in implementing new corporate governance requirements suggesting that the failures evident in the large corporate collapses of Enron, WorldCom and HIH will always occur, regardless of the corporate governance measures in place. Rather than focusing on corporate governance requirements Professor Francis has emphasised the need for reforming the legal environment and improving protection for investors so as to improve financial markets.

For more, see the media release.

Financial Reporting Obligations for Public Companies (ASIC Media Release No. 03-189, 19/6/03)

Australian Securities and Investments Commission (ASIC) recently issued public companies a reminder regarding their financial reporting obligations. Section 319 of the Corporations Act requires public companies to lodge annual financial reports with ASIC within four months of the end of the financial year, or within three months for a disclosing entity or registered scheme.

For more, see the media release.

Super fund Best Practice Guidelines Now Available on Disclosure and Risk Management (ASFA Media Release, 12/6/03)

The Association of Superannuation Funds of Australia has recently released two Best Practice papers on risk management and the development of product disclosure statements. The paper on risk management — 'A Risk Management Framework for Superannuation Funds' — is supported by APRA. This paper is in preparation for the new prudential licensing regime under FSR that will be introduced in April 2004. The second paper — on disclosure — deals with both statutory requirements and best practice guidance. Its purpose is to aid super funds in developing their Product Disclosure Statements (PDS) and complying with their requirements under the FSR regulations. Most funds will need to have a PDS, which effectively replaces the current Key Features Statement and new member booklet, by March 2004.

ASX Corporate Governance Council (ASX Media Release, 24/6/03)

The ASX Corporate Governance Council met for the first time since the release of its Principles of Good Corporate Governance and Best Practice Recommendations on 31 March 2003. The Council discussed the feedback it has received on the recommendations and its continuing role. The Council has committed to periodic review of the best practice recommendations and to establishing the Implementation Review Group to facilitate this. The Council will meet again on 7 August 2003.

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ASX Top 50 to Join S&P Global 1200 (ASX Media Release, 11/6/03)

Standard & Poor's have declared that from 23 June 2003 the S&P/ASX 50 will be included in the S&P Global 1200. Previously, ASX shares had been incorporated within the S&P Asia Pacific 100 index. ASX Managing Director and CEO Richard Humphrey has declared that the decision will result in increased interest from offshore and greater liquidity in the Australian market.

ASX FundConnect Not to Proceed (ASX Market Announcement, 27/5/03)

It has been recently announced that ASX will not go ahead with ASX FundConnect, a program aimed at providing a comprehensive electronic transaction infrastructure to the funds management industry. The decision is the result of an unfavourable present environment that did not present a viable business case for the venture. However, ASX intimated that the initiative would be reconsidered should conditions change.

Large Business and Tax Compliance (ATO Media Release No. 03/54, 10/6/03)

Tax Commissioner Michael Carmody has released a booklet entitled Large Business and Tax Compliance with a checklist of what attracts the Tax Office's attention and what it is likely to challenge. Mr Carmody encouraged board members, senior executives and tax advisers to review their tax responsibilities in order to comply with good corporate governance. He also announced an extension of the ATO's audit program and details of the compliance program for high wealth individuals and large corporates for 2003-04.

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Legislation update

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FSR Update

Legislation to Overhaul APRA Introduced Into Parliament

The Commonwealth Treasurer recently introduced into the House of Representatives a bill to change the leadership and governance of APRA, in accordance with the recommendations that were made at the conclusion of the Royal Commission into HIH. The four main objectives of the bill outlined in the Explanatory Memorandum are as follows: to replace the APRA board will a full-time executive group of 3-5 members; to refine APRA's statement of purpose and objectives; apply an enhanced disclosure and conflict of interest framework to enhance the integrity of APRA; and to clarify the operation of the provisions which apply to APRA's release of protected information and protected documents to other agencies in support of their functions and powers.

The legislation was introduced into Parliament on 5 June 2003.

Financial Services Reform Amendment Bill (The Parliamentary Secretary to the Treasurer Media Release No. 031, 6/6/03)

The Parliamentary Secretary to the Treasurer, Senator Ian Campbell, recently published a list of proposed legislative amendments to clarify aspects of the new arrangements under the Financial Services Reform Act. The main amendments are listed in the attachment to the media release.

Taxation of Financial Arrangements (TOFA) (The Minister for Revenue and Assistant Treasurer Media Release No. 044/03, 19/5/03)

The New Business Tax System (Taxation of Financial Arrangements) Bill (No. 1) 2003 was recently introduced into Parliament to reform the taxation laws relating to foreign currency gains and losses. These reforms represent the second stage of reforms to the taxation of financial arrangements recommended by the Ralph Review of Business Taxation. The measures within the bill will generally apply from 1 July 2003, however, the removal of taxing point on conversion or exchange of certain traditional securities will apply to traditional securities including interest bearing bonds and debentures issued after 7.30pm AEST on 14 May 2002.

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Review of International Taxation Arrangements (The Treasurer of the Commonwealth of Australia Media Release No. 032, 13/5/03)

The Commonwealth Treasurer recently announced the outcome of Australia's review of international taxation arrangements. A package of reforms was announced by the Government and the Board of Taxation's report — Volumes 1 and 2 — were released. The package of reforms includes reducing the costs of complying with controlled foreign company rules, reducing tax on foreign 'active' business income, and reducing foreign taxes by improving Australia's tax treaties. The reforms will also enhance the competitiveness and reduce compliance costs of Australian based managed funds.

CLERP 7 — Simplified Lodgement and Compliance (AAR Focus: Corporate Governance — June 2003)

The CLERP 7 amendments to the Corporations Act 2001 (Cth) will take effect from 1 July 2003. These amendments change the way companies and managed investment schemes need to report to ASIC.

For a detailed analysis see Focus: Corporate Governance - May 2003 .

Terrorist Insurance Bill (AFR, 17/6/03)

The Senate recently passed the Terrorism Insurance Bill. Under the bill the Australian Reinsurance Pool Corporation will be established which will administer a scheme including a commercial pool of levied funds and a $10.3 billion fund provided by the federal government for property owners and businesses damaged by terrorist attack. The bill is now awaiting royal assent.

Forex Gains Liable for Tax (AFR, 30/5/03)

Foreign currency gains and losses will have to be declared for tax purposes under a law recently introduced to federal parliament. The Bill is an attempt to clarify the law relating to taxation of foreign currency exchange earnings, which has had an uncertain operation since the High Court overturned an ATO position in 1996. The proposed law will apply from July 1 but will not affect banks and financial institutions until specific rules are developed by parliament.

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