Risk Watch: Financial certifi cates: why take the risk? By Grant Feary

Financial Certificates: Why Take the Risk?

GRANT FEARY, DEPUTY DIRECTOR, LAW CLAIMS

One of the most common questions received at Law Claims goes like this: “A client is looking to [borrow some money/ refinance/go guarantor] for their [son/daughter/ nephew/niece/family/trust/company] and the Bank wants me to sign a certificate about giving the client independent legal advice… I seem to remember that there is some issue with these sorts of things. Does my insurance cover this?”

There are indeed “issues with these sorts of things”—issues which go back over twenty years and which might not be known to less experienced practitioners, or which might have been forgotten by more experienced practitioners 1 . For present purposes, the story starts with the important High Court judgment in Commercial Bank of Australia v Amadio [1983] HCA 14 where a mortgage and guarantee provided by Mr and Mrs Amadio to support borrowings by their son’s building company was set aside, in summary because Mr & Mrs Amadio had no proper understanding of the effect of the documents they signed. This led to financiers seeking from borrowers’ security providers (i.e. mortgagors, guarantors, indemnifiers etc.—collectively referred to herein as security providers) greater comfort from those security providers that they did in fact understand the documents they were signing as a regular part of their lending procedures.

The financiers may seek a certificate from a lawyer engaged by the security provider that the lawyer has given the security provider legal advice about the nature and effect of the transaction being entered into. Some certificates even go so far as having the lawyer certify that the security provider “understood” the transaction. The very fact that the financiers are seeking such certificates should raise alarm bells—why do the financiers want these certificates? Two reasons spring to mind—the financiers are (1) seeking to outsource to the lawyers the task of explaining the documentation to the security providers and (2) looking to have someone else (i.e. the lawyer) to sue if

the borrower doesn’t pay and the security provider seeks to set aside the transaction based on Amadio type considerations.

The result of all this was, in the mid1990s, a number of legal practitioners were sued—by both financiers and security providers—in respect of the provision of these certificates—see, for example, Micarone and Bechara v Perpetual Trustees (SA Full Court) (1999) 75 SASR1 and Citibank v Nicholson; Pirrotta v Citibank (1997) 70 SASR 206. The effect of these and other cases was to set a very high standard required of lawyers providing these certificates and resulted in Law Claims issuing warnings about the extreme risks involved in such work.

The cases make it clear that advice on financial transactions goes beyond “traditional” legal advice on the nature of the transaction, the terms of the documents, and the rights of the parties. It extends to advice which takes into account commercial and personal matters, so that the client understands the actual legal, financial and personal risks he or she is undertaking.

Such a high standard of care for solicitors is set that it continues to be the view of Law Claims that it is better not to give certificates of independent advice in financial transactions. It has often proved the case that where security providers have gone back to the financier saying that “my lawyer won’t do this sort of work” the financiers may not insist on the provision of the certificates. Notwithstanding this, however, problems for lawyers continue to arise—see the recent Victorian case in this area of Jams 2 Pty Ltd v Stubbings [2020] VSCA 200 (5 August 2020) where one of the several lawyers involved in various financing transactions gave a financial certificate and was forced to settle the claim against him. The settlement was, in all probability, required in order to avoid findings of breach of duty.

There may, however, be occasions in practice where it is necessary to give independent advice on financial transactions, and where appropriate give a certificate of independent advice. Where that advice is unavoidable, the relevant cases make it very clear that, to fulfil his or her duty, a solicitor must: • make whatever investigations are necessary to fully understand the transaction, the interests of the parties involved in it, and the prudence of entering into it; and • give careful and substantial advice.

Certainly, solicitors without extensive commercial experience should not attempt to advise on financial transactions, nor give a certificate. Anyone giving this sort of advice should be familiar with the relevant cases, being at least those referred to above, as well as McNamara v Commonwealth Trading Bank (1984) 37 SASR 232.

In many cases, this advice is likely to involve hours of work, and several appointments. It is very difficult to strike a balance between too much and too little information, and it is not enough to merely go through the document clause by clause. The difficulties inherent in certifying someone else’s understanding ought to be obvious.

From a risk management point of view, key areas that a practitioner needs to address if considering providing legal services in this area are: • Open a file in the client’s name • Insist on identification • Keep copies of the identification documents • Use an independent interpreter when appropriate • If there is more than one security provider, consider whether their interests are the same. Does one need to obtain independent advice? • Advise any security provider independently of the borrower • Address the possibility of undue influence or duress • Advise the client about the key elements of the documents and the worst case scenario • Ask the client why they are entering into the transaction and record the answer • Make a comprehensive file note of all attendances on your client, whether in your office or elsewhere • Check that your file notes: ○ are dated; ○ identify the author; ○ record the duration of the attendance; ○ record who was present or on the telephone;

○ are legible to you and someone else; and ○ record the substance of the advice given and the client’s response/ instructions • Confirm your advice in writing and seek a signed acknowledgement from the client.

Make sure that your advice is complete. It is important to explain to clients in the simplest language possible important issues such as: • Joint and several liability • That where a mortgage is involved the mortgagors could lose their homes • That the amount the security covers can be more than the amount borrowed.

The client needs to understand the general nature and effect of the documents and what could happen in the worst case scenario. Asking your client at the end of your explanation what he or she understands to be the position, and recording such responses, is one way of ascertaining the degree of understanding. It is not sufficient evidence of understand for the client just to nod and say “yes, I understand”. The client needs to state what he or she understands.

Even though the cases say that the lawyers’ duty extends to making sure the client understands the actual legal, financial and personal risks he or she is undertaking, no actual financial advice should be provided—refer the client to a qualified accountant or financial advisor and ensure they have enough time to obtain this advice. Financial advice is not covered by the terms of the Professional Indemnity Insurance Scheme.

In the Bechara case referred to above, the Court found that it was not enough to advise that the client get independent financial advice about an aspect of the transaction. The solicitor should have declined to provide the certificate until that advice was obtained. In cases where any aspects of the transaction and risks are unclear, it seems that it is the solicitor’s duty to refuse to act further and to refuse to assist the client to enter into the transaction.

Further, given that doing such a job properly will likely involve a substantial bill—it would not be surprising, where everything properly required was done, if the bill was several thousand dollars and possibly more in complex transactions— it may be that the client is not actually prepared to pay. This, of course, is another reason to be especially wary of these sorts of matters.

The Law Claims Scheme recognises the heightened risks to practitioners in carrying out this sort of work by providing for a triple excess to be payable by the insured practitioner if a claim arises out of or is contributed to by any matter in relation to which the insured was retained to provide any advice or any certification in respect of a proposed guarantor, indemnifier, surety, mortgagor or co-borrower who was not to derive substantial direct financial benefit from the said transaction (Policy of Insurance, cl. 4.5). For small practices (three practitioners or conveyancers or fewer) this will increase the excess from $5,000 to $15,000. For the largest practices (fifty-five practitioners or conveyancers or more) it will increase the excess from $60,000 to $180,000. The message to take from this is that it is really not worth taking on this sort of work unless your client is prepared to pay properly for the substantial amount of work involved and the level of care and attention you are prepared to pay to the matter is commensurate with this greatly heightened level of risk.

Endnotes 1 For previous articles relating to this matter see Advice in Financial Transaction and Guarantee

Certificates by John White—Riskwatch March 2008, Risky Business: Financial Certificate Claims and Professional Indemnity Insurance by Graham

Edmonds-Wilson—Riskwatch September 2009 and Law Risk on Financial Certificates—by John

Doyle—Riskwatch July 2013. Much of this article is based on these previous articles.