The application of the Special Wives’ Equity on the enforceability of personal guarantees
It is common for the family home and other significant assets to be registered solely in the name of a wife in circumstances where her husband operates a business or is otherwise at risk of claims made by third party creditors (the opposite is also true, but that is not the subject of this topic for the reasons discussed below).
Lenders often require, as a pre-condition to an advance being made, that a wife personally guarantees the debts of her husband and/or his related entities and grants a mortgage over her property as security.
A wife may sign guarantee/mortgage documents without any real understanding of the legal relationship to which they give effect, and without proper appreciation that her property is being put at risk. A wife’s liability to the lender in these situations has been described as ‘sexually transmitted debt’.
The special wives’ equity (“SWE”) may operate to protect married women in such circumstances. Where the equity applies, a guarantee/mortgage may be set aside and become unenforceable. In such cases, the prospects of a lender recovering its debt may be significantly diminished.
The decision which established the SWE was made more than 80 years ago, at a time when gender disparities were more pervasive and non-heterosexual relationships were scarcely approved. The wisdom of the decision, and its usefulness in the 21st century, has been the subject of considerable judicial and academic critique – not least because of its failure to reflect modern social values and recognise areas of inequality outside of the traditional husband/wife relationship.
The High Court of Australia has expressly left open the question of whether the special equity ought to extend beyond just wives1. However, in a 2000 decision, the New South Wales Supreme Court was unwilling to extend the equity to a woman in a de facto relationship2.
For better or worse, the SWE continues to apply only in favour of women in matrimonial relationships.
Lenders should be aware of the equitable principles underpinning the SWE, and the steps that may be taken to avoid its operation, to ensure that security for loans are properly capable of being enforced.
Wives who have been charged with repayment of their husband’s debts should be familiar with the SWE and the considerable relief it may provide.
What is the Special Wives’ Equity?
In Yerkey v Jones3, the High Court of Australia held that:
1. it is unconscionable for a third party to be able to enforce a wife’s guarantee for her husband’s obligations in circumstances where:
(a) the guarantee is procured by the application of actual undue influence by the husband (the ‘first limb from Yerkey’); or
(b) the wife does not understand the nature and effect of the guarantee that has been provided (the ‘second limb from Yerkey’); and
2. in either case, a wife should have a prima facie right to have the guarantee set aside.
Justice Dixon stated that the proposition forming the basis for the second limb in Yerkey is that:
“[I]f a married woman’s consent to become a surety for her husband’s debt is procured by the husband and without understanding its effect in essential respects she executes an instrument of suretyship which the creditor accepts without dealing directly with her personally, she has a prima-facie right to have it set aside.”4
The 1998 decision in Garcia v National Australia Bank Ltd (“Garcia”)5 expanded on the decision in Yerkey and outlined the following circumstances which would, together, result in the enforcement of a guarantee being unconscionable against a wife:
1. the wife did not understand the purport and effect of the transaction (the “No Understanding Requirement”);
2. the wife was a volunteer to the transaction (in that the wife did not personally gain from the transaction) (the “Volunteer Requirement”);
3. the creditor did not itself take reasonable steps to explain the transaction to the wife (or ensure that an independent third party did so) (the “Reasonable Steps Requirement”).
Once it is established that the lender is aware of the spousal relationship, the creditor is taken to have understood that the wife may repose trust and confidence in her husband and, therefore, the husband may not have explained the effect of the transaction to the wife.
The No Understanding Requirement
It is common practice for lenders to require a guarantor to sign a written acknowledgement that the guarantor has read the terms of the loan and guarantee and has understood their obligations prior to signing.
However, unless there is evidence that a wife in fact understood the nature and effect of becoming a surety, such acknowledgements are unlikely to be effective to avoid the operation of the SWE. This is unsurprising, since a wife who does not read or understand a guarantee prior to signing is unlikely to read or understand such an acknowledgement.
Circumstances which may satisfy a court that a wife had an adequate understanding of the transaction may include:
1. where a wife has a sufficient degree of business acumen or work experience such that she is likely to have an understanding of the nature of a personal guarantee;
2. where a wife obtains legal advice with respect to the guarantee, or has previously obtained advice in connection with guarantees in the past; and/or
3. where a wife makes statements which are consistent with her having understood the nature of the guarantee at the time of signing (for example during recorded telephone conversations with bank representatives).
In the above circumstances, the SWE is unlikely to apply.
The Volunteer Requirement
The onus is on the party seeking to rely on a guarantee to show that a wife benefited from the relevant transaction the subject of guarantee, and therefore that the Volunteer Requirement is not satisfied.6
For the SWE to apply, the surety must act without recompense, except to the advantage of her husband.7 However, it is clear that a wife may still be regarded as a volunteer despite obtaining incidental benefits.
For a wife to excluded from the SWE, the underlying transaction must be of real benefit to her. It is not sufficient that a wife receives legal consideration, in terms of the law of contract (an acknowledgement in the terms of the guarantee that the loan was given at the request of the wife will not suffice).
Being listed as a nominated beneficiary of a discretionary/family trust which receives the loan is unlikely to be sufficient to exclude a wife as a volunteer (provided that the wife does not exercise discretion over the trust). This is the case even where the wife has a history of financially benefiting from the business of the trust over a prolonged period by receiving discretionary distributions of profit.
In Commonwealth Bank of Australia v Khouri,8 it was held that because the benefits received by the wife through a family trust were not as of right, but as a result of the exercise of a discretion by the husband, the wife was a volunteer to the transaction.
In Garcia, it was held that even though the wife was a director of and shareholder of the debtor company, the fact that her husband was in complete control of the company and that the wife was not directly involved in the company meant that, in effect, she received no benefit from guaranteeing the relevant company’s debt. This was despite the fact that, from time to time, some benefit flowed to the wife’s family from the relevant company.
However, where a wife expects to receive a direct profit from the transaction, she will no longer be in the position of a volunteer.
Circumstances relevant to determining whether the Volunteer Requirement is satisfied may include, for example:
1. the degree of control exercised by the wife in respect of the business of the borrower and the distribution of its profits; and
2. whether the wife has sources of income, independent from the borrowing entity.
The Reasonable Steps Requirement
The safest way for a lender to avoid the operation of the SWE is to require evidence that the guarantor receives independent legal advice prior to entering into the transaction.
Whilst the above is strongly recommended, the provision of independent legal advice is not strictly required.
In Garcia, Justice Kirby suggested that “unless there are special exceptional circumstances or the risks are large, a credit provider will have taken such reasonable steps … if it warns the surety (at a meeting not attended by the principal debtor) of the amount of the surety’s potential liability, of the risks involved to the surety’s own interests and advises the surety to take independent legal advice”.9
At minimum, a lender should:
1. ensure that a wife is provided with, and has read, copies of all relevant transaction documents (which should be provided to her directly, rather than through her husband);
2. meet with the wife, in the absence of her husband, and warn her of the legal and financial risks of providing a personal guarantee;
3. explain the material terms of the transaction and the guarantee, including:
(a) the extent of the debt being guaranteed;
(b) that the wife could become personally liable for the debt, that her property could be sold and/or she could be made bankrupt if payment is not made;
4. explain to the wife that she has no obligation to provide the guarantee, and could seek to limit her liability under the guarantee; and
5. recommend to the wife that she obtain her own independent legal advice prior to signing the guarantee.
A proper record of the lender taking the above steps be kept. This might take the form of an audio recording of any conversations, or by requiring that a written acknowledgement be signed by a wife (in the presence of an independent person and in the absence of her husband).
Takeaways
It remains to be seen whether the courts will seek to modify, limit or extinguish the application and scope of the SWE to more accurately reflect contemporary social and cultural values.
It is also unclear whether the equity principles underpinning the SWE will be extended to other relationships which fall short of marriage.
In the meantime, lenders should be careful to take appropriate steps to avoid operation of the SWE and its potentially significant consequences. Women who are charged with repayment of debts relating to their husband’s affairs should seek legal advice to determine whether they are entitled to relief under the SWE.
References
1 Garcia v National Australia Bank Ltd (1998) 194 CLR 395 at 404.
2 State Bank of NSW v Hibbert [2000] NSWSC 628.
3 (1939) 63 CLR 649.
4 Ibid at 683.
5 (1998) 194 CLR 395 at 409.
6 Schultz v Bank of Queensland [2014] QSC 305 at [32].
7 Yerkey v Jones (1939) 63 CLR 649, 676.
8 [1998] VSC 128.
9 Garcia v National Australia Bank Ltd 194 CLR 395 at 431.