Doing without the Wagyu and shiraz

In June this year the Full Federal Court delivered its decision¹ in an appeal by the Australian Securities and Investments Commission (ASIC) from the so-called ‘Wagyu and shiraz’ judgment.²

The proceedings concerned Westpac’s use of an ‘Automated Decision System’ (ADS) for the conditional approval of home loans. In a widely publicised judgment, the Federal Court at first instance³ dismissed ASIC’s claim that Westpac, in using the ADS, had failed to satisfy the responsible lending requirements prescribed by the National Consumer Credit Protection Act 2009 (Cth) (NCCP Act).

The primary judgment – dismissing ASIC’s claims – was upheld on appeal by a majority of the Full Court (Gleeson and Lee JJ), with Middleton J dissenting. This article explains the basis for the decision and the differing views, and explores some of its broader implications.

Background to the judgments

Westpac’s home loan process required customers to complete a form declaring their monthly living expenses. These answers were fed into the ADS, which applied over 200 rules to the information, and resulted in either a ‘conditional approval’ of the application, a ‘decline’, or referral for manual assessment.⁴

The key arguments in this proceeding centred around the application of two rules applied by the ADS: the ‘serviceability rule’ and the ‘70% ratio rule’.⁵

The serviceability rule made a calculation of the supposed ‘net monthly surplus/shortfall’ of a customer, but did not actually take account of their declared expenses. Instead, it used another measure of anticipated or potential expenses – the Household Expenditure Measure (HEM).⁶ The HEM is an estimate of the level of expenditure that a customer could reasonably be expected to spend “to participate fully in society with a reasonable standard of living”^.7

The 70% ratio rule was triggered if a customer’s declared living expenses were greater than 70% of their monthly income. Where triggered, the loan application was referred for manual assessment^.8

ASIC alleged that neither of these rules was sufficient to ensure that Westpac considered the suitability of proposed loans for particular customers. Such an assessment, it contended, was required by the NCCP Act.⁹

Sections 128 and 129 of the NCCP Act together required a licensee to make an assessment of whether a proposed credit contract would be unsuitable for a consumer. In support of this obligation, s130 required the licensee to make reasonable inquiries of the consumer before making the assessment.

Further, s131 provided that a loan had to be assessed as unsuitable where, relevantly, it was likely that the consumer would be unable to comply with the consumer’s financial obligations under the contract; or, it was likely that the consumer would only be able to comply with their financial obligations under the contract with substantial hardship.¹⁰

On ASIC’s argument, the bank’s assessment using the ADS did not take into account the declared expenses of customers, which ASIC argued that it was required to do.¹¹ The serviceability rule had regard to a statistical measure of likely expenses – not the customer’s actual expenses; and the 70% ratio rule had not been ‘triggered’ for the loans the subject of these proceedings (which had been given ‘conditional approval’ by the ADS).¹²

The decision at first instance

At first instance, Perram J dismissed ASIC’s case for essentially two key reasons:

• first, because a customer’s declared expenses could not be shown to be ‘necessarily relevant’, and
• second, because the declared living expenses had actually been taken into account, through the application of the 70% rule.

In relation to the first reason, his Honour considered that a customer’s declared expenses were not determinative of their ability to repay a loan – and therefore, of its suitability for them – in the absence of further information indicating that the customer could not reduce those living expenses. As his Honour colourfully remarked:¹³

“I may eat Wagyu beef every day washed down with the finest shiraz but, if I really want my new home, I can make do on much more modest fare.”

In relation to the second reason, his Honour considered that declared living expenses were taken into account by the rule referring cases in which a customer’s expenses exceeded 70% of their income to manual referral. The rule had been designed to gauge the risk of default, but his Honour considered that it could also be relevant to “the ability of the customer to meet their financial obligations under the credit contract”.¹⁴

The majority view on appeal

ASIC’s appeal to the Full Federal Court was dismissed by Gleeson and Lee JJ, each of whom wrote separately. Essentially, their Honours upheld Perram J’s two key reasons for dismissing ASIC’s allegations. In doing so, however, their Honours emphasised the fact that the legislation was not especially prescriptive in its requirements.

For example, Gleeson J observed that the NCCP Act “does not contain an express statement that a credit provider must use the consumer’s declared living expenses in making the unsuitability assessment”.¹⁵ Although the NCCP Act required Westpac to make “reasonable inquiries” about the consumer’s requirements and financial situation, it did not prescribe precisely what information had to be obtained for that purpose, nor did it “prescribe the use to which Westpac must put such information”.¹⁶ On its proper construction, the NCCP Act “does not support the degree of prescription contended for by ASIC”.¹⁷

Separately, Lee J wrote that if “Parliament intended to make it pellucid exactly what licensees needed to do before entering into a credit contract, that effort miscarried”.¹⁸ Given that there could “properly be said that there is an interpretive choice between tenable views” in this case, his Honour considered that it should be kept in mind that “although the penalties are not criminal, civil penalty provisions should be interpreted on the basis that it is expected that an obligation imposed would have been identified clearly and unambiguously”.¹⁹ That was not the case here.

The dissent of Middleton J

In dissent, Middleton J considered that the text of the NCCP Act – which required an assessment of “whether the credit contract will be unsuitable for the customer” – necessitated an assessment of whether it would be unsuitable by reference “to the specific customer in question”.²⁰

Other provisions, such as those concerning the collection and verification of information about customers, suggested that “the information collected…is collected for the purpose of assessing the loan against the unsuitability criteria”.²¹

In his Honour’s view, the serviceability rule clearly failed to consider the particular situation of individual customers. Its use of the HEM – as a statistical measure of what it may be possible for some people to subsist on – was not directed at particular individuals.²² His Honour’s response to Perram J’s observation about Wagyu and shiraz was that:²³

“It cannot be assumed, even in the case of housing finance, that a particular customer will forego or reduce discretionary expenses so as to be able to service the loan.”

If Westpac wished to rely on such an assumption, it “could have made inquiries of the customer” to satisfy itself that the customer was in a situation that would enable them to reduce such expenses – that is, to do without the Wagyu and shiraz, or whatever else their expenses may be.²⁴

His Honour also considered that the 70% ratio rule was insufficient because it “did not assess the consumer’s financial obligations under the particular credit contract to be entered into”, or include other liabilities (apart from declared expenses).²⁵

Although it may have been a useful rule to gauge the risk of default, that alone did not ensure that the assessment required by the NCCP Act – of considering the suitability of loans (which includes consideration of whether repayment would result in hardship) – had been undertaken.²⁶

Accordingly, his Honour’s view was that Westpac had contravened the NCCP Act and was therefore liable to pay a civil penalty.²⁷

Implications

In the Interim Report of the Financial Services Royal Commission, Commissioner Hayne was critical of ASIC’s approach to enforcement, noting that “[c]ivil penalty proceedings have seldom been brought”.²⁸ Seemingly in response, the corporate regulator has now adopted a ‘why not litigate?’ approach to enforcement.²⁹

The litigation involving Westpac’s ADS suggests that, in this new environment, entities regulated by ASIC may need to be prepared not only for a greater likelihood of litigation in general, but in particular for the potential that ASIC may litigate in order to establish its preferred construction of regulatory legislation.

Indeed, an “unusual” feature of this case (as Lee J described it) was that ASIC had not alleged that any particular loans made to customers had been inappropriate.³⁰ While ASIC’s preferred construction of the obligations in question was not adopted in this case, such an approach to enforcement may itself promote a greater focus upon consumer protection – and how ASIC may characterise corporate systems and processes – in the conduct of regulated entities.

In addition, it may be that ASIC’s unsuccessful appeal will trigger interest from government in further legislative reform. Notably, in the Financial Services Royal Commission Final Report, Commissioner Hayne indicated his view that banks should move away from reliance on the HEM. After noting that the resolution of the ‘Wagyu and shiraz’ proceedings was, at that stage, still pending, he went on to say that:³¹

“If the court processes were to reveal some deficiency in the law’s requirements to make reasonable inquiries about, and verify, the consumer’s financial situation, amending legislation to fill in that gap should be enacted as soon as reasonably practicable.”

On July 22, ASIC announced that it would not seek special leave to appeal the Full Court’s judgment to the High Court of Australia. In so deciding, ASIC said it had been mindful of “the impact of the additional time required to resolve this matter in the current challenging economic circumstances”.³² However, perhaps hinting at the potential for legislative change, ASIC added that:³³

“Any reform of the [NCCP Act] to clarify further the enforcement of those [responsible lending] principles is ultimately a matter for the Federal Government and Parliament.”

Accordingly, lenders may find that their freedom to choose the precise form of responsible lending processes, as confirmed by the Full Federal Court, may be removed in favour of a more prescriptive approach, albeit through legislation.

At the same time, the remarks of Commissioner Hayne about the negative impacts that over-particularisation of statutory norms can have on regulatory outcomes need to be considered.³⁴

William Isdale is an Associate Lawyer at Minter Ellison. Sam Walpole is a Legal Officer with the Australian Law Reform Commission and a sessional lecturer at the University of Queensland. The views expressed in this article are personal to the authors and do not reflect those of their employers.

Notes
¹ Australian Securities and Investments Commission v Westpac Banking Corporation [2020] FCAFC 111 (appeal judgment).
² Australian Securities and Investments Commission v Westpac Banking Corporation [2019] FCA 1244 (liability judgment).
³ Ibid.
⁴ Appeal judgment [24]-[25].
⁵ Ibid [102].
⁶ Ibid [27]-[30].
⁷ Ibid [108].
⁸ Ibid [31].
⁹ Ibid [85].
¹⁰ NCCP Act s 131(2)(a). All of the relevant provisions are extracted at Ibid [14]-[15].
¹¹ Ibid [1]-[2].
¹² Ibid [46], [39]-[40].
¹³ Liability judgment [76].
¹⁴ Ibid [25].
¹⁵ Appeal judgment [113].
¹⁶ Ibid [139].
¹⁷ Ibid [141].
¹⁸ Ibid [162].
¹⁹ Ibid [174].
²⁰ Ibid [52].
²¹ Ibid [118].
²² Ibid [49].
²³ Ibid [62].
²⁴ Ibid [62].
²⁵ Ibid [43].
²⁶ Ibid.
²⁷ Ibid [83].
²⁸ Financial Services Royal Commission, Interim Report, Vol.1, 271.
²⁹ Commissioner Sean Hughes, ‘ASIC’s approach to enforcement after the Royal Commission’ (36^th Annual Conference of the Banking and Financial Services Law Association, Gold Coast, 30 August 2019).
³⁰ Ibid [173].
³¹ Financial Services Royal Commission, Final Report, Vol.1, 57-59.
³² ASIC, ’20-166MR ASIC will not appeal Federal Court Decision on Westpac’s ‘responsible lending’ obligations’ (22 July 2020).
³³ Ibid.
³⁴ Financial Services Royal Commission, Interim Report, Vol.1, 271.