03 December 2010

Blue Chip: GE Custodians v. Bartle

Just because a commercial transaction runs at loss doesn’t mean that it is an “oppressive” transaction justifying court intervention. And it is not for lenders to investigate the commercial wisdom of a borrower taking out a loan, particularly where the borrower has received independent advice.

In what is a test case on the legality of funding lines set up to finance investments promoted by the Blue Chip Group, the Supreme Court has ruled mortgages securing loans can be enforced. This will result in elderly investors losing their family homes following the collapse of prices in the Auckland CBD apartment market.

Blue Chip targeted asset rich/cash poor elderly investors in what it described as joint venture development projects. Investors were encouraged to mortgage their family homes, buying into deals whereby they financed the construction of inner city Auckland apartments. The “profit-share” formula buried in the fine print saw Blue Chip entitled to some 90% of any realised capital gain on the sale of finished apartments, while not sharing in any capital losses.

Blue Chip sales staff smoothed the way for investors by helping complete loan applications for funding from independent third party financiers and by steering investors towards a legal adviser who was recommended as “understanding” the Blue Chip way of completing property developments.

Touted apartment valuations proved to be grossly optimistic. There was evidence of completed apartments selling for less than 50 per cent of pre-construction valuation. Realisations did not cover loans raised by investors to fund the construction. As a result, investors’ homes were forced into mortgagee sales.

The Supreme Court was asked to reopen loan contracts under the Credit Contracts and Consumer Finance Act 2003 on the basis that the loans were “oppressive”. This required evidence that the loans did not measure up to reasonable standards of commercial practice.

In particular, it was argued that it was not reasonable to enforce contracts where elderly pensioners on limited income had taken out substantial mortgages for terms of 25 to 30 years.

The Supreme Court, in this case, ruled there was no evidence of oppressive behaviour. Asset based financing (as distinct from cash flow based financing) is a perfectly legitimate form of financing. There was nothing in the documentation supplied to GE Finance in this case which signalled that the transaction was anything other than a normal commercial application from an investor seeking to profit from a real estate development.

The Supreme Court said there is no obligation on a financier to go beyond the information provided to investigate the commercial soundness of the proposed development or the personal circumstances of the borrower. To do so, said the court, would be economically inefficient.

GE Custodians v. Bartle – Supreme Court (03.12.10)

12.10.001