Chapter 8

Further examination of the Bankwest allegations

8.1        The previous chapter outlined the key common grievances that certain business customers had with Bankwest. This chapter utilises that evidence to explore whether there was an unusual incentive for the CBA-owned Bankwest to act as it did or, alternatively, whether developments in the economy or in specific sectors during and following the global financial crisis help explain the bank's approach. Specifically, this chapter includes a discussion of:

• the terms of the CBA's acquisition of Bankwest, a factor that a number of aggrieved borrowers consider directly influenced Bankwest's actions;
• other considerations, including the downturn in the property market and business activity in some sectors of the economy;

8.2        The chapter also examines the opportunities available for aggrieved borrowers to resolve their dispute or to seek redress, and considers the effectiveness of these options.

The terms of the CBA's purchase of Bankwest

Warranties in the purchase agreement

8.3        As noted in the previous chapter, the CBA's proposed acquisition of Bankwest and St Andrew's Australia[1] was announced on 8 October 2008. The CBA completed the acquisition on 18 December 2008. Some submissions received by the committee focused on speculation regarding the terms of the purchase agreement; in particular, whether an unusual "clawback" provision or warranty exists that provided an incentive for the CBA to act against existing Bankwest business customers. To put it another way, whether a clause in the agreement exists that either allowed the purchase price for Bankwest and St Andrew's to be reduced by an amount related to the bad debts on Bankwest's books, or otherwise acted as a warranty that could be called upon to the CBA's benefit. Such a provision, according to those who are convinced of this, would explain Bankwest's purging of its commercial property loans once it passed into the CBA's ownership.[2]

8.4        HBOS's 2008 annual report indeed reveals that there was a warranty of some form:

Under the share sale agreement HBOS plc has provided certain warranties to Commonwealth Bank of Australia, that all relevant, material circumstances and facts in relation to the sale have been disclosed and described in agreement. The share sale agreement provided for adjustments to the initial purchase price based on the risk weighted assets of Bank of Western Australia Limited and the net assets of St. Andrews Australia Pty Limited. As a result, the loss on sale of these businesses may be subject to adjustment for the contingent element of the commitment receivable.[3]

8.5        On 30 April 2009, Bankwest announced a loss of $139 million for 2008. This result included loan impairment expenses totalling around $825 million, nearly ten times the level in 2007.[4] In a statement to the ASX on the same day, the CBA announced:

As advised at the time of acquisition of Bankwest, the Group is purchasing a bank which is appropriately capitalised and provisioned. The final purchase price for Bankwest will be determined over the next two months taking into account its capital position and provisions for bad and doubtful debts.[5]

8.6        The Australian reported in May 2009:

In the $2.1 billion sale deal struck last year, CBA retained an agreement that Bankwest had to be appropriately provisioned when the WA institution came under its ownership. It is understood the new provisioning level is split evenly between collective and individual provisions.

CBA is expected to claim about $400 million, the individual provision amount, from HBOS.

The process is to go to an arbitration hearing, and most analysts expect the full-year loss and provision spike to reduce the total sale amount that is yet to be paid by CBA.[6]

8.7        The purchase price for Bankwest was finalised in early July 2009.[7] Submissions that focused on the warranty speculation argued that the CBA managed to successfully use the clause and obtained an additional discount on the purchase price from the new owners of HBOS (Lloyds Banking Group) by improperly increasing the impairments on Bankwest's books. Some submissions also claimed that, after the price adjustment process, the CBA still needed to ensure that impairment of the loans could be demonstrated.[8] The following statement by Mr Geoff Shannon details the argument:

The 2008–09 figure for the impaired loans is estimated at around $850 million—$620 million or so as the discount of the purchase price, and a further $200-plus million in that first part of 2009. The 2009–10 figure for the impaired loans was another $754 million ... as a result of an internal Bankwest audit known as 'Operation Magellan', a code named operation. This figure of $750 million is on top ... of the previous impairment charge of around $850 million ... it appears to me that, for at least the $850 million figure, there was a dollar-for-dollar reward for these impaired loans.[9]

8.8        Mr Geoff Shannon also argued that the CBA would further benefit through tax deductions associated with the impaired loans and, because it has allegedly claimed a price adjustment based on the impaired loans it has demonstrated, it also would profit through the sale of any impaired assets.[10] The contentions appear based on media reports (such as the article cited earlier) and the financial statements of Bankwest's former owners.[11] The 2009 reports and accounts for HBOS and the Bank of Scotland report a loss on the sale of Bankwest and St Andrew's Australia of £845 million in 2008, and a further loss of £100 million in 2009. Both reports include the following statement:

On 8 October 2008, the Group agreed the sale of part of its Australian operations, principally Bank of Western Australia Limited and St. Andrews Australia Pty Limited, to Commonwealth Bank of Australia Limited. The sale completed on 19 December 2008 and resulted in an estimated pre-tax loss on disposal of £845 million (including goodwill written-off of £240 million). The agreement provided for adjustments to the consideration received in certain circumstances and as a result a further loss of £100 million has been recognised in the current year.[12]

The CBA's response

8.9        The CBA strongly denied claims that the purchase agreement allowed it to benefit from terminating the loans of certain Bankwest business customers:

It has been suggested that CBA gained a commercial benefit from putting some Bankwest commercial loans into default which then allowed CBA to recoup subsequent losses from HBOS. Let me say categorically that that suggestion is simply untrue.[13]

8.10      The CBA argued that speculation about the sale agreement is 'based on an erroneous understanding of the purchase price adjustment process and the alleged "clawback" the CBA received from Bankwest's former ultimate parent, HBOS plc'. It is useful to reproduce the relevant statement from the CBA's submission at length:

The sale agreement set out a purchase price adjustment process, which is standard practice in this type of sale scenario. Under the purchase price mechanism, the initial price CBA paid for Bankwest could increase or decrease by reference to the financial accounts which were to be prepared for Bankwest as at 19 December 2008.

As part of this process, the parties agreed HBOS Australia Pty Ltd (as seller of the Bankwest shares) would prepare draft financial accounts for Bankwest to reflect its financial position as at 19 December 2008. The headline values reflected in the draft accounts for Bankwest would, in part, be impacted by the level of provisions which HBOS Australia Pty Ltd allowed for when preparing them.

Under the sale agreement, CBA would review the draft financial accounts and raise any issues with HBOS Australia Pty Ltd.

If the parties could not agree the final accounts between themselves, the sale agreement provided for a final determination by an independent expert to assist them resolve any outstanding issues.

Ultimately, the parties were unable to agree on a number of items, including that the level of individual provisions reflected in the 19 December 2008 accounts were appropriate in all cases.

Ernst and Young was appointed as the independent expert to determine these disputed items. Ernst and Young's determination was final and binding.

We are aware of speculation that HBOS plc paid CBA some $200 million as a result of the price adjustment process. This is not correct. The purchase price adjustment process was finalised by early July 2009 and resulted in a small increase in the purchase price for Bankwest.

The price adjustment process was designed to achieve a "zero sum" outcome. It could not, and did not, deliver any windfall gains. If the financial accounts finalised by Ernst and Young reflected an increase in value, CBA was to pay more and vice versa.

CBA paid for the independently determined value it acquired in Bankwest, and Bankwest, under CBA ownership, has borne any losses it has subsequently incurred from loans that were not assessed to be impaired or in default as at 19 December 2008.[14]

8.11      During their evidence to the committee at a public hearing, the CBA representatives expanded on this statement and advised that the CBA paid an additional $26 million for Bankwest as a result of the price adjustment process.[15] For absolute clarity, the CBA later confirmed in writing that the final price it paid was $2.1261 billion.[16]

Reconciling the competing arguments

8.12      As the preceding paragraphs show, in 2009 both HBOS and the CBA reported that they incurred further costs related to the finalisation of the acquisition—HBOS an additional £100 million and the CBA an extra $26 million. The question naturally arises as to how this could be so.

8.13      There do appear to be difficulties in comparing the financial statements of HBOS given it was itself acquired around the same time as its subsidiary Bankwest. The CBA observed:

We do not know what accounting policies or accounting treatment that Bank of Scotland plc applied to its accounts in order to determine (historically or at the relevant times) the carrying value of the Bankwest Entities. Consequently, CBA is unable to comment on the level of write offs disclosed in Bank of Scotland's 2009 Report and Accounts.[17]

8.14      HBOS's books were seemingly subject to more conservative treatment under its new owners; for example, shortly after the acquisition Lloyds increased the impairment losses from £3.3 billion (year to 30 November 2008) to approximately £7 billion (year to 31 December 2008).[18] The UK's financial regulator concluded that, under its previous owners, 'there was a collective denial within the Corporate Division of the impact of the financial crisis on the portfolio' which impacted the ability of the independent auditor to fully assess HBOS's accounts:

The culture of optimism which pervaded the business impeded the identification and effective management of transactions as they became stressed and delayed the referral of stressed transactions to the High Risk team. There was a significant risk that this would have an impact on HBOS's capital requirements. It also meant that the full extent of stress in the Corporate portfolio was not visible to Group, auditors and regulators ... Throughout [April 2008 to December 2008], HBOS's auditors KPMG agreed that the overall level of the Firm's provisioning was acceptable. However, in relation to Corporate, they consistently suggested that a more prudent approach would be to increase the level of provision by a significant amount. The Firm consistently chose to provision at what KPMG identified as being the optimistic end of the acceptable range for Corporate. KPMG's view of what constituted the acceptable range was informed by management's assessment of the degree of credit risk in particular transactions. Further ... the slow migration to High Risk meant that the full extent of stress in the Corporate portfolio was not visible to KPMG.[19]

8.15      Notwithstanding the statements in HBOS's report and accounts, the CBA added that it 'categorically confirms that the initial price agreed by HBOS Australia and CBA for the Bankwest Entities was not reduced by an amount equal to £100 million or by any other amount'.[20]

The post-GFC property market and business environment

8.16      Another possible explanation for the actions taken by Bankwest can be based on the types of business loans held by Bankwest and the impact of the global financial crisis on the businesses and assets related to these loans. As the relevant submissions were largely from individuals involved in enterprises where the nature of the property is a key feature (such as hotel owners and property developers), it is necessary to consider the state of the market for these types of properties.

8.17      The CBA provided an overview of how it considers the crisis impacted the position and options of many business:

The economic environment since the commencement of the GFC has adversely impacted the financial profile and flexibility of many enterprises, as well as some individuals. As a result, these enterprises and individuals have found it increasingly difficult to meet normal (unchanged) criteria relating to maintaining existing debt facilities or loans. Since the commencement of the GFC there has been a reduction in second tier lenders who would ordinarily consider these enterprises and individuals a suitable refinance proposition. In some cases this has resulted in overall borrowing increases (both working capital and term debt in the case of enterprises) from larger lenders such as the CBA. Normally, however, this is only if the borrower has shown a continued ability to meet commitments and/or pledged additional collateral. In the main, the aggregate debt offered to borrowers of a stable credit profile would have remained the same over the GFC, but many borrowers with stable credit profiles would have reduced their indebtedness based on their more conservative settings for leverage.[21]

8.18      It is also significant that Bankwest, under its previous owner and prior to the global financial crisis, was approving business loan applications that other banks were not. During the period following the crisis, the new owner is likely to be additionally sceptical of the quality of the loans that they were unwilling to finance prior to the crisis.

Property market

8.19      In a letter to the committee, a senior manager at the Australian division of Colliers International stated:

The demand for residential development properties deteriorated significantly as a result of the global financial crisis ("GFC"). In many instances, values of en-globo parcels of land decreased by approximately 70% due to the GFC.[22]

8.20      Figure 8.1 shows the scale of the downturn in commercial real estate prices that occurred during the global financial crisis.

Figure 8.1: Property price indicators

Source: RBA, Financial Stability Review, March 2012, p. 16; based on Bloomberg, Jones Lang LaSalle Research, Property Council of Australia, RBA, RP Data-Rismark and Thomson Reuters data.

8.21      The overall property values of hotels were particularly affected—a development which has also been relatively sustained. Developments in major Australian hotel markets are relevant to some of the evidence received by the committee. In its 2011 assessment of these markets, hotel advisory firm Dransfield concluded that hotel values have 'partially recovered' to pre‑crisis levels, however it added the following observation:

Many assets offered remain on the market with sellers unwilling to meet the market (where values have not fully recovered to pre-GFC levels) and with supply far exceeding demand. Again a significant proportion (estimated at around 20%) is distressed assets under administration, with the majority of these in leisure based/resort destinations.[23]

8.22      Bankwest's submission discusses how, in its view, its business lending portfolio was particularly impacted by developments in regional property markets:

A reasonable proportion of Bankwest's loan impairments were contained in its property lending portfolio and in particular a number of residential, hotel, aged care and land development exposures in regional Queensland and New South Wales. These sectors and regions in general have been suffering difficult financial circumstances since the GFC began such as lower revenues and earnings and a diminution in the value of the underlying assets.[24]

8.23      Bankwest advised the committee that up to 7.23 per cent of its east coast property developer, property operator and pub customers became impaired between December 2008 and 30 June 2012.[25] Concerns about the commercial property market were also expressed by other banks, such as HBOS which largely attributed an increase in impairment losses of 67 per cent in 2009 (the year after it divested Bankwest) to falls in the value of commercial real estate, noting in particular that '[s]ignificant provisions were required against the Group's Irish and Australian commercial real estate portfolios'.[26] NAB noted similar issues with hotels and other properties on the east coast:

On hotels generally that has been a problem area for us as well. You would have thought that it would not be a problem running a pub in Australia, but it has become one in some instances. On property development, particularly in south-east Queensland and in those areas that are exchange rate impacted that rely on tourism, we do have issues ... The hotel market will sort itself out. New buyers will come in at a lower price, I guess, and they will make the most of them work. On the property side there is some oversupply that will need to be cleared out, particularly in south-east Queensland, and that market should revert to something a little bit more normal, but it might take a little while.[27]

8.24      In this context, that revaluations were required by Bankwest does not appear unusual, particularly as the terms of the loans provide Bankwest with the ability to update the valuation at least once a year.[28] ANZ submitted that such risk management processes were actually required by the government's prudential supervisor:

APRA believes it's important to have more specific 'triggers' in lending policies as part of risk management procedures, to ensure that real estate held as security is revalued when there is a material change in the market value of real estate within an area or region.[29]

8.25      Of course, this is a high-level discussion on the commercial property market. Assumptions that the value of commercial property decreased across the board are contestable. For example, in his submission Mr James Neale declared that his five acre industrial property at Mount Kuring-gai was sold for $635,000, although prior to the sale he had refused a $4.1 million offer from an apartment developer and after the sale the property was valued at $3.58 million.[30]

Impact on business revenue

8.26      The Australian economy performed better than most advanced economies during the global financial crisis, with a significant factor being the mining boom caused by the increased demand in China for certain mineral resources. The crisis did have an immediate impact on the Australian economy, an impact also reflected by other measures such as unemployment, surveys of consumer and business confidence and household savings. The below charts provide some indication of the economy‑wide impact.

Figure 8.2: Nominal and real GDP growth Source: Tony McDonald and Steve Morling, 'The Australian economy and the global downturn Part 1: Reasons for resilience', Treasury Economic Roundup, 2011, issue 2, p. 12; based on ABS cat. 5206.0.

Figure 8.3: Unemployment rate Source: ABS cat. 6202.0.

Figure 8.4: NAB business survey

* Net balance; deviation from average since 1989.

Source: NAB, RBA.

8.27      These economic developments affected industries differently. For hotel businesses in the major markets, it is estimated that overall revenue was reduced by 6.8 per cent as a result of the economic downturn arising from the global financial crisis.[31] This would be a factor considered by lenders when assessing whether marginal hotel businesses are likely to be viable. As a number of aggrieved Bankwest borrowers operated pubs and small hotels in regional areas, some analysis of that sector is useful. To illustrate, Mr Geoffrey Reiher explained how the cash flow of the hotel he co‑owned in Cobar, New South Wales was affected following the global financial crisis:

We entered into a two-year interest only deal when the GFC hit. We made sure our commitments were all up to date. The hotel was doing up to $25,000 a week in the good times and through the GFC we went down to probably $11,000 a week. In that time the hotel bar takings actually went up 10 per cent; our downfall was gaming. From that we managed to get it back up to about $18,000 a week, until our termination.[32]

Value of property developments under construction

8.28      It is an acceptable premise that the value of a property is only proven when someone actually pays that amount. However, when a bank has been financing a property development that is partially or substantially completed, as a general principle it would appear to be in the bank's interest to work through any difficulties to the extent possible to ensure that the construction is completed, thus ensuring the best opportunity for the debt to be recouped. There is also an apparent contradiction between Bankwest's submission and evidence relating to individual cases. Bankwest's submission states that one of the characteristics often identified before it decides to appoint a receiver is that 'the underlying project or development has stalled or costs have blown out'.[33] However, borrowers counter that it was because previously committed funds were not forthcoming that construction had stalled. Additionally, selling projects that are nearing completion does not seem to maximise the value that could be recouped; one borrower argued that they had $8 million worth of committed pre‑sales for a project that was 70–80 per cent completed, but which was ultimately placed in receivership and sold for $2.215 million.[34]

8.29      Mr Guy Goldrick, who was involved in a development linked to Bankwest, explained that:

Our project was going well when, out of the blue, we were told to stop work. We were left hanging for nine months, all the while being told our development was fine and then, in 2009, we were given 24 hours to pay back $6.4 million.[35]

8.30      The project was sold in its incomplete form for around $3.2 million. The value of the completed project was estimated to be around $15 million.[36] Mr Goldrick argued:

If they had worked with us in any way, shape or form, we could have finished the development and moved ahead. Maybe if we had sold two at a reduced price, we could have paid out the debt. Even if we had had to sell three to pay out the debt, we would not have been in the position where the bank were still owed money.[37]

8.31      Bankwest's general response to these types of cases was to state that 'it is not in our interest to sell an asset for a lower value and take a loss'.[38] Even so, as previously noted, the new owners of Bankwest had decided to redirect the focus of its business portfolio away from the property sector.[39] The tension between this decision and decisions about individual developments was highlighted by a senior Bankwest executive:

When developments get into difficulties, there are debates between the bank and the customer as to whether or not it is better to put more money in to finish the development at that point. The reality of what was going on globally at that point was that all banks, because we were at the point where we entered the financial crisis, were looking at the sectors that they wanted to lend into. At that point in any cycle lending into development of property always starts to slope.[40]

8.32      Mr Corfield added:

... there are of course a number of development customers where we have finished the development with those customers in order to make sure, as you say, that we can realise the value for the bank and for the customer ... However, the reality is equally, unfortunately, that in some of these development cases putting in further money will not realise any extra value either for the customer or for the bank and unfortunately the reality of what happened in the GFC was that values fell very significantly, especially in regional development centres.[41]

Revaluations, receivers and 'market value'

8.33      This section examines concerns about how valuations were conducted, the appointment of receivers and, from an overall viewpoint, whether the best price of the properties being sold was achieved.

Revaluations

8.34      Revaluations were a recurring feature in the evidence from borrowers who feel aggrieved by Bankwest's actions. Some borrowers also posed questions about the relationship between Bankwest and its panel valuers[42] and the nature of the instructions from the bank about how the revaluation was to be conducted.[43] That valuers are independent from the banks was a point emphasised by many organisations in response to these suggestions. For the valuers it uses the CBA requires, among other things, that they hold associate membership of the Australian Property Institute, that the valuation report be signed by a valuer with at least five years' experience of valuing the relevant type of property (and be countersigned by the director of valuation in the firm if the amount of the valuation exceeds $1 million) and not have a direct or indirect interest in or association with the client or the property concerned.[44] The Royal Institution of Chartered Surveyors (RICS Oceania) stated that the valuation provided by professional valuers is done at a point in time and under professional standards, such as the RICS Valuation Standards and the International Valuation Standards Council.[45]

8.35      The previous chapter detailed some of the evidence regarding revaluations, and how the outcomes of revaluations were significantly lower than previous valuations conducted, placing the borrower outside their LVR. In its submission, RICS Oceania noted that the global financial crisis and the related fall in property prices presented challenges for valuers:

The unfortunate and grim reality of the global financial crisis is the devastation to businesses and livelihoods, as property prices fell in response to the changing international financial environment. Through this period valuers and the valuation profession struggled to determine what a market value [was] in a market place that became so difficult so quickly.[46]

8.36      In addition to changes in market conditions related to the global financial crisis, RICS Oceania also stated that the outcome of revaluations could differ significantly from the initial valuation:

Revaluations of properties may have some greater variance as valuers may not see the previous valuation. They are instructed to value the property as it is presented to them by the client. This may cause a variance of the valuation that may seem excessively different from the previous valuation.[47]

8.37      However, many borrowers had specific objections to how the initial valuation or the revaluation was conducted.[48] The integrity of these valuations is important given the evidence of significant detrimental consequences that an inadequate valuation can have for the borrower, such as termination of the loan and bankruptcy. Some submissions were critical of the interpretation of 'market value'. Agtion Consultancy Services director Mr Lindsay Johnston submitted that he is aware of up to five different methods that can be applied to value a property:

Values of mortgagors' properties for mortgage lending purposes are invariably lowered to the bottom of the possible range and the terms of reference that are adopted deviate from the principle set out in the legal authority Spencer v Commonwealth. It appears that valuers acting conservatively under the influence of their bank appointers adopt a valuation based on a distressed sale outcome of the property being potentially sold as "mortgagee in possession" or by a bank appointed receiver.

The highest value method appears to arise when a property is ... being valued for a deceased estate. These valuations often exceed the likely market value.

What happened to market value, within the meaning of Spencer v Commonwealth? Surely there is only one market value?[49]

8.38      Mr Geoff Shannon provided the committee with an example of a revaluation undertaken of a property at Nambucca Heads which also highlights the multiple methodologies available for valuing a property:

... wherein the valuer describes two methods of establishing a valuation price. Method one, as is, gives the current market value of this particular project as $4.3 million. Method two, in one line, gross realisation, gives the value for the same project as $2.8 million. I highlight that that is two different values for the same property on the same day and on the same page. This is understandable, given the alternative sales options individually versus in one line. However, I draw your attention to the fact that the facility terms at the time of entering the loan contract describe the method that is required to be adopted. So why did Bankwest obtain a second valuation via the second method? I believe that Bankwest is instructing the valuers to value the property using different—and lower—valuation methods to those outlined in the original facility terms. This would mean that the bank has breached the client's loan contract by opting for an alternative method to that stated in the facility documents.[50]

8.39      As this is relevant for many of the examples put to the committee, the following is the Australian Property Institute's guidance for valuations of multiple properties in a single development:

Where a Member undertakes a valuation of multiple properties in one development, such as lots in a subdivision or units in a building, the sum of the individual values or gross realisation assessed on the basis of an orderly marketing and sale program should be clearly defined as the total gross realisation.

The valuation of multiple properties in one development should be completed on the basis of a single transaction or sale in one line to one buyer. This valuation approach should incorporate an appropriate discount to reflect the costs incurred in realising the proceeds from the sale of the individual properties. These costs normally include marketing and sale costs, holding costs and a profit and risk factor.[51]

Receivers

8.40      Banks, to protect their position as a secured creditor, generally include in a loan contract the right to appoint a receiver and to sell the customer's assets if the customer defaults. Receivership:

... is an administrative procedure by which a person—who must be a registered liquidator—is appointed to administer property on behalf of a secured creditor ... The appointment may be limited to mere protection of one particular item of property—for example factory premises—or it may extend to general control over all of the property and business affairs of a company—for example the factory and the engineering business carried on there. A receiver may be appointed privately under contract, or by the Court ... the former ... is by far the most common type of receivership and the type that is relevant to this inquiry.[52]

8.41      Receivers are subject to requirements under the Corporations Act 2001, general law,[53] ASIC regulatory guidance and, for members of the Insolvency Practitioners Association of Australia (IPA), the IPA's Code of Professional Practice.[54] While the receiver's primary responsibility is to the secured creditor the receiver has certain duties to the company. ASIC advises that case law indicates that receivers have the duty to:

(a) exercise his or her powers in good faith (including a duty not to sacrifice the company's interests);

(b) act strictly within, and in accordance with, the conditions of his or her appointment; and

(c) account to the company after discharging the secured creditor's security, not only for the surplus assets, but also for his or her conduct of the receivership (including the duty to terminate the receivership as soon as the interests of the secured creditor have been satisfied).[55]

8.42      Some borrowers suggest that it is too easy for the bank to appoint receivers:

There is a trend to liquidate rather than workout a loan. With liquidation comes downward pressure on asset values which in itself triggers further defaults through non compliance of loan covenants ... Receivership is a "death warrant" to a borrower. Once this is on record it is impossible to attract first and second tier lenders to the funding table. The appointment of a receiver is all too hastily done. It destroys any creditability of both borrower and business.[56]

Market value and best price requirements

8.43      The committee received evidence suggesting that the properties of a number of businesses, once placed in receivership, were:

• sold for a price substantially below the value stated in recent valuation reports;
• not being sold in a way that would maximise value; and
• ultimately sold at a price that was less than other unconditional offers that were not accepted.

8.44      Some examples of these concerns are below:

The "market valuations" obtained by St George Bank, ANZ and the NAB were in excess of $10 million compared to the Receivers sale of the properties at approx. $5m.[57]

* * *

Senator WILLIAMS: Were you a company?

Mr Butler: Yes.

Senator WILLIAMS: Under section 420A [of the Corporations Act] they must make the best effort to get the maximum price.

Mr Butler: Yes.

Senator WILLIAMS: And it did not go to auction?

Mr Butler: No.

Senator WILLIAMS: They had offers of $14 million and it was sold for $9.5 million?

Mr Butler: Yes.[58]

* * *

November 27, 2008 (9 months after the Bank received $500,000 from the proceeds of the sale of the Motel) the property was auctioned by a Receiver appointed by the Bank (Earnst [sic] & Young). At auction, the property passed in and a later offer of $2,850,000 was declined by the Receiver and ultimately sold for $1,000,000 less (ie: $1,800,000).[59]

8.45      When a receiver sells the property of a company, both legislation and professional standards govern their conduct. Subsection 420A(1) of the Corporations Act requires that all reasonable care be taken to sell the property at market value or the best price that is reasonably obtainable:

In exercising a power of sale in respect of property of a corporation, a controller[60] must take all reasonable care to sell the property for:

(a) if, when it is sold, it has a market value—not less than that market value; or

(b) otherwise—the best price that is reasonably obtainable, having regard to the circumstances existing when the property is sold.

8.46      A key concept is 'market value'. According to the International Valuation Standards 2011, market value:

... is the estimated amount for which an asset should exchange on the valuation date between a willing buyer and a willing seller in an arms length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.[61]

8.47      The IPA explained how section 420A works in practice:

The sale of assets at market value is a significant legal obligation of a receiver and it is one that is sometimes contested in the courts ... The law generally requires receivers to engage in a competitive process, for example, involving tender or auction, and based on valuation and sale advice. Assets sold by receivers also attract those looking for a reduced price. Most court challenges to receivers' sales do not succeed.[62]

8.48      The actions taken by receivers in seeking market value were criticised, particularly when properties were sold by receivers for less than the amount of alternative offers the borrowers had secured but which were not accepted by the receiver. This issue was pursued when Bankwest appeared before the committee:

CHAIR: We have also heard evidence through the course of this inquiry that some of the customers are aware of potential buyers, or alternatively have actually found them, for all or part of their businesses and have approached the receivers you have appointed and have either been ignored or had those offers rejected. Then, subsequently, the property on which the security was held was sold at a much lower level. Are you aware of stories along those lines?

Mr Corfield: Yes. Obviously over the course of the financial crisis valuations fell very dramatically.

CHAIR: That is right. But if your customer is trying to work with you to sort out their problems and comes to you and says, 'I have somebody who is willing to buy this part of the security for this amount of money,' and that would have substantially paid off a lot of the money that is owed to you, but then that is rejected and later on the whole of the security is sold for a price that is even lower, it does not fit in with what you were saying about the GFC lowering prices, because in the midst of it they had somebody who was willing to pay more.

Mr De Luca: That sounds unusual.

CHAIR: Over the past few days probably two cases involving those issues have been put to us. They are cases where, particularly, the receivers—I do not know whether Bankwest was involved—just would not entertain it.

Mr Corfield: Again, there are very often two sides to every story.

CHAIR: Which is why I am putting this to you.

Mr Corfield: During the financial crisis we saw a lot of potential sales of assets, but ultimately those sales fell through because buyers were as spooked by the financial crisis as sellers were.[63]

8.49      From the evidence received, it is apparent that the sale of a partially completed development may not reflect the expenses spent on the project. Further, forced sales by a receiver are likely to result in a lower value than a stated valuation for a number of other practical reasons, such as a shorter period for marketing and because it is widely known that they must be sold. As one submission described the process:

... a Receiver Sale is taken by prospective buyers as a flag to a bargain because they are aware that the properties "must be sold". I challenge anyone to prove that a Receiver/mortgagee sale obtains a higher price than would otherwise be if the properties were market[ed] without notice of the receiver appointed.[64]

8.50      The same submission recommended that the concept of market value be amended to reflect a reasonable time for sale:

It is not accepted that just because an aggressive advertising program is implemented that the properties will fulfil "market value" status. Too many forced sales hide behind the "promotion activities" of receivers and banks to justify a "market value" and think that they have compiled with Section 420A of the Act.[65]

8.51      ASIC noted that the courts have taken an interpretation of section 420A that focuses 'more on what was the process taken, rather than focus on whether the best possible price was achieved'.[66] Further, the IPA contends:

... we find that the owners of the business often have an overly optimistic view of the value of the business, and a limited sense of their responsibility for its decline. Also, questions of market value are often contentious, more so in what we may call a post GFC climate when expectations of sale price have to be adjusted.[67]

Treatment of GST revenue

8.52      As GST is levied on the final consumer of a good or service, a business that supplies final consumers is required to charge GST on these goods and services. The business is then required to calculate, report and remit the GST amounts to the Australian Taxation Office (ATO) on a monthly, quarterly or annual basis. Effectively, the business collects the tax for the ATO.

8.53      Mr Iannello and Ms Pagano, who were involved in a residential property development in Western Australia, submitted that Bankwest would not release approximately $425,000 that was set aside in a bank account for GST. After the ATO demanded payment, the business appointed an administrator and Bankwest subsequently appointed a receiver.[68] Questions about what happens to any monies that a business has set aside for GST after a receiver is appointed to that business by a bank were asked by the committee. Whether the GST revenue incurred from the sale of developments was ultimately forwarded to the ATO was also a particular focus:

Senator WILLIAMS: Why has Bankwest been so reluctant, because the receivers were selling these joints up and giving you all the money after their fees, to hand over the GST component to the Australian Taxation Office?

Mr De Luca: I am not aware that we have been.

Senator WILLIAMS: Let me make you aware of it. Lauderdale Projects Pty Ltd and the Bank of Western Australia—the sale went through for $9 million. Bankwest agreed to the sale contract. There was $900,000 of GST. So the sale price was $9.9 million. The receiver gave Bankwest $9.9 million. If Lauderdale did not get the $900,000 they could not pay the Australian Taxation Office in their quarterly or monthly BAS. You held on to the money. You would not hand over that $900,000. So what happened? The parties—and Bankwest agreed to this—called in a bloke called Ron Merkel, a former judge. You agreed to abide by Mr Merkel's decision as an expert ... He said 'The GST amount is properly to be regarded as an expense occasioned by the sale rather than as part of the purchase price payable to the bank by the sale.' ... He went on to say that 'Bankwest as secured creditor under its mortgage and charges is not entitled to the GST amount in priority to the ATO as of date of completion of the sale or at any time thereafter and the payment of the GST amount to Bankwest without making provisions for the payment to the Australian Taxation Office of the GST due on the sale of the property will in the circumstances of the present matter be unlawful' ... When you got that $9.9 million, you clearly knew that $900,000 was the GST component. Why would Bankwest not hand that over to the ATO?

Mr De Luca: I am not aware of that matter. I am happy to look into that one for you.

Senator WILLIAMS: You had better look deep because I am sure that there are going to be other people looking into it as well.[69]

8.54      Bankwest subsequently provided a statement to the committee emphasising that it is not responsible for the GST liabilities of its customers and, although receivers are responsible for paying GST liabilities arising after their appointment, neither the receivers nor the bank are responsible for payment of GST liabilities that arise prior to this. A relevant extract from that statement is provided below:

... in February 2010, Lauderdale exchanged contracts for the sale of its property with a purchase price of $9 million plus GST of $900,000. The Bank had not appointed receivers to the Company in question. As the sale proceeds were insufficient to repay the debt due to Bankwest, Lauderdale queried whether it was entitled to keep the GST component of the sale proceeds in the sum of $900,000 and later remit those monies to the ATO. At this time the Bank had concerns that the customer was diverting funds to related parties. Rather than allow this query to hold up settlement, Lauderdale and the Bank agreed to proceed on the basis that the funds would be paid into a solicitor's trust account at settlement and the parties would agree to abide by the views of Ron Merkel. Following Ron Merkel's opinion the $900,000 was released to Lauderdale. The money had never come into Bankwest's control. As the sale was made by Lauderdale prior to the appointment of any receiver, the operation of the GST law is such that any GST obligation is that of Lauderdale and not the Bank who had no obligation to account to the ATO for GST.[70]

8.55      The CBA advised that information it has received from insolvency firms indicates that businesses entering receivership do not generally have amounts specifically set aside to fulfil their GST obligations. The CBA also noted that, once a receiver is appointed, amounts owing to the ATO for unremitted GST would be treated as an unsecured claim and do not have priority under either the Corporations Act or relevant sections of the GST legislation.[71]

Committee view

8.56      The committee notes that there are disputes about particular cases where GST revenue had been collected, but was not ultimately passed on to the ATO. The committee would be concerned if these payments were not remitted to the ATO, particularly as the payments were made on the understanding that the purchaser was fulfilling a tax liability. While there are different viewpoints about the particulars of individual cases, there are sufficient issues for the ATO to examine. If the ATO considers that there are issues with the treatment of GST revenue but that it is unable to take enforcement action under current legislation, it should recommend appropriate policy changes to the government.

Recommendation 8.1

8.57      That the Australian Taxation Office (ATO) investigates allegations that GST revenue was not handled appropriately by banks and receivers and that, if necessary, the ATO makes recommendations to the Australian government about legislative changes in this area.

Options available for borrowers to seek redress

8.58      The remainder of this chapter turns away from the possible explanations for why a significant number of small business customers of Bankwest had their loan terminated to examine options that aggrieved borrowers have available to them for their case to be heard.

Contract law and statutes

8.59      For aggrieved borrowers, contract law based on common law and equity generally applies although additional legislative protections are contained in Commonwealth, state and territory legislation. Overall, the law is structured to generally allow lenders and borrowers 'to enter freely into agreements that they consider appropriate for their circumstances', although 'there are a number of legal protections for [consumers and] small business borrowers to ensure that they are not subject to treatment that is generally considered unfair, and that the process for lenders to exercise their contractual rights over secured assets is appropriate'.[72]

8.60      Protections for borrowers from various lending practices are currently directed toward consumer credit, rather than small businesses and other commercial activities. These provisions are contained in the National Consumer Credit Protection Act 2009 (NCCP Act) and the Australian Consumer Law.[73] Some of the issues addressed include unfair contract terms, responsible lending by licensees and the right to apply for a repayment arrangement on the grounds of financial hardship.

8.61      Some statutory protections, however, apply to financial institutions' dealings with small businesses. The Australian Securities and Investments Commission Act 2001 includes broad prohibitions against misleading or deceptive conduct and false and misleading representations in respect to the provisions of financial products and services.[74] Specific unconscionable conduct[75] provisions also apply to dealings with consumers and small businesses:

A person must not, in trade or commerce, in connection with:

(a) the supply or possible supply of financial services to a person (other than a listed public company); or

(b) the acquisition or possible acquisition of financial services from a person (other than a listed public company);

engage in conduct that is, in all the circumstances, unconscionable.[76]

8.62      On the Bankwest issue, based on the legislative boundaries in place and the resulting matters that fall within ASIC's jurisdiction, as well as the number of complaints it has received, ASIC advised that it considers it has not 'received any evidence to suggest some sort of systemic misconduct by Bankwest', nor as at August 2012, has it received 'anything that warrants further pursuit'.[77]

Possible small business credit reform

8.63      On 3 July 2008, the Council of Australian Governments (COAG) agreed to transfer responsibility for the regulation of consumer credit from the states and territories to the Commonwealth. This ultimately led to reforms such as the National Credit Code (a schedule to the NCCP Act). As part of these reforms, possible changes to the regulation of the provision of credit to small businesses were mooted.[78]

8.64      In July 2010, the government released for consultation a green paper on the remaining proposals being considered as part of the credit reform agenda. The issue of credit to small business was covered in this paper. The paper noted:

The reasons put forward in support of small business borrowers being afforded the same degree of protection as consumers include similarities in the types of securities used for small business loans (such as the primary residence); and similarities in the level of sophistication of small business borrowers' understanding of credit contracts and credit products.

However, it is difficult to assess the significance of these issues due to the diversity of the small business sector and the relatively small number of small business complaints reported compared with complaints from individuals. Despite this, there is merit in examining whether small business borrowers would benefit from some statutory protections.[79]

8.65      The three options canvassed by the green paper for small business credit reform were:

• limited application of consumer credit protection regulations;
• full application of consumer credit protections regulations; or
• development of tailored regulations for small business lending.

8.66      A decision on the proposed reform has not yet been made or publicised. In its submission to this inquiry, Treasury stated that 'consultations to date have identified as a key concern the need to balance benefits to small businesses against any possible increase in the cost of credit or decrease in its availability'.[80] In its submission, CPA Australia stated that it strongly recommends that the proposals to extend the national consumer credit regime to small businesses not be pursued.[81]

Industry codes of conduct

8.67      There are a number of voluntary codes of conduct that govern the lending activities of financial service providers and the dealings of these providers with their customers. The codes include the Code of Banking Practice, the Mutual Banking Code of Practice and the Mortgage and Finance Association of Australia Code of Practice. The most well-known and relevant code for this inquiry is the Code of Banking Practice administered by the Australian Bankers' Association, which is a voluntary code of conduct that outlines a bank's commitments and obligations to its personal and small business customers. The Code was released in 1993 and is reviewed every three years, although the last review was concluded in December 2008.

8.68      The Code of Banking Practice includes provisions on:

• disclosure of fees and charges and other terms and conditions;
• changes to terms and conditions and fees and charges;
• disclosure of general information about banking services;
• privacy and confidentiality;
• statements of account;
• copies of documents;
• direct debits;
• credit card chargebacks;
• debt collection; and
• complaints handling.[82]

External dispute resolution—the Financial Ombudsman Service

8.69      There are two main external dispute resolution (EDR) schemes relevant to the banking and financial sector. They are the Financial Ombudsman Service (FOS) and the Credit Ombudsman Service. As the evidence received by this inquiry refers to banks and FOS is the most relevant to the subject matter, this report will focus on FOS rather than the Credit Ombudsman Service.

8.70      FOS is an EDR scheme approved by ASIC which commenced on 1 July 2008 after the consolidation of other EDR schemes.[83] FOS is structured as a not‑for‑profit organisation governed by an independent board of representatives of consumers and the financial services industry.[84] FOS notes that it reports to ASIC quarterly on systemic issues and identifies financial services providers that have engaged in serious misconduct.[85]

Difficulties in seeking redress

The judicial system

8.71      A recurring theme in evidence has been the difficulties that aggrieved borrowers have faced in seeking to challenge the decisions and actions of banks and receivers. Prior to any legal action being considered, attempts to resolve the situation can cost the borrower significantly:

In one meeting it was me and my wife against two [receivers] and three lawyers all on about $500 per hour and being paid for from my company and they told us so!! In other words shut up and go away as every time you ask us a question we will charge you.[86]

8.72      In terms of the resources available to pursue and continue legal action, an individual engaging in legal proceedings against a major bank is undertaking an inherently unequal endeavour. As noted in the previous chapter, in many instances the result of the borrower's loan being terminated is that the borrower had been forced to seek government income support or assistance from family and friends. Accordingly, the prohibitive expense of mounting and sustaining legal action is beyond the reach of many, especially once the assets have been sold. Further, there are other factors which add to the difficulties; for example:

... the legal system requests that the claimant put up surety for the bank's legal costs. An impossibility in most cases so litigation "dies on the vine". There is a practice of deferring proceedings which continually runs up costs to all. Remembering that all of the bank's legal costs are ultimately charged back to the borrower, the borrower in effect is doubled dipped with legal costs.[87]

8.73      There are also more practical challenges:

I found that requesting the services of a major law firm to represent me against Bankwest was difficult. In [a] confession made by many large Sydney based firms it was stated that they would have a conflict as they have banks as their clients. One firm stated that the bank business is more profitable to them then my case. It shows that profit is the motive and selection for litigation cases.[88]

8.74      One borrower also alleged that, after their company's assets were sold and the debt to Bankwest was repaid, their company's receivership was prolonged until they agreed to discontinue legal action and not to take legal action against the bank in the future:

[Bankwest] [c]onditions release of our funds with dropping all current legal action & undertaking not to hold either Bankwest or receivers accountable in future. Otherwise, Bankwest will continue to debit monthly costs to the said surplus funds until they are depleted. Receivers inform me their role was completed many times, and direct to Bankwest, all questions as to why receivers [were] not discharged from [the] companies.[89]

Possible class action against Bankwest

8.75      Indicating that the justice system may yet provide some comfort to ex‑customers of Bankwest that feel aggrieved by the bank's actions, Slater & Gordon, in conjunction with litigation funder IMF Australia, has indicated that it is conducting due diligence with respect to a potential class action for aggrieved borrowers against Bankwest and the CBA.[90] In April 2012 it was reported that about 130 people had registered as claimants.[91]

Limitations of FOS

8.76      In addition to difficulties faced by aggrieved borrowers in seeking examination of their case by the courts, limitations with EDR schemes such as FOS were identified. The terms of reference for FOS outline the types of disputes it may not consider. Of relevance, FOS may not consider disputes where the value of the applicant's claim exceeds $500,000.[92] The maximum compensation that may be decided by FOS is limited to $280,000. FOS notes that there is 'often confusion' as to whether it has jurisdiction in relation to small business disputes. It publishes the following explanation:

In assessing whether we have jurisdiction to consider a claim about financial difficulty lodged by a small business, we will consider the amount of the loss that is claimed. The account balance or facility limit is not relevant when assessing jurisdiction. It is the amount of loss suffered that is significant. This potential loss usually encompasses the "moneys worth" of any variation sought, any default margin levied on the contractual interest being charged, enforcement expenses and costs of any Receiver or controller appointed over the secured assets.[93]

8.77      A number of former Bankwest customers who lodged submissions to this inquiry were critical of FOS. These criticisms were generally about the assessment of their case and the limitations about what FOS can examine. An instructive example was provided by Mr Sean Butler, who lodged a complaint with FOS that could not be examined because:

• the business was in receivership and FOS requires the authority of the receiver to consider the dispute;
• receivers are not a financial services provider—FOS can only examine the actions of entities that have provided a direct financial service and which are members of FOS;
• the loss claimed exceeds $500,000; and
• FOS is unable to consider the actions of a third party to the dispute.[94]

8.78      There were examples, however, where the involvement of FOS was clearly effective:

In April 2010 Bankwest sent me a letter of demand for an extra $500,000 worth of charges that they claimed we still owed.

Bankwest would still not speak to us.

I contacted the banking Ombudsman and within 48 hours Bankwest phoned me and advised me that conditionally on me signing a document saying I would not take any legal action against them they would forgive the $500k.[95]

8.79      The founder of the Unhappy Banking group, Mr Geoff Shannon considers EDR schemes such as FOS to be 'a fantastic system' and advises aggrieved borrowers that contact him to lodge a dispute with FOS rather than with ASIC.[96] He suggests, however, that because banks are appointing receivers 'far more quickly now than they were before' a loophole exists because the receivers can refuse to grant authority for the dispute to be considered by FOS.[97]

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