Equity and the Unconscionable Transaction

Introduction

Equity and trust law is founded upon the principle of equity in bargaining power between two parties, including the importance of fiduciary duty. The instrument of agreement is intended to ensure that both parties benefit on an equitable basis from the contract. However, there may be instances when one party benefits to an extent that is unjust to the other party. Sometimes agreement may have been secured from one party on inequitable terms and may be liable for unconscionable dealing.

Potential use of unconscionability arises where a stronger party exploits a weaker party due to the combination of circumstances in which they find themselves – and undue influence through unfair treatment to a third party.  In the case of ACCC v GG Berbatis Holdings Pty Ltd, the establishment of unconscionability as the central principle underlying the law of equity was laid out by French J, to corroborate the case of Amadio.  Sir Anthony Mason has laid out the grounds for unconscionability as the basis for grounds for equitable relief. Jacobs ACJ  in the case of Louth v Diprose,  said “It is an oversimplification to say that because the respondent acted as he did with his eyes open, and with a full understanding of what he was doing, he was not in a position of disadvantage, and therefore not the victim of unconscionable conduct.”

The Unconscionable transaction

A transaction may be deemed to be unconscionable if it constitutes fraud under common law and a definite intention exists on the part of one party to defraud or cheat another party. In the case of Pasley v. Freeman, the grounds for fraud were established as existing when a representor “intentionally induced another to act upon it to his detriment”. In the case of Derek v Peek, Lord Hershell in his speech stated: “To prevent a false statement being fraudulent, there must, I think, always be an honest belief in its truth…… one who knowingly alleges that which is false obviously has no such belief…. if fraud be proved, the motive of the person guilty of it is immaterial.” In the case of Hedley Byrne and Co Ltd vs Heller and Partners, a negligent misstatement was also construed to represent a case of fraud. Under Common law, the principle of fraud will constitute deceit because it impels one party to enter into a transaction on the basis of information that is false and misleading, thereby placing the defrauded party at a disadvantage.

Under the law of equity however, the major focus lies on fiduciary duties in the construction of contracts, since a fiduciary is in a position of implied trust, which gives rise to the potential scenario of personal gain through an abuse of the trust reposed in it. Therefore, there may be more stringent remedies exercised for fraud under equity than those that may arise from negligence or a breach of contract.  Lord Dunedin stated in the case of  Nocton v. Lord Ashburton “there was a jurisdiction in equity to keep persons in a fiduciary capacity up to their duty.” Therefore, while at common law, there may be contractual duties of the parties to a contract,  in courts of equity there is a parallel fiduciary duty of solicitors and executors of trusts that must also be considered.

An inequity in bargaining power between two parties or undue influence exerted upon one party by another will yield grounds for unconscionability.  The case of Lloyds Bank v Bundy is the best example of  the inequity in bargaining power and undue influence exercised by the bank, since the old customer Bundy reposed the utmost trust in his bank which has a fiduciary duty of care to its customer. But in the case of National Westminster Bank v Morgan, Lord Scarman clarified that the Bundy case may not be applicable in every case because it rested on its very special facts. The existence of inequality of bargaining power cannot in itself constitute grounds for unconscionability. A bank’s relationship with its customers will only cross over into fiduciary duty when it undertakes to act on behalf of the customer in special circumstances that involve a high degree of trust and confidence. When the bank functions in its normal capacity and has not achieved any special benefit, it cannot be held liable, unless the weaker party had acted to his or her detriment. For example in the case of Morgan, the bank obtained the guarantee from the wife for the husband’s debts for purposes of avoiding loss of the house which was important to her.

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But this principle could not be clearly applied in subsequent cases and the case of Barclays v Bank revisited the problem of unconscionability. Scott LJ, in setting aside the bank’s action to enforce a security on a loan obtained from the wife of the defaulting party, stated that the wife came under the protection of a “protected class” of weaker parties. Lord Wilkinson  Browne of the House of Lords, in affirming the decision stated that while the law protected the weaker sections of society, it did not mean that the matrimonial home could not be deemed as security; a Court of Equity could set aside a security granted by a wife to a bank if there was proof of undue influence by the husband as the bank’s agent and the bank had knowledge about the undue influence being exerted upon the wife and her consequent right to set aside the equity of the transaction in question. Therefore, in this case, a proper application of the doctrine of notice was established, whereby the bank must be put on equiry as to whether it has duly taken notice of the wife’s right to set aside the transaction on grounds of equity. A creditor is put on enquiry when (a) the wife stands at a considerable financial disadvantage through the transaction and (b) when the husband commits wrongs that would enable the wife to set aside the transaction on grounds of equity.

In the Edtridge case however, the Courts acknowledged the difficulties that lay inherent in a bank determining the exact nature and circumstances under which a wife was agreeing to stand guarantor for her husband’s loans. Lord Browne Wilkinson suggested that the bank take steps to satisfy itself that the wife’s consent was freely given by seeking a meeting of the wife alone with a bank representative wherein she could be notified of the extent of her liabilities and her informed consent and knowledge obtained, which would satisfy the bank’s enquiry. Lord Scott clarified that clear explanations have to be provided to the wife of the extend of her husband’s liabilities and the risks involved, together with the fact that the choice in the matter is hers. Lord Nicolls’ speech in this case stated that undue influence would constitute the use of improper means to solicit entry into a transaction and this could be exerted in the form of pressure or the existence of an inequitable relationship between the parties. But the difference between actual and presumed undue influence will lie in the consideration of where the burden of proof lies between the parties where a prior relationship exists. Lord Scott emphasized that the bank should ensure that the wife is acting of her own free will and understands that she is at liberty to seek independent legal advice if she so chooses. A bank must not proceed with a transaction until consent is obtained directly from the wife, a consent given of her own free will and will full understanding of the facts of the matter at hand. The application of the equitable doctrine was also established in the case of Garcia v National Australia Bank Ltd, in the use of superior bargaining power by one party to the detriment of another party who is in a dependant or disadvantaged position, since the wife did not fully understand the facts of the transaction.

These principles established in the above cases are applicable in all relationship cases, not merely those of husband and wife. According to Lord Denning, “as a matter of common fairness, it is not right that the strong should be allowed to push the weak to the wall.” Due to the inequality of bargaining power in the case of females, the doctrine of equity states that a contract is rendered liable if; “without independent advice,  (a party) enters into a contract which is very unfair  or  transfers property for a consideration which is grossly inadequate, when his bargaining power is grievously impaired by reason of his own needs or desires or by his own ignorance or infirmity, coupled with undue influences or pressures brought to bear on him for the benefit of the other.”

Unconscionability and undue influence are therefore grounds that have been developed in courts of equity as a matter of conscience, where the intentions behind a transaction and the manner in which it was obtained also play an important role.