Lack of Independent Legal Advice: Part I – Consequences for Lenders
If you are a spouse or family member of a person seeking to obtain a loan with your assistance either by guaranteeing the loan or offering other security, you may have been directed to a lawyer who is independent of the borrower or the lender to give you legal advice. The reason for this is to mitigate the risk to the lender that you are being unduly influenced in offering your assistance.
As a general rule, the security may be set aside by the courts where one party was induced into entering into a transaction by another party’s undue influence. The undue influence may be actual or presumed for certain relationships of trust and confidence. A court will look to the relationship to determine if there is a presumption of undue influence and will likely reach this conclusion where there is a potential for domination. The potential for domination can exist where the parties to a transaction are unequal in terms of their bargaining power, financial strength, sophistication or reliance on one another. The best way to rebut the presumption of undue influence is to insist that parties obtain independent legal advice prior to providing the guarantee or security to the lender.
An example where the need for independent legal advice may arise is when one spouse offers security to finance the other spouse’s business venture. Assume that the family home is in the name of the wife and the bank requires the wife to grant a mortgage over the home to secure the loan to the husband. Although a spousal relationship does not automatically trigger the presumption of undue influence if, in this example, the wife is financially unsophisticated and/or financially dependent on her husband, the courts may find that she had been unduly influenced to grant the mortgage by her husband. Other examples of undue influence may be where the wife was asked to guarantee a loan or to give security over personal assets for the loan.
Canadian case law has outlined the importance for parties in a financial transaction to obtain independent legal advice. In the above example, the consequences for the bank in failing to ensure that the wife obtains independent legal advice could mean that the bank’s security is unenforceable against the wife. Where it is likely that a relationship can lead to undue influence, the lender should insist that the party receive independent legal advice, rather than allow that party to waive their right to independent advice.
However, the courts have held that independent legal advice is not the only way to rebut the presumption of undue influence. The Ontario Court of Appeal in Bank of Montreal v. Duguid stated that, in the absence of independent legal advice, the presumption of undue influence may also be rebutted where the defendant lender can prove that the contract was signed by a free and independent mind. In that case, the court believed the wife to be knowledgeable about the financial transaction and knew about the risks of providing the security to the bank. Accordingly, the guarantee provided by the bank was enforceable.
Lenders typically insist that those providing security for the loans to others obtain independent legal advice prior to signing documents. This is done to ensure that the security stands in the event the loans go into default and the lenders take action to collect from third parties. Independent legal advice is part of the arsenal of lenders to enforce security.