The Defence of Failure to Understand and Other Reasons for ILA

By Bruce Duggan

Independent Legal Advice

One of the most frequent questions/irritants Borrowers raise/experience in a commercial transaction is the requirement for their spouse to obtain independent legal advice. Typically, the complaint is that the spouse knows that what they are signing is a guarantee and that it is an inconvenient and needless expense to have to obtain independent legal advice, especially if it is being repeated for a second time in the case of refinancing.
The function of independent legal advice is to overcome defences that the Bank would not have been aware of. Defences such as failure to understand, mistake, undue influence, duress, fraud and misrepresentation are ready weapons available to guarantors. If successful, any of these defences would leave the guarantee or other loan documents signed by such person unenforceable. This article reviews the defence of failure to understand also known as non est factum.

Failure to Understand/Non Est Factum

The basis of this defence is that the person signing did not understand the document signed, that the document was represented as being different from what the person signing thought they were signing and they were not careless in signing. Where this defence is established it becomes the Bank’s obligation to prove that the person signing did know what they were signing. Such “at risk” people can include those who have, for example little formal education, a lack of fluency in English, little understanding of the purpose of the financing or a lack of understanding regarding the loan terms. This defence is demonstrated in these two examples:

• Bertolo v. Bank of Montreal : Mrs. Bertolo was the widow of a post office employee who died in 1965. She had no business experience and little formal education. She was not fluent in English and was unable to read and discern such documents as promissory notes, collateral mortgages and financial statements. She took no part in the negotiations for the loan and was unaware of the terms of either the business purchase being financed or the bank’s loan agreements. “All she knew”, the trial judge found, “was that her son was buying a restaurant and she was willing to help him”. The Bank required ILA but it was provided by the same lawyer acting for the Bank and the Borrower and so was not “independent”. The bank was unable to enforce its loan agreement against Mrs. Bertolo.
• Chaplin & Co., Ltd. v. Brammall : Chaplin & Co. agreed to supply goods to Mr. Brammall on credit if his wife would guarantee payment. Chaplin & Co. sent the husband a form of guarantee in order that he might obtain his wife’s signature to it, leaving the matter entirely to him. The husband obtained his wife’s signature without sufficiently explaining the nature of the document which she did not understand. No ILA was obtained. The company was unable to enforce its guarantee against Mrs. Brammall.

The Consequences for the Bank

The mere lack of independent legal advice does not invalidate lending agreements or guarantees but in the absence of ILA, the Bank becomes responsible for the manner in which the bank documents are signed.

In the above case, when Chaplin & Co left it entirely up to Mr. Brammall to obtain his spouse’s signature to the guarantee, Chaplin & Co assumed the consequence of Mr. Bartolo obtaining his spouse’s signature without her understanding what she was signing.

The “I” in ILA is critical. In Bartolo, above, the Bank did require ILA but Mrs. Bartolo received it from the lawyer representing both the Bank and the Borrower and so the legal advice could not be said to be independent. Given the evidence of Mrs. Bartolo, the Bank could not prove that the transaction was adequately explained to her. The bank had to abide by the consequences of Mrs. Bartolo signing without understanding the terms and consequences of the transaction.

Defending against claims of non est factum

Where a person signing loan documents does not receive a financial benefit from a lending transaction (for example, the spouse who is not a shareholder of the borrower), the Bank must always be in a position to prove that the person signing the guarantee, for example, knew what they were signing. In the absence of ILA, the Bank has to prove that the person who otherwise can credibly claim non est factum did, in fact, receive a proper explanation of or had an accurate understanding of the loan documents. Obviously, proving this can be very difficult.

The adequacy or inadequacy of legal advice received by the person signing is never an issue: the Bank is not responsible for the quality of the legal advice provided by an independent lawyer. If the legal advice was wrong or insufficient then that is left as a problem as between the independent lawyer giving ILA and the person signing. It is not up to the Bank to enquire whether the ILA was sufficient.