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Finance Brief - 1 October 2013
- Upcoming changes to the Consumer Credit Regulation Regime
- Does a lender have to disclose commission paid to broker?
- When is default interest penal?
- Jurisdiction clauses: can the lender have it both ways?
- A Chink in the Corporate Veil?
- A Guide to Corporate Jet Finance
It is common practice for lenders to pay a commission to brokers, but issues can arise if that commission is not disclosed to the borrower. This briefing paper is a general introduction to the subject, outlining the position following Wilson v Hurstanger Ltd [2007] EWCA Civ 299 and subsequent cases and highlights some traps for the unwary.
Is the broker an agent of the borrower?
If it is clear from the documentation between the borrower and the lender or the borrower and the broker that the broker is the borrower's agent, it is likely that there will be a fiduciary relationship between broker (as agent) and the borrower. In this situation, the broker would be under a duty to the borrower not to make a secret profit, as this would constitute a breach of fiduciary duty and could also be treated as a special category of fraud in which it is unnecessary to prove motive, inducement or loss, up to the amount of the secret profit (effectively treating it as a bribe). The borrower in this situation would have alternative remedies against both the briber (i.e. the lender) and the broker for the money had and received, where he can recover the amount of the bribe, or for damages for fraud, where he can recover the amount of any actual loss sustained by entering into the transaction in respect of which the bribe was given (Mathesan -v- Malaya's Housing Society [1979]). In addition, the transaction is voidable at the election of the principal (i.e. the borrower) who can rescind it (Panama & South Pacific Telegraph Co v India Rubber, Gutta Percher and Telegraph Co [1875]).
If the broker is not paid a fee by the borrower and there is no written contract between the broker and the borrower, it is highly unlikely that there will be an exclusive agency agreement or fiduciary duty between the broker and the borrower. This was the case in Buckingham & Buckingham v Black Horse Limited (2011). Further, if no fee is paid by the borrower to the broker and any agreement between the broker and the borrower does not state that the broker is the borrower's agent, it is also highly unlikely that there will be a fiduciary relationship between the broker and the borrower.
Wilson v Hurstanger Ltd
Wilson v Hurstanger Ltd held that in circumstances where a borrower was advised that his broker might receive commission from the lender, this may be considered to be sufficient disclosure to negate secrecy. This will not however constitute informed consent on the part of the borrower. Consequently, the court ruled that unsophisticated borrowers should be provided with a statement of the amount that the broker will receive from the lender in order that they are aware of any potential conflicts of interest that may arise.
Sealey and Winfield v Loans.Co.UK Ltd (1) and GE Money Secured Loans Ltd (2)
This case established that while brokers owe a duty to their clients to act in their best interests and introduce them to a lender who will give them a good deal on the financial accommodation they are seeking, this does not result in them pledging their individual loyalty and hence give rise to a fiduciary duty. Their obligation is to do no more than fulfil their contractual duty to act in their clients' best interests. In that case the lender's documents said that commission was paid to brokers, but did not define the broker as being the borrower's agent. He was simply acting as an intermediary under the terms of his contract. The court also said that even if the broker had been acting as a fiduciary, the borrowers had given informed consent to the commission even though the amount of such commission had not been disclosed. It follows that unless the broker is clearly defined as the borrower's agent, the relationship between the parties will be on normal contractual principles and no fiduciary relationship will exist. Moreover even if commission is paid, it will not necessarily be secret even if the amount is not quantified, provided the commission arrangement is brought to the attention of the borrower.
Unfair Relationship under Sections 140 A/B of the Consumer Credit Act 1974 ("CCA")?
In Harrison & Harrison v. Black Horse Limited there was an appeal by the borrowers that the non-disclosure of the sizeable commission created an unfair relationship under sections 140A and 140B of the CCA. This section applies to any credit agreement between a lender and an "individual" (whether or not regulated by the CCA). The Insurance Conduct of Business Rules ("ICOBS") were also considered. The Court of Appeal unanimously held that the taking of undisclosed commission, no matter how big or small, does not of itself create an unfair relationship. The case made clear that there is no obligation on a lender or intermediary to disclose the amount of the commission and any failure to do so cannot create an unfair relationship. Furthermore, provided a lender complies with ICOB there should not be any grounds for arguing that there was an unfair relationship for the purposes of section 140A/B of the CCA.
The Requirement of Disclosure
The Finance Industry Standards Association's Borrower Guide clearly records the fact that a commission will be paid to the broker. If it can be shown that the borrower received a copy of this Guide, this may sometimes satisfy the Court that the requirements for disclosure have been met.
Disclosure of commission payments may be required under the Financial Conduct Authority's ("FCA's") rules on inducements in the Conduct of Business Sourcebook ("COBS") (in respect of investment services), Mortgage Conduct of Business Sourcebook ("MCOBS") (in respect of regulated mortgage contracts) and ICOBS (in respect of contracts of insurance). The COBS inducement provisions apply to payments, fees or non-monetary benefits regardless of materiality. There is a requirement that a fee, commission or non-monetary benefit, where paid or provided to or by a third party, must be designed to enhance the quality of the relevant service to the client. A firm must disclose to the client the existence, nature and amount of the fee, commission or non-monetary benefit or the essential details in summary form, and must undertake to provide further information at the request of the client. Whilst the MCOBS and ICOBS inducement provisions do not exactly replicate the COBS provisions, there remains a requirement that inducements must be considered and payments to intermediaries disclosed.
A person who introduces "individuals" (which includes partnerships of 2 or 3 persons) to businesses providing credit is likely to be a "credit broker", which is an activity regulated by the CCA. The Office of Fair Trading (the "OFT") published guidance for credit brokers and credit intermediaries in November 2011 (the "OFT Credit Broker Guidance") which includes guidance upon fees received by a credit broker both from the borrower and from the creditor. The OFT indicate that a reason to call into question a credit broker's fitness to hold a CCA licence includes if the broker fails to make to the borrower sufficiently full and early disclosure of the existence of any commission fee (or other form of remuneration) payable by the creditor when appropriate to do so. The OFT would regard it as appropriate to do so if the existence of the commission might potentially impact on the impartiality of the broker in terms of the credit products it promotes to a potential borrower. If a borrower asks, the broker must inform the borrower of the amount of the commission or, if not ascertainable, the method of calculation. This does have an impact on the creditor. The OFT Credit Broker Guidance makes it clear that the OFT expects creditors to take appropriate responsibility for the actions or omissions of brokers acting as their agents or business associates. (Whether a broker is an agent or business associate of a creditor is a question of fact and degree, but is likely that the broker will be at least a business associate of the creditor if the creditor and the broker have an ongoing relationship.) The OFT expects a creditor to take reasonable steps to satisfy itself that such brokers are not engaging in unfair business practices. There are serious consequences for a creditor if it fails to take such steps: (i) a creditor's own fitness to hold a CCA licence may be called into question and (ii) an agreement entered into following the introduction by an unlicensed credit broker is unenforceable without an order made by the OFT.
Prudent steps for the Lender to take
For the purposes of this briefing paper, it is assumed that the FCA's rules on inducements in COBS, MCOBS and ICOBS (referred to above) do not apply. It is therefore concluded that claims against lenders and brokers for paying secret commissions can only be successful if a fiduciary relationship exists between the broker and the borrower. A fiduciary relationship is highly unlikely to exist unless: (a) a fee is paid by the borrower to the broker; and (b) the documentation between the borrower and the broker (or possibly between the borrower and the lender) expressly or by implication provides that the broker is the agent of the borrower.
Ideally, the lender should therefore consider:
- asking the broker to represent and warrant: (a) that they are not being paid any fee by the borrower/lessee; and (b) that they are not acting as agent for the borrower/lessee; OR
- if the broker cannot represent and warrant (a) and (b), that they have disclosed to the borrower/ lessee the amount of the commission payable by the lender to them.
In addition, if the lender's borrower/lessee is an individual for the purposes of CCA (which would include a small partnership) the lender should ask the broker (who is likely to be a credit broker for the purposes of CCA) to represent and warrant that it holds a valid credit licence under the CCA and that in relation to the borrower/lessee, the broker has complied with all the requirements of the CCA, its credit licence and the OFT Guidance for Credit Brokers and Intermediaries, including disclosure of commission where appropriate.