When commission is paid by a lender to a broker, in circumstances where the lender knows that the broker is acting as the borrower’s agent, care needs to be taken to ensure that the borrower is aware of any such payments. Where a finance company is proposing to take an assignment of all or part of a lender’s loan book, it is also important that checks are made as part of the due diligence process to ensure that disclosure of commission arrangements has been given to borrowers on every occasion.
Why this is necessary was laid bare in a recent case which came before the High Court and Court of Appeal. An order was made against a lender which entitled a borrower to rescind loans, collectively worth close to £4 million, and to recover nearly £100,000 because commission paid to a broker had not been properly disclosed.
According to Paul Sheeter of Ingram Winter Green Solicitors in London, this case has serious and wide-ranging implications for anyone involved in property finance.
Facts of Wood v Commercial First Business Ltd and Business Mortgage Finance Plc
Mrs Wood ran a buffalo farming and organic mozzarella cheese-making business from two farms in Somerset: Higher Alham Farm and Dean Street Farm. In 2016 she borrowed £1,020,000 from Commercial First Business, which was secured by a mortgage over Higher Alham. In July 2007, she borrowed a further £1,427,320 from the same lender which was secured by a mortgage over Dean Street, and in November 2007 she borrowed another £174,474 which was also secured on the Higher Alham property.
All of the loans were arranged through brokering company, UK Mortgage and Financial Services Ltd, which had been retained by Mrs Wood and to whom she had paid fees totaling £18,226. Unbeknown to Mrs Wood, for each of the loans that UK Mortgage and Financial Services had arranged for her, they had also been paid commission from Commercial First Business which amounted to £92,927.
Mrs Wood’s business subsequently ran into financial difficulties, which resulted in her defaulting on the loans. As a consequence, enforcement action was taken by Commercial First Business which led to possession orders being made in respect of both farms.
In resisting attempts to enforce the possession orders, Mrs Wood claimed that the undisclosed payments made by Commercial First Business to UK Mortgage and Financial Services amounted to secret commissions, which are not permitted under UK common law and which also fall foul of the Consumer Credit Act 1974. As a result of this, Mrs Wood maintained that she was entitled, as of right, to rescind the loan contracts on which the mortgages over her farms were based and to claim payment of a sum equivalent to the commission that had been paid or, alternatively, to the losses that she had sustained.
Mrs Wood’s claim was disputed by Commercial First Business, who by this stage were in liquidation, and also Business Mortgage Finance to whom the loan accounts had since been assigned. The arguments advanced were essentially that:
- there needed to have been a fiduciary relationship between Mrs Wood and her broker in order for any right of relief to apply in respect of the commission paid, and in this case no such fiduciary relationship existed; and, in any event
- the payments made could at best be described as half-secret commissions, given that the possibility of commission being received from the lender was flagged in the broker’s terms of business, and in view of this there was no right for Mrs Wood to insist on the loan contracts being rescinded as of right, although it was acknowledged that rescission could be ordered along with the payment of damages should the court so direct.
It is worth noting that the provision in the broker’s terms governing the possible payment of commission was expressed as follows: “We may receive fees from lenders with whom we place mortgages. Before we take out a mortgage, we will tell you the amount of the fee in writing. If the fee is less than £250, we will confirm that we will receive up to this amount. If the fee is £250 or more, we will tell you the exact amount.”
Mrs Wood was provided with a copy of the terms, but at no point was she advised that commission had in fact been paid or given any details about the amounts involved.
Mrs Wood did not make a claim against UK Mortgage and Financial Services Ltd, even though she was entitled to, as the company had been dissolved prior to proceedings being instigated.
Decision of the court
At both first instance in the High Court, and in a conjoined appeal to the Court of Appeal, Mrs Wood was successful in her claim against Commercial First Business. The courts agreed with her contention that the payments made by the lender to UK Mortgage and Financial Services should be categorised as secret commission, as opposed to half-secret commission, and that accordingly she was entitled to insist on rescission of the loan agreements as of right.
While it was true that the broker’s terms did make it clear that commission might in some cases be paid, the provision in question went on to impose an unqualified obligation on the broker to inform the borrower, before a mortgage was taken out, of the amount of the fee that would be received, and indeed, as each of the commissions paid was in excess of £250, there was in fact an obligation for the exact amount of the commission to be disclosed.
In the absence of such disclosure having been given, Mrs Wood was not actually on notice that any commission might be paid. On the contrary, as the court noted, “the only conclusion from the absence of any notification as required was that no commission was to be paid.” The undisclosed commission payments were therefore secret, not half secret, and as Commercial First Business knew of the agency arrangement and yet had failed to ensure that Mrs Wood was aware of the commission that was to be handed over, they were liable along with the broker for providing her with appropriate relief.
Accordingly, the court made an order directing that:
- the loan agreements for which secret commission had been paid should be rescinded, subject to Mrs Wood making appropriate counter-restitution to Business Mortgage Finance for the benefit she had derived from having the loans in place; and
- Mrs Wood should also be paid the sum of £92,927 to reflect the total amount of commission that had been paid to UK Mortgage and Financial Services.
In confirming the law around the issue of secret commissions, the Court of Appeal held that:
- it is not necessary to establish that a fiduciary relationship exists or existed between a borrower and a broker in order for relief to be granted against a lender who is found to have paid the broker secret commission (although this might be necessary in half-secret commission cases). All that needs to be established to expose both the lender and the broker to the risk of relief being ordered is proof that the broker was under a duty to the borrower to provide information, advice or recommendation on an impartial or disinterested basis;
- once payment of a secret commission is found to have occurred, a borrower will become entitled as of right to have the relevant contract or contracts affected by this special category of fraud rescinded at their election, provided that they can give counter-restitution through the repayment of any benefit that they have obtained as a result of the loan(s) that have been secured on their behalf; and
- in addition to rescission, the borrower will also become entitled to claim either a sum equal to the amount of the secret commission that has been paid, or a sum equal to the losses that they have sustained as a consequence of having entered into the contract(s) to which the secret commission relates, but not both.
It should be noted that, given Commercial First Business was in liquidation, Mrs Wood asked the court to hold Business Mortgage Finance (as assignee) liable to account for the secret commission payments that had been made. However, the court refused her request. She also sought permission to deduct the amount of the secret commission (by way of equitable set-off) from any monies that she might have to pay Business Mortgage Finance to achieve counter-restitution in respect of the rescission order, but this request was also denied. It was in a sense, therefore, a bit of a pyrrhic victory for Mrs Wood in this case.
Implications for lenders and the buyers of loans
The decision in this case highlights the risk that lenders face when they agree to pay a broker commission in circumstances where they know that there is an agency relationship between the borrower and the broker, and where any payments made breach the terms of the agency arrangement, e.g. because the payment of commission or the amount to be advanced has not been disclosed to the borrower in circumstances where it ought to have been.
Where non-disclosure occurs, an affected borrower will be within their rights to apply to the court for appropriate relief to be ordered, as against both the broker and the lender, and which may include a request for recission and either recovery of the commission paid or any losses that have been sustained.
An order of this sort has the potential to dramatically reduce the value of any security that a lender may hold, and for that reason it is vital that appropriate procedures are put in place to manage the commission arrangements that exist and to ensure that every loan approved or indeed assigned is scrutinised to ensure that it does not fall foul of the rules on secret, or half-secret, commissions.
Need more detail?
For further information about how we can help both lenders and the buyers of loan books to ensure that arrangements with brokers are handled appropriately, please contact Paul Sheeter on 020 7845 7417 or via email at paulsheeter@iwg.co.uk.
This article is for general information only and does not constitute legal or professional advice. Please note that the law may have changed since this article was published.