When is a secret, secret?
Two business owners walk into two separate broker’s offices and order £100K of (unregulated) finance of the same equipment type from the same dealer with funds from the same lender. Both sign up to the broker’s terms and conditions which both charge the customer the same fee and say the Broker may also get commission from the funder if a deal is accepted. Both customers default at the same time under their respective agreements with the same lender. The lender terminates both agreements on the same day and issues identical proceedings against both customers in the same court. Both customers issue the same defence claiming to be able to rescind their respective finance agreements. The same Court decides one customer can rescind, but the other cannot.
What’s going on?
How come the customers have any defence in law at all? Why was the outcome different between the customers when everything else seemed the same?
Risk of harm
Well, the law looks to protect people when there is risk of harm being done to them. The law recognises that there is a risk of harm where conflicts of interest arise and does not like payments to one counterparty to a contract which the other counterparty does not know about.
Conflict of interest
It seems obvious that a solicitor cannot act and be paid by both a claimant and a defendant to a court case. There is a conflict of interest, placing the solicitor in an impossible position to act impartially and in the best interests of both. What is good for the claimant is not good for the defendant and vica versa. Both expect the Solicitors to give, and they will rely upon, professional impartial advice in their best interests. Exactly, the same point may arise where a broker is advising the customer and takes a fee from the customer and a commission from the lender. To whom does the broker owe a contractual duty? How does the broker square the circle? Scary answer - the broker cannot and it is conflicted.
Likewise, it seems obvious that in commercial transactions no one should pay or receive a bribe, to induce a contract or an outcome. The law will intervene and void any contract induced by a bribe. Exactly, the same point may arise where a payment (commission) is made by a third party intended counterparty (the lender) to an agent (the Broker) of the other intended counterparty to a contract (the Customer) where the other counterparty is not told about the payment. How does the broker square the circle? Scary answer - the broker discloses the commission and obtains informed consent from the customer
Wood v Commercial First Business Limited 2021 and Wilson & ANR v Hurstanger Ltd 2007
The Court of Appeal had to grapple with these facts and issues in the Wood case, while keeping a half eye on its earlier decision in the Hurstanger case. In both cases, the broker took a fee and a commission. Both sets of terms and conditions informed the customer that the broker may receive commission. Crucially, in the Wood case the terms and conditions stipulated if they received commission from the Lender, the Broker would tell the customer the amount if over £250. The Broker did get a commission over £250 but it did not tell the customer it had received any commission.
In both cases, the Court decided that the mortgage broker was the agent and fiduciary of the Customer. In the Woods case, the court allowed the customer/borrower to rescind the finance agreement and related security as of right based on secrecy. In the Hurstanger case, the court did not allow rescission as of right but had discretion to do so, chose not to do so, but did grant damages in the amount of the undisclosed commission and interest.
Terms and conditions of business are key
The only operative factual difference between the two cases was the precise wording of the brokers’ terms and conditions.
In Hurstanger the judge said:
“Here the claimant knew that the broker was the defendants’ agent and so it had to show that it paid commission to him in circumstances where its borrowers had given their informed consent to such a payment. That was obviously the purpose of the document the defendants were asked to sign. The question is whether it achieved that purpose. Did it negate secrecy? I think it did. If you tell someone that something may happen, and it does, I do not think that the person you told can claim that what happened was a secret. The secret was out when he was told that it might happen. This was the Recorder’s view and I agree with him. To rescind the transaction altogether would be unfair and disproportionate.”
In Woods the judge, after referring to the above last paragraph wording from the Hurstanger case, went on and said:
“The difficulty for the appellants lies in the remaining sentences of the provision in the broker's terms of business. They imposed an unqualified obligation on the broker to inform the borrower, before a mortgage was taken out, of the amount of the fee. As each of the commissions in both cases exceeded £250, the exact amount had to be disclosed. Without such disclosure, the borrowers were not on notice that any commission might be paid. On the contrary, the only conclusion from the absence of any notification as required was that no commission was to be paid. The undisclosed commissions were, therefore, secret, not half-secret, commissions.”
The Wood case is not authority that all commissions must be disclosed - only that if you contractually promise to disclose and then don’t, that is a secret commission. Indeed, in the unregulated market, there is no positive obligation to disclose, merely the risk that if you do not, then the law may assist the customer to rescind the agreement and related security. Hurstanger is still good law and authority that generic disclosure that commission may be paid, negates secrecy. Woods did not overrule it.
So what is the best course of action? Clearly, full disclosure removes all risk of a finding of secret commission as the customer will have provided their fully informed consent to the payment of commission. But to do so is ahead of the law, unnecessarily mirrors non-applicable FCA regulations and is commercially risky.
Is there a sensible practical alternative?
- Don’t take a fee and a commission. That removes one immediate conflict of interest.
- Generic disclosure that the Broker will obtain commission is recommended. That will negate secrecy and may confine claims to damages for the commission amount + interest.
- Amend Broker terms and conditions of business to etch the perimeter of the contractual engagement with customers so that brokers are not advising, nor have instructions to conclude legal contracts nor are offering a full market review of products/providers and that the broker is linked to specified funders to one of whom the broker will effect an introduction only.
- Don’t over promise and under deliver contractually, as the broker in the Woods case did to its peril.
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