Dangerous secret agents: loans void when undisclosed commissions paid to brokers

Insight

23.07.2021

James Bond once remarked that "we all have our secrets". That is certainly true for "secret agents" in the 007 sense of the phrase. It may also be true of agents in the commercial and financial sense: they too might have secrets; and those secrets can be costly, especially for those dealing with the agents.

In this briefing, Jolyon Connell and Sally Mantell consider the recent Court of Appeal decision in Frances Elizabeth Wood v CFBL [2021] and explain why it is an important reminder for lenders and other financial institutions paying commissions to brokers / introducers.

Background

Two farmers, Mrs Wood and Mr Pengelly (the Farmers), took out mortgage loans with Commercial First Business Limited (the Lender). They did so having each retained a broker, UK Mortgage Financial Services Limited (the Broker), to identify appropriate lenders and mortgages. The Farmers each paid the Broker a fee for its services and the Broker in turn identified mortgage loans which were borrowed by the Farmers from the Lender. Unbeknownst to the Farmers, the Lender also paid the Broker substantial commissions for introducing the mortgage loans.

The Farmers ultimately defaulted on their mortgage loans and the Lender (in fact, by that stage, another entity to which the loans had been assigned) sought to enforce its security by seizing the farm properties over which the mortgages were secured. The Farmers discovered the commission payments to the Broker by the Lender and sought a direction from the Court that the mortgage contracts should be rescinded (ie cancelled) on the basis that they had been arranged via the payment by the Lender to the Broker of a secret commission which was tantamount to a bribe – as such, the contract(s) should be cancelled because they had been procured by fraud / bribery.

Judgment

The High Court sided with the Farmers. On an appeal by the Lender, the Court of Appeal also gave judgment in favour of the Farmers. The following key points arise from the Court of Appeal’s judgment:

If a broker is paid a commission by the lender and that commission is not disclosed to the borrowers, the Court is very likely to treat the commission payment as a form of bribe. Predictably, given the public policy against corruption, contracts which have bribery as part of their foundation will almost certainly be subject to successful challenge by the borrower.
No wrongful or dishonest intention by the lender (or broker) is required for the secret commission payment to be treated as a bribe. The crucial point is whether the borrower had knowledge of the commission, not the basis on which the commission was paid to the broker.
It is not necessary for the broker / agent to be a fiduciary (ie someone owing a special duty of trust and confidence) for the contract to be challenged because of a secret commission payment. All that is required is that the "agent" owed a duty to be impartial and to give disinterested advice, information or recommendations. If that duty existed and may have been corrupted by the payment of a secret commission, the contract will be subject to challenge and (in all likelihood) overturned. The effect of the contract being overturned is not that the loan does not need to be repaid, but instead is that any fees, interest (which could be significant) or other charges cannot be enforced. Only the principal sum of the debt must be repaid.

Key lessons for lenders and others paying commissions to agents

Self-evidently, the greater the disclosure to the borrower / client of commission payments, the less prospect of a contract being challenged/overturned because of a secret commission payment.
If possible, lenders should have sight of the broker/agent’s contractual documents with the borrower / client. This will help the lender to ascertain whether the borrower/client has a true picture of the exchange of payments which form the basis of the contract.
References in terms and conditions to the possibility of commissions being paid will not save the lender / broker from the contract being rescinded. In Wood, the Broker’s terms and conditions mentioned that such commissions might be paid, but the borrowers themselves had no knowledge that commissions were in fact paid.
Terms and conditions stating that commissions will be paid – but which do not specify the amount of the commission to be paid – may or may not prevent the contract from being rescinded. These cases are considered by the Court as "half-secret commissions" and the Court then has a discretion to award the most appropriate remedy in the particular circumstances of the case, which could (but would not necessarily) include rescission of the contract.
The risk of a lending agreement being challenged because of a secret commission is separate from the risk of any challenge based on a breach of a regulatory duty or FCA Principle in respect of the payment of commissions or the separate obligation to treat customers fairly.
Those purchasing or taking assignments of mortgage loan portfolios should undertake careful due diligence concerning any commissions paid by lenders to the brokers at the relevant time so as to hedge against the risk of the loans becoming unenforceable and therefore devaluing the loan portfolio.

If you require further information about anything covered in this briefing note, please contact Jolyon Connell, Sally Mantell, or your usual contact at the firm on +44 (0)20 3375 7000.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.