Court of Appeal finds lenders liable in motor finance broker commission cases

The Court of Appeal has handed down a single judgment in relation to three appeals considering lender liability in the context of secret and so-called "half-secret" commissions paid by lenders to credit brokers: Johnson v FirstRand Bank Ltd (London Branch) (t/a MotoNovo Finance) [2024] EWCA Civ 1282. The decision is likely to have implications for both the consumer-finance sector and other consumer-facing industries with a business model involving the payment of discretionary commissions to third parties.  Arrangements operating in the insurance sector may be affected.

The judgment considers the specific scenario of the sale of motor finance to financially unsophisticated consumers, buying a second-hand car from a dealership which also arranges the finance, in circumstances where the dealer receives a commission payment from the lender (either not disclosed or only partially disclosed to the customer). Pending any appeal to the Supreme Court, the decision clarifies the requirements for transparency in respect of commissions paid by lenders to dealers, and demonstrates the potential liability of lenders directly to customers where the court deems that disclosure has not been sufficient. Although the decision makes clear that the context of the relationship between the dealer/broker and customer is significant, the ruling will be of interest to any institution engaging with brokered finance, in particular those operating under a discretionary commissions structure.

On the facts of each appeal, the Court of Appeal found that the car dealer (when acting as broker) owed a fiduciary duty akin to agency to the customer. It found that this ad hoc fiduciary duty arose in tandem with and in consequence of there being a "disinterested duty" (a duty to provide information, advice or recommendations on an impartial or disinterested basis, first conceived in Wood v Commercial First Business Ltd [2021] EWCA Civ 471, see our blog post). This meant that the dealer (again, when acting as broker) had to act in the best interests of the customer and not put themselves in a position of conflict.

Given the fiduciary relationship finding, the Court of Appeal said that the car dealer could not lawfully receive a commission from the lender without first obtaining the customer's fully-informed consent to its payment. The Court of Appeal found that none of the customers in the cases under appeal had given such informed consent. In its view, references in documents provided to the customer as to the possibility that commission might be paid to the dealer were not sufficient, even where the reference appeared on the face of a document which the dealer had specifically prepared for the customer. Accordingly, the lenders were liable either by way of direct personal liability to the customer on the basis that the commission payment was a bribe, or as an accessory to a claim for breach of fiduciary duty against the broker. The Court of Appeal found that the customers were in principle entitled to rescission of the finance agreements or equitable compensation/damages, ordering the lender to "repay" the commission to the customer, together with interest.

A practical question for the industry left open by the Court of Appeal, is the nature and scope of the disclosures required to ensure that a customer's informed consent has been obtained. This will inevitably be fact specific and is likely to be impacted by the financial sophistication of the customers in question; whether there is a preferential arrangement between the broker and the lender in operation; the prominence and detail of the disclosure; and the clarity of the explanation of the broker's role.

In this context, two particular features of the judgment are important to highlight.  Firstly, the Court of Appeal expressed the view that references to the possibility of a commission being paid were "buried in the small print", giving greater weight to its dissatisfaction with this approach than to the general principle that parties are bound by the terms of a contract even if they did not read it. Secondly, the judgment makes it clear that lenders cannot rely on an assumption that the broker has made the required disclosure in line with the broker's fiduciary duties or terms agreed with the lender. The lender must satisfy itself that consent has been obtained, for example by giving full disclosure to the customer directly. These features suggest the potential for a strict approach to disclosure in these cases by the judiciary.

While an intention to apply for permission to appeal from the Supreme Court has been indicated by the lenders, the Court of Appeal's decision will be binding until the outcome of that appeal. In the interim period, motor and other consumer-finance industries will need to adapt to the new legal framework, and the courts will need to grapple with the impact of the decision on current and future claims.

We consider the decision in more detail below.

Background

Each of the three appeals (Johnson, Wrench and Hopcraft) were based on similar facts. The claimants were financially unsophisticated individuals who purchased a second-hand car from a car dealership. Each car dealership acted as a credit broker, assisting the claimant to obtain finance to fund the purchase of their car, as well as selling the vehicle itself. In doing so, the car dealership was acting in two separate roles. However, the Court of Appeal considered that unsophisticated customers such as the claimants would not appreciate this distinction and would have considered the sale of the car and the provision of finance to be one transaction.

The claimants entered into car finance agreements arranged by the dealerships with the defendant lenders. The defendant lenders paid a discretionary commission to the car dealerships for arranging the finance. The commission structure permitted the car dealer a degree of discretion to set the interest rate under the car finance agreement. The higher the interest rate for the borrower, the higher the commission for the car dealer.

The level of disclosure of the commission payable was different in each case:

• In Wrench, the lender's terms and conditions disclosed the possibility of a commission in a sub-clause under the heading "General".
• In Johnson, the lender's terms and conditions disclosed the possibility of a commission as well as within a "Suitability Document" prepared by the broker.
• In Hopcraft, no disclosure was made in the documents of the possibility of a commission being payable.   

There were variations to the general fact pattern in two of the cases, which were material to the Court of Appeal's decision:

• In Johnson and Wrench, unknown to the borrower, the broker and the lender had entered into a tied arrangement whereby the broker would give the lender first refusal on any financings, irrespective of the suitability of that product for the borrower. 
• In Johnson, the broker also indicated to the borrower in a pre-contractual document that it would carry out a suitability assessment and suggest a finance deal based on answers provided by the borrower. The broker thereby represented that it was carrying out an assessment of a select panel of lenders (which were listed in that document) for the most appropriate product for that borrower.

Regulatory context

In the present case, each of the car finance agreements was regulated. Until 28 January 2021, there was no express regulatory prohibition on car dealers adopting the difference in charge (DIC) model used in the three cases.  A DIC model permits the dealer to decide, usually from a range, the interest rate to be paid on the finance. The car dealer is then paid a commission calculated as a percentage of the difference between the lowest interest rate set out in the agreement between lender and car dealer and the rate agreed with the borrower. However, since 28 January 2021, the FCA has banned DIC discretionary commission arrangements, including DIC models, in the context of regulated lending. The FCA's definition of 'discretionary commission arrangement' was calibrated to be deliberately broad; the regulator's aim (as explained in PS20/8) is "to make clear that it includes where any commission, fee or other financial consideration is payable directly or indirectly in connection with the regulated credit agreement, and where this is wholly or partly affected by the interest rate (or other item within the total charge for credit) set or negotiated by the broker". 

In addition to the specific rules, regulated firms are also subject to the wider obligations imposed by the Principles for Businesses – not least the relatively new Principle 12 which enshrines the Consumer Duty.

Decision

The appeals were allowed in their entirety. There were five key issues dealt with in the appeal, which we have summarised further below, together with a brief recap on the key legal principles considered in the judgment.

Key legal principles

Prior to the present judgment, there were two principal appellate authorities setting out the law relating to disclosure of broker commissions.

• In Hurstanger Ltd v Wilson [2007] EWCA Civ 299, the Court of Appeal found that the broker owed a fiduciary duty to the borrower and had disclosed the fact (but not the amount) of a commission being paid. While the Court of Appeal held that this partial disclosure was not enough for the lender to escape liability altogether (as the borrower's fully informed consent to the payment of the commission was not obtained on the facts), it found the partial disclosure of the commission was sufficient to negate secrecy. The Court of Appeal said that in this "half-way house" category of case, the full armoury of remedies in a true secret commission case were not available. However, the lender was found liable to the borrower in equity as an accessory for procuring the broker's breach of fiduciary duty (by making the commission payment to the broker).
• In Wood v Commercial First, the Court of Appeal held that it was not necessary for a broker to owe a fiduciary duty to the borrower for there to be liability on the part of the lender paying a commission to a broker, if the payment of the commission was "fully secret". Instead, it was sufficient that the broker was under a "duty of disinterest" (a duty to be honest and impartial). In that case, the court found the brokers did owe a duty of disinterest and that there had been no (rather than partial) disclosure of the commissions to the borrower.

The Court of Appeal acknowledged some difficulty reconciling tensions between Hurstanger and Wood. As the judgment itself references, both decisions have been followed in subsequent similar cases in the County Court (which continue to deal with these types of claims on a virtually daily basis), but this has given rise to inconsistent decisions. The judgment was therefore expressed to be an attempt to provide guidance to the County Court to resolve such claims in a consistent manner.

(1) Did the car dealers owe (i) a disinterested and (ii) a fiduciary duty to the claimants?

The Court of Appeal confirmed that the car dealers in question owed a duty of disinterest and an ad hoc fiduciary duty to the claimants, and that the fiduciary duty arose "in tandem with and in consequence of" there being a duty of disinterest.

In relation to the duty of disinterest, the court found that the car dealers were undertaking credit broking activities on behalf of the claimants and that a duty of disinterest was part of the very nature of these duties. The court found that a car dealer could not comply with the duty of disinterest unless they made it very clear to the customer that they could not act impartially because they had a financial incentive to put forward specific lender(s) or were putting their own needs above the customer's needs. That finding was sufficient for the Hopcraft appeal to succeed, following the decision in Wood, as it was common ground there was no disclosure relating to the commission payable by the lender to the car dealer. Accordingly, Hopcraft was a "fully secret" commission or "no disclosure" case, for which the bank had primary liability to the customer as a result of paying the secret commission. 

In relation to the fiduciary duty, the court commented that the duty arose from the nature of the relationship, the tasks the car dealers were entrusted with, and the duty of loyalty enshrined within the duty of disinterest. The brokers were not carrying out a purely ministerial function. The role carried out by the brokers related to the sourcing and selection of a lender who offered the most advantageous (or at the very least competitive) terms and handling all of the dealings with the lender. The claimants placed trust and confidence in the car dealers to secure a competitive agreement (and the car dealers were in a position to take advantage of vulnerable customers) and that gave rise to a fiduciary duty.

(2) Does the reference to the fact a commission may/will be payable in the finance agreement terms and conditions mean that secrecy has been negated?

The court found in Wrench that references in the lender's standard terms to the fact a commission may be payable to a broker (with the amount available from the broker on request) were insufficient to negate secrecy. The reality was there had been no disclosure of the commission at all.

In particular, in the court's view, the relevant clause was not adequately signposted (it was "hidden in plain sight") and there was no evidence that it had been read/referred to. The court commented that the failure to draw attention to such a clause is a relevant factor when considering if disclosure was adequate to negate secrecy (ie whether it should be treated as a partial or no disclosure case), although it was not decisive. The question in each case was "…whether enough was done to bring the salient facts to the attention of the borrower in a way which made their significance apparent".

Accordingly, the lender in Wrench was in the same position as the lender in Hopcraft. It was a "fully secret" commission or "no disclosure" case, in which the car dealer failed to comply with the duty of disinterest. This was sufficient for the Wrench appeal to succeed following Wood, giving rise to primary liability on the part of the lender directly to the customer, as a result of the lender making payment of a secret commission.

Although obiter, the court did comment that there was a distinction between referring to a commission that will be paid, as opposed to one that may be paid (as was the case in the present scenario).

(3) If there was partial disclosure sufficient to negate secrecy, was there fully informed consent?

In Johnson, it was accepted by the parties that there was sufficient disclosure of the possibility that the broker may receive a commission. This was agreed to negate secrecy such that it was a partial disclosure case. However, the question for the court was whether – notwithstanding that partial disclosure – the borrower had provided informed consent to the commission being paid.

In the Court of Appeal's view, telling the borrower that the broker may receive commission was not sufficient disclosure for him to have given his fully informed consent to the payment of the commission. In particular, the contract did not inform the borrower that a commission would (as opposed to might) be payable.

The documents provided to the borrower also failed to reveal the fact that the lender and the car dealer had entered into an agreement which obliged the car dealer to give the lender first refusal to provide finance to borrowers introduced by the broker, the amount of the commission, how it was calculated or that a significant portion of the price paid for the car was used to finance payment of the commission. In totality, the pre-contractual material in fact suggested that the car dealer was providing impartial advice to the borrower and the lender had been chosen as the most suitable lender from a panel (which was not the case).

(4) What is necessary to establish the accessory liability of a lender in partial disclosure cases?

In Johnson, the court also considered what was necessary to establish the accessory liability of a lender in cases of partial disclosure. The parties accepted that to find an accessory liable in equity for assisting in a breach of fiduciary duty, the lender must act dishonestly, in the sense explained in Twinsectra Ltd v Yardley & Ors [2002] UKHL 12.

It found that dishonesty in this context means knowing about, or deliberately turning a blind eye to, the breach of the car dealer's fiduciary duty to the customer. Addressing the position of lenders in similar cases, the court commented that it should be "relatively easy to establish the requisite knowledge of the essential facts", principally because the lender would know:

• of the agency relationship between car dealer and customer which gives rise to the fiduciary relationship;
• that the car dealer is acting for and on behalf of an unsophisticated customer to obtain a competitive offer of finance for a car and would naturally trust and expect the car dealer to act in the customer's best interests;
• that the car dealer, in taking a commission, would be put in a position of conflict of interest; and
• of the fact of the payment, its amount, how it is calculated and whether the car dealer was tied to a first refusal obligation (which, in the Court of Appeal's view, did not sit easily with the picture portrayed by the car dealer to the borrower as acting as a normal credit broker).

The Court of Appeal was satisfied that in Johnson, the lender knew that payment of a commission to the car dealer would put the dealer in breach of fiduciary duty, unless Mr Johnson had given his informed consent to the payment (and there was nothing to suggest that informed consent was given). The lender was therefore liable as an accessory to the breach of fiduciary duty by the dealer.

The Court of Appeal confirmed that, in cases of partial disclosure, there is no further requirement for the customer to establish that the lender knew or turned a blind eye to the fact that the borrower's informed consent was not obtained. In other words, the lender's accessory liability cannot be defended on the basis that it genuinely tried (but failed) to obtain informed consent.

However, the Court of Appeal proceeded to consider (obiter) the state of the lender's knowledge concerning the extent of any disclosure. It concluded that it would have been straightforward for the lender to provide full disclosure about the commission and require confirmation of understanding/consent from the customer directly (eg in the finance documentation or in a covering letter, which the customer is required to countersign). However, on the facts of Johnson, the lender did not obtain Mr Johnson's informed consent itself, and also took no steps to satisfy itself that the car dealer had obtained fully informed consent. The Court of Appeal therefore concluded that the lender was on notice, and must have suspected that Mr Johnson had not given his fully informed consent to the payment.

The Court of Appeal specifically rejected the lender's argument that it could shield the allegation of dishonesty by specifically requiring the car dealer to disclose the existence of the commission to the customer (for example in the terms and conditions between the lender and car dealer).

(5) Was the relationship unfair under s.140A of the Consumer Credit Act 1974 (the CCA)?

In Johnson, the Court of Appeal was also required to decide whether or not there was an “unfair relationship” between  Mr Johnson and the lender pursuant to s.140A of the CCA. The Court of Appeal determined that a relationship will not necessarily be found to be unfair only because a broker receives a commission from a lender and there has not been disclosure of that commission – the court will consider all the facts. However, on the facts, the relationship was rendered unfair by the significant amount of the commission relative to the sum that was borrowed and the fact that the true nature of the relationship between borrower and lender was not disclosed (and was actively concealed by the broker).

Next steps

We understand that the lenders have been denied permission by the Court of Appeal to appeal to the Supreme Court. However, they may apply directly to the Supreme Court.

The FCA is monitoring the progress of this decision, liaising with affected parties, the industry and the government, as the outcome feeds into the regulator's review of motor finance DCAs which was announced in January 2024. The FCA is using its powers under s.166 of the Financial Services and Markets Act 2000 (FSMA) to gather information from firms. It has also introduced arrangements for the handling of motor finance complaints by regulated firms and by the Financial Ombudsman Service (FOS) to accommodate the review. This included a pause for the 8-week deadline for a final response relating to such complaints, which was subsequently extended on 30 July 2024. The FCA plans to set out its findings of its review in May 2025.

Speaking to market analysts in late July 2024, FCA CEO Nikhil Rathi observed that, "based on the work we have done to date is that we think that it is more likely than when we started the exercise that we may need to make a structured intervention to ensure appropriate redress to consumers". Such an intervention could be in the form of a structured redress scheme under s.404 of FSMA 2000 which would be subject to formal rule-making processes (eg consultation, cost v benefit analysis); the most recent example of such a scheme is that put in place for British Steel Pension Scheme members. There is, of course, always the option for supervisory or enforcement action at an individual firm level if the FCA determines this is warranted; enforcement action would be publicly disclosed.

The Administrative Court is also due to hand down its judgment in respect of a lender's application to judicially review a decision of the FOS, in which the FOS upheld a complaint relating to the use of discretionary commission arrangements.