Driving change in the world of commission disclosure: under the bonnet of the UK motor finance case

On 25 October 2024, the UK Court of Appeal handed down a single judgment which unanimously upheld the appeals of claimants in three motor finance test-cases brought by consumers against motor finance lenders: Hopcraft v Close Bros, Wrench v FirstRand and Johnson v FirstRand. 

The judgment found the lenders liable in respect of secret and previously-called 'half-secret' commissions (now called 'partial disclosure' commissions) which they had paid to car dealers who had been acting as credit brokers.  The Court established a high bar for transparency in respect of commissions paid by lenders to dealers and confirms that lenders can potentially be directly liable to customers for payment of a 'civil bribe' where there has been insufficient disclosure of the commission.

This decision is likely to have significant consequences for both the consumer-finance sector and other industries that involve paying commissions to intermediaries where it may not be clear to the consumer that such a commission is being paid.  In this article, we consider the case in further detail and some of the ramifications for firms.

Background

The three claimants had all obtained finance to buy second-hand cars through a car dealer (acting as credit broker).  The car dealer would receive commission from the lender where it arranged motor finance.  

Importantly, in each case the car dealer had presented an offer of finance to the customer on the basis that it had selected a product which was competitive and suitable for the customer's needs.  This created a potential conflict of interest between any duties the car dealer owed to the customer, and the car dealer's own financial interest in receiving the commission.

In each of the three cases, the factual position on disclosure of the commission arrangements was different.  In none of the cases were the customers informed orally about the existence of the commission arrangements.  In Hopcraft, there was also no reference to commission arrangements in the loan documents.  In the other two cases, Wrench and Johnson, the documents that they signed referred to the possibility of commission but not the amount.  Mr Johnson was given some further information about the commission arrangements, which he signed.  All the claimants gave evidence that they were not actually aware of the commission payments and, in any event, did not give their fully informed consent to the dealer receiving them. 

Following a series of unsuccessful County Court claims, the Court of Appeal was asked to consider, in the context of the case law on secret and half-secret commissions: 

• the nature of the duties owed to the customers;
• the adequacy of the commission disclosures made to the customers in the light of those duties;
• any liability of the lenders to the customers; and
• in the case of Johnson, the Court also considered whether the resulting credit agreement amounted to an unfair relationship under the Consumer Credit Act 1974 (CCA).

What were the key points arising from the judgment?

The nature of the duties owed to a customer – and in particular whether or not a fiduciary duty or a disinterested duty is owed by the broker to the customer - will depend on the factual circumstances of the relationship between the broker and the customer.

The Court of Appeal held that in the circumstances of the three cases, the motor dealers, acting in their role as credit brokers, owed both a 'disinterested duty' and a broader fiduciary duty to customers when carrying out credit broking activities:

• 'Disinterested duty' – a duty to provide information, advice or recommendation on an impartial or disinterested basis; and
• Fiduciary duty – where one party owes the other an obligation of loyalty, and the repose of trust and confidence in relation to the specific duties they are tasked to perform.

This was because, as noted above, in each case the car dealer had presented an offer of finance to the customer on the basis that it had selected an offer which was competitive and suitable for the customer's needs.  The nature of this relationship gave rise to both the disinterested duty (in the sense of providing a disinterested selection of offers to the customer) and the wider fiduciary duty (to recommend a lender who offered the most competitive and suitable terms).

Secret commissions

Where there had been no disclosure at all of the commission (ie not even disclosure that a commission may be paid within the customer documentation) in circumstances where the disinterested duty was owed, the payment of that commission was judged to be a 'secret commission', and the lender would therefore be directly liable to the customer for payment of a 'civil bribe'.  This was judged to be the case in Hopcraft.

However the Court went on to decide that even where the customer documentation disclosed that the intermediary will or may receive a commission from the lender, this could nevertheless still constitute a secret commission if insufficient steps are taken to bring details of the commission to the attention of the customer.  Including this disclosure in terms and conditions alone was not considered sufficient to prevent it being treated as a secret commission.  The Court concluded (paragraph 118): "The question in each case will be whether enough was done to bring the salient facts to the attention of the borrower in a way which made their significance apparent."

The Court therefore concluded that in all three cases the commission amounted to a secret commission (albeit that the Johnson case had previously been conceded as a case of 'partial disclosure' in his first appeal) because insufficient steps had been taken to bring the details of the commission to the attention of the customer in a way which made their significance apparent.

For secret commissions, there is no need to establish that the broker was the agent of the customer or even owed any other fiduciary relationship to the customer – the breach of the 'disinterested duty' alone is enough to establish a lender's direct liability for payment of a 'civil bribe'.

Partially disclosed commissions

To assist the lower Courts in dealing with cases with similar but different factual circumstances, the Court of Appeal also considered the legal ramifications of partially disclosed commissions.

Where the fact of a commission being paid is brought to the attention of the customer (or appropriate steps were taken to do so), but without all salient details of the commission arrangement, then the Court concluded that it should be treated as a case of 'partial disclosure' (previously called a 'half-secret commission'). 

Although not specifically discussed in the judgment, it therefore appears to be the case that, where only a disinterested duty is owed to the customer (and not a broader fiduciary duty), then no breach of duty to the customer will arise where there has been a partially disclosed commission arrangement. 

In partial disclosure cases where the car dealer owes a fiduciary duty, even though the customer knew (or ought to have known) of the existence of a commission arrangement, the car dealer will have acted in breach of that fiduciary duty unless the customer provided fully informed consent to the commission arrangement.  This requires full disclosure of the material elements of the commission arrangement, sufficient to enable the customer to provide fully informed consent. The primary cause of action in the case of a breach of fiduciary duty (and no secret commission) is against the car dealer, rather than against the lender.  However, a claim in equity may lie against the lender (as an accessory to the car dealer's breach) if the lender is aware of the existence of the fiduciary duty and the fact of payment of the commission and the lender has not satisfied itself that the customer has given fully informed consent.  

Was there an 'unfair relationship' under the Consumer Credit Act?

The Court found that the mere fact of secrecy or partial disclosure of commission arrangements is not sufficient  to make the relationship between lender and borrower unfair for the purposes of s.140A CCA.  Whether or not a relationship is unfair will depend on the full factual position.  

In the Johnson case, the Court found that the existence of various factors (in particular the high commission of 25%, the right of first refusal to the lender under the broker/lender terms, along with the misleading language in the Suitability Document) led the Court to regard this relationship as 'unfair' under the statutory test. 

What must lenders and brokers do to structure future transactions in a lawful way?

The three principal options for lenders and intermediaries in ensuring that sales arrangements are lawful are as follows:

1. Ensure no disinterested or fiduciary duty is assumed by the intermediary

The arrangement could be structured so that it is clear to the borrower that the intermediary does not assume the disinterested duty or any wider fiduciary obligation to the borrower.  Paragraph 87 of the decision provides some possible (but fairly unsubtle) wording that would achieve this:  "I may offer you a product which may be chosen because it benefits me directly, even though it may not be the best product for you.  Are you happy with that?".  This ensures that the borrower understands that the intermediary is not accepting the role of providing information on a disinterested or impartial basis, or any wider fiduciary obligation.  As a consequence, there is no conflict of interest as the intermediary has not assumed any disinterested duty or fiduciary duty to the customer.

2. Procure the customer's informed consent to the conflict of interest

If the intermediary does owe a disinterested duty or wider fiduciary duty to the customer, then if the intermediary wishes to receive a commission from the lender then it will be required to ensure that the customer is aware of the details of the disclosure arrangements (including the amount of the commission the intermediary will receive), understands the conflict issues that this gives rise to, and provides agreement to the intermediary that it can receive the commission despite the conflicting duties owed to the customer.  Each of these steps should be fully documented and recorded.  

In our view obtaining the fully informed consent of the customer is, in practical terms, more challenging than negating the duty under (1) above.  Fully informed consent is a high threshold to meet and is therefore inherently more susceptible to challenge by a customer in the future (for example on the basis of their subjective evidence that they did not understand what they had been told).

3. Avoid the conflict by taking no commission

A third option which some firms are currently considering as a short-term measure is to remove the commission element entirely in the context of motor finance.  As a result, there will be no conflict with the intermediary's duties to the customer.  The process of arranging finance for customers will support them in their ability to buy the vehicle but would not operate as a separate income stream for the intermediary.  For obvious reasons, this option may be undesirable for car dealers in the longer term.

The lender as well as the intermediary will wish to ensure that whichever route is adopted meets the necessary requirements to minimise the risk of future claims.  Alongside these considerations will be ensuring that the relationship meets the requirements of the Consumer Credit Act.  

What might the Supreme Court say?

Both lenders have sought permission to appeal to the Supreme Court (the Court of Appeal having refused consent on 28 October 2024). 

Should the Supreme Court grant  an appeal, there will still be a significant delay before its judgment is handed down.  The FCA has stated that it will write to the Supreme Court to ask that its appeal decision and (if an appeal is granted) the hearing itself is conducted on an expedited basis.

In our view, the most obvious potential areas for the Supreme Court to clarify the law in a more balanced way are:

• The view that a commission can still be a secret commission when it is disclosed in customer documentation (especially where the customer signs to confirm that it has read and understood the document). In our view the Court should recognise the significant middle ground that exists between a commission being actually disclosed and it being treated as secret.
• The nature and extent of the duties owed by a car dealer to a customer in the relevant circumstances.
• In the case of partially disclosed commissions, the requirements necessary to obtain the consent of the customer.
• The test for accessory liability of lenders where an intermediary has given partial disclosure of the commission and not obtained informed consent of the customer.
• The concept of 'disinterested duty' could be abolished and the Court could just decide, in each case, whether or not there was a fiduciary duty.

What is the FCA's position? 

Somewhat controversially, the requirements of credit brokers to disclose details of commissions to customers under the Court of Appeal judgment go well beyond the disclosure requirements under FCA rules.  It appears that many firms had designed their processes and disclosures based on regulatory duties, on the assumption that these were at least as onerous as disclosure requirements under the general law.   

On 13 November 2024, the FCA has confirmed that it plans to expand its pause on complaints handling and FOS referral time limits beyond complaints about the use of Discretionary Commission Agreements in motor finance, to cover complaints about all motor finance commission arrangements.  

Any future appeal to the Supreme Court, together with the outcome of the pending judicial review of the FOS test case and the findings of the FCA-commissioned skilled person's review of motor finance discretionary commission arrangements, are all factors that the FCA will need to assess and have regard to when putting together an industry wide compensation scheme.  Pending possible intervention from the Government on redress schemes, such a scheme under s404 FSMA would in all likelihood need to be at least as generous to consumers as seeking compensation through the courts. 

What are the read-across implications of the Court of Appeal judgment?

Pending any appeal, the decision has obvious implications for the high volume of similar motor finance commission claims before the courts.  The Court's willingness to find that a case involving some disclosure, but which was considered insufficient, will undoubtedly encourage further claims.  It is currently unclear whether the lower courts will start following the Johnson, Hopcraft & Wrench decision immediately or whether they will agree to stays depending on an appeal. It may be there is a mix of both approaches.

There are also potential risks for the auto loan securitisation market, as any widespread remediation exercises ordered by the FCA could in turn affect the issuers of asset-backed notes secured on auto-loan portfolios, and therefore investors.  If the originators of the securitised loans do not make sufficient and timely redress payments to issuers and investors, there could be a downrating of the notes issued. 

The decision is also likely to have implications for both the wider consumer finance sector and other consumer-facing industries with a business model involving the payment of commissions to intermediaries, such as insurance products.  Where a financial services product is sold by an intermediary as an ancillary sale to another product or service (and therefore it may be less clear to the consumer that the intermediary will receive a premium), the sales of those ancillary products are likely to be at particularly high risk of challenge.

The FCA is currently conducting a market study of the premium finance market including an examination of how commission structures work and therefore this is a potential area of focus, and an area where future commission claims, along the lines of motor finance, might arise.  

We are working closely with a range of product providers and intermediaries to review historic sales practices in the light of the Court of Appeal judgment and how sales should be structured in the future to minimise legal and regulatory risk.  If it would be helpful to discuss any of these issues then please contact any of the authors of this article or the contacts listed below.