The November 2008 judgement of the New South Wales Court of
Appeal in the Integral Home Loans case provides further guidance
for the mortgage industry in negotiating broker and management
As is usual in slower economic times, agreements prepared and
signed in haste are being examined in greater detail to determine
the respective rights of funders, brokers, and managers. The
Integral decision will help that examination.
Origination and management agreements are vital contracts which
often have a long life (the trail can last as long as the term of
the mortgage). The amounts payable under these agreements can be
significant and the risk of dispute is high.
These agreements should not be "set and forget". They
need to be regularly reviewed to ensure they are up to date.
Key issues for consideration are:
who owns the customer?
under what circumstances can the trail or management fee be
what liability has the broker or manager for losses that are
caused by the broker or the manager or their sub-originators?
does the lender have to wait until an actual loss is finally
incurred before withholding trail to cover potential losses?
Obviously the interests of the lender on the one hand and the
broker or manager on the other hand are not necessarily
The Integral case related to a mortgage management agreement
originally with Interstar. Interstar stopped the management fee
when it terminated management on the basis that Integral or its
sub-originators had acted fraudulently. The lower court had held
that Interstar could not stop the management fee as the provision
entitling them to do so was void as a penalty.
The rule that penalties will not be enforced has been a long
standing common law principle. A penalty is a provision in the
contract that provides for an unrealistic payment (or possibly a
forfeiture of property) consequent upon a breach of the contract.
There are two elements involved:
there must be a breach of contract; and
the amount payable or forfeited must be excessive having regard
to the innocent party's loss.
The Supreme Court decided that neither of these two tests were
satisfied in the Integral case because:
payment was not being stopped because of a breach of contract,
but rather because the management had been validly terminated;
even if the termination was for breach of contract, forfeiture
of ongoing management fees was not an excessive penalty having
regard to the significant damage that could be incurred by
Interstar, including reputational damage.
A key issue was whether the income was earned upon settlement of
the loan or is only earned progressively as the management
functions are performed. In Integral, the court held that the
management fee was a fee for ongoing management, and so there was
no loss of income for work already performed. This highlights a
significant difference between origination agreements and
management agreements. If a lender wants to bolster its ability to
terminate trail, origination agreements should provide for ongoing
duties, and make it clear that the whole income is not earned at
the time of origination.
It is important to remember that relief against forfeiture is
not the only legal principle under which the manager could have
reviewed the agreement. Courts can also review agreements if any of
the provisions are unconscionable. Unconscionability was not argued
in the Integral case as it was considered that the two parties were
quite sophisticated. The same conclusion may not be reached in
relation to a broker agreement between a large bank and small
family run broking firm.
So where does this leave somebody trying to draft origination
and management agreements? There is still a risk that in some cases
forfeiture of trail or management income could be struck down as a
As Gadens have previously pointed out, arguing about forfeiture
after a loss is finally incurred (for example after a borrower is
made bankrupt) may be far too late because there may be little
trail left to forfeit and the broker may have few assets to satisfy
any claim. Accordingly, lenders' agreements should provide that
the lender can withhold (not forfeit) trail/management
fees sufficient enough to cover the potential loss as soon as a
loss event is identified, and appropriate that money once the loss
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