ARTICLE
5 February 2025

Car Finance Commission Arrangements: Implications For Speciality Finance Transactions

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Travers Smith LLP

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Speciality finance transactions typically take the form of a "borrowing base facility" (BBF) where lenders (often referred to as "funders" to distinguish them from the financial institutions they lend to).
United Kingdom Finance and Banking

This article was first published in the January 2025 issue of Butterworths Journal of International Banking and Financial Law.

Overview

In this briefing, we explore the impact of consumer claims for rebate of commission on speciality finance transactions.

1 SPECIALITY FINANCE TRANSACTIONS

Speciality finance transactions typically take the form of a "borrowing base facility" (BBF) where lenders (often referred to as "funders" to distinguish them from the financial institutions they lend to) make available debt facilities to financial institution borrowers (for example, SME lenders, mortgage providers and auto financiers) in order to refinance (in part) loans originated by those borrowers to their underlying customers. The exact structure and composition of the BBF will depend on the asset type. However, in each case a BBF provides a flexible source of funding against a company's receivables portfolio. Recent events shine a spotlight on cases where customer loans were originated by a broker who was paid a commission by the lender.

In this article we refer to "funders", "consumer finance businesses" and "customers".

2 COURT OF APPEAL JUDGMENT ON COMMISSION DISCLOSURES

In a landmark decision in October 2024 (Hopcraft, Johnson and Wrench [2024] EWCA Civ 1282), the Court of Appeal (CA) held that it was unlawful for car dealers (who acted as brokers) to receive a commission from a lender providing motor finance without obtaining the customer's informed consent to the payment. This would have required the consumer to be told all material facts, including the amount of the commission and how it was to be calculated. The CA judgment related to fixed commission in motor finance agreements as well as so called "discretionary commission arrangements" (DCAs), which were banned by the FCA in 2021. The court held that, in each of three cases brought by aggrieved individuals, the lender was liable to compensate the consumer for the commission that had been paid by the lender to the dealer.

Much has been written about the merits of the CA judgment. The Supreme Court will hear an appeal of the decision in April 2025. It also remains to be seen to what degree the Financial Conduct Authority (FCA) will intervene to facilitate the orderly processing of related customer claims.

3 IMPLICATIONS FOR CONSUMER FINANCE BUSINESSES

What then are the potential impacts of the judgment on consumer finance businesses? In relation to DCAs specifically, motor finance firms are likely to have been inundated with complaints from customers in relation to pre-January 2021 loans. Since the CA judgment, they will also have received wider commission-based claims. Many large lenders have already publicly announced the extent of their financial provisions for potential customer claims.

In some cases, this could lead to concerns as to the solvency of affected lenders, as it may impact on their ability to pay other debts. Directors of such businesses must have regard to their duties at all times. If the company becomes insolvent, or is bordering on insolvency, the directors may have to balance the interests of creditors against those of the shareholders. Consumer finance businesses will need to engage with their own funders to ensure that they are supportive.

As a result of the CA judgment, in the absence of guidance to the contrary from the Supreme Court, any business that has paid "secret" or "half-secret" commissions may have to compensate its customers. The court's view on what information should be disclosed, and how it should be disclosed, went beyond existing FCA guidance on the disclosure of commission arrangements and so the FCA may be expected to issue revised guidance in this regard. This could require significant changes to the way that firms currently do business.

Meanwhile, consumer finance businesses will need to assess the scope of any potential liability for unlawful commission, consider how the business might fund those liabilities and ensure that they have sufficient administrative support to assess any additional related complaints received from customers. They will need to review their standard approach to the disclosure of commission and reconsider how they write new business. This may require amendments to their standard lending documents and operations. For instance, lenders might consider disclosing all material facts relating to any commissions paid to dealers/brokers, including the rate of commission, how it is calculated and details about the relationship between the dealer and the lender.

In some cases, the CA judgment may not necessarily be problematic. Lenders should consider to what extent commission was paid in relation to loans:

  • where commission was fully disclosed;

  • where a consumer used a third-party broker (one from whom they did not purchase the vehicle); or

  • where the borrower might not be regarded as financially unsophisticated or vulnerable.

Some lenders may already disclose the possibility of commission with adequate explanation documents.

The court has made it clear that the lender takes the risk in relying on the dealer to ensure that the customer has given informed consent to the commission. Accordingly, consumer finance businesses might request further comfort from both dealers and customers in this regard. This seems particularly important where financially unsophisticated consumers are concerned.

4 IMPLICATIONS FOR FUNDERS

Funders (ie the lenders who extend finance to consumer finance businesses) should make enquiries as to the quantum of potential exposure for commission-based claims and consider whether, and perhaps how, they intend to support businesses in paying that redress. Given the use of different funding structures in speciality finance transactions, it is important to understand which entity is the lender of record in relation to any claims and the extent to which legacy claims could taint future fundings extended to those entities and their affiliates.

Pending the outcome of the Supreme Court decision in April 2025, some funders may temporarily pause lending to consumer finance businesses which have vulnerable commission arrangements in place. Others are keen to do new deals but need to understand how to protect their interests. A distinction is to be made between the risk inherent in the "back book" of loans originated to date (vulnerable to claims for unlawful commission) and the protocols applicable to loans originated in the future.

Questions for funders in relation to borrowing base facilities include:

  • Has the lender of record now suspended commission arrangements? Has it received commission rebate claims from customers and how are these being handled?

  • To what extent does the CA judgment result in loans falling outside the eligibility criteria for the BBF (eg as a result of customer loan representations proving to be incorrect)? Has this resulted in a mandatory prepayment event?

  • Have there been breaches of other terms of the BBF? For instance, could the CA judgment arguably trigger a material adverse change event of default, given the potential impact on the business of the aggregated potential claims?

  • Is it possible to "open up" the terms of live BBF financings, for instance to amend eligibility criteria or related provisions to further protect the funder?

In live BBFs where a funder is contemplating enforcement, the funder will need to better understand the risks inherent in seeking to take a transfer of legal title to customer loans. Even prior to the current issues surrounding commission this would be an unusual option, not often pursued on enforcement; a managed run-off or sale of the loan book would be a much more common option. Nevertheless, it is important to understand that such steps could lead the funder itself (as the new lender of record) potentially being liable for commission-based claims, which may be subject to FCA-mandated protocols that are yet to emerge. This means that such enforcement action under a BBF may be unattractive. Depending on the structure used, there may not be clarity as to whether a new or replacement lender of record would automatically assume liability for any commission-based claims.

There will be a delicate balance to strike when faced with a consumer finance business in financial difficulties. It is important for all parties to speciality finance transactions to fully examine their options.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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