Bribery – “corrosive practice which undermines the country’s social, economic and commercial values and well-being”.
The essence of agency is that one party (the agent) facilitates contracts between the principal and a third party on the principal’s behalf. Typically, the agent receives a commission from the principal for his or her efforts. Occasionally, less honest agents have also benefitted by receiving another (secret) commission from the third party.
Such behaviour may call into question the real reason the agent caused the principal to enter into the contract with the third party. Did the agent believe entering into the contract was in the best interests of his/her principal? Or was the agent acting in their own interest? If the latter, when the principal finds out, it will no doubt feel aggrieved. So, what can the principal do about this?
Agents as fiduciaries
Often, the agent has undertaken to act for and on behalf of his principal in a particular matter in circumstances which give rise to a relationship of trust and confidence. The law calls this a fiduciary relationship. As a result, the agent will have several additional duties imposed on him/her, including a duty not to make a profit out of his/her trust without the informed consent of their principal.
An agent who receives a commission from a third party without his/her principal’s prior approval will be in breach of that duty. This will entitle the principal to terminate the agency and claim compensation from the agent for his/her breach.
In addition, the fact that there has been a secret commission will also entitle the principal to alternative remedies, not only against the agent but also against the third party who paid the secret commission. This is because the law treats the payment of a secret commission as a special type of fraud or a bribe. Often the most appealing remedy for the principal in this situation is the ability to cancel the contract with the third party.
Fully secret or half-secret commissions
But does the agent need to owe his/her principal a fiduciary duty for the principal to be able to claim these enhanced remedies? That would seem unfair in circumstances where the agent has gone off on a frolic of their own and entered into a secret side deal. Until recently, the case law seemed to suggest that the agent had to owe a fiduciary duty. Further the principal would only be entitled to the full suite of remedies available if the payment of the commission by the third party was fully secret, as opposed to half-secret.
This has proved to be unsatisfactory as it is not always easy to tell if an agent owes his/her principal a fiduciary duty. This is particularly so where an agent acts for many clients such that the distinguishing feature of a fiduciary – being the obligation of loyalty – does not seem to be in existence. Travel agents and estate agents are prime examples. Other examples can in some cases be discretionary investment portfolio managers and insurance brokers.
The requirement that the commission payment be fully secret as opposed to half-secret has also created problems. What makes the payment of a secret commission only half-secret?
The Court of Appeal’s decision
Recently the Court of Appeal has clarified the position. In two separate but joined cases (Wood v Commercial First Business Ltd and Business Mortgage Finance (4, 5 and 7) Plc v Pengelly) the issue of secret commissions arose in the context of loan agreements between a borrower (the principal) and a lender, which had been arranged by the agent broker.
In both cases, lender and broker were the same. The respective borrowers (Wood and Pengelly) took out mortgages and secured loans but defaulted on the payments. They wanted to get out of the loan agreements and mortgages on the ground that the third party lender had paid commissions to the broker without their knowledge or consent.
Issue 1: is a fiduciary relationship a necessary pre-condition for relief?
The main issue on appeal was whether a fiduciary relationship between borrower and broker was a necessary pre-condition to the grant of relief against the lender who had paid the undisclosed commission (i.e. the cancellation of the loan agreements and corresponding mortgages). In approaching this issue, the Court of Appeal looked at the policy which underpins the law of bribery. It noted that both the Courts and society have for a very long time viewed bribery as a “corrosive practice which undermines the country’s social, economic and commercial values and well-being”.
Accordingly, and due to the difficulties that often arise in trying to determine whether or not an agent owes a fiduciary duty, the Court of Appeal decided that when there has been a payment of a secret commission, the question to be asked is whether the agent owes a duty to be impartial and to give disinterested advice, information or recommendations. If the answer to that question is yes, the principal should be entitled to claim all applicable civil remedies, regardless of whether or not it was owed a fiduciary duty by the agent.
Issue 2: fully secret vs half-secret commissions
The appellant lenders / brokers tried to argue that the borrowers in each case knew or would have known if they had read the terms of business that the broker might be paid fees by the lender. Relying on earlier case law, they said this made the commissions half-secret as opposed to fully secret, although they accepted that the borrowers were not told the amounts of the fees or commissions.
What the terms of business actually said was that a commission may be received and that before a mortgage was taken out, the broker would tell the borrower the amount of the fee in writing. If the fee was less than £250, the broker would confirm that they would receive up to that amount. If the fee was £250 or more, they would tell the borrower the exact amount. In both cases, the fees were well in excess of £250!
The Court of Appeal decided that the terms imposed an unqualified obligation on the broker to inform the borrower, before a mortgage was taken out, the amount of the fee. As the commissions in both cases exceeded £250, the exact amount had to be disclosed. In the absence of such disclosure, the borrowers were not on notice that any commission might be paid. On the contrary, the only conclusion the borrowers could come to was that no commission was being paid. As such the commissions paid were secret, not half-secret commissions.
Take home points
1. A fiduciary relationship is not a necessary pre-condition for relief against the payer of a secret commission. If an agent owes a duty to be impartial and to give disinterested advice, information, or recommendations and accepts a secret commission or bribe from a third party, the principal will be entitled to cancel the contract with the third party.
2. An undisclosed commission will not be considered half-secret if there is an unqualified obligation to inform a customer of the amount of a fee. That said, if the commission is not fully secret, it will likely not fall within the remit of fraud or a bribe, in which case the principal will not be entitled to the full suite of civil remedies.
If you have any questions about these issues please get in touch with a member of the team or speak with your usual Fox Williams contact.
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