COURT OF APPEAL ALLOWS CANCELLATION OF COMMISSIONS FOR ALLEGED FRAUD

19 December 2008

A Supreme Court judgment that sent shockwaves throughout broking industries because it voided the cancellation of future trailing commissions by a lender, has been overturned.

On 24 November 2008 the New South Wales Court of Appeal handed down its judgment in Interstar Wholesale Finance Pty Limited v Integral Home Loans Pty Limited [2008] NSWCA 310.

Interstar Wholesale Finance Pty Limited (the lender) had engaged Integral Home Loans Pty Limited (the originator) as one of its loan originators. The origination agreement provided that:

the lender was obliged to pay the originator an ‘upfront fee’ on settlement of a loan introduced by the originator and in addition an originators fee (“trailing commission”) calculated as a percentage of the outstanding loan balance each month for the remaining term of the loan; and
the lender could terminate the agreement if the originator engaged in deceptive or fraudulent activity, or if the lender reasonably suspected such activity, and in those circumstances the originator would have no further entitlement to trailing commission on any of the loans that it had introduced to the lender.

The lender terminated the appointment of the originator after forming a reasonable opinion that the originator had engaged in fraudulent or deceptive conduct in connection with a loan application. The originator disputed the cancellation of trailing commissions by the lender.

A fundamental issue before the Court was whether the right to trailing commission on settled loans was an accrued right which could not be affected by termination of contract.

The lender argued that the originator had agreed to the forfeiture of the trailing commissions in those circumstances and that the Court should not interfere with the terms of the origination agreement.

The originator argued that the forfeiture of the commissions was penal in nature because the value of the commissions forfeited was out of all proportion to the damages suffered by the lender as a result of the originator's conduct. Under common law, a contractual penalty which exceeds a genuine pre-estimate of the damages sustained by reason of the particular event is void and unenforceable.

Justice Brereton of the NSW Supreme Court had held in favour of the originator in the original proceedings. His Honour stated that the lender's proper remedy for the originator's conduct was compensatory and pecuniary damages.

However the Court of Appeal took a different view. In a unanimous decision, Allsop P, Giles JA and Ipp JA held that the clause was not a penalty for the following reasons:

To determine if a clause is penal the Court will look at what was agreed when the contract was made. The events after the date of the contract, such as the events that triggered the termination, are irrelevant.
The doctrine of penalties only applies when there is a breach of contract. A provision cannot be a penalty if it applies to an event which is not a breach of contract. This case falls within that category because the lender had simply formed an opinion about the originator's conduct.
The alleged penalty must be "extravagant and unconscionable in amount" or "out of all proportion" to the damages likely to be suffered as a result of the breach. In this case, the value of the trailing commission was not necessarily disproportionate to the damage to the lender's reputation arising as a result of the originator's alleged conduct.
The trailing commissions were not fully earned and the originator's right to receive them was dependent upon fulfilling its responsibilities under the contract. Accordingly, there was no forfeiture of fully earned or accrued property or rights.

The case is of key importance to lenders, managers and aggregators that rely upon origination agreements to be able to terminate payments to originators who engage in fraudulent or deceptive conduct.

It confirms that trailing commissions do not necessarily 'belong' to originators after a loan has been introduced. The right to future commissions will normally be subject to the terms of the contract under which they are paid.

In all cases, the enforceability of provisions that cancel future commission payments will depend on the circumstances of the parties and the terms and conditions of the contract they have signed.

Stuart O’Neill | Partner

Mullins Lawyers

t +61 7 3224 0275

f +61 7 3224 0333

soneill@mullinslaw.com.au