Implications of Johnson v FirstRand – will secret commissions pave the way for claims from Auto ABS noteholders?
For the past 15 years, the private credit market has been one of the fastest growing areas of the finance industry. The IMF reported that the market exceeded $2.1 trillion globally in 2023,1 predominantly in the US and Europe, with estimates by other financial institutions putting this number closer to $3 trillion. Private credit funds have become a fundamental source of funding for many sectors including asset-backed debt, with a growing number of financial instruments in these markets being packaged into securitised products and traded on secondary markets. These products however, once an attractive component in a diverse investment portfolio in a low-interest rate market for many investors, may not be all as promised to be.
In the motor financing market, securitised debts are known as Auto Asset-Backed Securities (ABS). Issuing these products enables motor financiers to use cashflows generated from financing agreements with customers to realise immediate credit from loans which typically mature between 3 and 5 years, as well as transfer credit risk off their books. The provider of the financing, known as the Originator or Seller, sets up a special purpose vehicle Issuer to acquire a pool of the loans (which is usually ‘overcollateralised’ with more collateral than necessary to cushion against losses) and issue notes to investors. The Issuer receives proceeds from investors for the purchase of those notes, with the Originator in turn receiving from the Issuer the total purchase price for acquiring the loans. The Issuer makes payments on the notes over the product’s lifetime using the payments of principal and interest which the Servicer (usually the same entity as the Originator) receives from the obligors (the borrowers of the underlying loans). The notes are also structured in tranches which are ranked in a ‘waterfall’ according to their maturities and credit rating. Senior notes at the top of the waterfall are the higher-rated safer investments with lower yields, whilst the mezzanine and junior notes at the bottom have higher yields but are risker and are often the first to absorb losses once reserved funds set aside within the structure are exhausted.
For investors and their investment vehicles, tranches of Auto ABS products attracting varying yields and returns can provide them with options for diversification according to their risk appetite. Other risks such as fluctuating interest or FX rates can also be hedged using derivative products. The private credit market however, inhabited by many of these products, lacks the same levels of transparency which can be found in public markets; information on the underlying motor loans, their terms and their financial health are not always readily available to investors. The wider ABS market has also experienced recent turbulence with increasing rates of defaults on loans and many market participants having endured losses (including with other products such as Commercial Mortgage-Backed Securities). Moreover, cracks in the motor financing sector are beginning to emerge which could expose Auto ABS investors to similar losses.
Cue the Court of Appeal decision in the case of Johnson v FirstRand Bank Ltd T/A MotoNovo Finance Limited2 in October 2024, in which the Court oversaw three separate appeals (Johnson, Wrench and Hopcraft) to decide the degree of liability of motor finance lenders for failures to disclose to customers commissions which were made to credit brokers at car dealerships. The commissions included a ‘difference in charge’ model whereby the lender permits the broker to negotiate with the customer the interest rate of the credit, with commission being calculated as the difference between the lowest rate of interest in the permitted range and the agreed rate. Following an assessment by the FCA, these models have been banned since January 2021 and appropriate rules and principles were codified into the FCA Handbook.3 The case also included a ‘revenue share of advance’ model, effectively a fixed percentage commission.
The Court concluded that the concealment or secrecy of such payments can amount to a bribe: an actionable wrong at both common law and in equity which bestows a number of remedies against the payer of the bribe as the primary wrongdoer, including (where feasible) recission of the contract.4 In these proceedings, none of the three customers had provided their fully informed consent to the brokers for the payment of those commissions. In addition, the level of disclosure of the commission varied in each case which ultimately led to different outcomes. In Johnson and Wrench, the terms and conditions disclosed the possibility of a commission being made which was “buried in the small print” of documents signed by the customers. This did not go far enough to secure fully informed consent. In Hopcraft, no disclosure was made in the documents at all. All three claimants were entitled to compensation.
For Auto ABS issued with underlying loans containing commission payments, if Originators are not satisfied that the fully informed consent of customers has been obtained and that the appropriate level of disclosure has been achieved, noteholders should be alive to recourse for losses which could potentially be suffered. For example, if the Originator failed to disclose issues facing the commission this could breach the terms of the receivables sale agreements documenting the acquisition of the pool of loans by the Issuer, as well as possibly other transaction documents underpinning the structure, which could lead to an event of default (or in some cases an early amortisation of the notes) and claims for damages. MotoNovo in their own Auto ABS 2020 issuance named ‘Turbo Finance 9 plc’ warranted and represented in their Receivables Purchase Agreement that no finance document was “entered into as a consequence of any conduct constituting fraud, misrepresentation, duress or undue influence by MotoNovo”.5
Following the lenders’ successful application for permission to appeal, Johnson v FirstRand is set to be heard in the Supreme Court on 1st - 3rd April. In a rare step made by the Government, lawyers from the Treasury recently made an application to the Court requesting permission to intervene and make submissions at the case, warning of the “considerable economic harm” which could result in a decision made against the lenders, emphasising the need to deliberate on compensation to consumers which is proportionate to the losses suffered.
Should the Supreme Court find in favour of the consumer, it could have potentially significant ramifications for the motor finance industry; recent estimates put the total cost of compensation claims at £44 billion.6 Financial instability of motor financiers resulting from reputational damage and compensation payments (which may need to account for multiple years of interest) could ultimately impact the value of Auto ABS notes on the secondary market, with junior noteholders possibly bearing losses. Where rescission of hire purchase agreements is available to wronged customers, for instance in the event of complete non-disclosure and where rescission is a suitable remedy, this could have a major impact on underlying assets in Auto ABS structures and therefore the Originators’ ability to generate the necessary cashflows which would compromise the viability of these products. Rating agencies could downgrade the notes if confidence in the Iender’s ability to service the notes diminishes. There is also industry concern that there is not sufficient collateralisation in these pools to deal with such stresses.
Investors ranging from sophisticated institutional investors to family offices and ultra-high-net-worth individuals could be blindsided by these ramifications which diverges from the story they were possibly once told, namely that as far as the Originator was aware there had been no material breaches under the contracts which affects the amount or collectability of the receivables.7 Such express representations made by lenders may assist to overcome the difficulties previously experienced by others in bringing successful proceedings on the back of implied misrepresentations relating to inappropriate conduct.8 The Supreme Court’s decision is highly anticipated; if investors become exposed to resulting losses, they should be aware of their options for potential claims.
Originally published published in ThoughtLeaders4 Dispute Magazine.
1 International Monetary Fund: Global Financial Stability Report, April 2024 - Chapter 2
2 Johnson v FirstRand Bank Ltd (London Branch) (t/a MotoNovo Finance) [2024] EWCA Civ 1282
3 The rules relevant to secret commissions are helpfully summarised in the recent letter of Nikhil Rathi, Chief Executive of the FCA, to Lord Forsyth of Drumlean, Chair of the Financial Services Regulation Committee dated 17 January 2025 - https://committees.parliament.uk/publications/46298/documents/233083/default/
4 Wood v Commercial First Business Ltd & Ors [2021] EWCA Civ 471 at [92]
5 Turbo Finance 9 PLC Prospectus, page 92 - https://pcsmarket.org/wp-content/uploads/Prospectus-Turbo-Finance-9-plc-00110.pdf
6 Motor Finance Online: UK intervenes in car finance mis-selling case to protect lenders, 22 January 2025 - https://www.motorfinanceonline.com/news/uk-intervenes-in-car-finance-mis-selling-case-to-protect-lenders/?cf-view
7 Investor Presentation, Turbo Finance 9 PLC, page 29 - https://www.firstrand.co.za/media/investors/presentations/Turbo-Finance-9-investor-presentation-September-2020.pdf
8 Examples include Property Alliance Group Ltd v The Royal Bank of Scotland Plc [2018] EWCA Civ 355 and Leeds City Council & Ors v Barclays Bank Plc & Anor [2021] EWHC 363 (Comm).
