A decision of the NSW Supreme Court in late April 2007 in the case of Integral Home Loans Pty Ltd and Another v Interstar Wholesale Finance Pty Ltd and Another [2007] - NSWSC 406 (27 April 2007) - will have far-reaching ramifications for the non-bank sector and in particular, the relationship between mortgage managers and their wholesale funding providers. The ramifications will go even further as the issue decided in the case will impact on the broking sector as well.

The case related to the right of the wholesale funder (Interstar - now Challenger Mortgage Management) to terminate the "originator's fee" (often called "management fees" or "trailing commission" in the industry) upon the occurrence of certain events. In this case those included an insolvency event in relation to the originator and a situation in which the originator, or its representative, had engaged in deceptive or fraudulent activity in relation to a loan.

Key issue

The main question to be decided in the case was whether upon termination of the agreement due to alleged fraud, Interstar was entitled to terminate the originator's entitlement to any outstanding and ongoing originator's fees.

The finding of Brereton J in the NSW Supreme Court was that Interstar was not entitled to terminate the originator's right to receive the originator's fee because the provision in the agreement enabling it to do so was void as a penalty. At common law, a provision that is intended to punish a party to an extent beyond the loss suffered by the party seeking to enforce it, is void (of no effect).

The originator/mortgage manager in this case argued that the clause in the agreement was a penalty (intended to punish) and should be declared void.

Most cases about penalties relate to clauses in agreements which require the offending party to pay a sum of money upon a breach of a condition in the agreement. Generally speaking the provision is secondary to the primary purpose of the agreement. In this case, the provisions entitling Interstar to terminate were described as events and not conditions of the agreement. As well, there was no imposition of an actual payment by the originator but rather the removal of a right to receive the originator's fee.

Brereton J referred to a number of cases that supported his conclusion that such a provision was still a penalty if it involved forfeiture of an accrued right. He also found that even though an "event of default" was not a breach of a condition of the contract in the circumstances of the case, it was collateral or secondary to the main purpose of the contract, and that was for the originator to continue to receive the ongoing originator's fee/trailing commission/management fee for the life of the loan.

Challenging times ahead

It will be the findings stated in the above paragraph that will ultimately be challenged. At the time of writing, the author understands that Challenger is likely to appeal the decision. Additionally, this decision is only law in NSW and yet to be determined in any other state or higher court.

Perhaps, from a technical point of view, the most interesting aspect is the description of the originator's fee as an "accrued right" that arose on settlement of the loan. In the Interstar agreement, the right to receive the originator's fee arose on settlement of a loan and was payable as a percentage of the outstanding loan balance of the portfolio of loans at the end of the month.

Brereton J suggested that the clause enabling termination of the originator's fee would not have been a penalty if the right to receive the originator's fee was conditional upon certain events not happening, ie insolvency or fraud being established.

Mortgage managers

What does this mean for mortgage managers? Particularly if you are in NSW, if your funder seeks to terminate your agreement and also your entitlement to receive management fees/trailing commission, you may be able to contest the enabling provision on the basis it is a penalty.

Wholesale funders would be wise to review their agreements in light of the decision.

In spite of the Supreme Court decision, this issue is far from over. An appeal may be lodged and will no doubt take many months to reach a conclusion. The case in point, whilst highly technical in nature, seems to fly in the face of what is right if indeed Interstar properly terminated the agreement due to alleged fraud.

Stephen Moulton
Chairman of partners
Mills Oakley Lawyers