Avoid Turning Your Referral Partner into a DSA/LSP

Simrat Singh | Finserv@vinodkothari.com

RBI regulatory framework for banks and NBFCs recognise entities such as LSPs and DSAs, but do not define the term “referral partner”. Consequently, several lenders engage referral partners under agreements that merely replicate the DSA arrangement with a change in the nomenclature but without altering its substance. This is a risky approach. Courts have held that the existence of an agency relationship depends on the rights created between the parties, not on the title of the agreement. Therefore, if a referral partner agreement authorises the intermediary to represent the lender or perform functions ordinarily discharged by a DSA or outsourced agent, the intermediary may be regarded as a DSA irrespective of its contractual designation. Accordingly, while drafting a referral partner agreement, equal attention must be paid not just to the scope of what can be done but also  what the agreement does not permit. To understand the difference between a LSP, Referral partner and DSA, may refer to our resource Referral or Representation? The Fine Line Between LSP, DSA and Referral Partner.

Set out below are contractual provisions that should be avoided in an agreement with a referral partner.

1. Do not confer authority to make commitments: Such authority is inconsistent with a mere referral arrangement and indicates an agency relationship. The agreement should not permit the referral partner to:
   1. assure loan sanction;
   2. quote specific interest rates since that is a function of borrower risk and lender’s credit evaluation and interest rate model;
   3. commit timelines for approval or disbursement; or
   4. make any representation which is binding on the lender
2. Do not permit the referral partner to hold itself out as representing the lender: A referral partner should not portray itself as the lender’s representative or create the impression that it is authorised to act on the lender’s behalf. Accordingly, the agreement should prohibit the intermediary from describing itself as the lender’s agent or representative, using the lender’s name or branding in a manner that suggests an affiliation beyond a referral arrangement, or making any statement or representation that could lead customers to believe that it has authority to act for or bind the lender. 
3. Do not permit collection or processing of loan applications and loan repayments: These functions form part of customer acquisition, onboarding and servicing, which are characteristics of DSAs or LSPs. A referral partner should not collect or verify KYC documents and/or scrutinise applications and collect customer information/documents in any manner. Further, activities such as identity verification, obtaining customer consents, conducting due diligence or facilitating KYC should remain with the lender or its authorised service providers. A referral partner should not participate in the lending process beyond introducing the customer.
4. Keep performance obligations limited to referrals: The referral partner should not be evaluated based on portfolio quality; recovery performance; or loan servicing metrics. Performance obligations should relate only to successfully introducing prospective customers. 
5. No compensation linked to lending functions or loan performance: A success-based referral fee, by itself, does not create an agency relationship. However, the consideration should not be linked to underwriting, servicing, collections, portfolio performance, recoveries or any other lending function. The agreement should make it clear that the referral fee is payable solely for successful referrals and not for performing any activity connected with the lending process.
6. Do not authorise communication of lending decisions/negotiation: All customer communications should originate directly from the lender. The referral partner should not communicate sanction or rejection of applications; loan terms; deficiencies in documentation; repayment schedules; or disbursement confirmation. Further, negotiation on behalf of the lender is a strong indicator of representation/agency. The agreement should not authorise the intermediary to negotiate pricing; tenure; collateral requirements; repayment schedules; or restructuring terms.
7. Do not assign post-disbursement responsibilities: Its role should ordinarily cease once the customer has been introduced. The referral partner should not undertake collections; recovery; repayment follow-ups; customer grievance handling; restructuring assistance; or foreclosure processing.
8. Avoid clauses indicating exclusive representation: Clauses requiring the intermediary to exclusively promote the lender’s products or act as its sales representative reinforce the impression that the intermediary is representing the lender rather than merely referring customers.
9. Avoid excessive operational control: Compliance obligations may be imposed, but they should not amount to day-to-day supervision. Operational control is a recognised indicator of agency. Accordingly, the agreement should avoid prescribing detailed supervision clauses or detailed operational instructions unrelated to regulatory compliance.
10. Include non-agency provisions: The agreement should expressly provide that:
    1. the referral partner is an independent contractor;
    2. the relationship between the parties is on a principal-to-principal basis;
    3. it has no authority to represent or bind the lender;
    4. the referral partner shall not collect, process, or handle customer documents, KYC records, or sensitive customer information;
    5. all lending decisions are taken exclusively by the lender;
11. Avoid agency terminology: Last but not the least, expressions such as authorised representative; sales representative; marketing representative; branch; agent; or authorised person should be avoided throughout the agreement because the language used often reflects the intended legal relationship.