Last ditch defence

 Lessors are vulnerable to litigation arising from
particular finance agreements, they, and what preventative measures
lie before them?

Paul Collett and Andy Thompson

 In the UK, and in many other countries with mature leasing
markets, finance companies place great reliance on contractual
exclusion clauses. Often referred to as ‘hell and high water’
provisions, these require the lessee absolutely and unconditionally
to pay rental to the lessor – or sub-lessor – notwithstanding
non-delivery, non-conformity or malfunctioning of the equipment or
any other claims or defences.

Nevertheless, questions arise from time to time as to whether
the courts will, or indeed should uphold exclusion clauses.
‘Bundled’, or service-inclusive leases, bring an added dimension to
the issue.These generally include extra exclusion clause provisions
pertinent to the ongoing supply of maintenance services (and
sometimes consumable materials, like paper and printing ink for
reprographic machines), as well as those affecting the initial
supply of the equipment.

The finance company will normally insist on full payment, at
least for the finance part of the rentals, even if the service
supply initially bundled with it collapses.

Within certain contractual set-ups the lessee may have at least
some redress directly against the equipment supplier for any
failings on the supplier’s part. However, under most UK
arrangements for the leasing of new equipment, and especially in
point-of-sale finance in the small ticket market, there is no
direct contract between the equipment supplier and the lessee. The
contract of sale is between supplier and lessor, while the
equipment is to be delivered to the lessee.

Failure

This leaves a triangular problem. If there is some failure of
performance on the part of the equipment supplier – or in a bundled
lease by the service supplier – the lessee may have no contractual
recourse directly against the supplier. In principle the lessor may
have recourse against the supplier – except that if the lessor is
fully protected by exclusion clauses in the lease, it could be
argued that the lessor has suffered no loss.The lessee has suffered
a loss, but his only contractual remedy is against the lessor and
is blocked by the exclusion clause.

 Thus it sometimes happens that lessees challenge the
enforceability of the exclusion clause in response to a grievance
against the supplier. The usual route to litigation is via the
lessee withholding rentals. The lessor will eventually have to sue
for the contractual default settlement sum, and the lessee will
resist all claims by challenging the exclusion clause.

Even in cases where the lessee might have some form of potential
recourse against the supplier it may prefer to take on the lessor,
based on the ‘deep pocket’ principle. The supplier may have been an
independent dealer rather than the manufacturer, and may not even
still be in business when problems come to light.

UCTA

The legal issues are not always straightforward. To some extent
lessees are protected by the Unfair Contract Terms Act 1977 (UCTA).
“In general, businesses are assumed to be free to enter into
whatever contracts they agree between themselves,” points out James
Watters, a partner at Watson, Farley and Williams.

“Yet the Act does place a number of restrictions on the contract
terms to which business customers can be bound. Specifically, it
lays down rules for the ways in which vendor parties [including
lessors for this purpose] can use exclusion clauses to limit
liability in certain areas.

 “For example, excluding liability for death or injury is
not permitted in any circumstances; and excluding liability for
losses caused by negligence is permitted only if it is reasonable.
Excluding liability for defective or poor-quality goods is also
permitted only if it is reasonable.

 “That said, UCTA does not define precisely what is meant
by ‘reasonable’. However, courts will usually take into account the
information available to both parties when the contract was drawn
up, including whether the contract was negotiated or in standard
form, and whether the purchaser had the bargaining power to
negotiate better terms.

 Protection

 “Business customers do not have the same protection as
individual consumers. A consumer credit contract excluding
liability for defective goods would be automatically invalid. By
contrast, in business asset finance it is up to the lessee to check
in advance what terms and conditions he is agreeing to,” says
Watters.

Many players in asset finance are sympathetic to problems that
can face the lessee. Sandy Neville, director of EMC Global
Financial Services, makes the point: “How can you expect a customer
to pay for a service that is not being carried out? That is basic
customer service.”

Derek Soper, partner at The Alta Group consultancy, agrees that
in the case of a complete failure of delivery, lessees should not
be legally bound to continue payment regardless of performance:
“The concept of non-delivery being acceptable, because a ‘hell or
high water’ provision is in place in the lease, is not
appropriate.”

In general, UK lessors still feel protected by a landmark ruling
of the English Court of Appeal in 1969, in the case of Branwhite v
Worcester Works Finance. This upheld a standard type of exclusion
clause in a hire purchase contract by determining that the finance
company was not the legal agent of the customer’s chosen supplier
in connection with equipment supply issues.

There is nevertheless one important category of leasing business
where the Branwhite precedent has been eroded. This is ‘white
label’ or ‘badged’ agreements where a noncaptive lessor in a vendor
programme uses a trading name related to that of the supplier. The
key precedent there is a 1994 ruling by the Appeal Court in Lease
Management Services v Purnell Secretarial Services.

Purnell

The Purnell case involved the lease of a Canon photocopier. The
sales representative, employed by a Canon franchised dealership,
had wrongly assured the customer that the machine had a certain
technical capability that the customer wanted. The lease agreement
was documented in the name of Canon South West Finance, but this
was a trading name adopted by the third party leasing company (LMS,
originally part of a small banking group and later absorbed into GE
Commercial Finance after serial mergers). The court held that in
these circumstances the lessor was bound by a legal agency in
respect of the salesman’s misrepresentation, invalidating the
exclusion clause provision to the contrary.

Pure captive lessors would probably never attempt to use
exclusion clauses in relation to equipment supply issues, nor would
the courts support them if they did so. Yet on bundled leases all
lessors including manufacturer-captives will commonly rely on
exclusion clauses in connection with servicing. In volume leasing,
the service supplier in a bundled lease may be a franchised dealer,
trading under the manufacturer’s name. So even a captive finance
company could face Purnell type legal issues in connection with
servicing.

If the service supplier goes out of business, a replacement
supply source can usually be arranged. Yet this may cost
significantly more than the original bundled servicing, especially
if that had been offered on promotional terms to help sell the
machines or the finance product. The lessee may expect the lessor
to absorb the additional cost, but the relevant exclusion clause
will usually have been designed to make the lessee take such a
hit. 

“The more complex the bundled offering is, the more care the
lessor should take in making sure that each supplier of services is
a quality player,” says one industry source. Another remarks:
“Where lessors have not ensured that the suppliers under bundled
leases are of a high quality, then should the lessor be taking some
responsibility for that? In my view not enough lessors take enough
notice of the quality of their suppliers.”

 Lessors that buy portfolios – bundled or otherwise, and
whether from other independents or from captives – need to be
careful about exactly what they are acquiring. The general quality
of the assets, viewed in the light of the contractual provenance of
exclusion clauses, has to be part of the due diligence process.
“Lessors are not always as smart as they should be on these
issues,” says Soper.

Notwithstanding this, the number of complaints to the UK’s
Finance & Leasing Association from customers unhappy with their
lease contracts on supplier-related issues is very low. “I see
around 10 of those cases a year,” says a lawyer close to such
issues. However, it is likely that complaints to the leasing
industry’s trade body represent no more than a small portion of the
underlying problem area, given the other avenues for lessees –
including ultimately the possibility of legal challenges to
exclusion clauses.