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.
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.
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.
“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.
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.