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Asset Finance: Fraud in the Arena
With the industry still reeling from revelations emerging from the demise of a certain Lessee, and taking into account the sensitivities of referring to any of the specific current or forthcoming matters in which we are instructed, we thought it might be worthwhile making some general remarks on steps which Funders may wish to consider to prevent being the victims of serious fraud going forward.
Funders with negative experience of the Civil Court process in relation to money recovery claims are sometimes pleasantly surprised to learn that modern English commercial law can offer a highly effective armoury of remedies to counter fraud—but this depends upon the Funder having had the foresight to protect itself by suitable procedures.
This brief review of the situation approaches the topic from the perspective of the Funder’s relationships with Suppliers, Brokers, Lessees and Third Party Buyers and then briefly considers some other specific points.
- Suppliers
By far the most important consideration for the Funder is to protect itself by imposing suitable Terms of Purchase upon its Suppliers of equipment.
This should be done by requiring the Supplier to sign and return a copy of the Terms of Purchase at the inception of a trading relationship.
One key provision should be that a sale of equipment only takes effect when the Funder accepts the finance agreement. Without such a provision as a matter of law the Funder may be bound to complete the sale at a very early stage of the transaction, even before an invoice has been raised.
Other terms which can rescue the Funder in a fraud situation include:-
- that the equipment is new and unused;
- that the price of the equipment does not exceed its list price;
- that any upgrade of previous finance has been separately disclosed in writing;
- that the Lessee’s signatory of the Lease Agreement is duly authorised; and
- that the equipment has not previously been in the Lessee’s possession (save as expressly disclosed) and that all facts known to the Supplier and likely to influence the Funder’s decision on whether to accept the transaction have been disclosed.
- Brokers
From a purely fraud protection perspective the Broker should if possible be in the invoice chain. If the Broker is not in the invoice chain and merely receives commission, the Funder’s rights against the Broker are very limited unless the Broker is prepared to agree to a written agreement giving the Funder the right to an unwind.
It is better for the Funder to impose its Terms of Purchase upon the Broker, and these Terms should provide that the Broker will at the Funder’s request assign its rights against the Supplier to the Funder. This can be invaluable in the event of the Broker’s insolvency or inability to meet claims by the Funder.
Note also that well drawn Terms of Purchase with a Broker will enable the Funder to recover the settlement figure on a Lease rather than simply the return of the price paid to the Broker — in return the Broker takes an assignment of the Funder’s rights under the Lease.
- Lessees
In a fraud situation the Funder’s vulnerability in many small ticket and some larger deals is of course increased by the fact that it usually never sees the equipment and has very little knowledge of what may have transpired between Supplier and Lessee.
In general terms the Funder is not liable for fraudulent misrepresentations made by the Supplier to the Lessee, but the existence of fraud may in certain circumstances provide a Lessee with a Defence to a claim by the Funder.
It therefore becomes essential to analyse the various points of contact between Lessee and Funder.
(1) Pre-Lease Information
Although FLA requirements no longer prescribe the use of Lease Proposal Sheets for certain assets, some Funders voluntarily use Lease Proposals signed by the Lessee in a wider context, and this practice has proved useful in a number of cases e.g. where the Lessee seeks to contend that an upgrade was involved when this does not appear on the signed Lease Proposal.
(2) Signature on Lease
A common fraud technique is for the Supplier to obtain the Lessee’s signature on a partially blank document and misrepresent the financial terms. Since the decision in United Dominions Trust Limited v Western (1976) the Courts have held that the Lessee is bound in these circumstances (except in CCA regulated business) because the Supplier is not the Funder’s agent and a Lessee who signs a Lease Agreement in blank does so at its peril.
More problematic for the Funder is a situation where the signatory on the Lease Agreement is not authorised. Where the Lessee is a limited company the job description of the signatory should be stated and verified. Unless it appears to be a suitably senior position within the organisation further enquiries should be made.
Even if the signatory was not authorised, if the Lessee makes a number of instalment payments and uses the equipment it may be held to have ratified the agreement and will therefore be unable to resile from its liability.
(3) Confirmation of Delivery
This is crucial, and its importance cannot be overstated.
In deals of significant value there is no substitute for the Funder having someone it can trust physically “touch the metal” at the time of delivery and, if practicable, by regular audits during the course of the hiring.
If the Lessee is to be relied upon to confirm the existence and/or delivery of the equipment then its signature on an Acceptance Certificate may be of limited value, since this can be forged by a fraudulent Supplier. The Funder should therefore also consider confirming delivery by a telephone check with the signatory of the Lease Agreement.
Points to note:‑
- the telephone number should be the same as appears on the records of a Credit Reference Agency or public directory;
- the equipment should be described to the Lessee;
- the status of the person confirming should be verified;
- the Lessee should be informed that on the basis of a positive confirmation the Funder will pay the Supplier for the equipment in full;
- confirmation of the telephone call should be timed, dated and kept by the Funder.
The reason why confirmation of delivery can be essential in a fraud situation is because of the legal doctrine of “estoppel” – that in certain circumstances a party cannot resile from a statement that is made in the knowledge that another party will act on that statement.
On a topical note Sale and Lease back deserves special mention since it carries a particular risk of fraud. In addition to insisting on clear proof of the Lessee’s title to the equipment by production of original invoices, in appropriate situations an attempt should be made to check that the equipment is not already on finance by checking the Lessee’s sales ledger or the purchase ledger for direct debits to finance companies.
- Third Party Buyers
Perhaps the most common fraud in the asset finance industry is where the Lessee purports to sell financed equipment either to another Funder or a Buyer without knowledge of the Lessee’s lack of title in the equipment.
There is a common fallacy amongst many businessmen and more than a few lawyers that the second Funder or Buyer acquires title provided that it was acting in good faith, but this is not the law: the original Funder almost always has the right to sue the second Funder/Buyer for damages for conversion.
Damages are the value of the asset at the time it first came into the hands of the second Funder/Buyer and in appropriate circumstances the Court will order the return of the asset.
The main exceptions to the original Funder’s right to recover damages and/or the equipment is where there has been double sale and Lease back, and in certain cases involving motor vehicles.
- Additional Points
(1) Individual Responsibility
It is important to note that in the law of fraud there is both individual responsibility and vicarious liability; so for example a director or senior employee actually involved in fraud by a limited company or partnership cannot hide behind the “corporate veil” and will be personally liable in the tort of deceit for any damages caused by his or her individual actions which can be demonstrated to be fraudulent.
Likewise a corporate entity such as a limited company or an LLP will be vicariously liable for the fraud of individuals acting on its behalf.
This is very different from the position in contract where only the contracting party assumes any legal liability rather than the individuals themselves behind a contracting party such as a limited company or an LLP.
(2) Guarantees and Indemnities
There are very many different ways of drafting security documents such as Guarantees and Indemnities. Experience has demonstrated that by far the most effective form of security provides for the Funder to be indemnified “in respect of any loss arising from or relating to” a Lease Agreement”.
This is particularly useful in fraud situations since in certain circumstances the Lessee may have a defence against the Funder which may also be available to a Guarantor or Indemnifier in the absence of such wording.
(3) Tracing Claims
If an asset has been sold dishonestly and the proceeds of that sale are used for an identifiable purpose, the Funder may be able to trace its claim through into other assets or property which has been acquired with the proceeds of fraud. This can be invaluable in the event of the likely insolvency of those directly involved.
(4) Claims for Fraud Survive Bankruptcy
Finally, it is worth noting that there is a special provision in 281(3) of the Insolvency Act 1986 which enables an individual fraudster to be pursued in a fraud claim even after a subsequent bankruptcy has been discharged:
“Discharge does not release the bankrupt from any bankruptcy debt which he incurred in respect of, or forbearance in respect of which was secured by means of, any fraud or fraudulent breach of trust to which he was a party”.
We intend to report further on the current situation when confidentiality allows.
Contact Bermans Asset Finance team