Court confirms that Termination Sum must give credit for Net Sale Proceeds

The recent County Court case of Volkswagen Financial Services (UK) Ltd v Ramage (9 May 2007) has been commented upon by a number of lawyers, but in our view the only surprise about the decision is the fact that Volkswagen’s liquidated damages clause was plainly defective.

The case involved the lease of a new vehicle for 3 years with the provision of a road fund licence and a breakdown recovery service. After approximately 12 months, the Lessee defaulted in payments and Volkswagen treated this as a repudiation of the Agreement and sought arrears, together with damages under its liquidated damages clause which claimed the full amount of future rentals subject only to a discount of 4% for early receipt.

The Lessee correctly contended that the liquidated damages clause was clearly unenforceable as a penalty rather than a pre-estimate of Volkswagen’s loss, for the obvious reason that it did not give any credit for the net sale proceeds of the vehicle.

Volkswagen was therefore required to prove its actual loss arising from the Lessee’s repudiation of the Agreement.

Although this decision is clearly correct, the Court’s analysis did not properly consider the distinction between a Finance Lease and an Operating Lease, and in one sense it is perhaps simpler to move away from these technical concepts developed for taxation purposes and to concentrate in this context on the expectation of any significant residual value in the leased asset at the end of the anticipated period of hire.

Significant Residual Value Anticipated Here the liquidated damages clause should give credit against discounted future rentals for the amount by which the net sale proceeds realised exceeds the anticipated residual value, since it is this sum which is the “windfall” accruing to the Financier in the event of early termination.

Here the Financier needs to give credit for the whole of the net sale proceeds, since had the Agreement been performed to its end, the Financier would have gained no worthwhile value on the return of the leased asset.

In Hire Purchase cases credit should also be given for the whole of the net sale proceeds realised, since had the Agreement been performed title in the asset would have passed to the Hirer.

A further reason why Volkswagen’s liquidated damages clause was struck down was because it made no allowance for the saving to Volkswagen of not having to provide the road fund licence or a breakdown recovery service after termination. Although these savings were relatively minor this in itself would have been sufficient to render the clause an unenforceable penalty.

The Need for a Repudiatory Breach

It is worth mentioning that Financiers should also ensure that they are using termination provisions which deem a failure to pay rentals to be a repudiatory breach of the Agreement, since otherwise a liquidated damages clause which complies with the above requirements will still be vulnerable to being struck down on the grounds that it operates irrespective of the seriousness of the breach. This point was not directly relevant in the present case, but featured in Anglo Auto Finance Co Ltd v James (1963), a Court of Appeal decision which was cited to the Judge but which does not seem to have been properly understood by some of those who have commented on this decision.