Legal Remedies in Asset Finance Fraud
Most Financiers have first hand experience of the increasing amount of fraud and deception which is being perpetrated across much of the small and middle ticket asset finance industry.
Financiers 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 Financier having had the foresight to protect itself by suitable procedures.
This brief review of the situation approaches the topic from the perspective of the Financier’s relationships with Suppliers, Brokers, Lessees and Third Party Buyers and then briefly considers the law of injunctions and some other specific points.
By far the most important consideration for the Financier 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 Financier accepts the finance agreement. Without such a provision as a matter of law the Financier may be bound to complete the sale at a very early stage of the transaction, even before an invoice has been raised.
Example: Glasgow Computers
Lessee in Glasgow orders 12 state of the art PCs. Information on Proposal from Supplier shows limited company with several years trading and this checks out with Experian Search, although Financier does not notice that telephone number given on Proposal and Lease Agreement differs from those recorded with Experian.
Supplier is told that deal is approved and equipment is delivered, but Financier then becomes suspicious and investigates further resulting in a decision to refuse credit approval and decline to execute Lease.
Lessee disappears with the equipment and Supplier threatens to sue Financier for the price.
Other terms which can rescue the Financier 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;
• that the equipment has not previously been in the Lessee’s possession and that all facts known to the Supplier and likely to influence the Financier’s decision on whether to accept the transaction have been disclosed.
From a fraud protection perspective the Broker should be in the invoice chain. If the Broker is not in the invoice chain and merely receives commission, the Financier’s rights against the Broker are very limited unless the Broker is prepared to agree to a written agreement giving the Financier the right to an unwind.
It is better for the Financier to impose its Terms of Purchase upon the Broker, and these Terms should provide that the Broker will at the Financier’s request assign its rights against the Supplier to the Financier. This can be invaluable in the event of the Broker’s insolvency or inability to meet claims by the Financier.
Note also that well drawn Terms of Purchase with a Broker will enable the Financier 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 Financier’s rights under the Lease.
In a fraud situation the Financier’s vulnerability in many small ticket and some larger deals is often increased by the fact that It never sees the equipment and has very little knowledge of what may have transpired between Supplier and Lessee.
In general terms the Financier 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 Financier.
It therefore becomes essential to analyse the various points of contact between Lessee and Financier.
(1) Lease Proposal
FLA requirements demand that Lease Agreements for office copiers and multi-function equipment costing less than £50k should be preceded by a Lease Proposal Sheet.
Some Financiers 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 regulated business) because the Supplier is not the Financier’s agent and a Lessee who signs a Lease Agreement in blank does so at its peril.
More problematic for the Financier 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 bound.
(3) Confirmation of Delivery
This is crucial, and its importance cannot be overstated.
In deals of significant value there is no substitute for the Financier 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 Financier should therefore also confirm 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 Financier will pay the Supplier for the equipment in full;
• confirmation of the telephone call should be timed, dated and signed and kept by the Financier.
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.
Example: The Upgraded Photocopiers
The Supplier supplied 4 photocopiers to the Lessee on finance with F1 on a 5 year Lease signed by the Lessee’s Finance Director (“FD”).
3 years later the Supplier contacts the Lessee and persuades it to take 6 new copiers on Lease with F2, on the basis that the Supplier will settle the Lease with F1.
F2 approves the transaction and obtains a telephone confirmation of delivery from FD.
The Lessee makes payments for 18 months but FD then leaves and his replacement carries out an audit which reveals that the Lessee is still making payments to F1 in respect of the original 4 photocopiers, and appears to be paying F2 for the same 4 photocopiers and the 2 new photocopiers.
By now the Supplier has disappeared and an examination of the photocopiers reveals that the manufacturer’s serial numbers have been obliterated. Maintenance records support the Lessee’s contention that the original 4 photocopiers have remained in place throughout and have simply been joined by an additional 2 photocopiers when the Lease with F2 was written.
The Lessee purports to terminate its agreement with F2 on the basis that it only received 2 new copiers. F2 responds that the Lessee is estopped from raising this argument by reason of the FD’s confirmation of delivery.
Sale and Lease back deserves special mention since it carries particular risk of fraud. In addition to insisting on clear proof of the Lessee’s title to the equipment by production of original invoices, an attempt should be made to check that the equipment is not already on finance by checking the sales ledger or the purchase ledger for direct debits to finance companies.
4. 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 Financier or a Buyer without knowledge of the Lessee’s lack of title in the equipment.
There is a common fallacy amongst many businessmen and some lawyers that the second Financier or Buyer acquires title provided that it was acting in good faith, but this is not the law: the original Financier almost always has the right to sue the second Financier/Buyer for conversion.
Damages are the value of the asset at the time it first came into the hands of the second Financier/Buyer and in appropriate circumstances the Court will order the return of the asset.
The main exception to the original Financier’s right to recover damages and/or the equipment is where there has been double sale and Lease back.
In appropriate circumstances injunctions can be obtained from the Courts with great speed.
(1) Interfering with Assets
The commercial Courts will readily grant Financiers a without notice order restraining a named party from disposing of or dealing with equipment for a short period until the legal position can be further investigated.
The Court will normally set a further hearing 7 or 10 days later to give the Defendant the opportunity to respond to the claim, and unless there is effective opposition at that subsequent hearing the Court will often make a mandatory order requiring the Defendant to immediately return the equipment to the Financier.
(2) Freezing Injunctions
Where there is real evidence of serious dishonesty and an inference that a Defendant will be likely to dissipate his own assets if given proper notice of a claim, the Court will grant a Freezing Injunction.
This will prevent the Defendant from dealing with or disposing of his assets either within the UK or in suitable cases worldwide, and normally requires the Defendant to make a full Affidavit of means within a short time.
There may be ancillary orders for disclosure of bank accounts as against the Defendant or if necessary his bankers.
(3) General Points on Injunctions
Injunctions can be an extremely effective remedy in asset finance fraud but they must only be used when appropriate:
• the Financier must give an undertaking in damages in case it later proves that the order should not have been made;
• there must be a “full and frank disclosure” of all points including those in the Defendant’s favour;
• they often lead to the speedy disposal of the whole case.
6 Additional Points
1 Individual Responsibility
It is important to note that in the law of fraud there is both individual responsibility and vicarious liability; in the example of the Upgraded Photocopiers above the Finance Director would be personally liable if the Financier could prove that he was in collusion with the Supplier, and in addition the Lessee as a limited company would probably be held vicariously liable for the acts of its Finance Director.
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.
2 Guarantees and Indemnities
The most effective form of security provides for the Financier 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 has a defence against the Financier 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 Financier may be able to trace its claim through e.g. into other assets or property which has been acquired with the proceeds of fraud. This can be invaluable in the event of the Defendant’s insolvency.
4 Claims for Fraud Survive Bankruptcy
There is a special provision in 281(3) of the Insolvency Act 1986 which enables a Defendant to be pursued in a fraud claim even after a subsequent bankruptcy has been discharged.