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Receivables Financing: Hell or High Water?

It has been the practice of Funders for some time to take assignments of receivables due from business Customers to Lessors under Lease or Hire Purchase Agreements on the assumption that the receivables are payable by the Customer on a “hell or high water” basis, without regard to issues which may arise relating to the performance of the Equipment or services which are being provided.

In our view this assumption is ill-founded in many situations and it is necessary for Funders to be aware of the risk of lawful non-payment by the Customer as a result of problems with the Equipment or services supplied by the Lessor.

This issue arises whether or not the Funder takes ownership of the Equipment in addition to an assignment of the receivables, and applies whether the Funder’s role is initially disclosed or undisclosed.


Transactional lawyers have approached this issue by examining the Master Sale and Purchase Agreement (“MSA”) imposed by the Funder on the Lessor and noting the extensive warranties and provisions for recourse in the event of non-payment by the Customer. The Funder’s transactional lawyers will also normally review the underlying Lease or Hire Purchase Agreement between the Lessor and the Customer and be comforted by their ubiquitous extensive exclusion clauses seeking to exclude any liability or remedies relating to performance issues.

However, it is necessary to also bring the experience of hard-fought litigation into the analysis when it is sometimes perhaps overlooked by some purely transactional lawyers. The starting point is that Lease and Hire Purchase Agreements are subject to terms implied by statute to the effect that the Equipment supplied is:-

(1) of satisfactory quality; and

(2) reasonably fit for the purpose for which it was supplied. ((Lease – Section 9 of the Supply of Goods and Services
Act 1982; Hire-Purchase – Section 10 of the Supply of Goods (Implied Terms) Act 1973.

In addition, in a contract for the supply of services there is an implied term that the Supplier will carry out the service with reasonable care and skill. ((Section 13 of the Supply of Goods and Services Act 1982))

Unfair Contract Terms Act 1977

Some transactional lawyers are under the misapprehension that the Unfair Contract Terms Act 1977 (“UCTA”) applies only to consumers and therefore does not need to be considered when dealing with business Customers. This is a fallacy; there are indeed different provisions applicable to those “dealing as a consumer” and others, but a very important part of UCTA does relate to the control of exclusion clauses in contracts with business Customers.

The main provisions in UCTA dealing with the statutory implied terms as to performance of Equipment in Lease and Hire Purchase Agreements are in Section 7, which essentially provides that such liability may only be excluded “insofar as the term satisfies the requirement of reasonableness”.

In addition, Section 3 applies where the Customer deals on the Lessor’s written Standard Terms of Business, and strikes down clauses excluding liability for breach of contract unless the term satisfies the requirement of reasonableness.

The “reasonableness” test is defined in Section 11(1) of UCTA “that the term shall have been a fair and reasonable one to be included having regard to the circumstances which were, or ought reasonably to have been, known to or in the contemplation of the parties when the contract was made.”

Schedule 2 then sets out guidelines for the application of this test, including:-

(a) the strength of the bargaining positions of the parties relative to each other, taking into account alternative means by which the Customer’s requirements could have been met;

(b) whether the Customer received an inducement to agree to the term, or in accepting it had an opportunity of entering into a similar contract with other persons without having to accept a similar term;

(c) whether the Customer knew or ought reasonably to have known of the existence and extent of the term;

(d) where the term excludes or restricts any relevant liability if some condition is not complied with, whether it was reasonable at the time of the contract to expect that compliance with that condition would be practicable; and

(e) whether the goods were manufactured, processed or adapted to the special order of the Customer.

In addition, Section 11(4) provides that where a contract term seeks to restrict liability to a specified sum of money, the availability of insurance is relevant in deciding the issue of reasonableness.

The burden of proving reasonableness is on the Lessor (( Section 11(5) of UCTA)).


UCTA contains sophisticated anti-avoidance provisions. So it has been held that excluding a right of set-off is a variety of the exemption clause controlled by UCTA. (( Stewart Gill Limited v Horatio Myer & Co Limited [1992]QB 600, CA.))

Evasion of UCTA by means of a secondary contract is also prohibited, so in practice whatever the web of Agreements or relationships between Customer, Lessor and Funder the fact is that the Funder will always be vulnerable to a challenge by the Customer to the Lessor’s ability to exclude liability or remedies arising from performance issues under the Lease or Hire Purchase Agreement.

Case law

There are relatively few precedents dealing with the reasonableness of exclusion clauses in Lease and Hire Purchase Agreements.((For an analysis of relevant cases see Bermans’ Guide
to Leasing and Hire-Purchase Law (Second Edition) at page 16-available from our website.))

The leading case is perhaps Lease Management Services Limited v Purnell Secretarial Services Limited [1994] CCLR 127, in which the Court of Appeal held a very wide exclusion clause in a photocopier Lease to be unreasonable, particularly since it sought to exclude express as well as implied terms. The Court bore in mind the fact that the Lessor had no opportunity to inspect the goods and did not participate in negotiations preceding the transaction, but equally the Customer had no proper chance to inspect or test the machine actually delivered, and the Lessor’s role in the transaction and the use of eponymous names was strongly criticised by the Court.

Since Purnell there have been cases which have suggested a movement by Judges towards a more commercial approach recognising the validity of some exclusion clauses, including in a decision involving Anglo Leasing in March 2000. (( Anglo Group plc v Winther Brown & Co Limited.))

There has been a similar trend towards upholding some exclusion clauses in non-leasing cases, particularly in the case of computer Equipment.

Regus (UK) Limited v Epcot Solutions Limited

However, the fact remains that it is very difficult to predict the view a Judge is likely to take of the reasonableness of an exclusion clause, and this uncertainty makes it necessary to proceed cautiously in litigation concerning the issue.

This is illustrated by the recent case of Regus (UK) Limited v Epcot Solutions Limited . This was not a leasing case, but involved the provision of serviced office accommodation by industry leader Regus to Epcot, a small but ambitious provider of professional I.T. training. The decision is in our view of particular significance to Funders in view of the increasing trend away from the simple leasing of Equipment towards the provision of Equipment with a significant element of “soft” services or as part of a managed service agreement.

Part of the package provided by Regus to Epcot included air conditioning, and it was accepted that the air conditioning did not work properly as a result of Regus’ fault. Epcot refused to pay Regus’ continuing charges and eventually moved to other premises. When Regus sued for unpaid charges Epcot counterclaimed for the astonishing sum of £626 Million consisting mainly of alleged lost profits.

Regus sought to rely on an exclusion clause in its Standard Terms which the Judge construed as seeking to exclude any liability for the non-performance of the air conditioning; the clause also went on to restrict any liability to £50K in respect of losses other than damage to personal property, which itself had a maximum cap of £1M.

In the High Court the Judge found that the air conditioning was significantly defective, but that these defects did not present a real threat to Epcot’s business.

The Judge took the view that Regus’ exclusion clause failed to satisfy the requirement of reasonableness and would therefore be struck down, entitling Epcot to proceed with its Counterclaim for alleged loss of profits.

The Judge’s decision was reported in June 2007, and attracted analysis from a number of legal commentators none of whom suggested that the Judge had got it wrong.((For example on the Lexology website there were at least 6 articles reporting the first instance decision, none of which were critical))

The matter then came before the Court of Appeal on 15 April 2008. The Court of Appeal disagreed with the Judge’s interpretation of the scope and extent of Regus’ exclusion clause, and also disagreed with the Judge’s view that the clause failed to satisfy the requirement of reasonableness. In particular the Court of Appeal took into account the following factors:-

(1) in principle it is reasonable for a contracting party to restrict damages for loss of profits and consequential losses for which it may become liable when in breach of contract;

(2) Epcot’s Managing Director was an “intelligent and experienced businessman”;

(3) Epcot’s M.D. accepted that he was well aware of Regus’ Standard Terms, and had contracted before on those terms;

(4) Epcot used a similar exclusion of liability for indirect or consequential losses in its own terms of business;

(5) Epcot had sought to renegotiate other terms of Regus’ Standard Contract, but not the exclusion clause;

(6) there was no inequality in bargaining power: although Regus was by far and away the bigger enterprise, Epcot had made skilful use of negotiations with competitors and of market factors;

(7) Regus’ exclusion clause expressly advised Customers to protect themselves by insurance, and it would have been far more cost effective for the relevant risk to be borne by Regus’ Customers rather than by Regus itself.

Thus the Court of Appeal consisting of 3 Judges unanimously took the view that Regus’ exclusion clause did satisfy the requirement of reasonableness, contrary to the view of the trial Judge. This in itself demonstrates the uncertainty of litigation concerning UCTA.

Protection Against Risk

How can Funders take steps to protect themselves against the risk of Customers seeking to avoid payment on the basis of performance issues relating to the Equipment or services provided by the Lessor?

Firstly, if the Funder can persuade the Customer to declare that payment will be made to the Funder irrespective of performance issues and that the Customer’s sole remedy lies with a claim against the Lessor or a Supplier, that would weigh heavily in the Funder’s favour but would not be conclusive. Of course this approach would only work if the Funder’s role was disclosed to the Customer at the outset.

An alternative is a tri-partite agreement between the Supplier of the Equipment or services, the Lessor and the Customer, which again declares that the Customer will pay the Lessor irrespective of performance issues and that the Customer’s sole remedy will lie directly against the Supplier in that regard. We have seen this type of device used effectively in software transactions, and if the Lessor would succeed in upholding such a non-set-off clause the benefit should be capable of assignment from a Lessor to a Funder.

However, the problem with this approach is that it effectively requires the Court to treat the Lessor’s role as similar to it providing a Loan and therefore being able to remove itself from any liability for performance: the obvious retort which the Courts are likely to make is that if the Lessor wished to divorce itself entirely from performance issues, it could have done so by granting the Customer a Loan rather than becoming involved in the chain of title and providing Lease or Hire Purchase services whether for fiscal reasons or otherwise.

It is therefore necessary for the Funder to cater for the worst case scenario of a challenge to the validity of the Lessor’s exclusion clauses and/or any ancillary documentation involving the Funder and the Supplier by assessing the underlying risk:-

(1) What is the Supplier’s track record in providing this type of Equipment or services?

(2) What is the Supplier’s credit-worthiness in case it becomes necessary for the Funder to pursue a claim against the Supplier?

(3) What is the Lessor’s credit-worthiness in case it becomes necessary to enforce the warranties or recourse provisions in the MSA?

Receivables financing is increasing in both volume and scope, and continues to push the boundaries away from simple deals involving the provision of Equipment into the provision of software and managed services. The Courts are traditionally some way behind developments in the marketplace and it may be the case that some of the issues described above remain unresolved for a while longer. But one day there will be an authoritative Court decision demonstrating that the assumption by many Funders that they have a “hell or high water” rental stream is an assumption too far.