Sale and HP or Lease-Back
These types of transaction are usually executed with the desire on the part of the customer to raise funds by selling the equipment to a lender who then lets them back to the seller on a Hire Purchase or Hire Agreement. Such transactions need to be very carefully structured and documented as particularly in the case of a Sale and HP-back there is a danger that the transaction could be re-characterised by a Court as a loan with potentially disastrous consequences for the financier in the event of the customer’s insolvency.
Even if the documentation is sound the financier runs the added risk, both in HP and Lease, that it might lose title in the equipment if the seller, who is still in possession of the equipment, re-sells the equipment to a bona fide third party.
In a typical Sale and HP transaction equipment is sold to a financier then let back to the seller on a Hire Purchase Agreement. The seller receives money from the financier for the price of the equipment, but then pays instalments over a period of time to the financier as hirer for the use of the equipment with the option to purchase the equipment back upon payment of the final instalment and an option to purchase fee. Because the financier retains title to the equipment during the currency of the HP Agreement, the title is essentially the financier’s security, much like a mortgage securing a loan.
However, in the event that the seller falls into bankruptcy, a Court may scrutinise the Sale and HP transaction to see if it is, in fact, a loan. In other words, the Court will seek to determine whether the sale was genuinely a sale and not simply a disguised loan and mortgage.
If the Court were to determine that the transaction was a loan, the financier’s claim to have title to the equipment would be void and, in the seller’s bankruptcy, the financier would become an unsecured lender. In order to be a secured Creditor, the financier would need to have registered the equipment as its security for the loan.
The consequence would therefore be that, having believed all along that it had good title to the equipment, the lender, not having registered its security over the equipment, would simply be an unsecured Creditor.
It is therefore very important indeed that Sale and HP-backs are structured and documented to reflect a true Sale and HP-back and not a disguised security.
Another reason to be wary about Sale and HP-backs or Sale and Lease-backs relates to the seller retaining possession of the equipment. In such transactions, when the equipment has been sold to a financier, the seller typically transfers title of the equipment, yet maintains possession throughout.
According to Section 24, Sale of Goods Act 1979, if a “seller in possession” of the equipment sells the equipment again to a third party (and the third party has no notice of the previous sale to the financier) then the third party, as opposed to the financier, would obtain bona fide title to the goods once the goods are transferred or delivered. Essentially, the financier would lose its rights in the equipment once the seller in possession sells the equipment to the third party.
The danger to the financier is plainly illustrated by the facts in the case of Michael Gerson (Leasing) Limited v Wilkinson (2001) QB 514 (CA) where a Company called Emshelf sold goods to Gerson under a Sale and Lease-back Agreement. Several months later, Emshelf sold some of the same goods to State also under a Sale and Lease-back Agreement. Throughout, the goods remained in Emshelf’s possession and neither Gerson nor State were aware of the other’s interest in those goods.
Emshelf defaulted in paying Gerson and so Gerson terminated the Lease. State also terminated its Lease and sold the goods which were the subject of its Agreement to Sagebush who subsequently sold them to Wilkinsons.
The Court held that there was a constructive delivery of the goods between Emshelf and State at the point of execution of the Sale and Lease-back with State and so that State (and ultimately Wilkinson who purchased through State) obtained good title from a “seller in possession” under Section 24 of the Sale of Goods Act 1979.