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Reading the small print

4th December 1997
Page 50
Page 50, 4th December 1997 — Reading the small print
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Which of the following most accurately describes the problem?

Transport companies often lease equipment believing they are getting a good deal and hanging on to capital. But the reverse could be true unless they read the small print.

How often do hauliers read the contracts they sign? In one case, a company began leasing a tyre fitting machine and balancer on a five-year term. The advantage to it doing so appeared to be a reasonably lucrative return in the margin which could be made on tyres which were also to be supplied.

Perhaps the greater than usual margin should have alerted the company that something was not quite right—possibly the fact that there were two lease agreements and a separate agreement for the supply of tyres should have rung a number of alarm bells. But they didn't. The leasing costs were £25,000 over five years. The cost of the tyres soon resulted in the good margin evaporating.

Leaving aside such horror stories, the most important consideration for many businesses when signing a contract is the cost. Lease con tracts are generally transactions which are essen tially an alternative to buying the equipment outright. A leasing contract usually provides security for the lessor by maintaining its interest in the equipment; the lessor will retain ownership of the goods whilst the lessee carries the risk. There may also be the need for maintenance by specialist personnel and so the leasing contract may include a maintenance contract. This holds the attraction for the lessor of guaranteeing regular maintenance payments.

The prospective lessee should work out the total cost of the contract over its whole duration. He should check that the overall payment to be made over the contract is competitive. The lessee may find that the cost of the equipment over the contract period plus interest vastly exceeds its value to him.

Insurable interest

As the risk will he left with the lessee it is important to check the provisions relating to insurance. If the machine is damaged or destroyed. the lessor will usually want a grossed-up sum representing the monthly payments for the remaining period of the lease. But the lessee's insurable interest in the goods is limited to the payments already made to the lessor. However, it is usually possible to overcome the problem by arranging insurance on the same basis as if the lessee were the purchaser of goods.

The lessee should also check that his insurance covers claims made by third parties that suffer loss or damage as a consequence of the machine's use.

Insurance will become especially important if the leasing contract contains an indemnity provision in favour of the lessor requiring the lessee to bear the financial consequences of the physical loss of or damage to the goods. Additionally, it may make the lessee liable to indemnify the lessor against third party claims.

It is also important to consider the termination provisions in the contract. It is common for leasing contracts to require payment of a settlement sum by the customer if it terminates the contract before it expires. Typically, such a settlement sum will be the lease and service charges for the remainder of the contract period, less the trade-in value of the equipment and a discount for accelerated receipt of around 5%. By terminating the contract early, the lessee may be faced with an immediate demand for almost the total amount which would have been payable over the whole duration of the contract.

Settlement term

It may be possible to challenge such a settlement term on the grounds that it is a penalty. At law, where the parties to a contract agree that if it is broken by one party, the contract breaker shall pay to the other a specified sum of money, the clause may be classified by the courts either as a penalty, which is unenforceable, or as liquidated damages, which are enforceable. Enforceability depends on whether the clause in question represents a genuine attempt to estimate in advance the loss which the injured party would be likely to suffer in the event of a breach of the relevant obligation. If a settlement figure cannot be shown to be a genuine pre-estimate of loss, it will not be enforceable.

Consequently, it is necessary to look at the length of the proposed contract in relation to the lifespan of the equipment leased. Many leasing contracts are for fixed periods of several years, and exceed the useful life of the equipment leased out under them. A business with a six-year contract to use a balance machine could find itself with a machine which has come to the end of its useful life after four years. However, the contract has a further two years to run. If the business terminates the contract, it may find itself faced with a settlement claim from the supplier for the remaining two years of the contract running into tens of thousands of pounds.

Restraint of trade

A lessee already tied into a leasing contract, should check the contract to see if there is an obligation on him to purchase, say in the case above, tyres only from a particular manufacturer. If there is, this could be challenged as a restraint of trade.

It may also be worth making a call to the Office of Fair Trading: 0171 269 8901. The Director of Fair Trading is under a statutory obligation to take action on any trade practice which is detrimental to the interests of consumers in the UK. He might consider leasing agreements such as those afflicting tyre fitters as having detrimental effects for consumers. O Stephen Sidkin and Claire Frater Stephen Sidkin is a commercial law partner and Claire Frater a trainee solicitor in City law firm, Fox Williams.


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