This may be (i) before the contract for sale is concluded with the supplier (where the customer acts as agent for the asset financier in purchasing the goods), (ii) after the contract has been entered into but before title in the equipment passes from the supplier under the contract (where the customer transfers their rights under the supply contract to the asset financier) or (iii) after title in the equipment has already passed to the customer.
This note focuses on this third route, where a typical transaction involves the equipment being sold to the asset financier by the customer, to then be hired back to the customer by the asset financier under a hire purchase agreement. In this way, the customer receives payment for the sale of the equipment, but can continue to use it and repay to the finance company the price paid by the finance company, by way of instalments under the hire purchase agreement.
Which law applies?
This is not determined by the domicile of the hirer, nor by the governing law of the finance agreement, but rather by the law of the place where the equipment is located at the time title to it passes to the finance company (Jurisdiction A). This is the case even where the equipment is being hired to a company registered in Jurisdiction B, with the intention (and result) being that the equipment is ultimately relocated to Jurisdiction B following the sale.
So, what is the issue?
- The Sale of Goods Act 1979 (the Act) contains the basic rules which govern the sale of goods.
- The Act provides that title to goods on sale passes when the parties intend it to - this rule is equally part of both Scots and English law, but it was new only to Scots law when first enacted.
- There is an exception in Scotland which means that this provision of the Act does not apply to a sale intended to operate by way of security (i.e. a loan secured on the asset financier's title to the equipment in question).
- Whilst the Act doesn’t go as far as to say so, it is likely therefore that old Scots common law still applies to these types of transaction, meaning that delivery is required for title to pass.
In addition, in the leading Scottish case on sale and hire purchase back (which involved a sale of tractors by a farming company to a finance company, followed by their hire purchase back to the farming company without the finance company ever taking delivery of the tractors) it was held that this type of transaction was intended to operate by way of security, meaning that no title in the tractors had passed to the finance company.
The risk of sale and hire purchase back transactions being successfully challenged (most likely by an administrator in the insolvency of the relevant company), resulting in the financier's title to the equipment being void and the financier becoming an unsecured lender, understandably creates a degree of caution amongst asset financiers when approaching this type of transaction.
However, this does not mean that financiers will not do sale and hire purchase back transactions, and where genuine circumstances of a sale can be established rather than the characteristics of a security it may still be done but, given the Scottish position, does require financiers to pause and consider the potential risk involved.
Attempting to mitigate the risk
Against this legal background, there are a number of approaches we have seen funders takein order to attempt to mitigate the risks outlined above to some extent, though every transaction will obviously depend on its own circumstances. These include:
1.Ensuring that the sale price represents a fair price for the equipment being sold;
2.Setting out the justification for this route to title (for example, if the goods are being imported from another country ora complex assembly of plant of which the asset is only part) in the properly documented sale agreement;
3.Letters of intent may be entered into which show that onward sale to the finance company was always planned; and
4.Physical delivery (given the likelihood, as explained above, that old Scots common law continues to apply to these transactions) - whilst it is not clear exactly what is required in order to show actual, physical delivery of the equipment, it is likely to require more than simply the asset financier laying their hands on the equipment, so whether this is an option will depend on the circumstances of each case and the assets in question.
Finally, in the Scottish case mentioned above, it was made clear that the debt obligation remains valid and that it is the transfer of title itself which may be successfully challenged. Therefore, a number of financiers take the view that the risks outlined above can be alleviated to a large extent in a proposed transaction if the customer's credit covenant, taken with any available guarantee or other security (a chattels mortgage in England or floating charge in Scotland) is undoubted so that the goods themselves are not an essential part of the security package and therefore the concerns around the sale and hire purchase back being deemed to operate by way of security have little relevance.