Insolvency special report: buying a lease portfolio – caveat emptor!
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The credit crunch is causing a significant increase in activity levels for legal specialists in the area of asset finance. Leasee default levels have been relatively low since the early 1990s, when major insolvencies, such as that of Atlantic Computers, kept many lawyers busy for many years.
Some leasing companies are now in trouble as a consequence of the increasing levels of distressed leases in their portfolios. Just as many have nothing fundamentally wrong with their business models, but are encountering major problems due to disappearing sources of funding.
In the market there are a number of potential buyers of leasing portfolios and leasing companies, with access to the necessary funding.
The extent of the legal role in advising the buyer of a lease portfolio varies enormously, depending to a large extent on how well the portfolio has been put together and managed. Leasing is an industry which has over the years been the subject of fraud, often carefully concealed, and the legal due diligence exercise needs to take account of that possibility.
Whether the buyer intends to buy the shares in the leasing company, or just its portfolio, careful legal due diligence will be necessary. Key points to consider are the following:
A thorough check must be made as to whether the seller has good title to the leased assets. Original invoices from the supplier are usually sufficient on account of the protection offered by the Sale of Goods Act. Where possible, any relevant asset register – eg House Price Index – should be searched.
Where title has been acquired by the seller from its prospective lessee – ie a sale and leaseback – care should be taken to ensure that the lessee itself acquired good title in the first place.
The seller’s standard lease documentation is likely to be satisfactory, since this is a mature industry. Apart from the occasional need to add wording to cover new legislation, such as the Contracts (Rights of Third Parties) Act 1999, leasing documentation has remained the same for many years.
One perennial documentation problem is that of side letters, some binding, some not, which significantly affect the lessee’s obligations, and the existence of which may only come to light at some stage in the future. These are usually written by enthusiastic salesmen in order to get a deal done, and it takes strong management to ensure that this does not happen.
Where a portfolio only (as opposed to the shares in the leasing company) is being bought, a careful check must be made of the seller’s right to assign the leases. There is usually no problem if the lease documentation is silent on this issue, since, under common law, legal rights are usually capable of being assigned without the consent of the obligor – in this case the lessee.
If a seller has been having difficulty in obtaining funding, it may have had to accept finance from a variety of sources on increasingly disadvantageous terms, both as to cost and the nature of the security offered.
Where a portfolio is only being bought and the seller has offered a funder fixed security over the leased assets and receivables, there are two particular areas of potential difficulty:
• if a notice of assignment has been given by the funder to the relevant lessee it will be necessary to direct the lessee to make changes to the rental payment arrangements, which may well be difficult to achieve
• it will be necessary to obtain the consent of the security holder. If a floating charge has been created over the seller’s assets, including future book debts, an express waiver from the floating charge holder will also be needed.
Many of the problems which arose during the last recession were due to poor internal housekeeping on the part of the lessor. For example, where agreement had been reached with a lessee as to an extension of the term, the original of the supplemental agreement would be left on the file and not placed with the other originals, so that anyone doing due diligence might not be aware of the extension.
Surprisingly often, leases are signed by people without the necessary authority – so that the lessee might contend that it is not bound by the lease – and guarantees are given to the lessor where the guarantor does not have the necessary corporate authority.
This is an area where the legal due diligence exercise is even more important than is usual on a purchase.
Hugh Homan is legal counsel to LPM Outsourcing and former partner at Berwin Leighton Paisner.