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FAQs - challenging financial leases

22 February 2013

How finance leases work and the options available to schools looking to exit unscrupulous schemes has become a popular query for our team following recent exposure in the media relating to photocopier contracts. Below we answer some key questions on these leases and what schools can do if they are a victim of such schemes.

Why have finance leases in the education sector been portrayed negatively in the media?

Many schools have been encouraged by certain suppliers to enter into lease agreements relating to IT and office equipment. The agreements have attracted negative publicity as they contain significantly inflated prices (often 10 to 20 times of the equipment’s true value) but with the supplier agreeing to assist the school with repayments.

How do we identify these types of leases?

The agreements are usually for a 3-6 year term and require the school to make payments to a third party (usually a bank or finance company) rather than back to the supplier who originally contacted the school. Payments will usually be due quarterly and the total repayments over the life of the agreement often total tens or hundreds of thousands of pounds.

The approaches taken by suppliers vary, but we have commonly seen ‘cash-back’ being paid to the schools to assist with the repayments. In some circumstances the equipment is described as being “free” as the supplier will meet the entire cost.

Another feature of these arrangements is that the total repayments due under the contract with the finance company are significantly higher than the actual value of the equipment. Schools should check the total repayable against the value of the equipment purchase on the current market. A significantly higher sum may indicate that the school has entered into this contentious type of finance lease.

If the supplier has agreed to assist the school with, or pay all of, the payments, what’s the problem?

If the supplier stops making the payments (or its company is dissolved), the school will be responsible for making the full repayments to the finance company. Without the promised cash-back, these repayments are often unaffordable for schools.

We were told by the supplier that the monthly repayments would only be small sums, so why is the finance company saying they are much higher?

This is because suppliers commonly have subtracted their contribution when informing the school of its repayments. Without this contribution the repayments are generally much higher.

What options are open to schools who find themselves in this situation?

A number of finance companies are aware of these leases and are working with schools to agree settlement figures. Often the companies are offering discounts of 5-20% on the repayments. However, many schools still find these figures unaffordable. In these circumstances, schools may wish to challenge the validity of the leases.

Are there grounds on which we could challenge this type of finance lease?

Yes, there are possible arguments to run in both private and public law which we explain further below. Schools should have in mind that even if liability under the leases can be avoided, extracting themselves from such arrangements is likely to involve substantial time and expense.

In terms of public law, as schools are classed as public bodies, a route to challenge being explored by some schools is that entering into the leases was “ultra vires”. This means it was outside the school’s power. Most local authorities’ financial schemes of delegation prohibit maintained schools from entering into high value contracts without obtaining a number of quotes or running a full procurement exercise through the local authority. A failure to comply with these requirements may render the lease ultra vires. If the lease is ultra vires, then it is as if it has never been entered into. This would mean that the sums already paid by the school may be repayable back to the school, subject to a deduction for the fair use of the equipment.

Another argument is that the cash-back arrangements entered into by the school constitute borrowing without approval, which for maintained schools is prohibited by the Education Act 2002). Again this may render the leases ultra vires.

Finally, it is arguable that the schools’ actions were ultra vires if the terms of the lease were so onerous that no reasonable public body would have entered into them. If this is the case, the Governing Body has acted in a way which is so unreasonable that a court may declare the actions void and unenforceable.

What about remedy under private law?

One approach is to argue that the suppliers’ explanations of the scheme amounted to a misrepresentation which led the schools to enter into the contracts. Unfortunately the suppliers involved in these arrangements had a tendency to make their proposals verbally rather than in writing, making it difficult to prove exactly what was said.

Another approach is to sue the supplier for the cash-back repayments promised, although this does not remove the repayment liabilities for the school themselves. Opting for this route could prove difficult in practice for two reasons. Firstly, our experience is that such cash-back offers have rarely been made in writing. Secondly, the suppliers rarely have sufficient assets to meet their financial obligations. Indeed, we have seen suppliers make cash-back payments in respect of existing leases using the money received from finance companies for new leases. This means that in effect, the money from new schemes is being used to fund existing schemes, in a similar manner to a pyramid selling scheme. Supplier companies will often going into liquidation once the cash-back liabilities outstrip their incomes, making it very difficult for schools or authorities to recover the sums due.

Can academies also challenge these leases in these ways?

It has not yet been established whether the public law arguments above apply to academies. Until a test case reaches the courts, it is difficult to determine whether the same arguments could be run by a school which has converted to academy status. However, if finance leases (potentially as a form of ‘borrowing’) are prohibited by an academy’s funding agreement (through which the academy trust is bound by the terms of the Academies Financial Handbook), this may support an argument that the lease is ultra vires.

What steps should we take if we have entered into this type of arrangement?

The first stage is identifying which leases entered into are genuine and which are open to challenge. Schools may find it useful to seek assistance from their local authorities and/or take legal advice on whether the lease can be challenged.

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