David Wood, who is a partner in DWF’s Banking and Finance Team and who specialises in resolving disputes in relation to the supply and financing of business assets, including commercial vehicles, discusses some common issues concerning the financing and managing of vehicle fleets.
The sourcing and securing of finance for business assets, including vehicle fleets can often, particularly in the current climate, be difficult. Capital investment is invariably a key requirement for funding growth or even ensuring survival. Many well established businesses may already have funding arrangements in place with lenders but a business often has to consider the myriad of financing options available for example when adding to or replacing its current fleet.
Vehicle fleet finance options
Asset finance is a type of loan used to acquire vehicles or equipment. The Finance and Leasing Association is the principal trade association for the asset finance sector and in 2011 its members provided funding worth £20.8 billion to the business sector and public services, representing about 25% of all fixed capital investment in the UK .
- Financing through existing bankers: Funding assets through working capital, bank overdraft or fixed term loan is not the usual, recommended or most efficient form of finance in these circumstances. However, most major banks have a specialist division which provide specific funding for assets for example, Lloyds Banking Group, Royal Bank of Scotland, Barclays and Clydesdale, although given the turmoil in recent years in the banking industry there has been much less available money through these traditional sources.
- There has been a growth in the availability of finance through less well known banks that have developed a particular reputation for providing finance in this sector. For example Close Asset Finance have become one of the major players providing finance for assets, along with others, such as Hitachi and ING, with Aldermore, a relatively new name in the banking industry more recently joining the ranks of growing businesses in this sector. Most of these organisations primarily provide asset finance which is by far the most widespread form of funding for business assets.
- There are many smaller independent asset finance businesses, such as State Securities, SG Equipment Finance, Arkle Finance, County Asset Finance, D & D Leasing as well as what are known as the ‘captives’, finance companies that are linked to particular manufacturers, such as Scania Finance or MAN Finance.
- Finance may be sourced through existing contacts, through internet searching or the use of brokers, many of whom will be members of the National Association of Commercial Finance Brokers. Brokers may well be able to shop around for the best deals but sometimes direct approaches to asset finance companies may secure viable alternatives. Many dealers may have their own links with finance companies and offer their finance, but it is often worth considering what other options might be available before accepting any package on offer through a dealer.
Types of asset finance
Traditionally, finance is offered through hire or lease purchase, which will require payment of monthly rentals for a fixed period, but with an option to purchase for an nominal sum at the end of the fixed period. Many funders offer arrangements with lower monthly rentals but with a balloon payment, ie a larger lump sum payment, at the end of the period. This is usually based on the anticipated value of the asset at that time. There may or may not be the option to hand the vehicle back as an alternative to paying the balloon.
It is important to read and understand the finance terms carefully. Sometimes, dealers do not get their explanation of these terms right and disputes subsequently arise when vehicle values don’t match the amount of the balloon payment requiring the shortfall to paid.
Sometimes, leasing without the option to purchase may be the best for the business, given its different treatment for taxation purposes. Your accountant’s guidance may be invaluable here.
If in doubt about terms, get a clear explanation, if you can from the lender direct. Better still, get legal advice.
It is sometimes possible to get agreed facilities in place where drawing down funds for each asset purchase can bypass standard approval processes. Further details can be obtained from lenders.
Often maintenance and servicing is part of the deal. Make sure you understand who is providing this; is it part of the lease? Or is it a separate arrangement with the dealer?
Understand the documentation and terms offered. Failures in the servicing don’t always give the right to stop the finance payments and doing so can result in the loss of the asset and also a costly finance settlement. What other incentives have been offered. Are they dealer incentives? Again, understand that these may not be part of the financing arrangements and a failure by a dealer to deliver on a pre finance incentive is down to the dealer not the finance provider.
Usually, the finance provider is not liable for delivering on any of these incentives and a failure to provide them gives no right to stop payments. This may be different if you are sole trader or partnership and your agreement states that it is regulated by the Consumer Credit Act.
Understanding end of term arrangements in hire purchase or leasing agreements
Often confusion arises when a finance agreement finishes as to the extent of the customer’s rights and obligations. In straightforward hire purchase agreements, payments will usually include an option to purchase fee and payment of the final instalment will be deemed to be the exercise by you of the option to purchase. Providing all required payments are made in full, once you make the final payment, including the option to purchase fee, you will acquire ownership and you can continue operating the vehicle, or sell it as you wish.
However, given that finance arrangements are often structured to suit your requirements, and that there are different products available in the market, it is important to understand both at the outset, and on completion of the term, what rights and obligations arise once the term is completed.
Finance is frequently provided through straight leasing terms, which do not provide for ownership to pass at any time. In the absence of specific provision to the contrary in the lease, the vehicle must be returned to the owner at the end of the term. Some leases automatically provide for leasing to continue into a ‘secondary term’ until notice is given by you in accordance with the terms of lease. The lease will set out what rentals are payable in the secondary period; sometimes monthly or quarterly rentals change to annual rentals but, again the lease will set out what is required.
Sometimes a final larger lump sum, or balloon, rental is provided for; this is usually fixed by the finance company based on what it anticipates the value of the vehicle to be at the end of the term. Often problems are caused if the vehicle is worth less than the balloon rental at the end of its term. Suitable plans should be put into place to meet this payment, with consideration given from time to time to depreciating vehicle values. It should be borne in mind that most contractual payments will have to be met by direct debit and an unanticipated and unplanned final payment may result in the bank rejecting this payment with the inevitable consequences.
In many leases, where ownership does not pass, there may nevertheless be a provision in the lease for you to sell the vehicle at the end of its term as agent of the owner (providing all payments are up to date). Detailed terms in the lease may then provide for you to retain an agreed percentage of the sale proceeds which, for tax reasons, is expressed ‘as a rebate of rentals’. Usually, a net amount of 5% of the sale proceeds, together with VAT on that sum must then be paid to the owner.
When requesting settlement figures towards the end of the term, allowance should always be made for any balloon rental and any requirements in relation to any proposed sale proceeds, should the lease give you the right to sell.
Particular areas of caution
Contract hire, and other similar agreements, can pose particular issues, with regard to excess mileage and repair charges, for which the owner can invoice you. Always ensure that information is kept to enable you to verify whatever charges may be imposed.
Detailed inspection of the vehicle, before collection by the owner, is always advisable. It is important thereafter to check repair costs being claimed carefully, and ask for confirmation as to which repairs have actually been carried out.
Also check that no items are claimed which relate to matters which might be simply consistent with the age and mileage of the vehicle. Claims for excess mileage and additional repairs caused by the excess wear and tear might strictly be irrecoverable. Don’t be afraid to challenge, but don’t encourage litigation over what may be relatively small amounts.
It is important to remember that financing business assets is not a straightforward matter. It is important to understand the terms of finance and what obligations they impose, what happens if the assets aren’t up to expectations and what happens when the finance period expires. Some of these issues will be covered further in future articles. In the meantime, DWF is able to advise on any finance related issues, and has considerable experience with asset finance.