Thursday, November 23, 2006

Avoiding ‘cede and run’ contracts: How to win against Wynn’s Car Care
Kevin Iles

Bowman Gilfillan was recently asked to advise two clients in two unrelated matters where the clients have fallen victim to ‘cede and run’ contracts. In one case a service provider offered to install and maintain entertainment systems in a hotel owned by our client. In the other matter a service provider supplied hospitals with equipment which the supplier was to maintain for a fifteen year period. In each case the equipment was leased to the client, and the rental agreement and the maintenance agreement were separate contracts. In one case, the fee payable under the maintenance agreement was nominal, and bore no relationship to the actual ongoing cost of maintenance, the supplier seemingly having sought to recoup most of the maintenance costs in the rental agreement. In both cases the supplier ceded the rental agreement to a financing institution to raise money for the installation of the equipment at the clients’ premises and then failed to honour the maintenance contract and failed to make payment to the financing house. As a result the financing houses called on their security, the ceded rental agreements, and demanded payment from our clients.
The rules of cession provide that when the financing houses demand payment, the clients are entitled to raise any defence they would have had against the supplier under the rental agreement, against the financing houses. But, because the suppliers provided the equipment to our clients they had not breached the rental agreements, only the maintenance agreements. As the maintenance agreements had not been ceded to the financing houses, the clients consequently had no defence to raise against the financing houses. So even though the equipment supplied to the clients was valueless if not constantly maintained, in both cases the clients were obliged to continue to make payments to the financing houses under the ceded rental contracts, despite the default by the supplier on the maintenance agreement.
The Appellate Division, what is now the Supreme Court of Appeal, heard an almost identical case in 1991. In Wynn’s Car Care Products v First National Bank Wynn’s Car Care hired computer equipment from a company called CICS. The agreement of hire was made conditional upon the conclusion of two further separate contracts between Wynn’s Car Care and CICS. One of those contracts provided that CICS would maintain and service the computer equipment. CICS ceded the rental agreement to First National Bank (‘FNB’). When CICS failed to maintain and service the computer equipment, Wynn’s Car Care stopped making payments under the rental agreement. FNB relied on the acceleration clause in the agreement to demand full payment from Wynn’s Car Care of the entire amount owing under the rental agreement. Wynn’s Car Care contended that it was not obliged to pay FNB because CICS had defaulted under the maintenance agreement and the two contracts formed part of one integrated transaction in terms of which the payment of rent and the servicing of the equipment were reciprocal obligations. The Appellate Division found for FNB. It held that the parties had chosen to conclude separate and distinct agreements and that unless the terms of the agreements considered as a whole clearly evidence an intention that the terms of the separate agreements are to be reciprocal to each other, a court will not read in an inference to that effect.
South African contact law provides that where agreements are recorded in writing, the written contract will form the sole evidence of the agreement between the parties and a court will not entertain any extrinsic evidence in order to interpret the contract. It is therefore not permissible for a party to a dispute arising from a contract to argue that they understood the contract in a different way or that the supplier told them the contract would operate in a particular way or that certain provisions of the contract would not be relied upon. Even conversations or letters or emails about the way in which the contractual relationship would operate in practice are inadmissible where the words of the written contract have a plain and unambiguous meaning.
Although the danger of ‘cede and run’ contracts is clear, it may nevertheless be necessary to contract in this form. Suppliers will often need to discount their rental or supply agreements in order to raise the necessary cash to purchase and supply the equipment to their client. It is therefore often not possible to include a clause in the agreement preventing cession of the rental agreement. Similarly, the supplier would not want to cede the maintenance agreement to the financing house as those obligations remain live obligations as between the parties after the cession in a way that the supply or rental agreement does not once the equipment is supplied. It is therefore not uncommon for the two agreements to be drafted as separate agreements. What can one do then to save oneself from becoming the victim of a ‘cede and run’ contract?
The most obvious way of preventing a ‘cede and run’ is to ensure that the two agreements, the rental agreement and the maintenance agreement, cross-refer to each other. The agreements, and particularly the rental agreement, should state that the payment of rental is a reciprocal obligation to the fulfilment of the supplier’s obligations in terms of the maintenance agreement. However, a financing house may be reluctant to accept cession of an agreement where the performance in terms of that agreement is contingent on the performance of a party over which it has no control. Another solution is for the client to include a clause in the maintenance agreement which refers to the reciprocity between that agreement and the payment of rentals under the rental agreement, and provides that, in the event of any default in terms of the maintenance agreement, the supplier will become liable to the client for all amounts still outstanding in terms of the rental agreement. If the supplier becomes insolvent or turns out to be a man of straw this provision would also not assist the client, who would end up paying the financing house with no recourse against the supplier. Clients should therefore ensure that when they enter into these forms of contracts they accompany the breach clause in the maintenance agreement with appropriate sureties and securities wherever possible.