Quickies From/For Busy People
(Let us know if you would like more info or any of these
should be articles for future issues)
More on Converting Leases to EFAs
Way back in 2014 we did a couple of articles about drafting and operational pitfalls in switching between Lease and EFA forms. Here is more to think about
you pick up a pencil:
Especially those of you in the high risk, micro-ticket or motor vehicle finance sectors:
can be an issue for lenders as opposed to lessors. There have been courts that refuse to allow lessees under $1-out leases to claim a usury violation because no "interest" as such is charged. Others look to substance over form and treat a buck-out lease as a loan. There is not much argument that an EFA is anything other than a loan.
Then again, it can be argued that an EFA is more of a retail installment sale than a loan. This can be good as it gives weight to citing the time price differential exception to usury laws in some states (Tennessee). On the other hand, we worry that any reference to that doctrine brings up the question of whether the lender should be charged with responsibility for damage caused by the equipment and whether the EFA is truly a hell-or-high-water document, like most promissory notes. Also, retail installment sales are subject to licensing in some states (see below).
Retail Installment Sales
RIS agreements are a little like equipment finance's weird siblings. Basically, as the name seems to say, a retail installment sale of equipment is simply a sale of equipment over time. Before the UCC was adopted, the term "conditional sale contract" (as opposed to "loan" or "chattel mortgage") was often used.
What gets confusing (at least for some state regulators) is:
1. the same terminology is used for sales to consumers; and
2. there has long been an active after market for sales, which is regulated by many states.
This means that state usury, licensing and other laws might apply to EFAs, while they do not generally regulate leases. In most cases, the only regulated parties are those who
RIS agreements from vendors; neither the vendors nor third party lenders who simply finance equipment with loans or leases are subject to licensing requirements. Usury issues are harder to distinguish.
Then there is Pennsylvania, which we recently learned changed its laws in 2014. The law apparently requires ALL parties who finance equipment over time (EFAs, loans, probably $1-out leases) to register with state officials. The first person we asked said it was only buyers of RIS agreements; his boss emailed back and reversed the position.
Bottom line: vendor captives and those who buy retail installment sale agreements from vendors should look into state regulation. The rules for lessors and other lenders may not apply. This is a big and complex area of law in our industry.
A Few Words From Atlanta
In connection with the opening of our Atlanta office, we have taken a look at Georgia law. (Ian and Barry are Ga. Bar members). A couple of interesting notes:
Jury trial waivers are unenforceable.
Like California, Georgia law prohibits most pre-litigation jury trial waivers, meaning a lender or lessor will almost certainly be facing a jury if there is a default or other dispute. By all means, your contract should dictate choice of law, jurisdiction and venue in your home state or another state where the selection can be justified. We usually recommend this anyway, as may aid in the enforceability of other provisions and avoiding usury limitations.
Keep litigation out of small counties. Like Merry Old England, Georgia is divided into many small fiefdoms, each historically ruled by some often colorful family (think
Cat on a Hot Tin Roof
) but sometimes also plagued with judges and aggressive counsel who engage in home cookin' - punishing carpet -baggin' Yankees and such a every turn. We are not saying that justice will not be done outside the major cities, but, as with Alabama, there are places where angels and lessors fear to tread. Again, check the consent to jurisdiction clause in your documents.
Georgia collects use tax on true leases and sales tax on leases intended as security.
Usury. Georgia law provides that a lender lending more than $3000 but less than $250,000 can charge, through a written contract with the borrower, "any rate of interest, expressed in simple interest terms...". The written contract "expressed in simple interest terms" requirement does not mean a specific interest rate necessarily. It can be satisfied by reference to a prime rate or other methodology so long as it is "easily computable" by the borrower. Loans over $250,000 may be "any rate of interest, expressed in simple interest terms or otherwise" (presumably including compound interest).That is true for
law purposes only. Georgia law provides that charging interest in excess of 5% per month (60% per year) is a cr
Original Chattel Paper in UCC Terms
1. Leases and EFAs are chattel paper as defined by the UCC.
2. With respect to chattel paper, the person holding the original of the document has a perfected security interest. That possessory security interest has priority over anyone who files a financing statement.
3. Obviously, there can be trouble where more than one copy of a Lease or EFA is signed by the parties. Which one is the "original"? Trouble can also arise where the no single copy will be signed by both parties or where one party transmits the partially-executed document to the other by fax or email for the second signature.
4. The parties to chattel paper can specify what constitutes an "original." This means that a Lease or EFA can state that the copy that "matters" for UCC perfection purposes is one with copies of signatures instead of wet signatures, special designations, etc.
5. The key issue is what the lender will accept as assurance that only it holds the "original." Some will insist that it have two wet signatures, but the UCC provides alternatives if the lender is willing to consider them. Often, the question will hinge on the creditworthiness of the lessor/lender who is assigning its rights to the bank or other lender: can the lender rely on the assignor's representation that only the delivered copy is the original and all others have been designated duplicates or otherwise are not eligible to be the original.
Speaking of signatures.
One of the basic issues we see people ignoring is being certain that the title (office) of the person signing is on the signature block, and that the officer is authorized. As per our last issue, resolutions, incumbency certificates and other evidence of authority should be taken seriously. Why? Because there are fraud issues (see below) and questions of whether a lease or loan is binding on the lessee or borrower. We don't see a lot of those issues, but as business becomes more active (we hope and expect) and customers look to expand, we are going to see someone get burned. Soon.
In 2009 and 2010, many businesses that took a hit in or after the Great Recession went under. That was when a lot of folks who looked like geniuses found themselves wearing dunce caps. It seems that the go-go years resulted in a lax attitude toward fraud prevention. The result: some lessors and lenders found out that they were making unsecured loans because the equipment collateral never existed.
Now is the time to take this issue seriously. Beware last minute deals with lessees and/or vendors you don't know - anything that creates an excuse why you cannot do normal due diligence. Don't fund on blank/copied/unclear invoices. Be suspicious if the vendor and lessee have the same zip code, area code and exchange (they may be one and the same person!). Check secretaries of state. Get evidence of authority. There is lots more to do and to avoid.
Want to hear war stories about famous frauds? The lessee who had multiple phones on his desk and was vendor, bank and lessee on deals? The guys who "bought" the government records on defunct banks and other companies by curing delinquent annual report fees and then had ready-made proof of a long existence? The multi-million dollar fraud by a former vice president of a Fortune 500 company who kept his business cards and letterhead? The fake RVI company that hit a bank for millions? The longtime customer who kept signing for equipment that didn't exist because his son had a drug problem? We got plenty of 'em.
Can I have a "second" security interest in collateral?
Of course you can, BUT bear in mind that it might not be worth very much. If the first secured party (senior lender) forecloses, your interest is cut off. This is true even if the foreclosure does not follow the UCC's rules protecting the debtor (commercially reasonable sale, etc.). 9-621.
What the UCC does for holders of subordinated security interests is to provide that they receive notice if the senior lender wants to foreclose and take collateral in full or partial satisfaction of the borrower's debt. 9-620. This is also true if the senior lender proposes to sell the collateral to a third party without first foreclosing. 9-611-613.