Marks & Associates, P.C. 
Newsletter
June 2018
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Summer Time, and the Living is...Easy?
 
Yessireee, 2018 is half over and it has been a lovely time indeed. Business is rolling along and we don't have a care in the world.

State regulators continue to ignore our industry and the folks at ELFA who used to run from statehouse to statehouse putting out fires are taking long vacations. No one is worried about whether some decades-old licensing law will be used by an aggressive attorney general to plug up the state budget. We all know that no usury statute will ever be used by an aggressive borrower to evade his obligations; criminal usury laws designed to keep Tony Soprano away from Pop's Candy Store don't give any of us nightmares.

Most important, the more aggressive companies are not making headlines and giving state legislators fodder for crusades to restrict legitimate equipment finance. No one is talking class actions over any of the practices that are perfectly reasonable in one type of transaction but, maybe, questionable in another. The folks on Main Street love their counterparts on Wall Street and are way too smart to shoot small business in the kneecap by making it hard to get a loan.

Uh huh.

It never fails. As we do more business, the engine revs up and the Bugatti runs away with us. Approval times drop and C credits begin to look like B- again. New leasing companies open and it all looks easy once more. As I sneak off to a couple of weeks in Italy, treating the right side of my brain to some time without the bellowing of the left, I leave y'all with this somewhat annoying issue of our newsletter. Don't fret, it is just another lawyer fussing at you about his paranoid nightmares.

It IS a good time to be in our business. That doesn't mean that it isn't also a good time to stop and think about where the business is taking us and what potholes may be ahead: the faster we drive, the bigger the bump and the greater the risk of a busted axle. See? Not even landed at FCO and I'm already waxing poetic. Have a safe and relaxing summer, y'all.

B  
Buying? Selling? A Word or Two on M&A
 
We have written about portfolio acquisitions in the past, and will do so again, but a recent article in the  Equipment Finance Advisor by Susan Koss of the O'Keefe accounting firm got us thinking.  Ms. Koss stresses the need for  qualitative due diligence: going beyond the standard checklist and looking at how the selling and acquiring businesses fit together.
 
From a legal perspective, this can mean avoiding unpleasant surprises for both buyer and seller. Sellers sometimes forget that some, if not most, of their profit is dependent on the success of the combined venture. Many acquisitions pay the seller through an "earn-out", often based on complicated calculations involving meeting established targeted earnings. These provisions may create adjustable sales prices and/or compensation to sellers through consulting contracts.
 
Some of us recall the attempt at the turn of the century (wow, do you believe I just typed that?) to combine many leasing companies all over the country into one publicly traded mega lessor. The effort failed, in part due to something that had many industry veterans shaking their heads: the various target companies used different computer systems and had different corporate cultures and policies, as well as expetise in financing a wide variety of equipment for multiple industries on varied structures. The promoters of the venture were smart guys who intended to diversify, but it seemed to many of us, as outsiders, that they underestimated just how difficult it is to match up businesses that define the word "lease" differently and are miles apart on the merits of relying on PMSI, whether to require landlord waivers, and whether equipment should be  deemed accepted or rejected if the lessee doesn't sign a D&A.
 
Symbiosis in mergers is a key concept: if one and one do not equal three, the venture may not be worth the effort. Sellers need to do as much due diligence as buyers if sellers are to have any continuing interest in the business or to rely on any form of deferred payment. Buyers need to involve their own operations people early in the process. Both need to be sensitive to the ill effects of protracted negotiations on staff and customers.
 
From the lawyer's perspective, carefully wording disclosures is a key. We have seen what happens when a seller does not fully disclose potential issues with leases and funder relationships and it isn't pretty for either side. The wording of representations and indemnities (yes, the boring lawyer  boilerplate ) can make all the difference down the road and translate to real dollars.
 
As to checklist items, don't forget these:
  • How does each party handle PMSI?  Does either require UCC searches?
  • Does the seller file UCCs properly? What about titled equipment?
  • Do (or will) any of the leases or loans involve financing equipment that will be rented out or is similar to equipment the lessee/borrower rents or sells to third parties?
  • Do insurance certificates show the lessor/lender as additional insured and loss payee and is insurance compliance tracked?
  • When was the last time the documents were reviewed by counsel?
  • How long has it been since guarantors confirmed their obligations for future schedules or were notified that new schedules were added?
  • What due diligence is done on vendors and what has the company's experience been with vendor/customer fraud? Have the staff been trained on fraud prevention?
  • If the seller/target buys deals or takes referrals from brokers, are the assignments and broker agreements in good form and does the buyer have the chattel paper originals?
  • Have proper ECOA disclosures been made and does the application process comply with FTC rules?
  • Does the seller/target comply with state usury limitations and does it have any necessary licenses in states where it operates?
  • How are state and local taxes handled?
Of course, any due diligence checklist will contain much more, but these examples of the sort of issues should raise even more. Success requires a careful, businesslike approach to both the numbers and the legal issues, along with the hard-to-quantify management issues.
WHAT? ME WORRY?

It's Never Been a Problem Before/I've Been in the Business Since They Leased Chariots/All the Other Guys Are Doing It/Biggie Bank Buys My Paper and They Don't Care/You Lawyers Just Look for Trouble Because You Want to Charge More Fees

Sorry, but we are going to say it again. If you jump from a 40-story building, for 39 floors....you're flying. It's that last one that you need to worry about. Until then, it's all "so far, so good!".

There are some issues in our industry that have already raised their heads and there are others we are expecting. There are some that may...or may not....We are not saying that any of these are necessarily right or wrong or legal or...the other. It's a question of safety and best practices.
  1. Forced Place (or Force Placed?) Insurance. A spate of cases came out of (of all places) LA (that's Lower Alabama) when a smart lawyer figured the same theory of law that applied to mobile home financers could be used to squeeze equipment lessors. It worked pretty well. Lessors who buy insurance to cover the risks their lessees were supposed to insure were sued in class actions claiming, among other things: they were actually selling insurance without a license, they didn't warn the lessees that the insurance the lessor bought was more expensive and covered only the lessors, the charges for the insurance included profit in the forms of administrative fees and "kickbacks" and were disproportionate to the losses. In response many lessors added disclosures to their leases that seem to have addressed the risks. Have you?
  2. Interim Rent. Charging 1/30 of a rent payment for the stub period between acceptance and the first rent payment date is standard. Should the provisions look the same for loans and leases? What does the interim payment do to the interest rate?
  3. Usury and Licensing. Are lessors and EFA lenders getting burned all over the U.S.? Not that we can tell, but this one is absolutely on the books in many states. Some regulate vehicle lessors only. Some only vehicle lessors who sell the cars or trucks when they come off lease - even if to their lessees. Some laws only apply to micro-ticket loans. Some states recognize choice of law provisions in the documents and allow lessors and lenders to choose the laws of favorable states. Do you lease or lend in all 50 states? Have you ever looked at the laws in any of those states?
  4.  Automatic Renewal. We ain't seen nuthin' yet.
  5. FMV definitions. We keep seeing very loose language and even leases where the term is undefined.
  6. Grace periods. Does your lease say the lessee has 10 days before the late fee applies AND that there is a 10 day grace period to cure payment defaults? Next economic downturn, what is to prevent your lessees from paying 9 days late every month?
  7. Brokers/Originating Lessors/Funders. In your agreements with one another, who has the risk of a fraud? Forgery? Do you know what the reps and warranties all mean?
  8. Chattel Paper Original. Does your Lease or EFA make it clear that you (or your assignee) is holding the ONLY copy that could be deemed an "original" by the court - the "sole original counterpart" which is the only one that is actually "chattel paper"? Gibberish? You might want this translated.
  9.  Electronic Documents? Electronic Signatures? Ready?
  10. How do you calculate casualty value? Default damages? Do you present value at less than the deal rate in EFA's? If you do that, does your document say anything about the spread between the actual "principal" outstanding and the amount you are demanding the borrower pay? Is the rule different for leases?
  11. Equipment Cost. Implicit Rate. Do you disclose the actual amount on which rent or EFA payments is calculated? Do you disclose the interest rate used to calculate rent or EFA payments? Is there any way for the borrower or lessee to calculate the rates it is paying? Should you care? Does it matter if you do disclose some of this but it could be argued that the disclosure is incorrect?
  12. Retail Installment Paper. Do you buy EFAs or other paper generated by an equipment vendor? Under state law, do you need a license?
  13. Bundled lease/service contracts. Ask any lawyer who is really in the business of equipment finance. This is a big and growing issue. If rent includes services or upgrades, is the lease really hell or high water? How far can you push this issue before it becomes a real danger?
  14. How much should your lease cover? Everyone wants a customer-friendly document that runs one page and covers every possible risk. Sure, we have a form right here....somewhere. Where do you draw the line?
  15. Prefunding/Pre-delivery acceptance. Yes, some lessors  still have the lessee sign a D&A before the equipment is delivered. Good luck on that if the equipment never arrives or is rejected. More and more vendors demand some sort of prefunding payment or commitment from the lessor or lender. Do you have a Safe (ish) way to address this risk?
  16. Audits and Training. Just sayin'...no matter how good your documents, no matter how smart your lawyers are or were, if your staff doesn't have periodic Q&A sessions, if new people aren't properly trained, if no one ever looks at your files after deals are booked (unless they go into default) how do you know UCC's are properly filed, PMSI protected, insurance certificates in proper form, antifraud measures consistent
  17. Confidentiality/OFAC/Know Your Customer. Do you have a plan for IT or paper privacy breaches? Are you compliant with new current law?
Insurance Issues...Again

It seems as though we go over these things every couple of months, but a recent case caught our attention. In May, The US Court of Appeals for the 5 th Circuit ruled against the lessor in Sierra Equip., Inc. v. Lexington Ins. Co. The case itself is not all that earth-shaking, but the topic is one that has potentially serious ramifications for the less-than-careful lessor.

In Sierra, the lessor did not get a standard insurance certificate from its lessee, stating that it was an additional insured (liability, if not both policies) and loss payee (fire, theft and casualty policy). In fact, the lease required only that the lessee insure the equipment with a policy in form, in terms, in amount and with carriers reasonably acceptable to the lessor.

The lessee did, in fact, obtain insurance on the leased equipment before the lessee filed for bankruptcy. The policy made no mention of the lessor. On inspection, the lessor found that the equipment had been damaged and tried to recover insurance proceeds. Let's stop here for a moment.

In theory, if the lessee sent its policy to the lessor and the policy did not indicate that the lessor was a loss payee, the lessor could have demanded that the policy be reissued or that an endorsement be prepared. (At lease in the case of liability insurance, an endorsement is much, much better than a mere certificate, because the certificate is not binding on the insurance company according to several court cases).

The lessor, however, did not demand to see the insurance policy. Thus far, the law is pretty clear: the lessor has no rights under the lessee's policy. If the lessor was named an additional insured, it could file a claim. As a loss payee, when the claim was filed by the lessor or the lessee, the lessor would be paid. 

What makes the Sierra case unusual is that its lawyers tried a creative argument: that the bankruptcy court should impose a lien on the insurance proceeds, so that instead of going into the lessee's bankruptcy estate they are held for the lessor's benefit as if it were a secured party for whom the insurance proceeds were collateral.

That may well have worked if the lease clearly required the lessee to name the lessor as additional insured. If so, there were cases in which the lessor, like a mortgagee, had the right to enforce insurance policies taken out for its benefit. While "everybody knows" the insurance was intended by the lessor for that purpose, the lease only said that the insurance would be satisfactory to the lessor.

If we take a step back, there are two reasons a lessor might want a lessee to have insurance: to (1) protect the lessee and its creditworthiness, and thus to protect the lessor as the lessee's creditor generally and (2) to protect the lessor as to the specific assets that are its property or collateral. In equipment finance we always look for reason (2) primarily. An unsecured creditor would look only for reason (1).

What the court was saying was that the equitable lien would only be imposed where reason (2) could be seen in the lease itself, not by implication. In fact, there is even more at issue here.

First, the lessor's rights will be limited to what is on the certificate. If the insurance certificate says that the lessor is additional insured for $1,000,000 of liability coverage, the insurer is not obligated to provide more even if the lessee has a $5,000,000 policy. Before accepting "acceptable" coverage, it may pay to find out what the lessee carries.

Second, in case there is any doubt, unless the lessor is named as loss payee, the insurer does not have to send the lessor a check. Another question is whether the lessor is the Sole loss payee - joint checks can be a problem. What you want today is to be "lender loss payee" which, we are told covers this and a host of other issues, such as waiver of misrepresentation by the lessee and notification of cancellation.

Third, only the insured and additional insured can file a claim on any insurance - liability or casualty. We have heard of oddball situations where the lessee refused to file the claim, preferring to be sued by the lessor under its indemnity. And be sure that the lessee is obligated to indemnify and to pay for damage to the equipment because just having insurance without the obligation raises issues and possible defenses.

For more on insurance, visit our website, www.leaselawyer.com .

Words to Remember
 
In 1835, after travelling about America and taking notes on what our 60-year old republic was all about, Alexis de Toqueville published Democracy in America. These days, there is more reason than ever to take a look at his words and remember what WE are all about. Whatever your politics, even if you are French, these things make sense.
 
America is great because she is good. If America ceases to be good, America will cease to be great.

Tyranny in democratic republics...ignores the body and goes straight for the soul.

The greatness of America lies not in being more enlightened than any other nation, but rather in her ability to repair her faults.

The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money. (uh oh!)

And while we are getting patrio-philosophical, these statements, sometimes misquoted, also bear repeating. The first is often ascribed to de Toqueville:

Every nation gets the government it deserves. - Joseph de Maistre

Those who don't know history are doomed to repeat it. - Edmund Burke

Those who cannot remember the past are condemned to repeat it. -George Santayana

No man is above the law and no man is below it: nor do we ask any man's permission when we ask him to obey it. -Theodore Roosevelt

400 Century Park South
Suite 100
Birmingham, AL 35226
(205) 251-8301

Direct Mail To: 
P.O. Box 11386
Birmingham, AL 35202
 
Barry S. Marks   
Direct:  205.251.8303 │ barry@leaselawyer.com
 
Matthew D. Evans   
Direct:  205.251.8302  │ matt@leaselawyer.com
 


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