"DEAR LESSEE"

A Brief Set of Answers to Common Lessee Questions

 

It is not at all uncommon for lessees and their counsel to ask what seem to be perfectly logical questions about equipment finance, only to have lessors and their counsel sigh and shake our heads. Here are a few of our customary answers to common lessee questions.

Why do I have to pay rent whether or not the equipment works?

There are two types of "leases" you will run across in your business. The first is what we often call a rental agreement or lease from inventory. This is like a rental from Hertz or UHaul, a lessor in the business or renting equipment it holds for that purpose. Those "lessors" are responsible for the equipment; generally, if the equipment doesn't work, you bring it back and stop paying until it is repaired or replaced.

Leasing in equipment finance is different in many respects. Essentially, a lease of this type takes the place of financing business equipment by borrowing money from the bank.  In a lease that is called a finance lease by the Uniform Commercial Code ("UCC"), which is part of your state's law, the lessor is like the bank. It is only in the transaction because it is providing financing, not because it is in the equipment rental business.

Also, many "leases" are leases in name only. They are actually loans. Leases with $1 or mandatory purchase options, for example, are treated by the UCC as security agreements. You should read them the same way you would promissory notes, loan agreements and security agreements. There are other types of leases, but we will deal here only with UCC finance leases and loan-type leases.

Always keep in mind: If you borrow money from a bank to buy equipment, and use the equipment as collateral, you must pay the bank whether or not the equipment works. If you have a problem with the equipment, you must look to the vendor to fix the problem. In a UCC finance lease, or a lease that is really a loan, the situation is the same. You pay rent and then take whatever action you can against the vendor. (Note that your lease says that you have the benefit of vendor warranties, even if the lessor "owns" the equipment for legal purposes.

Why can't I cancel the lease? Why can't I just prepay the principal?

The lessor has paid the vendor for the equipment. It has also incurred expenses in preparing the documents and closing the transaction. The Lessor used its own cash or credit lines and expects to make a reasonable profit from the transaction. It has taken a risk regarding your credit. Unlike a loan, there is no "principal" in a lease. Unless your lease otherwise provides, you may not "prepay" without the lessor's consent. The lessor has the legal right to require you to compensate it for its costs, risk and anticipated profit, and not just get its money "back." As it is not in the equipment business, it probably does not want the equipment back before the end of the lease term and has not made arrangements to sell equipment that comes back unexpectedly.

Why can't I reduce rent payments for disputed amounts or money owed to me by the lessor?

The lease operates the same as a promissory note or any other "unconditional" agreement. The lessor and often its creditors and assignees are relying on a steady stream of rent in quoting you the rate you are paying. That stream cannot be interrupted because you think the lessor has done something wrong. Read the lease carefully and ask about anything you do not understand BEFORE signing. You can bring an action against the lessor after you pay your rent; you are not giving up the right to hold the lessor accountable, only to withhold rent because you feel justified.

Why must I agree not to assert defenses against an assignee of the lessor?

Many lessors reserve the right to borrow against the rent stream or to sell the lease to another lessor. This is essential to the lessor's business and for the rate you are quoted. Agreeing to pay the assignee no matter what happens is just an extension of your agreement to pay rent to the lessor (no matter what), BUT this language in the lease does not release any right you have to sue the lessor (as opposed to the assignee) if the lessor has violated your rights or injured you in some way.

What is an indemnity?

An indemnity is your obligation to provide the legal defense to a claim or to pay, or reimburse the indemnified person for, any losses.

Why do I have to indemnify the lessor?

Again, the lessor is only providing financing. You selected the equipment and you are using the equipment. Almost every time someone is suing because of injury caused by the equipment, or because they claim they have somehow been damaged by the lease, the first person they look to is you. The lessor, however, may be an attractive target as well. There are many old laws and cases in which owners of equipment who rent it to others are held accountable. Even when the lease is really a loan, some judges will allow a damaged party to sue the "lessor."

The lessor looks to you to keep it out of any litigation, and to reimburse it or pay directly any claim made against it due to the lease or your use or possession of the equipment. This includes not only lawsuits but taxes, expenses, claims by workmen and repairmen and any other cost or exposure related to the lease.

Why do I have to have so much insurance?

This is both a credit protection and to protect the equipment's value as collateral. If the lease is a UCC finance lease and not a loan, the lessor is looking to the equipment both as collateral and as a source of additional income when the lease ends and you buy it or it is sold to someone else. Your indemnity obligations and the risk of litigation are why liability insurance is required.

Why are there so many potential defaults and why don't we have more notice and grace periods?

Always remember that the lessor does not make a profit if your business does well. At most, it is paid the rent and, in a finance lease, some benefit from disposing of the equipment when the lease ends. Lessors want to be certain that, if you do not honor your agreements, or your business falters, they can take action necessary to protect themselves. In many cases, your failure to adhere to the terms of the lease exposes the lessor to immediate loss or liability. Also, many defaults cannot be cured and in some cases, the lessor cannot give you notice because it will not know that you have defaulted.

Why are there so many "remedies" and can the lessor collect twice?

No judge will allow the lessor to collect from you more than you owe. In a finance lease, the equipment belongs to the lessor so, in addition to damages you pay, the lessor might be able to sell the equipment if it has appreciated in value. Read your lease carefully because most lessors will not change the remedies language.

Why doesn't the lessor make representations? Why isn't there a lessor default provision?

The lessor has one and only one duty after it pays for the equipment: to observe your right to the use and "quietly enjoyment" of the equipment so long as you are not in default. What would you expect any lender to do other than provide a loan? If the lessor does something in violation of your rights, including anything unrelated to the lease it may have legal liability to you through a separate action, although not through your cancelling the lease or withholding rent.

What if the lessor is affiliated with the vendor?

Some vendors have formed lessor subsidiaries or other affiliated entities. Courts have acknowledged that these are separate legal entities and their leases can qualify as UCC finance leases. Before you question any of this, remember that, even if the lessor is the vendor and not a separate company, the lessor may be selling the lease or assigning the rent to a third party. That third party is enabling the lessor to do business with you by transferring funds to the lessor. Your rent rate and the availability of the lessor to do business with you is dependent on the lessor and its own lenders and buyers to be assured that you will honor your agreements to the best of your ability and not interrupt the flow of rental payments. Whether the lessor is a vendor, an affiliate of the vendor or a totally separate company, you must pay the rent in all events, but you still have legal recourse against the vendor for warranties and other claims.

 This 'N That and More of The Same

 

Chattel paper.  In case you missed it, there are two ways to perfect a security interest in leases, efas and such: by filing a UCC financing statement or by possessing the chattel paper. If you have filed and I have but chattel paper in my possession when the obligor (lessor/lender) on the lease or efa goes bankrupt, I win. My possession of the chattel paper gives me priority. Seems pretty straightforward, but wait....

What it the lessor/lender got its signed document by pdf or fax? What about electronic copies that are printed and signed by the lessor/lender? The short version of a long story is that the paper itself, the form of lease or efa, can specify which copy ("counterpart") is the chattel paper and which copy is the copy (that is why we say counterpart, "original copy" sounds odd).

In thinking about this remember that there is a limit to what we can do to prevent the lessor/lender committing actual fraud by designating multiple counterparts as originals. We are mainly looking to protect the assignee/funder/lender against a court holding that it cannot determine one from the other, so the guy with the filed financing statement wins.

Which brings up the somewhat controversial issue of whether to file as well as possess. We save that for another day (or your 2 cents, welcome any time).

Collateral description. Please raise your right hand and solemnly promise not to file against "all assets" or "the equipment listed on exhibit and all other equipment" if you are leasing or lending against only specific items. This sort of thing has plagued lessor and lender counsel for decades. It continues. No, you do not have to include serial numbers and it might not be a good idea (fear of typos makes cowards of us all), at least where there are no similar items in your customer's possession. Remember that you can be liable for expanding your description beyond the actual collateral, and it doesn't actually give you a security interest in anything not specified in your lease or loan documents. It just gives the rest of us headaches.

Small business bankruptcies. We are looking forward to getting into the text of the new law and seeing what it means. Sort of.

State laws. Who needs to look into local licenses and usury? Motor vehicle lessors. Lenders with interest rates (including implicit rates) in excess of...well, 15% or so. Micro ticket lender/lessors. Purchasers of vendor retail installment paper. Bank subsidiaries who were at one time protected by federal preemption and are now exposed to local laws.

Partial casualty. Once upon a time, a lessor financed a whole bunch of stuff and one unit of the stuff got broke. So the client called a lawyer and said, "I am having a problem because without the broke thingie the system isn't worth much as collateral. What is worse, I am not sure how much casualty value I am owed because my lease doesn't say 'higher of replacement cost or casualty value' and the table is tied to the entire original cost of the system. So if we apportion the total equipment cost, do we do so by original price, current value or...what?" I don't know the ending, because I woke up at this point. And couldn't get back to sleep.

Leasing or lending to renters. Yes, we are going to talk about inventory again, but this time, a little about rental agreements. Does the lessee rent to just one or two companies, long term, like a transportation affiliate of a conglomerate? If so, there should be no reason not to hand to the lessor or lender the chattel paper counterpart of the rental agreement (see above - YES, the rental agreement is chattel paper). Also, the lessee's (sub)lessees should be able to sign an acknowledgement that the rental agreements have been assigned and the rights of the lessor/lender take priority; if the lessee defaults, the renter loses the equipment. If the lessee is a rental business and the equipment is going in and out of rent, that may not be practical and the lessor/lender may have to rely on a UCC filing and assurance that the form of rental agreement includes a notice of assignment and statement of subordination.

EFA v. Lease. We have seen a sea change over the last 10 years from the buck-out lease to the equipment finance agreement. Some lenders are recognizing that a good efa takes the place of a note and a security agreement and a loan agreement (yawn). There are some big differences between lease and efa language, however, and if someone in your shop just did a global search and replaced a few  lessees with  borrowers you might be headed for trouble.