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.
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.