Marks & Associates, P.C. 
March 2018
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How's your crystal ball? Given all the turmoil these days, it is all the more difficult to predict where the industry is heading. I was at the NEFA Funding Symposium in Las Vegas last week. Maybe it was the gambling vibes circulating (along with the cigarette smoke) or maybe it was the optimism of the 326 attendees, but I started thinking about just that.

Think about it. Here are a couple of things that may influence the direction we take:

Death of the Operating Lease. Presumably, customers will still have an appetite for keeping some equipment acquisitions off the balance sheet. While the new accounting rules may mitigate the pain of doing only capital leases, we have to expect something will replace the operating lease.

Will we see more service contracts or full-service leases? How will we engineer hell-or-high water treatment? How will banks be involved as they cannot lease from inventory or provide servicing themselves? Will we see multi-level structures like the old (gasp) wrap leases?

Technology. One of the many things the fin tech/merchant cash advance/cash flow lending (you name it, I'm tuckered out trying) revolution has taught us is that lenders stuck in the old paper and ledger sheet world are being left behind. Lenders who can take applications over the internet, run credit scores and estimate cash flows, get documents e-signed and in a vault, use technology to sweep accounts daily or weekly and predict and monitor performance on an extreme low-touch basis outperform their big, battleship-like competition. And the guys who used the UCC services to find prospects, often glomming onto one another mined a lot of gold with minimal digging.

Consider the borrower will half a dozen (or more) stacked cash-flow lenders who doesn't pay his bank line. After 10-20-30 days, the bank sends him one of those "in case you forgot" notices with the little bird singing or something. Then comes the threat of sending it to the lawyer. Then the lawyer letter. Then someone notices that the account is empty because the lenders have swept it day after day.And the sweeps are draining an account at the very bank that made the line of credit available in the first place.

Before we all throw money and caution down the well, more technology means more and more risk of information theft, government regulation and false steps as the technology improves, competes, is adjusted and...whatever became of Betamax?

Equipment Finance or Money, Money, Money? I recall (old man speak) when we started putting on seminars at the NAELB telling brokers they could make more money brokering working capital loans and real estate mortgages as well as hawking equipment financings. It looks more and more as if the future involves one-stop shopping. Will it be at a bank? More and more are getting into equipment finance. Will leasing companies expand their product line? Will brokers take to walking in the door and asking, "What money do you need?" instead of "What equipment do you need"?

And from the legal front, as lines blur and deals are combined, will knowing leasing law be enough? I would say "stay tuned" we really have a choice?

Ian Platt has moved over to our friends at Freed & Howard in Atlanta. We will still have access to his expertise in various types of finance and can meet with clients in Atlanta at our virtual office.

The conference season is upon us and Barry, Matt and/or Tammy will be attending the the ELFA Vendor Roundtable and Funding Conference in Chicago in April and the ELFA Legal Forum in Washington,  D.C. in May, among others. Barry just got back from the NEFA Funding Symposium in Las Vegas.  Let us know if you plan to attend any of these.
A List of Legal Issues You Have Asked About...
Or Should Have

While most of our work these days is in preparing or upgrading forms and negotiating and documenting transactions, we do get a fair share of questions from clients and folks who simply find us on the internet ( ), read published articles or hear about us who-knows-where. Lately, these questions have focused on a few specific and troublesome areas of the law. The following is a short and truncated list with a short and very general synopsis of what we want our clients to know.
As always, if you have questions or there are other issues you would like us to address in this newsletter, please drop a line to Matt, Tammy, or me Please bear in mind that this is the "down-to-Disney" or "10,000 foot view" version of what is often very complex laws that may rely on specific facts.
State Usury and Licensing. Since adoption of the heinous portions of the Dodd-Frank Act that affect business transactions, bank subsidiaries are no longer protected by federal preemption for the banks themselves. This has kindled a lot of interest in state laws affecting equipment leasing and finance. The fact is that non-bank lessors should have been concerned about these laws for a long time, but until the 2008 crash and resulting squeeze on state revenues, the states themselves tended to restrict their interference to consumer transactions.
  1. Loan transactions, including EFAs and Leases Intended as Security ("buck-outs" and such as opposed to true fmv leases) are generally subject to interest rate limitations (often called usury laws). About 20 states have laws that apply to commercial transactions as well as consumer loans. As a general rule, usury laws do not apply to true leases, but a lessor with a very high implicit rate lease may find itself arguing whether the lease qualifies as a true lease (more about that later).
  2. In some states, usury laws carry a criminal penalty.
  3. There are a couple of states with special laws governing financings of less than $25,000.
  4. There are several states with special laws requiring licensing of motor vehicle lessors.
  5. There are several states with special laws requiring additional licenses if a motor vehicle lessor sells leased vehicles to third parties or to the lessee (including by exercise of a purchase option). These laws can be extremely onerous as they may require the lessor to maintain a "showroom" or other business location, which exposes the lessor to additional taxes and licensing requirements.
  6. There are several states in which require licensing of purchasers of retail installment sale paper (vendor-financed sales, which might include leases intended as security).
Since 2010, we have been engaged by two dozen banks and commercial lessors to evaluate their exposure to state laws. These surveys are expensive and time-consuming. There is no reliable handbook out there and we often recommend the research be limited to specific states where the exposure may be greatest. Each survey we do is tailored to the specific nature of the lessor's business, so we don't have one we can publish. We are currently updating our research. It is serious business too long overlooked by our industry.
Landlord Waivers. Everybody's (least) favorite closing document. A good landlord waiver provides that the landlord of property where the lessee will keep and use leased or financed equipment:
  1. ...waives the right to any "landlord lien." These liens are provided by state law and generally are subordinate to purchase money security interests and the rights of an owner/lessor under a true lease. However, there are states where the landlord's rights might come ahead of the lender's or even the lessor's. Also, if the equipment is financed through a sale-leaseback, or if it was installed prior to funding (there is no 20-day grace for this purpose), the landlord's rights are probably superior to the lender's or lessor's.
  2. ...agrees that the equipment is not a fixture, meaning it is not part of the building or land owned by the landlord. This can upset the argument that the lender's or lessor's rights are superior to the landlords, among other bad things.
  3. ...agrees that the lender or lessor can enter the premises and remove the equipment without running afoul of a claim of trespass or having to beg for a key if the lessee is locked out.
  4. ...allows the equipment to remain on the premises for a reasonable time after a default and may provide other rights that, as a practical matter, make a lot of difference in recovering and selling the equipment.
When do you need a landlord waiver? We all have war stories about unreasonable landlords who refuse to sign or rewrite the waiver requiring the lender or lessor to pay rent or give up the property on default. No good lawyer will say it is not a good idea to get a properly-worded landlord waiver, but the document becomes more important in sale-leasebacks or any time the equipment is installed before funding, in EFAs and buck-out leases and if the equipment is hard to move or affixed to the building or land so that it might be a fixture.
And remember that a mortgagee waiver may be necessary even if the building and land are owned by the lessee or if the landlord grants a waiver and the equipment might be a fixture.
True Lease or Financing? All EFAs are financings (loans). All leases with nominal purchase options (token payments) are financings. If a lease is for a term that will equal or exceed the economic (useful) life of the equipment, the "lease" is a financing (don't lease something that will be scrap in 5 years for 5 years so that there is really no residual and think you have a true lease because you added a fair market value purchase option - it won't work if the judge reads the UCC).
The rules for "operating leases" are accounting rules. The IRS regulations apply for federal (and some state) income tax purposes only. For bankruptcy, sales and property tax, UCC filings and protections, and most likely licensing and usury, UCC 1-203 (as codified under state law) governs characterization of the lease and the first paragraph of this section applies.
PMSI. Do you rely on purchase money security interests or do you always do a UCC search and get bank and other lender subordinations? PMSI is essential to most small ticket and middle-market loans and leases that might be deemed loans. Everyone knows that the lender has 20 days to file a UCC financing statement, but remember that the 20 days runs from delivery, not funding, and that the only protection is for funds paid to the vendor, not reimbursements to the lessee.
Original Counterparts/Chattel Paper. The UCC provides that possession of chattel paper perfects the secured party's security interest in the chattel paper or instrument. A lease is chattel paper. An EFA is also chattel paper. The same rule applies to both. If one lender has possession of the chattel paper and another files a UCC financing statement, the one with possession wins. If two lenders both have what they think is chattel paper, either (i) one is right and the other has a copy or (ii) both have the same thing and the one who also has the first filed financing statement probably wins. The lease or EFA itself can state what copy ("counterpart") is the chattel paper for perfection-by-possession purposes - which is the original and all others are copies.
Things get dicey when there are more than one, or no, wet ink counterparts. Customers may want to fax or email the signed documents. If so, we want to provide in the lease or EFA that the one signed by the lessor or lender and marked "original" or something similar is the sole original counterpart - the counterpart that is chattel paper for perfection-by-possession purposes.
This is all about rights in the document and rent or p & i payments, NOT security interests in the equipment. A financing statement filed to protect a lender's security interest in the equipment does not automatically perfect rights in the paper in the hands of a funder.
Electronic Documents. Much of what we have said about chattel paper and instruments applies to eDocs. If you contemplate using electronic documents, there is language to be included in your documents. Federal and state law recognizes eDocs and most funders are getting comfortable with perfecting rights in them. Problems arise when lessors and funders who don't have experience try to "paper out" electronic documents without proper procedures.
Syndication Documents. We keep seeing vendor and lessor originator programs with loosely-worded agreements. Confusion between nonrecourse loan assignments and outright sales can be disastrous. Vendors should distinguish between referral-type programs and discounting where the vendor has the lease or loan papers signed and sells or borrows against them. Either version can be on a private label, with either the funder or vendor servicing. All originators should have protection against taxes and lawsuits after they assign and any right to repurchase a defaulting lease or loan should be clear. Funders should be assured that they are not buying an originator's problem without the opportunity to protect themselves. The difference between indemnities and buybacks should be understood by funders and originators alike. There is a big secondary market these days and what is "market" is becoming more of an issue. A funder who buys paper under a weak program may find itself in an uncomfortable position if it tries to sell the paper, or itself, to a more careful company.

It's common practice to include some form of break cost, make-whole or other additional prepayment premium number in calculating stipulated loss value or casualty loss value tables. It is also common practice - we do it in some leases - to include a reference to those tables in the lease or EFA remedy section: "...Lessee shall pay to Lessor, as liquidated damages and not as a penalty, the Stipulated Loss Value of the Equipment as of...."

In using the same term in the Remedies section that we use in the Casualty Loss section, we recognize that the classic definition of loss value is essentially identical to the damages we want to see upon default: discounted present value of future rents or other periodic payments and any residual, using the implicit rate as the discount factor. In EFA terms, we discount at the pre-calculated interest and get...principal. Clear?

There is nothing inherently wrong with including a premium in the calculation, but note that part of the language about as liquidated damages and not as a penalty. If a judge sees that a lessor or lender is making more money because of a default than it would if the deal went to term as bargained, he or she might well rule that the remedies section exacts a penalty. Premiums may be okay, but penalties are not. This is why we never want the damages to be the undiscounted sum of future rents or payments and residuals. The risk is greater for EFAs, especially in states with old cases that limit prepayment premiums in some way or assume that all debts are pre-payable unless otherwise stated.

We have reported on this before, in describing the Montgomery Ward case, but special thanks to Frank Peretore, Robert L. Hornby & Ryan O'Connor for their recent article in Equipment Lease Advisor - well worth a read!

So what if the judge sees that the table is calculated using a discount factor that is less than the implicit rate of the lease or EFA? Or if the document provides that the amount is calculated by taking the present value of future amounts due and any residual at the implicit rate reduced by X%? The judge might rule, in either a casualty or (more likely) a default situation, that the calculation exacts a penalty and throw it out.

So what?

If the damages stated in a lease or EFA are thrown out, the judge should look to the UCC. Most will. Under UCC 2A-529 and 2A-532, the lessor is entitled to the discounted present value of future rents and assumed residual. The discount factor is not stated, leaving the judge wide latitude to do "fairness." In the case of EFAs, the calculation of outstanding principal, to which a lender is entitled, together with issues regarding the "commercial reasonableness" of any sale of the collateral can easily leave the lender out a portion of its investment and anticipated profit.

What to do? It is often better to state, at least in the Remedies section, that the lessor or lender is entitled to a prepayment premium to defer unamortized expenses, re-investment at current rates, restocking, etc. This language can be crafted to say that these amounts may be added or included in the SLV or CLV.  Will this be subject to negotiation by strong credit lessees and borrowers who take the time to read before they sign? You betcha. Can it cause other problems, such as raising question about closing costs and other up front payments which are being amortized in the premium? Yup. Is this all a complicated mess? Why do you think lawyers often have little hair and a fondness for single malts?

And while we are on the subject, please be sure your operations people know whether you lease provides for the collection of rent in addition to the casualty loss payment. Some leases and EFAs state that the payment is to be made on a rent or payment due date and that Lessee must also pay the payment otherwise due on that date. Others assume that the periodic payment will be included in the calculation of SLV or CLV. If the lawyer and the operations people are no in sync, you could lose a payment.

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 │
Matthew D. Evans   
Direct:  205.251.8302  │

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