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
, 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.
- 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).
- In some states, usury laws carry a criminal penalty.
- There are a couple of states with special laws governing financings of less than $25,000.
- There are several states with special laws requiring licensing of motor vehicle lessors.
- 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.
- 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:
- ...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.
- ...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.
- ...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.
- ...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
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.