Look Before You Lease
Understanding the pitfalls in equipment finance and lending arrangements
The best way to avoid costly litigation and disappointment in financing equipment is to read carefully the lessor or lender forms presented and, if you are not absolutely certain you understand the language, consult experienced counsel. This is not a matter of avoiding "tricks" by unscrupulous financial institutions and lenders. More than anything else, the process involves recognizing that equipment finance, whether in the form of a lease or a loan, necessarily involves risks that are not present in other legal arrangements.
The following is a list of matters that the attorneys at Marks & Evans, P.C. suggest clients consider before entering into a leasing arrangement. If you are going out with a request for proposal or otherwise entertaining competing offers, these matters, along with those described in other articles on this website directed to equipment users, should be considered before a transaction. Even if there will be only one potential financer, some of these items are negotiable and can be addressed fairly and reasonably as long as they're raised at the outset.
The differences between borrowing cash or renting equipment and equipment finance might be surprising
Note that none of these issues involve tricks or deceptive practices. They are simply part of any lease or equipment finance (lending) arrangement. An attorney can advise you should you have questions.
- The transaction is "hell or high water." Whether styled as a lease or a loan, your obligation to pay for the equipment will be absolute and unconditional. This means that even if the equipment does not work properly or even if it is not what you had originally contracted with the vendor to purchase, once the lease is signed and the equipment has been "accepted," you will be obligated to make all payments.
- There is no right to set-off. You will not be able to deduct any portion of your monthly payment because the vendor or a third-party service provider has not performed. This is true even if the vendor is the lessor or lender.
- Your obligations may substantially exceed the cost of the equipment. Rent or level payments under a lease or equipment finance agreement will include an interest factor that may be extremely high, even higher than is permitted by law for interest collected on a normal loan. There are computer programs that will allow you to calculate this interest rate, but your lessor or lender should be able to tell you what it is. Note that, even if the interest rate is reasonable, your obligations for maintenance and the return of the equipment at the end of the term could cause the payments to be significantly higher than if you borrower money from a bank and purchase the equipment outright.
- You will be required to insure the equipment and protect the lessor or lender. These obligations are not necessarily unreasonable but can be quite expensive. Be sure that your insurance coverage, including liability coverage, is adequate. The lessor or lender may have an option to buy its own insurance at your expense if you fail to do so.
- Unless otherwise agreed, you cannot sublease, assign or terminate. There is not automatic prepayment right under most state laws and unless it is clear that you may terminate a lease or prepay a loan prior to the end of a term, you have no right to end the transaction. This means that you might pay a substantial penalty, which is not disclosed to you in the lease or loan, to end your obligations early. Moreover, most documents state that you may not sublease equipment or assign the lease or loan to a third party without the lessor's or lender's consent. This includes transactions with your subsidiaries and other affiliates.
- You should understand all tax and accounting rules applicable to the transaction. Different types of financing are treated differently under tax law and the accounting rules. Generally, a lease with a $1.00 or other nominal purchase option, or a mandatory purchase at the end of the term is treated as a loan. You will own the equipment outright from the first day, subject to the lessor's security interest. The same is true for an equipment finance agreement. If the lease provides no purchase option or a fair market value purchase option, it may be a "true lease" in which the lessor owns the equipment and merely rents it to you.
- You should understand the purchase or renewal options. There are many variations on these options and they must be clearly stated. Know how the purchase option price will be calculated and what happens if you do not agree with the lessor's number.
- The transaction is a three-party deal. In most instances, the vendor who is selling you equipment is not the same legal entity as the lessor or lender. Very often, the vendor will sign up a transaction and immediately assign it, without your knowledge or consent, to a bank or other financing source. That party will have no obligation to perform services or provide supplies and you will have to look to the vendor directly for these. In some cases, the financing party is a subsidiary of the vendor. In others, it will be a third-party operating under a "private label" agreement and using a name that appears to be the same as the vendor's.
- The lessor or lender does not warrant that the equipment will work. If the equipment does not work properly, not only will you be unable to stop paying rent or other payments, you will not have any right against the lessor or lender. In most cases, where the lessor or lender is not the party selling the equipment, this is true by operation of law. In any event, it will almost certainly be stated in the documents.
- There may be substantial limitations on your business practices. Many leases and equipment finance agreements restrict or prohibit movement of financed equipment and prohibit mergers, reorganizations and other business transactions. Some require that you provide audited financials, even if that is not already a company policy. Be sure you understand your obligations not only with respect to the financed equipment but across the board.
For further information
For more information, please contact us online, email or call any of our lawyers at the numbers on our bio pages, or call Tammy Hogan at 205.251.8301.