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Ten Tips to Better Equipment Leasing

Guiding clients through leasing pitfalls

At Marks & Associates, P.C., our firm advises clients throughout the country on equipment leasing and transactional law. When needed, we can advise clients on bankruptcy options. Our attorneys are skilled negotiators and litigators, and, when needed, take an assertive stance in the courtroom.

Equipment leasing programs, providing financing for everything from computers to delivery vans to corporate jet aircraft, finance over $200 billion of equipment acquisition annually. Although leasing offers cash flow, credit, tax and accounting benefits, it is a highly complex type of financing unfamiliar to even sophisticated lawyers and businesspersons. Too often, lessees find themselves trapped in inflexible and costly legal entanglements because they do not know what to look for . . . and avoid . . . in “standard” lessor form documents.

Tips to make leasing a better experience

1. Deemed acceptance — Virtually all equipment leases contain “hell or high water clauses,” under which the lessee must make rental payments even if the equipment does not function properly or the lessee has a claim against the lessor. Although the traditional equipment lease provides that the term does not commence until the lessee has inspected the equipment and acknowledged it to be satisfactory, many recent forms used by leasing companies provide that the lease term automatically commences when the equipment is delivered to the lessee, or within a short time thereafter unless the lessee rejects the equipment by written notice to the lessor.

Your lease should always provide you a reasonable time to inspect and test the equipment and determine that the equipment is exactly what was ordered and is in satisfactory operating conditions.

2. Interim rent — This seemingly innocuous provision states that a per diem rent will be paid from the date the equipment is accepted by the lessee to the first day of the following month. The lessor will say that this is necessary for all rentals to be due the same day of each month. As rent includes a principal amortization as well as implicit interest, however, the provision can result in your paying more for the equipment than it actually costs the lessor. If the lease does not fully amortize the lessor's investment, this is not unreasonable. Even where the lease does not contemplate full payout of the lessor’s investment, interim rent provisions can increase the lessee’s commitment by nearly a full rental period. As many vendors do not expect payment until the first day of the following month, the result can be a significant windfall for the lessor.

Many lessors are willing to forego interim rent altogether, to accept only an interest payment during the interim period or to shorten the end of the lease term by the same number of days as are included in the interim period.

3. Avoid the automatic renewal trap — Many leases provide that, unless the lessee gives the lessor advance written notice of its intention to return the equipment at the end of the lease term, the lease automatically renews for a lengthy period. Although short renewals (such as month-to-month extensions) may be reasonable under the circumstances, these provisions often create traps for unwary lessees. Some leases are worded so as to allow the lessor to force extensions or the signing of a new "replacement" lease.

Know exactly what will happen when the term expires and do not agree to unreasonable or unclear language. If needed, an attorney at Marks & Associates, P.C. can explain the language of your contract.

4. Avoid the perfect return disaster — When multiple units of equipment are leased under a single agreement, the failure to return a single unit (such as a single notebook computer) can create a default or require the lessee to purchase all of the equipment at the end of the lease term.

You should have the right either to substitute similar equipment for anything that is lost or damaged prior to return or to pay a pre-agreed charge for any individual unit that cannot be returned in the condition required by the lease.

5. Carefully check casualty value calculations — The amount you are required to pay if an item of equipment is lost or destroyed should be calculated to cover the lessor’s investment as well as its reasonably anticipated residual value. If the lease includes a purchase option, only that amount should be used to calculate the residual value. All numbers should be discounted to present value at an amount that is not substantially below the implicit rate used to calculate rent so that the lessor is not receiving a windfall. Beware of end-of-term casualty values that exceed the lessor’s anticipated residual — they may be used against you in the event that you are unable to return any item of equipment.

Always insist that the casualty value calculations be explained and demonstrated.

6. “In default” does not mean “event of default” — It is generally not unreasonable for a lessor to limit your rights after an event of default has occurred. This means that if you breach the terms of the lease and any cure or grace period has expired you may lose your right to replace lost or damaged equipment, terminate the lease early or purchase the equipment at the end of the lease term. If the lease triggers the loss of these or other rights by your being “in default,” you may lose the right to exercise an option because of the occurrence of a technical default that is later cured as permitted by the lease.

Do not allow the term “in default” to be used in a manner that eliminates your right to cure an inadvertent default.

7. Insist on contest rights and tax compliance —Many leases provide that the lessor is responsible for paying taxes and the lessee must reimburse the lessor for those payments and keep the equipment free of liens. Unless clearly stated in the lease, you will have no right to contest any improper tax assessment and you may be responsible for penalties and interest caused by the lessor’s negligence in tax filings or payments.

Always insist on the right to contest tax filings and the imposition of liens by appropriate proceedings, with the lessor’s full cooperation.

8. What about a “lemon”? — Again, the “hell or high water clause” makes it clear that you are responsible to pay rent even if the equipment never works properly. This is true even if the equipment could be returned to the vendor for a full refund or replacement.  Most equipment leases do not allow you to terminate the lease even if such rights exist.

If possible, negotiate for the right to declare an item of equipment that is returned to the vendor under warranty subject to a casualty: the warranty payment should substitute for the amount payable under the lease in the event the equipment is destroyed or the lessor should agree to accept a replacement unit as replacement equipment under the lease.

9. Be sure any warranty assigned to you is assigned in full — The quid quo pro for agreeing to pay rent even if the equipment does not function properly is that the lessor usually assigns to the lessee the right to any warranty payment received from the vendor or manufacturer. Careful reading of this language will indicate, however, that lessors often reserve substantial rights in warranty payments.

The warranty assignment should include all payments, including any indemnity or other recovery of any kind from the vendor or manufacturer. Unless the lease is for a short term (compared to the total life of the equipment), the entire payment should be retained by the lessee.

10. Beware restrictions on movement and use of your equipment — Many leases prohibit the movement of an item of equipment and place other restrictions on the lessee’s right to attach supporting equipment or make alterations. Some of this language can be traced back to the old requirements of Article 9 of the Uniform Commercial Code or to types of equipment different from those that you are leasing.

Restrictions on the movement and use of the equipment should be reasonable and logical given the current state of the law and the type of equipment involved.

For further information

Marks & Associates, P.C. assesses contracts and guides your business accordingly. To discuss your contractual needs contact us at 205.251.8301. We serve clients throughout the country.