There have been changes in local, state and federal laws effecting the leasing industry that arise from the Dodd-Frank Act, which require scrutiny of due diligence processes before funding a lease transaction to ensure it is considered commercial in nature and not consumer.
If the Federal Reserve Board determines a matter to be a consumer transaction, then a lessor must comply with the Consumer Leasing Act (CLA), 15 U.S.C. 1667, 1667(e), which amends the Truth in Lending Act (15 U.S.C. 1601 et seq.) (TILA) and regulates personal property leases exceeding four months in duration and are made for “primarily personal, family or household purposes.” However, “primarily” remains undefined. Further, since the purpose of the Dodd-Frank Act and its cousin acts is to protect consumers from risky and speculative conduct of financial firms, as well as potentially fraudulent and unequal bargaining power conduct, the state and federal authorities have broad strength in their interpretations of lessees by the relatively new technical definitions for consumers engaging in “primarily personal, family or household purposes.” Therefore a leasing company must very carefully examine the particular state statutes governing consumers that apply to a lease transaction at the outset of the due diligence process and anticipate by examining the kind of equipment being financed and the nature of the lessee’s motives. It may not be too-far reaching to closely examine what “personal use” encompasses.
The CLA requires certain lease costs and terms to be disclosed, such as up-front costs, clear statements of the overall lease balance, payment schedules, maintenance, and insurance responsibilities. Limitations on penalty sizes for delinquency, default or termination are imposed, and the size of residual liabilities and certain disclosures in lease advertising are required.
A consumer lease is a lease or bailment for the use of personal property by a natural person for a period of time exceeding four months, and for a total contractual obligation not exceeding $50,000 primarily for personal, family or household purposes, whether or not the lessee has the option to purchase or otherwise become the owner of the property at the expiration of the lease, except that such term shall not include any credit sale nor a lease for “agricultural, business, or commercial purposes.”
Before feeling completely secure, please note that it is unclear from this language alone whether a transaction falls under a state installment sales act if the lessee purchases the personal property at the expiration of the lease term. The importance of excluding state installment sales acts in the definition of the term or any case law is that only some state installment sales acts apply to commercial vehicles and dealers requiring certain leasing and dealer licenses.
The CLA under 15 U.S.C. 1667 (a) requires that lessors give lessees, prior to the lease’s consummation, a dated written statement on which the lessor and lessee are identified, setting out in an accurate, clear and conspicuous manner the following information with respect to the lease:
It seems clear that the first order of business for commercial lessors to ensure that their lease is not a consumer transaction is to take precautions during the underwriting process and subsequently at the documentation stage. When underwriting the nature and credit-worthiness of the proposed lessee, it is useful to examine the lessee in depth to make sure that if it is a commercial transaction, the lessee is not a sole member LLC, a sole shareholder corporation or a sole proprietor.
Since the Federal Reserve Board is empowered to examine these transactions under the Dodd Frank Act to determine whether the underlining transaction is consumer, one has to be concerned with the nature of the lessee “at the time of the consummation of the transaction.”
When entering into a lease transaction, it is imperative to determine whether the purpose for the lease transaction is commercial or consumer. If the transaction starts out commercial but is really consumer in nature, there will be a violation of the CLA unless the disclosures thereof were met at the inception of the lease. However, if the lease transaction starts out as a consumer lease and the disclosures required are met despite the lease being used for commercial purposes, no violation of the CLA would apply as long as the transaction truly becomes commercial in nature.
In the case of Heaven v. Trust Co. Bank (1995 U.S. Dist. Lexis 22059), the court held that the time for determining whether the lease constituted a consumer or commercial lease is the time of the transaction. The Heaven court also stated that, “while it is true that the overall purpose of the lease is to be considered, and the mere checking of a box cannot be dispositive, the overall purpose of the lease should not legally be considered in view of unforeseen events that may have transpired subsequent to the transaction. The teeth of the TILA and the CLA statutes are found in their disclosure provisions. These disclosures, of course, have relevance at the time of the transaction, not during the course of the lease or the extension of credit. It follows, therefore, that the purpose of the transaction should be researched at the time the disclosures occur, which is at or about the time the transaction is consummated. To the extent that subsequent actions are relevant to determining the overall purpose of the transaction, the relevance inheres in the ascertainment of the motives of the lessor.”
In other words, the determination of whether the CLA applies is based on “foreseeability” and whether at the time of the transaction it could be foreseen what purpose the lessee put the equipment to use. It should be emphasized that the consequences of a lease transaction identified as a consumer transaction and governed by the CLA requires the leasing company to explore when structuring the transaction whether any consumer use could be anticipated. For example, the CLA would apply when leasing to an accountant for business purposes when it could be foreseen that the vehicle would likely be used for personal, family or household purposes. Therefore, where the purpose of the equipment subject to the lease transaction is ambiguous and could be used for personal or commercial purposes, a further examination should be conducted to determine the lessee’s motives at the time of the transaction.
Other changes in the law related to leasing and equipment finance are acts similar to Pennsylvania’s Motor Vehicle Sales Finance Act (MVSFA), also known as Act 98. Act 98 is important for motor vehicle dealers and retail sellers of consumer goods and services located in Pennsylvania or making sales online to Pennsylvania customers that provide financing through the use of installment sales agreements and by sales finance companies that purchase such agreements.
The methodology of providing equipment financing has changed so much in the past three to five years by documenting financing in the form of equipment finance agreements (EFAs), which are in substance, installment sales agreements. Therefore, an examination of the disclosures and licenses (which are outside the scope of this vehicle) required should be conducted to determine Act 98’s and similar acts’ application, and if so, when they should be applied to commercial leasing transactions documented through EFAs.
Pennsylvania’s MVSFA applies to a purchase by a business entity of a motor vehicle under an installment sales contract for its business use. In reaching its conclusion, the Genesis Leasing Co. v. Minchoff court relied upon the MVSFA’s definition of “installment buyer” or “buyer” as, “the person who buys, hires or leases a motor vehicle under any installment sales contract, MVSFA Section 603(3).” Person’s definition includes “an individual partnership, association, business corporation…or any other group of individuals however organized.”
Accordingly, if a lease is determined to be a disguised security agreement, or an EFA is truly an installment sale contract, then the MVSFA applies to both financial institutions and motor vehicle dealers.
The CLA and MVSFA draw our attention to the fact that if a lease transaction is determined to be consumer instead of commercial, there are limitations to the lessor and compliance issues, as well as documentation requirements that must be met. Both statutes warn us to be very careful in our due diligence before funding a leasing transaction and to undergo an analysis that judiciously anticipates what the use of the equipment will be at the time of the consummation. Determining the nature of the lease as an entity and what state statutes apply to the transaction also help to govern the characterization of the transaction.
Tony Lamm is managing partner of The Lamm Group and has more than 25 years of experience in secured lending including equipment leasing and asset-based finance, loan workouts, bankruptcy and litigation.
