Tipping the Scales: A Little Something to Consider When Crossing State Lines
by Kenneth Weinberg January/February 2019
Ken Weinberg takes a metaphorical trip around the country as he examines the ways cross-state transactions can be affected by each individual state’s laws and how companies can prepare themselves to address the subsequent issues in a lease.
Various common types of transactions in our industry result in equipment leasing and finance companies acquiring interests in transactions that are outside the primary states in which they are located. Some examples include the very active market pursuant to which equipment leasing and finance companies work together, including outright assignments, discounting of rent streams only and back-leveraging of the residual in true lease transactions. For these reasons, many equipment leasing and finance companies consider their footprint to be nationwide. Unfortunately, state laws are not always uniform, and questions arise as to what additional steps may need to be taken with respect to transactions in states in which the lessor or lender has no physical presence.
Over the years, the primary goal of this column has been to provide clear, concrete advice on various topics important in our industry, to be more like a short film than a long trailer. Unfortunately, the issues raised by having a nationwide footprint are too non-uniform to address fully in a single column. Nonetheless, this month’s edition should provide the reader with a roadmap useful for a “walking around feel” of the issues. So put on your hiking shoes, and get ready for a walk across the country!
STEP ONE: KNOWING WHAT IS IN YOUR BACKPACK
Any meaningful analysis of these issues requires a clear understanding of the nature of the applicable lessor’s or lender’s business. Here are some items to consider:
(a) Are the lessees or borrowers using the funds and financed equipment solely for commercial purposes? State regulations involving consumer transactions are usually more prevalent, intricate and associated with higher penalties than purely commercial transactions.
(b) What types of lessees or borrowers are involved in the transactions? Consumer-type laws sometimes cover loans or leases to individuals, including sole proprietorships, even if for commercial purposes.
(c) What sizes are the transactions? Consumer-type laws sometimes cover smaller transactions even if for commercial purposes.
(d) What types of interest rates are involved? Some state law requirements are blended with usury considerations, for example requiring a license only if interest rates exceed a certain amount.
(e) What type of equipment is involved? For example, transactions involving motor vehicles are often subject to additional, specialized regulation and licensing requirements under state law. These requirements are generally driven by a legislative desire to protect consumers from unscrupulous dealerships or financiers involved in what may be the second largest purchase an individual consumer makes.
(f) What type of entity is the lessor or lender? Some laws have exceptions for certain types of entities. For example, an exception from the regulatory requirements may cover national banks but not state-chartered banks or may cover banks but not bank subsidiaries.
(h) What is the volume of transactions (in terms of the number of transactions, the total dollar amount at issue and the amount of equipment) located in the applicable state? The answer to this question impacts qualification/registration issues, as well as certain licensing issues.
(i) What types of transactions are involved, and how does the lessor’s or lender’s interest in them arise? Different licenses are triggered by different structures and/or different origination and acquisition approaches. For example, licensing statutes may not apply to a collateral assignee of a lease or loan originated by a financing company who remains the lessor/ lender under the documents but may nevertheless be required in connection with a collateral assignment of an installment sales contract.
(j) If true leases are involved, how does the lessor dispose of off-lease equipment? For example, are sales only to lessees pursuant to the terms of the lease and/or through an auction? Or does the lessor sometimes sell at retail in a manner more likely to trigger dealer licensing requirements?
(k) Is the lessor or lender already qualified to do business in the applicable state(s)? Some statutes have exemptions depending on whether or not qualification has been obtained.
STEP TWO: THE LOWLANDS (GENERAL QUALIFICATION ISSUES)
Once you leave your home state and step into another state, a threshold question arises as to whether or not you are “transacting business” in that other state in a way that requires you to register, or qualify, to do business as a foreign corporation or other business entity.
Applicable state statutes vary, but there are some similarities. For example, when addressing the issue from the perspective of a corporate lessor or lender, it is worth noting that most states have adopted at least some portions of either the Model Business Corporation Act or the Revised Model Business Corporation Act (both referred to as the MBCA). Under both, it is clear that isolated transactions and transactions in interstate (as opposed to intrastate) commerce do not constitute “transacting business” for purposes of requiring qualification. Indeed, the Constitution of the United States prevents a state from requiring a foreign corporation to obtain a certificate of authority to do business in the state if its participation in the trade is limited to wholly interstate business. This limitation results from the fact that the U.S. Constitution grants Congress exclusive power over interstate commerce and precludes states from imposing restrictions or conditions on this commerce.
The MBCA also contains a non-exclusive list of activities that do not, in and of themselves, constitute “transacting business” such that qualification is required. Of that list, the following are particularly noteworthy: maintaining, defending, or settling any proceeding; soliciting or obtaining orders, whether by mail or through employees, agents, or otherwise, if the orders require acceptance outside the state before they become contracts; creating or acquiring indebtedness, mortgages, and security interests in real or personal property; securing or collecting debts or enforcing mortgages and security interests in property securing the debts; transacting business in interstate commerce and owning, without more, real or personal property. It should be noted, however, that not all of the states have enacted versions of the MBCA that include this entire list.
The effects of qualifying should also be considered from both an administrative and tax perspective, as should the penalties for failure to qualify in circumstances where it is arguable whether or not qualification is necessary. With respect to the latter, it is worth noting that qualification statutes routinely have “cure” provisions pursuant to which qualification to do business retroactively cures any failure to obtain qualification for most purposes. Except for the payment of fees and penalties, the most common penalty for failure to qualify to do business in a state is that the foreign corporation will be barred from use of the state’s courts until it is qualified. For example, Section 124 of the Model Business Corporation Act provides, “no foreign corporation transacting business in this state without a certificate of authority shall be permitted to maintain any action, suit or proceeding in any court of this State until such corporation shall have obtained a certificate of authority.” Alabama used to have certain exceptions to this “cure” concept, instead having a “door-closing” statute and Constitutional law which jeopardized a foreign entity’s ability to ever enforce contracts entered into when it was not qualified if necessary. Fortunately, however, Alabama’s laws have been modernized and now allow cure.
STEP THREE: TRAVELING IN THE MOUNTAINS AND GORGES (GENERAL LICENSING ISSUES)
As we move out of the lowlands, the landscape becomes more varied and treacherous. Depending on what is in our backpacks from step one, above, we need to consider which of the following licensing mountains need to be scaled:
(a) General Lending License. Many states require a license to make commercial loans or otherwise be a lender, creditor, or secured party. For purposes of clarity, “loans” should include capital leases, $1 buyout leases, leases with other bargain purchase options and similar products that are not styled as loans but have the economic substance of loans.
(b) General Leasing License. Some states require a license in order to be a lessor under a lease of personal property. For purposes of clarity, licenses required to lease vehicles, or to sell off-lease vehicles, are expressly excluded from this category.
(c) Vehicle Leasing License. Some states require a license covering the same general subject matter as a General Leasing License which is applicable solely because of the presence of vehicles.
(d) Vehicle Dealer Licenses. Many states require a license to sell a vehicle that was previously subject to a lease either to the lessee or a third party, although the applicability of these licenses to our business is subject to a careful review of the applicable statutes.
(e) General Installment Sales Contract License. Some states require a license to buy or lend against installment/conditional sales contracts (but not to originate such transactions directly as seller). For purposes of clarity, specialized licenses required to purchase commercial installment/conditional sales contracts relating to vehicles are expressly included in this category.
(f) Vehicle Installment Sales Contract License. Some states require a license covering the same general subject matter as a General Installment Sales Contract License which is applicable solely because of the presence of vehicles.
(g) Collections License. Some states require a license to engage in servicing, fiscal agency, administrative agency or collections activities supportive of any of the above listed activities.
STEP FOUR: LOST IN THE FOREST (USURY, DISCLOSURES AND OTHER WRINKLES)
For better or for worse, the laws across the country can be as varied as the nation’s geography, and there are inevitably laws that do not fit within the general framework listed above. You may now be thinking of the Great Sand Dunes in Colorado (a suitable location to film some Star Wars movies), Bryce Canyon in Utah (with its gorgeous red-orange-pink amphitheaters) or another spectacular locale.
Unfortunately, when it comes to this category of laws, a better analogy may be a thick, dark, scary forest. Consider, for example, specific disclosure requirements, documentary stamp tax or indebtedness tax requirements and regulations of auto-renewal clauses. In addition, even if the licenses obtained by the lessor or lender are sufficient to accommodate the interest rates carried in our proverbial backpack, other state laws may restrict the interest rate that can be charged on transactions. Violations of these usury statutes can result in the loss of interest, the loss of principal, or specific monetary damages owed to the borrower. Some states also have criminal penalties for usury violations.
At the end of the day, various elements of our industry afford us the opportunity to enter into or acquire transactions across this great nation. However, not all state laws are uniform, and prudent lessors and lenders will carefully consider what is in their backpack as they travel across state lines. After all, nobody wants to find themselves in Alaska without a warm jacket or in South Florida without a swimsuit. Safe travels to all!
Whether you are a third-party originator or a funding source/bank, the responsibility lies with all parties to build partnerships based on mutual trust, mutual commitment, shared ideas and common goals.
Global economic and political changes are affecting equipment leasing and finance markets in diverse geographies. In our interconnected economy, it pays to understand what is happening globally and to look at emerging opportunities.