Jennifer L. Howard is of counsel at Baker, Donelson, Bearman, Caldwell & Berkowitz, P.C., and practices in the areas of equipment leasing, equipment finance and renewable energy project finance.
A financing company cannot be willfully blind to a lessor’s fraud. Financing companies must perform adequate due diligence or risk being left holding the bag.
Periodically in the equipment leasing industry, cases crop up involving schemes in which equipment is marketed as being essentially “free,” because the lessee will supposedly receive payments for advertising on the equipment, in an amount roughly the same as the lease payments. Financing institutions should conduct careful due diligence before becoming involved in such arrangements, as a number of them have been found to be essentially Ponzi schemes.
The most recent example of such litigation is In re Brican America LLC Equipment Lease Litigation. Recently, the court issued an amended decision, clarifying the basis for an earlier holding that some of the leases in that case had been fraudulently induced and the financing company was not a holder in due course. (See 2015 WL 235409 [S.D. Fla. Jan. 16, 2015].)
This litigation involved the leases of plasma televisions and related equipment, known as “Exhibeos.” Brican marketed these screens to dentists and optometrists who installed them in their waiting rooms in order to exhibit educational and promotional material.
Brican’s customers signed a Financing Agreement, listing Brican LLC as the equipment vendor and its affiliate, Brican Inc., as the lessor. (Because the documents blurred the lines between these affiliates, and because one was found to be the agent of the other, both will be referred to here as “Brican.”) At the same time, the customers also entered into a Marketing Agreement with Brican and a third party, Viso Lasik, who jointly promised to buy advertising space on the Exhibeo and pay quarterly advertising payments. Brican also promised that if the advertising payments stopped, it would “buy back” the lease agreement or assume assignment of the leases. Brican marketed the Exhibeos as being “free,” because the customers would receive advertising payments in roughly the same amounts as the lease payments. Brican did not enter into any of these agreements until a financing company (usually NCMIC) agreed to take assignment of the lease, which contained a waiver-of-defenses clause.
Essentially, however, Brican’s business model was found to be a Ponzi scheme. For each assignment, NCMIC paid Brican approximately $24,000. From those funds, Brican loaned Viso Lasik $10,000, which Viso Lasik used to make the advertising payments. Because Brican also signed the Marketing Agreements, it was also committed to pay $29,000 over five years for each transaction. This business model only worked if Brican continued to lease more Exhibeos at an exponential rate and to obtain more financing from third parties, like NCMIC, and if Viso Lasik continued to pay. However, Brican was aware that Viso Lasik had only three planned locations, and its ability to pay advertising fees depended upon the loans from Brican. Still, Brican leased as many Exhibeos as possible all over the country, without attempting to sell advertising to any other company.
The Court found that the lessees had proven the common elements of their claims that Brican fraudulently induced them to enter into the leases. The Court reasoned that the buyback provision in the Marketing Agreement was a misrepresentation because Brican knew it could not keep its promise to buy back the leases if the advertising payments stopped, and it implied Brican and Viso Lasik had an independent relationship but failed to disclose that Brican was loaning the advertising fees to Viso Lasik out of the proceeds of each assignment.
It further found that NCMIC was not a holder in due course and could not enforce the waiver-of-defenses clause, because it did not take the assignment in good faith and without notice of the fraud. The Court found there to be a close connection between NCMIC and Brican, because NCMIC financed the vast majority of Brican’s leases, and NCMIC essentially performed all credit and underwriting because Brican would not enter into a lease until NCMIC agreed to take assignment of it. Additionally, multiple lessees notified NCMIC that Brican promised to pay advertising fees to offset the lease payments and to buy back the lease if these payments stopped, and NCMIC had notice that one of the owners of Brican had been accused in the past of a fraudulent scheme involving similar promises. Further, when it received such notice, NCMIC did not ask Brican or Viso Lasik to demonstrate how they planned to continue making the advertising payments, nor did it follow its own established procedures for investigating fraud.
The moral of the story is that a financing company cannot be willfully blind to a lessor’s fraud. Financing companies must perform adequate due diligence or risk being left holding the bag.
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