Equipment Leasing is Not a Form of Vendor Contracting

by Kevin Trabaris

Kevin Trabaris is a corporate and commercial finance transactional attorney with experience representing banks, financial companies, equipment lessors, insurance companies and other funding entities in connection with commercial and corporate loans, equipment leases, bank loans, bonds and many other types of financing. He has handled everything from small ticket transactions to billion dollar syndicated loans, asset-based loans, real estate, working capital and more. Trabaris also handles business transactions and has experience creating companies as well as selling them. This includes corporation, LLC and partnership creation and advice, contract drafting and negotiation, corporate governance, vendor agreements, sale documents and merger/acquisitions matters and more.

Kevin Trabaris, Partner at Edwards Maxson Mago & Macaulay, LLP, draws contrasts between equipment leasing and vendor contracting – two things that have little in common, while sharing insights on leases every lender should be aware of.

Over the years I have had many opportunities to represent equipment leasing finance companies negotiating leases and other related documentation with argumentative lessees.  Equipment leasing falls under the body of law for, and standard practice among practitioners of, a financing contract. It is not, for example, a technology contract or a consulting agreement or an arrangement to buy 1,000 pens.

Many of the larger lessees assign their in-house vendor attorneys to negotiate these agreements. Most of these lawyers are talented practitioners but do not recognize one very important fact:

Equipment Leasing is Not a Form of Vendor Contracting

As we know, leasing is a financial activity, whether true or finance leasing[1], and, other than both being a form of contracting, vastly more akin to business lending than any vendor or consultant agreement.

For example, there is no concept of mutuality in equipment lease agreements.  It’s not uncommon to hear lessee counsel question the necessity of one-sided indemnification, or lessor orientated limitation of liability clauses.  After all, is it not fair that both sides of a contract indemnify the other?  This may be true for other forms of contracting but for leasing, the economics (and duties) are very different.  Once a lease is funded by the lessor, and a lessee accepts the goods, almost all the lessor’s duties have been fulfilled but the lessee is not only required to make periodic rental payments but also maintain the equipment and purchase or return the leased goods at the end of the lease period, among other common requirements.  Whether the lessor has title to the equipment, as in a true lease, or the lessee owns the collateral under a finance lease, the goods have moved into the lessee’s control and any damage done to the equipment is lessee’s responsibility.  After all, the leased goods are at the lessee’s (or at another approved) location, and it has full control over its use and the surrounding environment.  If the collateral is damaged or causes damages, it is solely the lessee’s responsibility.  Meanwhile, the lessor bears the continuing credit risk of the lessee paying all amounts owed to the lessor.  Never accept a mutuality of indemnification argument from a lessee; such mutuality is, by its nature, unfair.

Hell or High Water

Even in the case when you have a name similar to a manufacturer (such as with a subsidiary or affiliate) or other seller of the collateral, it is likely not the same entity.  This bears highlighting because, as you know, the lessor has no liability with respect to malfunctioning or other issues or defects with the goods.  This is the seller’s problem, even if it is an affiliate of yours.  Remember you are a different legal entity (or should be) and are the one signing the lease.  If a lessee has an issue with the goods, it needs to consult its agreement and warranties with the manufacturer or distributor.  Every lease should contain a hell or high-water provision, requiring the payment of rent regardless of any outside issue affecting the use or the condition of the leased goods.  If the lessee argues that this seems unfair, ask your lessee to check its loan agreement with its bank.  Under typical secured lending documentation, if a piece of collateral is damaged or no longer functions as delivered, it is an issue for the borrower, not the lender, even if the damaged collateral represents a significant portion of the collateral pool.  This is also true with transactions with a borrowing base, a so-called asset-based loan or a similar transaction.  Because the lessor is not the manufacturer of the equipment, lessee needs to be aware that they will be required to disclaim – –

I Hereby Disclaim

The plurality of equipment leases requires lessees to disclaim and release the lessor from all warranties relating to the leased goods.  This may seem unfair but keep in mind that the lessor is almost always not the manufacturer (or seller) of the equipment.  Typically, you are a lender, looking at the goods as collateral.  The lessee identifies the supplier of the equipment where it has contracted to purchase the leased goods and, at lessee’s direction, lessor pays the supplier for the goods.   The lessor has not stepped into the shoes of the supplier, it has merely paid it.  There is no reason to expect a lessor to provide warranties on the equipment.  After all, the lessor may be financing computers one day and a farm tractor the next.  It has no responsibility for understanding the inner workings of the leased goods.  Neither does the lessee’s bank with its loan collateral.

Net, Net, Net

Most leases, in my experience, are triple net leases.  This means that the lessee pays all costs and expenses related to the goods, including all tax, shipping and insurance.  Does a bank pay these costs with respect to the collateral pledged to secure a loan?  You can be sure it does not.  Incidentally, the taxes do not include the lessor’s income tax.  A lessee can raise this issue, but this is a business issue with the lessor and goes to the dollar amount of required rental payments.

Why Does a Lessee Deem Accept

You may notice that your lease documentation require a certificate of acceptance or other proof that lessee has accepted the equipment.  This is usually followed by a statement that, whether or not the lessee provides written evidence that it has accepted the goods, it shall be deemed to have accepted the goods after the elapse of a certain period of time.  When a lender makes a loan, the lender must know for certain that the borrower is fully obligated under the loan after the signing of the loan documents.  For leasing, this is less certain.  In fact, acceptance (whether deemed or in writing) under UCC Article § 2A-516, provides the lessor comfort that the lessee is obligated to lessor under the terms of the lease once the collateral has been accepted.  Do not fail to enforce this provision, it is an important safe harbor for lessors.

Location, Location, Location

I can’t tell you how often I’ve been asked why the location of the equipment is restricted under the terms of the lease.  After all, many employees keep their company-provided laptops in their homes.  But, if the lessee has defaulted under the lease and lessor needs to recover the leased equipment, it needs to be certain of the location of these assets for collection.  This may be confined to a single town or warehouse, or more broadly by state, region or country as long as the lessee provides a list of the exact location of each asset.  This is also a common feature of asset-based loans as in other transactions where the collateral is a vital part of the lender’s recovery.  This is, at its base, an issue for risk and credit people to decide because it is an analysis of the financial condition of lessee.  For example, would you lend them the money unsecured?

An Ode to Risk Managers

As mentioned before, a lessee bears the cost of the loss or damage of, or liability related to, the leased property and the lessor bears the credit risk of lessee.  Your risk and credit people determine, according to financial models, the risk of default by the lessee or other reason it may not recoup its principal, interest (or other time value of the money funded), fees and costs of collection.  When coming to a credit decision, they need to rely on the fact that the lessee bears all other costs, expenses and related amounts.  This analysis is considered when determining the interest rate built into the lease rate (and periodic rental payments), and the amount of risk and profit you are seeking from the transaction and this is all based on the standard contractual terms of your form documentation.  The more risk the lessor suffers, in any form, including from contractual changes to its standard lease agreement, the more the lessor’s original credit analysis (and pricing) may suffer.  This is a reminder for the sales force that the lease is not written to be a impediment to their bonuses but to secure the return expected to your employers.

And the Rest

There are other ways an equipment lease is more akin to a loan agreement than a vendor contract.  The average lease will have events of default similar to those found in other financings.  Often these defaults go beyond nonpayment and bankruptcy but may include a change of control, cross-default (where a default to any creditor, or a default under another lease or financing by the same lessor, would cause a default under the lease), material adverse change, any default due to lien filed by any other creditors on the leased goods, or others.  Most leases (as is standard in lending) waive jury trials and do not include arbitration provisions.  Arbitration findings, in the context of leasing, may be, depending on the jurisdiction, more uncertain than court decisions and most lessors, understanding that you bear the risk of loss of amounts owed under a lease, want more likely outcomes.

I hope lawyers who handle vendor contracts will take these differences to heart but, in the meantime, a lessor’s attorney needs to fold fast on negotiating the lease and, in simple terms, explain why the lease contains its various provisions.  To do this, the lessor’s attorney needs the understanding and support of its clients.

[1] A finance lease is a type of lease (really more of a disguised loan) where lessee holds title to the property and there is a nominal buy-out of the equipment at the end of the lease.  With a true lease, title is held by the lessor and there is a more significant, often at fair market value, cost to acquire the property at the lease’s maturity or, if not paid, the equipment must be returned to the lessor.

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