How Much Insurance Do I Need?

The last time we polled lawyers asking how much liability insurance the lessee should be required, the answers were all over the place with five to ten million dollars the most common range given, but some much higher. Of course, it depends primarily on the nature of the equipment and secondarily on the lessee's creditworthiness, but that does not help when drafting forms for general use.

We might also point out that many lessors do not require liability coverage for EFA's, relying on a line of cases distinguishing secured lenders from owners of equipment for products and vicarious liability. Note: We are not certain that a lender cannot be tagged for its "negligence" where  it inspects equipment or has a relationship with the vendor that puts it in the position of knowing that equipment is dangerously defective.

Also, we do not believe that dollar-out leases are much safer than true leases. Proving that the lease is intended to create a security interest only gives the lessor a (reasonably good) argument that must be made in court. While a plaintiff's lawyer is likely to shy away from suing a lender, the word "lease" will get his antenna up.

Given the many issues with liability coverage, we recommend our lessor clients carry their own policies.  

What issues?

• In case you haven't been beaten over the head with it, liability insurance certificates do not bind the insurance company or "change" the actual policy. Only fullblown endorsements assure the lessor of actual coverage as additional insured.

First, as with lessee insurance, we advise taking into account the nature of your business. Do you finance motor vehicles? Only telephones and computers? Do you lease to risky credits who are unlikely to provide indemnification if things get rough and are themselves bad targets for the plaintiff? Do you do true leases?

Second, remember that there are two levels of insurance to consider: even in an EFA  and certainly in a lease intended as security, someone may have to cover legal fees to get you out of litigation. If there is any question of the lessee's ability to do this, a small policy would not hurt. At the same time, a policy protecting against true catastrophes, providing umbrella coverage for multi-million dollar claims should not be expensive.

Finally, there are umbrellas and there are umbrellas. Make your agent explain in detail what is and is not covered. If the lessee fails to provide required insurance? If the insurance provided is inadequate? If the claim is for your own negligence? Strict, vicarious, absolute and general products liability? Umbrellas with big holes are cheap without being a bargain.

A last observation: this article does not address errors and omissions policies for originators and other types of insurance some of our clients carry. Asking around is a good idea and it is why we belong to ELFA, NEFA and NAELB. You'd be surprised what you pick up if you listen. Even lawyers sometimes listen.

We learn a lot from our clients' questions.  One that showed up a couple of times recently is "must I disclose the implicit interest rate in an Equipment Finance Agreement?"

In many cases, the EFA form has a specific "box" for disclosure of the rate of interest used to calculate payments.  If the interest rate will not be an issue for the borrower, this is generally a good idea.  Disclosing the rate of interest knocks out one more argument that a borrower's lawyer might try to use as evidence of unfair or deceptive business practices, even where it is not required by law.  The disclosure must be accurate, however.  Under-stating the rate might occur if the actual payment will include something other than principal and interest, such as an amortization of overhead or taxes or other payments to be passed through to a third party. 

All that is well and good for those charging comparatively low rates of interest or for whom the interest disclosed will not cause some form of sticker shock.  For the others, the decision whether to disclose interest on the face of the agreement involves an element of risk and a judgment call.

There are other anomalies such as statutes that appear to be consumer-oriented (Oregon) or require interest rate disclosure only on request (Arkansas).

What about choice of law?  For many issues, specifying the law of a "friendly" state will be used to construe the EFA is very helpful.  In most cases, we advise that it provides at least some protection against usury claims.  There is a lingering question, however, as to whether a judge will interpret the statute at issue as protective of his states citizens and declare the choice of law void as against public policy with respect to the given statute.  This sort of thing is unlikely, but always possible and an interest rate disclosure law would be a good example of one such law.

This brings about another question we have kicked around for a couple of years:  can time-price differential, or a simple statement that the borrower in an EFA has elected to pay over time rather than paying cash, be used to avoid usury issues and/or interest rate disclosure requirements?  Our problem is that the borrower is not purchasing the equipment from the EFA lender in a non-vendor transaction.  It seems to us that implying the contrary might cause more problems than it is worth.

The  bottom line is that whether to disclose interest rates and how to deal with high rate loans requires careful consideration of the risks and cost of avoiding them.  As always, we think that the process is the key to the best answer.

Recently two unrelated clients repossessed leased motor vehicles.  In each case, shortly after repossession but before the clients sold the vehicles, the lessee filed for bankruptcy protection and the debtor's lawyer filed a motion to compel the lessor to return the equipment to the debtor.

It is a common scenario for a debtor to run to a bankruptcy lawyer immediately after a vehicle or other equipment has been repossessed. A lender on a secured loan can't do much to avoid this problem except to schedule a repossession sale as soon as legally possible.  In a secured financing or lease intended as security, the debtor owns the equipment subject to security interest of the lender/lessor. Under UCC 9-623, the debtor can redeem the vehicle from repossession until it is sold at a repossession sale (or has been accepted by the lender in satisfaction of the debt as provided in UCC Article 9). The Bankruptcy Code allows the trustee/debtor in possession to "redeem" the vehicle by paying the debt over time through the bankruptcy plan.  

In a true lease, the lessee does not own the equipment. The lessee has no rights in or to the equipment other that as provided under the lease. If the lease is effectively cancelled or terminated before the lessee filed bankruptcy, the lessee should have no remaining right to the equipment. The lessor can sell or lease the equipment even though the lessee is in bankruptcy. On the other hand, if the lease has not been terminated or cancelled the debtor's rights under the lease are a) "property of the estate" and b) the lease is subject to assumption by the debtor in the bankruptcy case.  

Unfortunately, bankruptcy courts have held that merely repossessing the leased property does not extinguish the rights of the lessee. This is why we recommend that on repossessing leased equipment that you send a notice of cancellation of the lease. The notice does not require specific language and can be included within the notice of sale that you send to the lessee. If you have repossessed the equipment and provided the notice of cancellation prior to the debtor filing bankruptcy, you should be able to avoid returning the equipment to the debtor.

Cancellation v. Termination

What is the difference between "cancellation" and "termination"?

'Cancellation' occurs when either party puts an end to the lease contract for default by the other party. UCC 2A-103(1)(b) .

'Termination' occurs when either party pursuant to a power created by agreement or law puts an end to the lease contract otherwise than for default. UCC 2A-103(1)(z).

With either a cancellation or termination you end the rights of the lessee under the lease, just for different reasons. UCC 2A-505 sets out the differing impact of these actions.

(1) On cancellation of the lease contract, all obligations that are still executory on both sides are discharged, but any right based on prior default or performance survives, and the cancelling party also retains any remedy for default of the whole lease contract or any unperformed balance.

(2) On termination of the lease contract, all obligations that are still executory on both sides are discharged but any right based on prior default or performance survives.

So based on section 2A-505 upon cancellation, but not termination, you retain the "remedy for default of the whole lease contract or any unperformed balance." With a true termination you would not be able to collect the present value of the rent payments for the remaining term of the lease although you should be able to collect any rent past due as of the date of termination. So unless you know that you will collect nothing else from the lessee after repossession you should send a cancellation notice rather than a termination notice.

Does the mere choice of words in the notice impact the lessor's right to collect future rents? It could.  If you have sent a termination notice rather that cancellation notice after a lessee default you can argue that despite the use of the term "termination" that the notice really is a cancellation under the UCC because you extinguished the lessee's rights for default rather than some non-default reason. This argument is stronger if your notice also included a reservation of the right to collect the full accelerated balance due on default under the lease. 

Despite the fact that you may be able to get around a technical argument about the meaning of "termination", we strongly recommend that you utilize the term cancellation in the notices rather than termination when the lessee has defaulted. Additionally, to make the point very clear include a statement in the cancellation notice that you are reserving the remedies for "default of the whole lease contract or any unperformed balance" or similar language.

The remedies section of some, perhaps many, leases provides that the lessor may terminate the lease but does not specifically state that the lessor can cancel the lease. However, this should not impact your ability to cancel a lease. The lessor should have all default remedies under the UCC as well as the remedies spelled out in your lease. UCC 2A-523(a) states that the lessor can cancel the lease on default by the lessee.

Final Note

If you have repossessed equipment and your customer files bankruptcy before you sell the equipment contact your lawyer immediately.  

Okay, this month we are going to make it easy:  just name Santa's reindeer and tell us where their names first appeared.