Marks & Associates, P.C. 
February 2014
In This Issue
Getting Started on the Right Foot
Bank Regulations
Trivia Test
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Snow Joke, It's a Pain in the Ice!


Ha Ha Ha. Birmingham has been snow-and-iced in twice in 2014 and our friends in Manhattan and Chicago are laughing their heads off at us. The folks in Colorado are at least being nice about it.


Thing is, it isn't supposed to get this way down here and there is a dearth of equipment to deal with even the inch or so we get, not to mention that folks down this way generally have no idea how to drive on this stuff. Watching 2-wheel drive pickups doing donuts and taking out every car near them gets old fast. (Memo to would-be truckers: your Ram Tough work truck is actually lighter in the back end than many soccer-mom rides unless you load up that ton of manure you use it for).

Meanwhile, we are continuing to see the slow rebooting of our industry. As predicted in many quarters, businesses are re-tooling and money is at least a bit more available for many of our clients. Now is the time to think about new products and opportunities, but it is also the time to do the homework necessary to expand safely. Those of us who have not learned the bitter lessons of the recent unpleasantness are doomed to re-learn them.


As we try to keep warm and make jokes about the mess down here, we want to remind you that we check voicemail and email whenever we are out and our system allows us access to our computers from anywhere. Don't be shy about asking us to call at any time, from anywhere. We appreciate the opportunity to work with y'all.



 Getting Started on the Right Foot

As we have advised clients many times, many of the problems with equipment finance documents concern either the beginning or end of the term. The following are a few thoughts about "Commencement Dates".

It is surprising how many otherwise well-drafted leases we see that are unclear as to the date commencement occurs.The most common mistake is to confuse the commencement of the term with the commencement of the rental periods.Some draftsmen insist that the Commencement Datecoincide with the first Rent Payment Date. This results in all manner of potential difficulties because paying rent is not the only duty of the lessee under a lease. The lessee's duties generally include maintaining insurance on the equipment and liability insurance in the case of true leases, indemnifying the lessor for losses related to the equipment and third party claims, and maintaining and using the equipment in accordance with a reasonable standard. If the Commencement Date has not occurred, the lessee may not have these duties yet even though it has possession of the equipment. The Commencement Date and first Rent Payment Date may coincide; but keep in mind they serve different purposes. In many cases, the two dates should be kept separate, as where the term commences upon acceptance of equipment but the first date for payment of rent (if in advance) is the first day of the following month.

In a finance lease the lessor clearly does not want to assume the risk if the equipment is damaged or injures someone while it is being shipped or tested. The common "F.O.B." language of Article 2 of the Uniform Commercial Code gets confusing when applied to a lease.  If the lessor is not careful, the language of the lease can cause the lessor to take on responsibility for delivery and installation.  If the lessor has made an advance payment, will pay on shipping (a dangerous proposition) or is subject to potential liability should the equipment injure someone while it is being tested the lessor may temporarily assume these risks.  If the lessor is going to encounter any of these situations it is best to either (a) have the lessee sign the lease before advancing any money and include a provision that certain of the lessee's responsibilities commence prior to the commencement of the lease term or (b) negotiate a prefunding agreement to deal with these issues.  This can be tricky, of course particularly in the context of a true lease.

Interim Rent is one of those wink-and-nod situations for many lessors.  While it makes perfectly good sense to charge interim rent in a true lease, particularly if the lessee will not be paying the entire cost of the equipment over the term (a full payout lease), the language is sometimes used in $1-out leases in a way that can (1) cause the lessee to pay more than 100% of the cost of the equipment and/or (2) raise the implicit interest rate to usurious levels.  The lessor can address this by shortening the last lease rental period by an amount equal to the additional interim rent period or adjusting the monthly rent payment amount so that the lessor's costs is paid with the originally contemplated rate of return.   


Our strong recommendation is that the lessor either simply bill on the day of the month corresponding to the Acceptance Date or include clear language regarding the interim period (whether rent is charged or not) to get to the first or last day of the month following acceptance.

Acceptance itself can be a bit of an issue. Some lessors, particularly vendor lessors, prefer to have the lease term commence if the lessee does not reject the equipment within a certain  period of time.  Others prefer to cancel the lease if the lessee does not accept within a stated period.  Either way, it should be clear that the lessee has a limited time to inspect and accept or reject the equipment so as to prevent difficulties where the equipment sits for a long period of time while the vendor is screaming for payment and the lessee is putting off the first rental.

We often advise that the lessee's first productive use of the equipment should also trigger the acceptance date, but this gets into another problem. Where a funder is taking assignment of the lease, obtaining a signed Acceptance Certificate is and should be a closing requirement.  In other words, the lessee must accept or the term does not commence.  We are seeing situations where the funder finds out after the fact that the lessee never actually accepted the equipment and was "working with the vendor" to address defects.  At the very least, this means the collateral does not have its intended value.  At worst, it means that the funder has purchased an argument.  Note, we do not recommend that you have the customer sign an Acceptance Certificate prior to delivery of the equipment.  This could cause major problems for the originator with both the customer and the funder.

However it is done, careful drafting will make it clear when the lease term commences, when the first rental payment is due and when the lessee's responsibilities with regard to insurance, indemnification and protection of the equipment kick in.  We will say a little something about lease terminations in an upcoming issue. 


Most of us don't look at the Events of Default section until the Lessee  does something wrong or a prospect wants to negotiate grace periods and such.  It would not be a bad idea to take out your form lease and take a look at this very important section before you make the call to your lawyer asking "is this a default?"   


Too often, we find situations arise that wriggle between the bars set up by the default section.  This is an area in which judges tend to read lease and loan agreements carefully and narrowly.  With that in mind, a few observations:


1.  Remember that the Event of Default section does more than give you the right to terminate (cancel) the lease and recover the equipment.  It also limits certain of the lessee's rights and provides leverage.  For example, the lessee's authority to terminate early, purchase equipment at the end of the term or sublease might only exist as long as an Event of Default has not occurred.  Consider carefully whether that language should refer to the lessee being "in default" (which is often read to mean prior to the expiration of a grace period) and whether the default must be "continuing".  At what point should the lessee lose its rights to exercise options?   Should it be when the lessee has allowed a lien to attach or is late paying rent?  If the lessee actually suffers an Event of Default, but cures it, should all rights be reinstated?


2.  Grace periods are often easily granted by lessors.  Care must be taken, however, in distinguishing different types of defaults.  While it is entirely reasonable for a lessee to ask that the house of cards not fall because it is a day late delivering a copy of its annual financials, what should happen in the event the lessee's liability insurance actually lapses (which, ideally, will be after the lessor has received notice and an opportunity to make other arrangements). If the lessee sells the equipment to a third party, must the lessor wait 30 days before taking legal action?


3.  Continuing that thought, there used to be good reason for a lessee to want to have notice and opportunity to cure failure to pay rent.  This is less true in the days of electronic funds transfers.  Moreover, if the lessee receives notice on Monday that it is late making rent payments and has five days to cure, that gives the lessee five days to file for bankruptcy and subject the lessor to the automatic stay.  If the lessor has declared an event of default to have occurred and demanded return of the equipment prior to the filing, the lessor's position is greatly improved.   


4.  Even the innocuous "rent is not paid within five days of its due date" language can present a problem.  In many cases, lessees read this to mean that the rent can always be five days late.  We prefer to include a statement that the lessee may exercise the five day grace period not more than once in any twelve month period or something along those lines.


5.  Grace periods for rent should be considered together with late payment obligations.  If the lessee is going to have a five day grace period to pay rent, shouldn't the late fee begin to run on the first day (to avoid the always-late rent described above)?  We see too many forms in which both the late fee and rent default have the same grace periods.   


6.   Cross-defaults are generally unpopular with lessees.  Sometimes this is more palatable if a minimum amount is specified.  The devil in this detail is often whether the amount is tied to the original obligation, the amount outstanding or the amount in default.  Moreover, if the default is with regard to a lease of the facility where the equipment is used, such as an office lease where computer equipment is located, should there be any minimum amount specified?   


7.  Where individuals are involved (sole proprietorships and individual guarantors) it is common for the document to fail to specify that death is an event of default.  Can the estate or heirs run the business?  Is the estate capable of satisfying the guarantor's obligations?   


As always, careful drafting and thinking before the form is approved or deal signed will make all the difference. 


Bank Regulations 

We are preparing an article on bank regulatory rules as they relate to discounted leases. If you have experience in this area, questions or war stories, we would love to hear from you. Please call or email Barry at 205.251.8303/ or Matt at 205.251.8302/ Look for an article on the limitations for nationally-chartered and state banks in an upcoming issue.



Trivia Test

Who was the first president to have a bathtub in the White House?  


Who was the first president to have an Air Force?


Who was the first to be born in a hospital?