Getting Started on the Right Foot

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.

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. 

Defaults 

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/barry@leaselawyer.com or Matt at 205.251.8302/matt@leaselawyer.com. Look for an article on the limitations for nationally-chartered and state banks in an upcoming issue.

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