Marks & Associates, P.C. 
Newsletter
July 2014
In This Issue
Firm News
Wall Street Journal Decries Advance-Fee Loan "Schemes"
Events of Loss
Down to Brass Tacks
Converting a Lease into an Equipment Finance Agreement
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FIRM NEWS

 

IN THE HEAT OF THE MOMENT...

Birmingham.  Alabama.  July.  Hot, humid...about like what folks from the rest of the country would expect. 

 

As usual, we are slowing down our publishing schedule and will only have one more newsletter before the leaves turn and leasing heats up.  This issue focuses on documentation, but, as always, we welcome your suggestions for articles and any other correspondence.

I will be attending this year's ELFA Annual Convention, hopefully speaking on state law issues (licensing, usury) that affect equipment finance.  I will also be at the 2014 NEFA Funding Symposium in San Antonio, participating as a panel of lawyers addressing similar issues in September.  Please stop me and say "Howdy!"  I will be the guy who is probably still perspiring.  (For those who haven't grabbed them yet, we still have "Evolution" t-shirts for anyone interested.  The new ones are grey and white). 

Have a safe summer.  Remind the kids to wear seatbelts in the back seat. 
                                                          Barry Marks

Here's your trivia question for this issue:

For 1,000,000 points and a burgundy polo shirt (seriously), can you identify this logo?  Hint:  One of the greatest movies ever made. 
 
WALL STREET JOURNAL DECRIES
ADVANCE-FEE LOAN "SCHEMES"


An article in the May 26th Wall Street Journal entitled "Loan Scheme Delivers Blow to Small Businesses" warned about schemes by "self-described loan brokers" that have "been around for years." These schemes involve frauds perpetrated by swindlers who claim to be able to produce loans for small businesses. According to the Federal Trade Commission, there were over 53,000 complaints last year regarding advance fee arrangements.

 

In response, many states have enacted loan broker statutes variously requiring the posting of bonds or registration. Some states outlaw the practice of securing a loan fee in advance altogether.

 

Whether financing through a dollar-out lease would be considered a "loan" for purposes of these statutes is an open question and one we think should be taken seriously. Unfortunately, some states have enacted versions of the statute that includes loans of "money or property", apparently covering advance fees taken on lease transactions as well as loans.

 

Ominously, Robert Kyonch, Chief of Financial Investigations at the Florida Office of Financial Regulation is quoted as saying "The vast majority of people who pay the advance fees to these unregistered entities do not receive a loan." Huh? That's news to honest lease brokers. Florida's loan broker statute can be found 687.14, Florida Statutes Annotated. Other states enacting similar legislation include Arizona, Arkansas, California, Connecticut, Georgia, Idaho, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Mississippi, Missouri, New Jersey, Nebraska, North Carolina, North Dakota and South Carolina.

 

The message here is simple: before accepting a fee to arrange a loan or lease, check the laws of the state(s) that may be relevant. If you are taking any sort of fee, a written agreement is essential and it should make clear the circumstances under which the fee will be forfeited.

 

 

EVENTS OF LOSS  

 

The theft or destruction of most types of equipment comes as a surprise to the lessor. With the exception of one or two high-risk items, most leased equipment is assumed to survive the term of the lease.  

 

It is not uncommon for a lessor to read the Event of Loss section of his lease for the first time when he receives notice that the equipment has been destroyed. Too often, the language of the lease and/or the calculation used for casualty value (or "stipulated loss value" as it is often called) proves inadequate. Consider a few items that may or may not be in your lease:

  • Does the lease provide for notice from the lessee any time a significant casualty occurs, or only if the equipment is actually determined to be destroyed, lost or stolen?
  • Who makes the determination whether or not equipment is damaged beyond repair?
  • In a tax lease, is the casualty value calculated so as to preserve tax benefits the lessor anticipated, including the timing of deductions?
  • Is the casualty value calculated assuming that the rent is then-current or is it payable on a rent payment date without providing that the rental payment then due must be made (in other words, does the casualty value assume that a final rent payment has been made or not?)
  • If there are any amounts outstanding at the time casualty value is paid, are they immediately due and payable?
  • If the lessee has the option to replace the equipment, must it be with equipment of at least the same value, utility, make and model?
  • Does the casualty value calculation include the lessor's assumed residual?
  • If the equipment simply disappears for a period of time, is it clear at what point the actual loss is deemed to have occurred?
  • Are you consistently getting insurance certificates at closing properly listing you as additional insured and loss payee?
  • Do you have coverage for the specific type of equipment that is your collateral?

The most important question may be none of the above, but whether you know what is in your lease and are in a position to deal with a casualty without first registering shock.

 

DOWN TO BRASS TACKS  

 

No one really knows where the expression came from but the earliest written usage was in 1863 in the Texas Tri-Weekly. So much for trivia.

 

The "brass tacks" we are talking about here maybe called the "basics" or "leasing law 101". Just for fun, we thought we would hit some of the high points in the advice we have been giving for the past 20-odd years in prior iterations of this newsletter.  

 

So here is what we think you should already know and be sure is covered (and if you don't have these items covered, please contact us or your attorney):  

 

A.        Legal and Regulatory Issues

 

1.ECOA ("Reg B") - Your application should have the standard Equal Credit Opportunity Act language if you are eligible to use that language in lieu of a formal denial letter. You should also have a denial letter on hand in case someone actually asks why they were turned down. The language and form are readily available in the Code of Federal Regulations.

 

 2.Usury - If you are in the high-rate / high-risk business, particularly if you are financing automobiles or doing micro-ticket loans , we recommend a standard usury savings clause be part of your lease. Yes, some lawyers object to them for a variety of reasons. No, they are not 100% effective in every jurisdiction. Your lease or loan document should also be designed to maximize the liklihood that the court will apply the laws of a state that does not have interest rate limitations.  

 

3.State Licensing - Unless you are aware of an exemption (such as for banks, at present) you should obtain a California Lender's License if you are making loans, or leases that could be interpreted as loans, to customers in the state of California. You should also be aware of other states that have some licensing laws applicable to motor vehicle financings, purchases of retail installment sale contracts and other specific types of transactions. If you have an office or agent in a state or if a substantial portion of your business is done in a state other than where your company was organized or incorporated, you probably need to qualify to do business as a foreign corporation/LLC.  

 

4.  OCC/FDIC Regulations - If you are a bank, you should aware of circumstances under which you must treat the originator as being your credit and what percentage of your leases can have residuals greater than 25%.  

 

B.         Documentation.

 

1.  Commencement Date - It is surprising how many leases are not completely clear as to the date the lease commences. Generally speaking, the best advice is to require execution of an Acceptance Certificate, but there should be a provision for what happens if the lessee holds the equipment without signing for it for an extended period of time, uses the equipment without accepting it or rejects the equipment.  

 

2.  Events of Default - If you are going to give grace periods to your lessee, should they create a situation in which rent can always be a few days late without penalty? How does the grace period for failure to pay rent mesh with the late fee language? If the guarantor dies or becomes insolvent, do you have the right to take action? What about the general default provision: Does the lessee have 30 days to cure lapse of insurance coverage or failure to return equipment?

 

3.   Disclaimers and Waivers - Is it clear that the lease is a UCC "finance lease"? Are the hell or high water clause and warranty disclaimers clear and comprehensive, covering not only failure of the equipment to operate but any other reason that might give a rise to a set-off? Is there a clear statement that the lessor is not the vendor's agent and vice versa? 

  

4. Taxes - Is the language of the lease regarding payment of property and other taxes consistent with your actual policies?  

 

5.General Indemnity - Is the general indemnity broad enough to include strict liability, intellectual property violation and alleged simple negligence on the part of lessor?  

 

6.  Assignment - is it clear that the lessor can assign without notice to or consent from the lessee?  

 

7.  Boiler Plate (as if all this isn't) - is there a precautionary grant to a security interest? Do you have the right to inspect the equipment? Must the lessee give you notice in the event it changes its form or does anything else that could impact your UCC filing (and as termination of the filing by the lessee an immediate event of default)?  

 

8.  Insurance - is your insurance language up to date? Changes in industry forms have required changes in leases. If you are in a force-placed insurance program, does the language adequately disclose that you will be making a profit, that the insurance does not cover the lessee, etc.?

 

9.Finally, If the lease is not a true lease does appropriate language protect you from sales taxes on finance charges and other confusion? Does it contain a grant of a security interest? Should you be using an EFA?

 

Presto Change-Oops: 
Unexpected Challenges in Converting a
Lease into an Equipment Finance Agreement 
 

The rise of the Equipment Finance Agreement or EFA has been nothing short of meteoric. Fueled by concerns about lessor liability, confusion among state revenue agents regarding application of sales taxes and concerns regarding the reputation of equipment leasing, the EFA may soon eclipse the familiar "buck-out" lease intended as security.

 

On its face, using an existing equipment lease form to document an EFA transaction would seem fairly simple. The economics of an EFA should be similar to those of a lease intended as security: full payout with implicit interest and either a mandatory balloon payment or no additional payment at the end, with the borrower/lessee owning the equipment subject to a security interest for the lender/lessor . As many practitioners have found, however, taking a client's standard-form equipment lease and creating an equipment finance agreement is more complicated than it appears.

 

Basically, an EFA is a Security Agreement and Promissory Note rolled into one document with several key provisions not normally found in standard Security Agreements. These provisions commonly relied upon in the equipment financing and leasing industry, satisfy several important aspects which relate to the equipment and the commercial acceptance of an agreement in the marketplace.

 

Before even beginning the conversion process of an equipment lease form to an EFA, two fundamental questions must be answered: First, Does the lessor want the EFA to look like a loan agreement or like a lease? Some lessors want to keep the transactions it offers as far from those presented by competing banks as possible. Others want the transaction to clearly be a loan so as to approach customers who are afraid of leasing. What about the disclosure of interest rates or other common loan agreement terms?

 

Second, what are the priorities? Does the lessor want the agreement to be as consistent as possible with existing lease documentation? What consistency must be preserved? Is length an issue or may language be added to protect against legal risks inherent in lending?

 

This article will examine these and other issues that arise in converting lease forms into equipment finance agreements.

 

An Equipment Finance Agreement is a Loan Document

 

There are many reasons to begin to create an EFA from an existing lease document. Among other things, consistency between the forms will facilitate administration and maintain branding. Working from an existing form is generally less time-consuming for the draftsman (which may be read as "less expensive for the client").

 

Against this consistency, however, is a simple fact clear to most lawyers but sometimes lost on their clients: an equipment finance agreement is a loan document. It is an entirely different animal from the true lease documentation on which most, if not all, leases intended as security are based. Many of the issues raised by this difference require counsel to be versed in lending as well as leasing, particularly if the EFA is to be sold to a bank represented by counsel familiar with traditional lending.

 

What is really happening is that documentation based on equipment rental agreements is being transformed into documentation based on many years of secured lending. Some of the concepts have always been a part of leases intended as security but others rarely come up in any type of lending.

 

One of the fundamental differences between a lease and an EFA is that EFAs always involve the collection of interest. This is true whether the EFA breaks down monthly payments between principal and interest or collects both as a single level payment. While "rent" charged in leases intended as security is often recharacterized as principal and (implicit) interest, the lender under an EFA does not even have a form over substance argument that interest is collected. This means that laws regarding the collection of interest, most notably usury laws, will apply to EFAs.

 

For usury purposes, interest is generally defined as a fee collected for the use of money or forbearance in collecting a debt. Many states have either or both civil and criminal usury statutes applicable to commercial lending as well as loans to consumers. While many lessors have ignored these laws, even for leases intended as security, EFA lenders must take them into account. A particular concern is that many leases include high late fees and additional charges for tax service, inspections or other services rendered by the lessor. These charges, in some cases, can be reinterpreted as additional interest, causing a seemingly safe transaction to exceed usury rates.

 

This brings about two important defenses used by lenders traditionally as a means of avoiding usury restrictions. First, a usury savings clause, stating that the parties do not intend to violate applicable law and that payments will be reduced as necessary to avoid the collection of excessive interest is generally advisable. These clauses are rarely found in equipment leases and it is understandable that many lessors prefer not to see anything that implies that their rent may be "too high" or that any payment should be reduced. Nevertheless, many courts have held that the presence of a usury savings clause protects against usury penalties.

 

Second, choice of law becomes even more important where interest at a high rate will be collected. Avoiding application of the laws of a state with a low usury ceiling, particularly a criminal rate, is highly advisable. Including a consent to jurisdiction designating the state whose laws are chosen to apply to the EFA strengthens the application of the preferred state's laws.

 

The collection of interest brings about other issues. While lessors rarely disclose implicit rates, disclosure of interest rates may be required in EFAs, either by law or market pressures. In Georgia, the requirement of a "stated" rate of interest is generally regarded as a requirement that interest rates be disclosed in order to avoid the state's restrictive usury laws.   Customers who recognize that the EFA is a loan document may want to see interest expressed in familiar terms. This will particularly be true where the EFA is offered as an alternative to traditional loan financing, as where the lessor is competing with a bank lender.

 

Specific Drafting Considerations

 

Briefly touching on a few of the many issues that are likely to arise:

 

Definitions.

 

Replacing "lessor" and "lessee" with "lender" and "borrower" may be easy enough but raises the question of how much like a bank loan agreement the parties want the EFA to appear. Likewise, the decision whether to replace "rent" with "payment" or a similar word or with an expression of "principal and interest" involves both the question of whether to disclose the implicit interest rate and whether to distinguish the EFA transaction from a competing bank loan.

 

Loan payments are generally collected in arrears whereas rentals are usually collected in advance. This is not an iron-clad rule and there is no reason why level EFA payments cannot be collected in advance, but a potential customer comparing loan and EFA proposals may ask.

 

Security Interest.

 

It should be clear that the borrower owns the equipment from day one and is granting a first priority security interest to the lender. This sort of language, if included in a lease form at all, is often an afterthought. Unlike a lease intended as security, the EFA can clearly identify the equipment as collateral, which can carry benefits. For example, in granting a security interest, it is not uncommon to include interests in proceeds such as receivables if the equipment is rented (whether or not permitted) and insurance proceeds.

 

The security interest should, if possible, be perfected as a purchase money security interest meaning, among other things, that the purchase price of the equipment is paid to the vendor and not as reimbursement to the borrower and that a UCC-1 Financing Statement is filed within 20 days after delivery of the equipment to the borrower.                               [Originally published in the LJN Leasing Newsletter] 

 

 

To be continued in next issue....