LANDLORD WAIVERS: WHO NEEDS THEM?

The answer from most lawyers is "you do". While that is the correct answer for your law school exam (should you ever attend), there are some qualifications. Anyone who has been in the business for a while is shaking his or her head because the landlord waiver is often one of the most difficult pieces of paper to obtain. That being said, here is our standard advice regarding landlord waivers:

A good landlord waiver accomplishes several purposes. First, it provides that the landlord will not assert a lien for unpaid building rent against your equipment. In many states, landlords have an automatic lien (sometimes called a "distress lien") on any equipment belonging to the tenant (and herein lies an obvious issue). Whether this lien takes priority over the lien of an EFA or lease intended as security depends principally on whether the lender/lessor's interest was in place before the equipment was delivered. Essentially, a PMSI defeats a landlord's lien in most states. The question may be: how hard do you want to fight over this issue?  

Second, a good landlord waiver includes an agreement by the landlord permitting the equipment financer to pick up the equipment in the event of a lessee default. Landlords have been known to padlock buildings and refuse to allow anyone to enter unless rent is brought current or to label the lessor's efforts "trespassing." This sometimes requires intervention of the local sheriff and anyone who has been to the movie knows the headache it causes.

Third, a landlord waiver may provide that the landlord will give notice of any tenant default, permit the lessor to leave the equipment onsite and permit inspection after default and may provide other useful benefits.  

Unfortunately, landlords often hold out for language of their own before signing a landlord waiver. Any insertion by the landlord or its counsel should be reviewed carefully. Often, the landlord's counsel will provide that the equipment financer must bring rent current or even pay rent for as long as the equipment is onsite. Mutual notice requirements are not rare. We have seen landlords refuse to sign anything, insist that the waiver be reversed so that the landlord has priority in the equipment, and take other positions, some of which are reasonable and sometimes ... not so much.  

On the other hand, it is quite reasonable for the landlord to insist that any damage caused by removal of the equipment be repaired. If, in fact, it is likely that a wall will be torn out when the equipment is moved, the equipment is more likely a fixture but the cost of repairing this removal must be taken into account.  

This leads to the inevitable question: how badly do you need the landlord waiver? A few thoughts for your decision matrix:

• How heavily are you relying on the collateral? Would you be willing simply to abandon it altogether in the event of a lessee default?
• Is your transaction a true lease or a financing? A landlord waiver is much more important in the case of an EFA or lease intended as security.
• Will you have a purchase money security interest or is the transaction essentially a sale-leaseback?
• Could the equipment be deemed a "fixture"? If it is possible that the equipment will be deemed part of the real estate, the landlords waiver is much more important. Similarly, the waiver is more important if it is going to be difficult to remove equipment without damaging the premises or making special arrangements for cranes, equipment movers and such.
• Are you doing a fixture filing? In some states (Alabama) filing against fixtures requires payment of the full mortgage recording taxes, which can be very expensive.
• Is the transaction big enough to be worth the bother and is the lessee willing to pay additional costs should there be delay or if you need to get a lawyer involved?

Ultimately, the biggest question of all: how high-risk is the transaction and is the lessee able to provide additional collateral if you cannot obtain the waiver?

WHY EQUIPMENT FINANCE?

We were asked recently to explain the difference between traditional lending and equipment finance. Volumes could be (and have been) written about this subject, both from the perspective of the lessor/lender and lessee/borrower. Here are a few observations:

1.    Equipment Finance is a term broadly used to define the financial product at one time called Equipment Leasing. That term proved inaccurate as the industry evolved and leases with nominal purchase options grew to represent as much as 75% of the transactions closed. Further evolution into the world of "equipment finance agreements" made it clear that this line of business, while very similar to secured lending, offered lenders and borrowers alike several advantages. Today, the term is used for true leases (including TRAC leases and tax-oriented leases), leases intended as security (nominal purchase option leases), and equipment finance agreements. The term is also applied to transactions that may be operating or capital leases and municipal or government leases that may or may not provide tax-free interest benefits.

2.     Equipment finance transactions open new lines of business for lessors, particularly banks. The product is now offered by many smaller community banks as well as the traditional larger institutions. Equipment finance also offers higher yields and, particularly in the case of true leases, better security in the event of a lessee bankruptcy.  

3.    Unlike traditional secured lending, which focuses primarily on the borrower's credit and secondarily on the value of collateral, equipment finance often relies at least equally on the collateral value, requiring documentation that better protects the value and accessibility of the collateral.  

4.     One of the reasons that equipment finance has become so popular with banks and other lenders is its popularity with the customer. Equipment finance offers 100% financing, often reimbursing the lessee for any down payment while giving it the benefit of vendor programs such as trade-ins and volume discounts. In a tax lease, the entire rental is deductible rather than only the interest portion and the lessee is not subject to alternative minimum tax restrictions. Leases that qualify for operating lease treatment are kept off the lessee's balance sheet, reducing debt.  

5.      Equipment finance documents can be tailored to provide all the protections of traditional lending, including financial covenants, audited statements and regular reporting, even floating rates.  

Why equipment finance? It is a multi-billion dollar financial product growing in popularity for good reason.

Hell or High Water.

One of the few comforting aspects of EFA transactions as opposed to leases is that loans are in inherently "hell or high water" obligations. Warranty disclaimers, unconditional obligation language and prohibitions on setoffs rarely appear in traditional loan documents. Nevertheless, particularly in the case of an equipment financing by a vendor captive, or any time that the EFA is to be based on a lease agreement form, it is probably a good idea to leave in at least a bare bones disclaimer of UCC warranties and statement that the transaction is free from rights of set-off and the like.

This raises the question of whether there is any downside to the EFA being interpreted as a lease. In most instances, lessors engaging in true leasing go to great lengths to avoid their transactions being interpreted by bankruptcy courts and tax agents as disguised loans. The reverse is rarely true but not inconceivable, as when a funder is concerned about possible bankruptcy of the originating lessor or a plaintiff whose client has been injured by equipment collateral seeks to establish ownership in the lender in order to sue for negligence or vicarious liability.

From a more practical perspective, some funder's counsel who have more experience is lending than leasing may be uncomfortable with including traditional lease language in what is acknowledged to be a loan document. If so, the belt-and-suspenders benefits of stating that the EFA obligations are absolute and unconditional may be outweighed by the need to appease a banker.

Use and Maintenance.

Lease documentation traditionally focuses on the equipment collateral as much as the creditworthiness of the lessee and it might be argued that language requiring specific maintenance and applying restrictions on use is unnecessary. While this language may be confusing to some bank counsel, careful consideration should be given to the effects of reducing the borrower's obligations from those of a lessee.

Insurance.

A major policy decision for many lessors is whether to require liability insurance coverage in an EFA. The lender under an EFA is significantly less likely to be successfully sued for damage caused by the equipment collateral than the owner of equipment under a true lease. Nevertheless, dropping the requirement for liability coverage may not come easy to many lessors or their banks. Similar drafting issues arise in the general indemnity section, which might be shortened if space is a concern.

Default and Remedy Language.

With particular regard to the use of remedies under Article 9 of the UCC, this language must be reconsidered as it relates to loan foreclosures as opposed to lease repossessions. One particular concern is whether damages are calculated with reference to Casualty Value, as discussed below. If Casualty Value results in charges in excess of the outstanding principal, the calculation might be deemed to create a penalty, which might not be enforceable. In addition, rules regarding "commercially reasonable" sales and other limitations are even more important in an EFA than a traditional lease.

Casualty.

Many lease casualty tables or stipulated loss value tables include protection from the loss of the lessor's bargain or additional charges to make the lessor whole should interest rates change since the inception of the lease. This calculation may not be enforceable in the case of an EFA because the lessor's loss is calculated with regard to equipment while a lender's loss is calculated with regard to the loss of principal. A make-whole provision or stated prepayment premium, if those protections are desired, should be a expressly stated rather than being added into the casualty value table calculation without disclosure.

Other Provisions.

-Originally published in LJN Leasing Newsletter