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FIRM NEWS
I remember the day one of my kids asked what it was like in the Great Depression. After assuring them I was not that old, I told them to ask their grandparents. I spent the next few minutes thinking over what it meant to my folks to live in the Great Depression and what scars it left. The experience of living through hard times taught them lessons that were probably very valuable later in their lives. They were cautious with money and highly distrustful of any get-rich-quick scheme. They played the stock market but insisted on a widely diversified portfolio. My mother still chews a half stick of chewing gum at a time.
So what did we learn in the Great Recession? The often and variously quoted observation by George Santayana that "those who cannot remember the past (or 'do not learn from history') are doomed to repeat it" comes to mind.
Already we are seeing app-only deals escalate into the $100,000 and above region.
Turn around times are measured in minutes as back offices are under pressure to move ever faster.
Anything beyond looking at a credit score seems doomed to become undue diligence.
There is money to be made and, as funds begin to flow again (however slowly), the ability to place money at high yields becomes ever more attractive. The growth of merchant cash advance companies seems likely to fuel a new acceptance of high rate equipment finance by small and emerging businesses.
We by no means want to rain on anyone's parade or slow the growth of business. We would be remiss, however, if we did not remind everyone of what happened between 2009-2011: many seemingly reliable lessees and borrowers were found to have committed some form of fraud and many credit departments were found to have succumb to pressure to believe that the economy's rapid growth would continue.
As opportunities begin to open again and we see welcome growth in equipment finance, we hope our clients and friends will remember that deals that are "too good to be true" are often just that, there is no reason to rush through a questionable deal or short-cut due diligence, and knowing your vendor and customer remains the best way to insure that your trust is justified.
Give Bill, Matt or me a call if you want to talk about how to protect yourselves from fraudulent deals.
Barry
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MARKS & ASSOCIATES HAS RELOCATED
The offices of Marks & Associates, P.C. have relocated to:
400 Century Park South
Suite 100
Birmingham, AL 35226
Our mailing address remains:
P.O. Box 11386
Birmingham, AL 35202
Direct Contact Information:
Barry Marks
205.251.8301
Barry@leaselawyer.com
Bill Phillips
205.251.8306
Bill@leaselawyer.com
Matt Evans
205.251.8302
Matt@leaselawyer.com
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SHOULD YOU BE CONCERNED WITH USURY?
In May, a decision by the Second Circuit Court of Appeals in the Madden v. Midland Funding, LLC case[1] sent shockwaves through the consumer credit industry. To the consternation of many, a Federal Appeals Court held that a bank's federal preemption of state usury law did not apply to a debt collector who purchased the credit card debt at issue.
Perhaps more troubling for equipment finance, the court gave an ominous nod to the possibility that the law in which the debtor was domiciled, rather than the law designated under the loan agreement, as applying to the transaction (a choice of law clause) determined which state usury law would apply. Because the usury law the plaintiff's attorneys argued should apply was that of the state of New York, this could, conceivably, bring about criminal penalties for the debt collector. We have been asked by several clients whether they should be concerned with usury law, laws limiting the amount of interest that may be charged for an extension of credit. In most cases, equipment finance companies have paid little attention to these laws for several reasons, including that equipment finance grew out of the equipment leasing business and, at least in theory, leases charge rent not interest. So, should you be concerned? Consider the following:
1. Are you a bank? Banks continue to enjoy federal preemption which means that state usury laws are not applicable to bank loans generally. There is, however, a big caveat: federal preemption no longer applies to protect bank subsidiaries or affiliates. As we have reported previously, the federal Dodd-Frank law limited federal preemption to the banks themselves.[2]
2. Are you charging interest? As a general rule, rent charged under a true lease is not subject to usury law. The question of whether rent charged under a lease intended as a secured financing (a $1-out lease, for example) enjoys similar protection is an open issue, however. While interest is not stated, such a lease could be argued to include a principal and interest payment as components of the rent. There is little question where an Equipment Finance Agreement (EFA) is involved. An EFA is a debt instrument and, whether broken out as interest or not, it is likely that the interest component of each payment would be subject to state usury law, if such law otherwise applies to the transaction.
3. Do you state the rate of interest in your document? Some states appear to require disclosure of interest rates on loan transactions. This can be tricky as equipment lessors generally do not state the imputed interest rate used to calculate rent on face of their lease documentation. We simply do not know how a court might treat a lease intended as a secured financing, as opposed to a true lease, in terms of this question. Again, the exposure is greater for an EFA. We have generally counseled that, if the interest rate is not going to be disclosed, the transaction documents should include a statement to the effect that borrower can calculate the rate using the loan amount and payments. This does not work if neither the loan amount nor interest rate is to be disclosed and the payment is going directly to a vendor.
4. Do your documents include a usury savings clause? This clause, sometimes called a "blue pencil" clause, generally states that, if the interest charged on the transaction exceeds the highest rate permitted by applicable law, the overage will not be charged or will be refunded. The theory is that it is better to lose a few dollars of interest if worst comes to worst than to suffer civil or even criminal penalties. Unfortunately, this seemingly strong protection is not bulletproof. At least one court has intimated that including a usury savings clause was evidence of the lender's intent to evade the law.
5. Does your documentation include a choice of law? What about a consent to jurisdiction? We generally advise that a consent to jurisdiction (forum selection clause) is a good way to support the choice of the law of a favorable state. In most states, the document can choose to apply any state's law if the state bears a reasonable relation (sometimes, a substantial relation) to the transaction involved. What this means and how much the relationship is necessary can be a complicated issue. As indicated in the Madden case, many courts will not simply accept the choice the choice of law stated in the document, but it is an important defense to usury defenses.
6. Are we talking about criminal or civil penalties? We have advised several of our clients to be extra conservative if they propose to do business in a state where there are criminal penalties for usury violations. It seems rather silly that laws designed to keep Tony Soprano from breaking people's legs should be applied to legitimate business transactions, but criminal laws for charging high rates of interest are on the books in several states, including New York and Florida.
At the end of the day, like many other legal issues, a judgment call has to be made as to how to interpret the answer to these and other questions as with many other legal issues, however, our point is that the judgment call has to be made and simply ignoring the issue is not a good policy.
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[1] Madden v. Midland Funding, LLC 2d Cirr. 2015)For a copy of the case, please contact us.
[2] In fact, most of the Madden case was concerned with whether federal preemption applied to credit card debt issued by a bank but sold to a debt collector. The court held that it did not under the facts of this case. This could be a terrible precedent for lenders who partner with banks to escape usury laws.
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OFF-THE-CUFF ADVICE
In case you have ever wondered,it seems the phrase "off-the-cuff" refers to the practice of writing debts on the "detachable" cuff of the lender's sleeve. An "off-the-cuff" loan would be one that is not written at all. Another version is that it came from actors who made notes about their lines on the cuffs of their shirts rather than memorizing the script.
1. Does your EFA provide for automatic renewal or pro rata interim payments? These concepts may survive where an equipment lease was used to create an EFA. The problem is that automatic renewal of an EFA simply extends the time for payment after payment in full has been received. Charging a per diem on a pro rata basis between the date of funding and the first full payment date means that the borrower is either paying a higher rate of interest than stated in the EFA or is actually paying more principal than is borrowed.
2. Do you need a separate certificate of acceptance? In many instances, the lease (or Schedule to a Master Lease) is signed only when the equipment is accepted by the lessee. In such a case, it would seem that having a separate certificate of acceptance is unnecessary. There are two significant exceptions to this rule:
(i) First, will the person signing the Schedule have full authority? It is not uncommon for a certificate of acceptance to be signed by someone on-site. This may not be a corporate officer of the lessee. (There is a lot to be considered if that is going to be the case, particularly in larger deals.) The more significant question is whether the fact that the schedule is going to be signed at the time of delivery means that only the master lease is signed by a duly authorized officer and the Schedule is going to be signed by someone who would otherwise sign the certificate of acceptance. It might be possible to arrange for a broader authority for whoever signs the schedule, but if the Schedule includes the most important business terms for the transaction, it may be essential that an officer sign it.
(ii) In Florida, the certificate of acceptance must be a separate document in order to avoid documentary stamp taxes for loans and leases executed in the state of Florida by Florida lessees.
Of course, all this assumes that the Schedule is not going to be signed until the equipment is delivered and accepted. Any documentation that facilitates getting lazy and having the lessee sign before the equipment is actually delivered, inspected and accepted should be discouraged as there have been judges willing to throw out a certificate of acceptance signed in advance.
3. Whatever happened to legal opinions? We are not complaining. Some of us remember years of fighting over opinion language in large ticket leveraged leases and it was time hardly well spent. Nevertheless, increased competition and the desire to close quickly have resulted in many transactions that should be supported by a legal opinion signed by the lessee's counsel being replaced with incumbency certificates containing legal conclusions and other shortcuts. If there is any question at all about (1) the authority of someone signing your lease, or (2) whether the Lessee has the legal power to enter into the transaction (such as a lessee who cannot produce its charter documents before closing or is a public entity or part of a complex corporate structure) you should consider having a lawyer bless the transaction in writing may be not only advisable but necessary. Ideally, this should be the lessee's counsel and at its expense.
4. Guarantee Limits. It is not uncommon for a good credit Lessor Guarantor to insist that its liability be limited. How these limitations are worded can be a lot more of a problem than meets the eye:
If the total liability with respect to a specific master lease is limited, and multiple schedules will be executed and assigned to different funders, the first few funders taking assignment need to be aware of certain risks. For instance, if there is no limit on how many schedules are executed, the value of the guaranty is diluted every time new equipment is placed on the lease. If cross defaults are not handled properly, a guarantor might pay out its full liability to address one lessee default before defaults even exist under other schedules.
Where more than one guarantor signs a guaranty, it is not uncommon for them to ask to have their liability limited in accordance with their percentage of ownership. If not properly worded, this limitation does not take into account allocation of costs of collection and other amounts owing over and above the debt itself. In addition, if the total percentages add up to 100, there is no protection if any one guarantor falls short or escapes liability. Even if it is not as good as "joint in several", insisting that each guarantor be obligated for slightly more than its percentage of ownership may avoid a significant shortfall. Another bear in mind that if one of the guarantors relies on the lessee or borrower for much of its income, the guarantor from that person is probably no more valuable than the lessee's obligations itself.
5. Do you use the same forms of secretary's/incumbency certificates for corporations, LLCs and partnerships? Do you have a policy for when you need to see the LLC operating agreement, partnership, by-laws or other charter documents over and above those that are public record?
6. Have you checked the Miscellaneous section of your lease document recently? Is your back-office aware of the requirements for notice and are these requirements up-to-date? Does your lease accurately reflect how you assess late fees?
7. Are you in good standing with the secretary of state of every state where you have an office or an employee who works out of his or her home or otherwise conducts business on your behalf as if you did have an office in that state?
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A GROWING TREND: ELECTRONIC CHATTEL PAPER
As technology rapidly expands and becomes more accessible, usage of electronic chattel paper is only going to increase. This article will address possible areas for confusion concerning electronic chattel paper.
What is electronic chattel paper and why is it important? First, do not forget, that a lease of equipment or an equipment finance agreement constitutes chattel paper.
(1) What is electronic chattel paper? It is a file on a computer, data on a server or in another words a document existing in solely electronic format.
(2) Is my PDF or scanned copy of a lease or electronically signed lease agreement electronic chattel paper? No, a document in this form, although in an electronic format, is not electronic chattel paper. For example, a lease scanned into PDF format or sent electronically over a email, printed out and manually signed then scanned and sent in a PDF format back to sender is not electronic chattel paper. Chattel paper in such format is still traditional non-electric, tangible chattel paper as it is not data on a computer existing. Once a document is produced in physical form it is no longer electronic chattel paper unless it contains certain acknowledgment identifiable on the document.
(3) How do I gain priority if I am purchasing or lending against electronic chattel paper? Possession with non-electronic chattel paper is the critical inquiry. Possession provides priority and critical rights to the chattel paper. With electronic chattel paper, the Uniform Commercial Code puts control of electronic chattel paper on the same footing as possession of non-electronic chattel paper. The Uniform Commercial Code states that a purchaser or lender has control of electronic chattel paper if a "system employed for evidencing the transfer of interest in the chattel paper reliably establishes the purchaser or lender as the person to which paper was assigned." Certain software in the marketplace can satisfy the safe harbor provision found under UCC 9-105 (b).
(4) What are the benefits of using electronic chattel paper? Ease of doing business, i.e., documents can be sent, signed, stored, and stored on a data vault all in one online database. This can include certain validation procedures, akin to a notary acknowledgement, that can ensure the signatory is the intended individual. These validation procedures when combined with the data vaulting technology can ensure that the electronic chattel paper original is retained and held by the party claiming ownership and can promote transferability and assignment with ease.
When assigning or selling a deal, this presents distinct advantages. A "data trail" can be produced and it can show all actions related to the electronic chattel paper.
(5) Disadvantages to electronic chattel paper? As with any new technology, a learning curve is always present. However, market trends all forecast the use of electronic chattel paper is on the rise. Many in our industry have often gotten used to utilizing "paper" documents. One point of continued concern in our current environment is data security. Data hacks and security breaches can be of potential concern. However, many industry experts think that this risk can be addressed with certain protocols and safeguards resulting in the benefits outweighing the risks.
In the long run, it is likely that the cost of switching to new software, learning and training new procedures and increased data security protocols will likely increase the usage of electronic chattel paper. So get ready...it is on the horizon.
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Marks & Associates, P.C.
400 Century Park South
Suite 100
Birmingham, AL 35226
(205) 251-8301
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P.O. Box 11386
Birmingham, AL 35202
- Barry S. Marks - 205.251.8303 - barry@leaselawyer.com
- William L. Phillips, III - 205.251.8306 - bill@leaselawyer.com
- Matthew D. Evans - 205.251.8302 - matt@leaselawyer.com
Nothing in this newsletter constitutes legal advice or is intended as a substitute for consultation with a qualified lawyer, accountant or other professional.
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