Marks & Associates, P.C. 
Newsletter
January 2016
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FIRM NEWS

HAPPY NEW YEAR!

We hope that you had a safe and replenishing Christmas and New Year Holiday and are ready to greet 2016 with some measure of enthusiasm.

As we look ahead, there are many challenging issues we think the industry will face. 
 
Our crystal ball is currently at the cleaners, and it is anyone's guess what the economy will do and how that will affect our business generally. Nevertheless, we can predict that if things get tight there will be increased defaults and more and more pressure on legal documents that look fine in the good times but fail under close scrutiny.  The last downturn saw a huge increase in fraudulent transactions being uncovered that had stayed on the books for years. 
 
Continued below...
Firm News...

The issues of automatic renewals and lessor ethics generally are likely to become even hotter topics. In one recently Alabama case, a lessee signed a fair market value purchase option lease, thinking it provided for the $1 purchase option he negotiated with the leasing company. When the leasing company attempted to collect automatic renewal rents, the lessee cried "foul" and the court agreed. The basis for the court's decision was that, despite the FMV purchase option, the lease was actually a secured financing because the equipment had, and was expected to have, no remaining economic useful life at the end of the term. 

In other words, the court looked to the economic reality of the transaction rather than the parties stated intent and FMV purchase option. 

The accounting changes resulting from the demise of FASB 13 will encourage creativity and almost certainly reduce the number of true leases closed in coming years. 

Something, probably not something good, will result from the changes to California's finance lender law. The bigger issue is whether we will see other states introduce licensing regulation. 

We expect that the recent meteoric rise in working capital loans will result in some states taking a hard look at usury laws. 

As a general matter, it appears that lessees and their counsel are paying more attention to documentation and we anticipate certain "standard" provisions to be challenged. It may be time for lessors to know what alternatives they can offer without giving up too much. 

As more banks and traditional lending institutions become aware of the benefits equipment leasing and finance, we expect to see more loan-type transactions and changes in EFA and lease forms to add financial covenants and other traditional loan features. Unfortunately, this also means that some banks and other lenders will attempt to get into leasing and other equipment finance products without sufficient training and experience. 

One way or the other, we expect everyone is going to be busier (which is good), including ourselves and other lawyers (which may be a bad sign, generally). 

Here's wishing you and your families a healthy, happy new year. Your thoughts on these and other issues are always welcome!
Barry
  
Loan Documents For Lessors:
Do You Know What You Don't Know?
 
Many of our clients take security interests in lessee/ borrower assets other than the financed equipment as additional collateral. The common question is: can we just add a sentence or two to our lease or EFA?

While pretty much anything can be drafted, something more than a couple of sentences is required, especially in the case of collateral for a lease. In some small ticket deals, all that the deal size merits is a short addendum or very brief security agreement (together with the customary lawyer qualifications and seat-covering cover email).  For better protection, a proper security agreement is needed.

It is also not uncommon for an equipment finance company to take the step into doing working capital lending or otherwise find the need to document the transaction as a traditional loan. This scenario requires some form of note and security agreement and, in more complicated transactions such as lines of credit, a formal loan agreement.

We find that some of our clients have this documentation readily available. In most cases, new documents must be drafted and the question comes up "what should be in a proper loan and security agreement?" (OK, no one actually asks, but they should, or at least they should know WHY these things are included).

Obviously, there are a thousand variations on this theme, depending on whether the document is merely a security agreement creating a security interest in specific assets or is covering "all assets" and whether loan agreement provisions for multiple closings are necessary. The documentation can be fairly simple, running no longer than the typical EFA, or extremely complicated.

Subject to all the usual mealy-mouthed lawyerish qualifications, here is a very general overview of what you might expect in a properly - drafted short form loan and security agreement.

Opening and Recitals:
Agreement should clearly delineate parties, and basic nature of transaction.

Basic terms:
The Agreement should specify amount of loan (or, if line of credit, maximum commitment), the interest rate and term. If line of credit, the term during which line will remain open should be specified. Use of loan proceeds should be stated. If one or more promissory notes are to be executed, they should be described and a form attached as an exhibit unless only one note will be signed and the Note is executed simultaneously with the loan agreement.

Payment terms:
Unless these are to be covered in a separate promissory note, terms of payment should be clear.

Security:
first priority security interest should be granted (if this is intended) and the collateral should be clearly specified. The grant should include proceeds, additions, replacements, etc. If UCC terms are used, reference to a state UCC version should be included. The language of this section may vary with the type of collateral. If real estate is involved, additional documentation such as a mortgage or deed of trust will be necessary. If the collateral is to be rented or sold by the borrower, special inventory procedures will be necessary. If accounts are taken as security, and a line of credit is established, the agreement should specify terms under which accounts will be accepted in calculating the borrowing base to determine the amount to be advanced should be specified.

The documents should limit the Borrower's rights to sell or otherwise deal with the collateral, specify its obligations regarding maintenance and movement of the collateral and address a casualty or theft of collateral. This will vary in importance with the type of collateral (a fleet of trucks, for example).

Conditions to Loan(s):
Generally, the Agreement should specify conditions to Lender's obligation to make loans, which may be different for the first and subsequent advances. Among other things, it is customary for:
  • All documents to be executed and delivered
  • The borrower should be in good standing and a secretary's certificate should be provided attesting to the incumbency of officers signing and the approval of the borrowing by the borrower's board of directors or other governing body. There should be similar requirements for guarantors.
  • Special collateral (real estate) will require additional documentation and reports (title examination)
  • There should be no material adverse change in the borrower's business or financial condition and no default.
  • Evidence of satisfactory insurance is often required.
  • All documents and conditions must be acceptable to the lender.
Representations and Warranties:
There is a long list of representations the borrower (and in many cases, the guarantor) should make, many of them backed up by documents to be delivered as a condition to the first or each loan. These include:
  • The borrower is duly organized or incorporated, in good standing, and authorized to enter into and perform the obligations without violating any law, agreement or other binding impediment.
  • The loan and agreements have been duly authorized, executed and delivered and are legal, binding, valid and enforceable in accordance with their terms.
  • The borrower is not subject to any government or private action that would conflict with the loan or borrower's performance.
  • There are no legal actions pending or threatened against the borrower that would affect its ability to perform.
  • The collateral is free and clear of liens and the borrower has the right to grant a first priority security interest to lender.
  • The borrower was formed in the indicated state and is located at the stated address.
  • All information furnished by the borrower (particularly financial information) is accurate.
Covenants of Borrower:
The borrower should agree to certain affirmative covenants, including:
  • To properly use and maintain the collateral
  • To pay taxes, keep the collateral free of liens, and maintain insurance in agreed amounts
  • To maintain its existence and not change its form of business or the state of its organization/incorporation
  • To furnish required reports and financial information
  • To indemnify lender against third party claims
  • To furnish additional documents and assurances when requested
  • To maintain agreed financial ratios, net worth targets and other financial covenants
  • To permit the Lender to inspect books, records and collateral and to file UCCs
 
Defaults and Remedies:
The Agreement should specify that certain actions and events are defaults and provide adequate remedies for the lender. These defaults (which in some cases should include similar events as to any guarantor) include:
  • Failure to pay principal or interest or any other amount due
  • Breach of any representation, warranty or covenant (which may or may not include a brief cure period)
  • Default on other obligations to lender or to others (this is often negotiable, with lender agreeing to some floor amount or other limitation)
  • Change in management or business
  • In some cases, material adverse change or the lender's becoming insecure as to the borrower's performance (often a sticking point for borrowers)
  • Bankruptcy or reorganization
Remedies should include all those permitted by law, including UCC remedies as to any collateral, the right to accelerate payments on the note and specific remedies as to collateral. Remedies should be cumulative and borrower should agree that exercise of any one does not constitute an election not to exercise others.

Miscellaneous:
  • Notices - specific means of communication and all to be in writing
  • Governing law AND place for litigation to take place
  • Waiver of jury trial
  • Right of lender to assign its interest in the loan.
  • Entire agreement (no other agreements except as specified, no oral agreements or modifications)
  • Waiver of borrower right to claim ambiguities should be resolved against the draftsman
  • Right to sign in counterparts, protection of chattel paper, severability of clauses if one found unenforceable
  • General terms of construction (inclusion of plurals and genders).
  • Usury savings clause (important for high yield loans)
  • Right to perform for borrower (buy insurance, remove liens, etc.)
  • OFAC and any other government-mandated programs (may depend on borrower)
This checklist is furnished to enable the reader to make a cursory examination of form or sample loan documents and determine the professionalism of the draftsman. It contains only very general information, does not purport to highlight all important issues and does not address important issues regarding wording. It is not a substitute for review by counsel. In many cases, issues may be addressed by other language in document as there are no "standard" forms.

Liability Insurance Coverage:
 All-Time Favorite Story

OK, stop me if you've heard this one.
 
A guy (not a client) doing small ticket leasing called one day with a question. (Yes, people do all the time and it is fine if you want to).
 
"Do I really need to require my lessee to have liability insurance or is that just something we like to get if we can." (Translation: can I just forget about it to book the deal).
 
Stroking my chin (which usually costs extra) I asked a few questions:
 
True lease, $1-out or EFA?
            FMV (true lease). Actually, given the other answers it wouldn't make much difference. Unfortunately, a $1-out lease isn't much safer because judges don't always get the distinction and, even though liability for damage caused by equipment financed by a loan or EFA is remote, there are a couple of issues to consider.
 
What is the equipment?
            A welding unit. If the equipment is a phone system or computer, some lessors will forego liability coverage for obvious reasons. I asked what was included in a welding unit the guy's description of the unit involved a heat source, pump/motor and propane tank.
 
What state(s) are we talking about?
            Some states impose vicarious liability (a lessee's negligence is imputed to the lessor) and even strict liability (no showing of negligence by anyone required). Florida. Florida has a "dangerous instrumentality" rule that says that if you own an inherently dangerous piece of equipment or other property, you are automatically responsible for damage it causes. Think about the law school example of a shed full of dynamite, properly stored, that blows up due to an unforeseen lightning storm. The Graves Amendment eliminated vicarious liability for automobiles, subject to a couple of notable exceptions.
 
OK, so what is the lessee going to do with the welding unit in Florida that you will own and lease to him.
            (No kidding. This was the answer). "He is going to weld it to the bed of his pickup truck so he can take it to jobs with him."
 
Ummmmm....so this guy is going to be driving up and down I-95 with this little bomb attached to the back of his pickup truck, which is not designed to haul this particular device. The guy probably has an automobile policy and that is good because welding the thing to his truck may mean it has to be covered by a motor vehicle policy, but it may be outside his coverage and may breach the policy terms.
 
Is he, like, super rich and able to pay any judgment through the lease indemnity?
            "Of course not. He is a welder. He is kinda, well, a storied credit."
 
So, even if you don't get sued, if he has an accident, the lawsuit against him will ruin him and your collateral will be gone. Liability coverage is a credit issue as well as a legal/protection thing.
            Oh, yeah. When you put it THAT way.
 
One issue that we didn't get into with the caller was that the standard insurance certificate is not necessarily ample protection for equipment that may violate policy restrictions. Absent an actual policy endorsement (and often, review of the policy itself), the lessor can be at risk. Judges have made it clear that the certificate is NOT binding on the insurance company in a manner that would cause it to serve as an amendment of the underlying policy. In other words, if an agent issues an insurance certificate saying the lessee has coverage, and the lessee does not have the coverage, the lessor may have an action against the agent but it does not have coverage.
 
 
There will be an insurance breakout session, chaired by Beth Henderson of Altec Capital, at the next ELFA Legal Forum. It should be very informative.
 

California Update: No News Is Bad News

As of this writing, the California Department of Business Oversight has not responded to the ELFA's questions regarding changes to the California Finance Lender License laws. The changes do NOT change the necessity for a broker to have a license to arrange loans for California residents. Anyone performing the services of a broker (no, it isn't defined) in California must have a license, This is not new.

What is new is that the lender who funds the broker's deal can be penalized for doing business with an unlicensed broker. It is possible that this is how the law, or the DBO's reading of the law, always worked. One way or the other, as of January 1, 2016, lenders doing business in California are charged with ensuring that their brokers are licensed.

There does not appear to be any transition provision or leniency granted to brokers scrambling to get licenses, which can take six months to a year, or to lenders doing business with them.

We are keeping abreast of the situation. While there doesn't seem to be any creative solution, we think some businesses whose activities might fall outside the definition of a broker may be able to at least make a good argument that they were never required to be licensed. There is also a big question regarding banks and the reach of the law. For the present, we must advise extreme caution and strict adherence with a statute we believe to be legislative overreaching. 

Published Articles for Additional Reading
Due Diligence for Municipal Lessors
By: Barry Marks & 
Bill Phillips
ELFA's Equipment Leasing & Finance Magazine, Nov/Dec 2015

By:  Matt Evans
Leasing News, Sept 2, 2015

By:  Bill Phillips
Leasing News, Sept 28, 2015




Marks & Associates, P.C.
400 Century Park South
Suite 100
Birmingham, AL 35226
(205) 251-8301
_________
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.