Marks & Associates, P.C. 
Newsletter
February 2019
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BIG DOIN's

Welcome to 2019. It's 35 years after Orwell's dystopia. Congratulations, you made it. Now, let's talk about what's in store for us in the year to come. No, we don't have a crystal ball-toting wizard (here in Alabama, it would be more like the weird witchy lady up in the hills who talks to her mandrake root, keeps a pot boiling that is suspiciously large and looks like her family tree ain't got no branches). Here are a couple of legal issues we in equipment finance may well be facing:

Interim Rent. Yes, it is perfectly reasonable to charge interim rent in leases. We are more than a little concerned about how a judge might do the math on charging it in financings where the lender is not actually out of pocket and the customer is arguably not receiving benefit of the loan during the interim period. This sort of thing can raise the interest rate (discussed later on) above state usury limits, or what is disclosed in the document, in a proposal letter, or in communication with the vendor that is passed to the customer.

Rate Disclosure and Fees. Very few states now require (or will when they get around to issuing regulations) disclosure of interest rates. So what happens if a borrower in a financing agrees to a stream of payments but cannot calculate the rate from the documents because the amount financed is not specified? Is the amount financed the same as the equipment cost?

If a financing does disclose the rate or amount financed, is the number accurate? Interest is "all amounts charged for the extension of credit or forbearance to collect a debt." Fees are either pass-throughs of actual expenses or compensation. If the latter, they might be added into the interest calculation for legal purposes.

The disclosure of "equipment cost" may be misleading if the number includes fees or points paid to the vendor or whatever. It might be better to call it "amount financed" or note that additional amounts are being advanced and included in the calculation of payments.

Commencement Date. How does the actual delivery of equipment, or the actual payment to the vendor match up with the commencement of the rent or payment accrual?

Usury and Licensing. We have spent a great deal of time over the past few years researching usury and licensing laws around the country. Suffice it to say that the protections on which most lenders rely are not 100% effective, especially where criminal usury is involved. While we don't expect new usury laws (we have been surprised before, however), it looks like other states will follow California's lead (nearly always a bad idea...sorry) and enact laws requiring lenders financing or leasing personal property for business use to be licensed in some fashion. Also, we expect more enforcement of laws regarding, among other things, motor vehicle sales and leases to be enforced more aggressively.

All of these issues are probably attributable to the industry's roots in actual equipment leasing. Is it the same to say that the lessee pays rent from the date it has the use of the equipment and agrees to pay rent based on the value of the equipment to it and that a borrower of funds used to finance equipment does the same? Is a lease or EFA immune from usury attacks because it does not specify "interest"?

There are other issues out there on which we are keeping a close eye:

Negligent entrustment. Way back when the Graves Amendment relieved motor vehicle renters and lessors from imputed negligence (a lessee's negligence charged against a lessor) and strict liability (liability for owning and leasing equipment whether or not the lessor is negligent). This law only applies to motor vehicles , which are defined elsewhere in the federal statute as:


"...a vehicle driven or drawn by mechanical power and manufactured primarily for use on public streets, roads, and highways, but does not include a vehicle operated only on a rail line."

The recent Florida Supreme Court case of Newton v. Caterpillar Financial Services Corporation caused a stir because Florida's strict liability law was held to apply to construction equipment. This should not have been a surprise, however. Construction equipment does not fall within the protection of the Graves Amendment and Florida's tough "dangerous instrumentality" doctrine has long applied strict, no-fault, liability to the owners of "inherently dangerous" equipment. A multi-terrain loader being included in this category is less of a surprise than a sailboat. See Samuel Friedman Family Enterprises v. Amoroso.

The bottom line is that various (unfair, ridiculous, anti-business and downright stupid) means of allowing injured parties to sue lessors who are not at fault have been around for years and the only protections a lessor has are (1) do a loan or EFA because they are very much safer in this regard (but watch out for usury limitations), (2) insist on the lessee carrying lots of liability insurance and be sure the lessor is an additional insured on the correct form - if it is a very risky credit or dangerous equipment, get an endorsement to the policy and do not rely on the insurance certificate alone, (3) lease dangerous equipment only to creditworthy lessees, and (4) carry liability insurance and an umbrella policy with excess liability coverage and coverage if the lessee's insurance lapses.

But wait, there is more. There is an ancient doctrine that is a favorite of law school professors and future plaintiff lawyers called, negligent entrustment. Under this doctrine, a court (actually, a jury) can find a lessor negligent if it allows the wrong lessee to rent equipment. For example, renting a car to a driver with no license, or a string of DUI's.

What about the Graves Amendment, you ask? It does not apply to a lessor's own negligence and that is what is alleged in negligent entrustment cases. In other words, this is a potential end run around Graves and might apply not only to lessors of equipment other than motor vehicles but to vehicle lessors Congress was trying to protect.

There are multiple schools of thought about how to protect against negligent entrustment liability. Again, insurance might be the best answer.

Force Placed Insurance. While we are on the subject, a recent case against a major financial institution shocked us. In case you haven't heard, requiring a lessee or borrower to pay for replacement insurance or pay a surcharge for failure to comply with insurance requirements can result in class actions. Insurance language in the lease or EFA must be checked and updated for the latest nightmares in this regard, especially if the lessor or lender is profiting from the lessee or borrower's failure to carry insurance.

Y'all know what is coming. A brief commercial message. Consider contacting a qualified lawyer and discuss whether you have exposure to these issues. We know someone to recommend, but we honestly want you to talk to someone who knows what he or she is doing.

Return to 1984, anyone?

ISSUE
LEASE
EFA and $1-out Leases
Who owns equipment?
Lessor
Lessee
Who owns equipment on "day one" whether or not a purchase option is exercised?
Lessor
Lessee
Usury issues
Generally, usury does not apply to true leases as there is no "interest" being paid.
The interest portion of the payments, whether or not stated in the EFA, is subject to usury limitations in most states. If the judge follows the law, he may apportion "rent" between principal and interest in a $1-out Lease.
How is rent apportioned and treated for tax purposes?
All rent is a payment and subject to state sales/use tax and income for federal and state income tax purposes; rent is deductible against income taxes by the Lessee.
A portion of rent is principal recovery and payment for the equipment. It is taxable for sales/use tax but is neither taxable as income to Lessor nor deductible by Lessee. The remainder (interest or service charge) is not subject to sales/use tax , is income to Lessor and deductible by Lessee for income tax purposes.
Lessor Liability
Potential liability for alleged negligence in entrusting equipment to Lessee and, as to equipment other than motor vehicles, possible strict liability without any allegation of Lessor negligence if equipment is inherently dangerous. "Creative" means for finding a Lessor actually negligent may be tried by plaintiff counsel.
Very low risk in EFAs.
 
Risk in $1-outs is somewhat lower than true leases, but much higher than EFAs. We generally follow the insurance industry in treating $1-out leases the same as true leases.
Is a special motor vehicle lessor or sales license required ?
In several states  even if not for leasing, sales at the end of the lease may require a license. 
Not for EFAs of vehicles specifically. Should not be required for $1-out lease lessors, but.....
Is California Finance Lender License Required?
No
Yes
Who takes income tax depreciation?
Lessor
Lessee
Who is primarily liable for property taxes?
Lessor
Lessee
Possibly off balance under OLD FASB rules
Yes
No

 
Possibly off balance under
 NEW FASB rules
Other criteria control
Other criteria control
Does this type include TRAC Leases?
Yes
No
Full Payout economics like a loan?
Sometimes
Yes
Does this type include leases with nominal (token) purchase options under the UCC?
No
Yes
Does this type include mandatory purchase or no-return leases?
No
Yes
 

JUST FOR "FUN" TEST
 
It's been a while since we got the newsletter "out" and the new year is a good time to take stock of what you know and what you might want to learn about, so here is a little test we put together some time ago.
 
Some of the questions represent your operations people should know, others may be helpful (!) to your sales people or at least keep them from making bad mistakes. Most are just stuff we are asked...or should be asked.
                                             
We will publish the answers in a few weeks or you can email Tammy at [email protected], or Barry at [email protected].
 
 
 
I.          Multiple Choice
Directions:    Choose the letter of the best response.
 
1.         The UCC section that applies to leases with $1.00 purchase options is:
 
(a)                Article 2.
(b)               Article 2A.
(c)                Article 9.
(d)               Article 3.
 
2 .         A Fair Market Value Purchase Option:

(a)         Is the only way to structure a true lease.
(b)         Requires lessor to refund amounts in excess of assumed residual.
(c)         Means the lease is not a true lease for state law purposes.
(d)         Protects the lessor from lawsuits if the equipment harms someone.
(e)         None of the above
           
3.     Without a personal guaranty, the owner of which of the following businesses is responsible for debts of the business?
 
(a)                A sole proprietorship.
(b)               A limited liability partnership.
(c)                A limited liability company.
(d)               A corporation.
 

4 .          A "finance lease" under Article 2A of the UCC is best described as:
 
(a)                A lease with a $1.00 purchase option.
(b)               A lease in which the Lessor is not the manufacturer of the leased equipment.
(c)                A lease in which the manufacturer of the equipment is the lessor.
(d)               Not a lease at all, Article 2A uses this term for leases that are really loans.
           

 
5.         Your customer under a $1.00 purchase option lease tell you it has granted blanket liens on all of its assets to its banks. You plan to enter into a lease of manufacturing equipment which is about to be delivered to the lessee by a vendor. What can you do to protect yourself?
           
(a)                Do a UCC lien search and refuse to fund unless the bank and any other lien holder releases its security interest.
(b)               Pay the vendor directly and file your UCC within 20 days after delivery of the equipment to the lessee to be sure you have PMSI protection..
(c)                Ignore the bank's lien because your rights in the equipment are superior.
(d)               Have the lessee pay the vendor and reimburse the lessee but file your UCC as soon as possible.
 
6.        A properly worded purchase order will:
 
(a)        Protect the Lessor from manufacturer's defects
(b)       Transfer ownership to the Lessor upon payment
(c)       Allow Supply contract to be exercised by Lessee
(d)       All of the above
(e)      None of the above
 
7.         It is not necessary to file a UCC financing statement with respect to which of these types of transactions (although it is a best practice to do so just-in-case!)

(a)         A lease with a $1.00 purchase option.
(b)               A sale-leaseback transaction.
(c)                A lease manufacturing equipment.
(d)               A lease governed by UCC Article 2A.

8.          Which type of "bankruptcy" is for business reorganizations?
 
(a)                Chapter 7
(b)               Chapter 11
(c)                Chapter 13
(d)               Chapter 10

  9.          If your lessee files bankruptcy you:
 
(a)                May immediately go and pick up the equipment.
(b)               May immediately pick up the equipment if the lease is a true lease but not a financing lease.
(c)                Must take action only through the bankruptcy court until the automatic stay is released.
(d)               May take action through the bankruptcy court or a state court against the lessee
 
10.       Which of the following is a legal entity formed by filing with the Secretary of State in most states?
 
(a)                A sole proprietorship.
(b)               A general partnership
(c)                An unincorporated association.
(d)               A corporation
 
 
11.       Following a default by a lessee under a true lease, who then files for bankruptcy, a lessor may take which of the following actions?
 
a.     Enforce the default provisions of the lease and immediately recover the    
                   equipment from the lessee
b.     Require the lessee to pay the contract rent pending assumption or rejection of
                   the lease in the bankruptcy court
c.     Enforce a guaranty of the lease obligations by the lessee's parent entity

d.    All of the above

e.     None of the above
 
12.       Corporate Resolutions (Board Resolutions) are required by many funders as evidence of which of the following.
 
(a)                The authority of the lessee and its officers to enter into the Lease.
(b)               The acceptance of the equipment.
(c)                The existence of the corporation.
(d)               The lease satisfying usury laws applicable to non-consumer transactions.

 
 
13.       A clause providing that the lessee must protect the Lessor against liability, tax penalties and other risks is called?
 
(a)                A tax benefit clause.
(b)               Representations and warranties.
(c)                An indemnity.
(d)               A liability clause.
 
 
14.       The UCC is a uniform body of laws governing commercial transactions that has been adopted by.
           
(a)                Every state and is uniform throughout.
(b)               The U.S. Congress.
(c)                Every state although some have made changes or enacted only parts of it.
(d)               Every state except Louisiana, New Mexico and Maine.
 
15.       Where do you file a UCC financing statement covering business equipment if your lessee/borrower is a corporation?
 
(a)                In the state where the corporation was incorporated.
(b)               In the state where the equipment will be located.
(c)                In the location where the equipment will be used.
(d)               In the state where the corporation has its principal place of business.
 

16.       Which of the following should never be significantly altered?

 
(a)                Default grace periods.
(b)               Choice of law.
(c)                The notice provision.
(d)               The "hell and high water clause".
(e)                All the above.
 
17.        A provision under which default under other obligations is a default under the lease is called a:
 
(a)                Cross Default.
(b)               Cross Collateralization.
(c)                Incorporation clause.
(d)               Parent guaranty.
(e)                Integration Clause.
 
18.        A fixture is:
 
(a)                Personal property affixed to real estate so that it is not easily removable.
(b)               Identified as such according to state law.
(c)                Sometimes a tenant improvement.
(d)               Equipment that requires filing in the real estate records to perfect.
(e)                All the above.
 
19.        You should always check UCC records for which of the following:
 
(a)                Every transaction.
(b)               A purchase from a vendor.
(c)                A purchase from a seller who is not a vendor.
(d)               Financing of equipment delivered to the lessee a month ago.
(e)                (b) and (d)
(f)                 (c) and (d)
 

 

20.      You should check UCC records in which of the following:

 
(a)                A Sale and Leaseback.
(b)               If we want a purchase money security interest.
(c)                In every transaction.
(d)               Never for a lease with a fair market purchase option.
(e)                Never for a lease with $1 purchase option.
(f)                 (a) and (b)
 

21.        If the lessee plans to sublease your equipment on a long term basis the equipment may be:
 
(a)                Goods.
(b)               Inventory.
(c)                Subject to claims of the lessee's trustee in bankruptcy.
(d)               Repurchased by the vendor.
 

22.        If a lessee intends to lease your equipment for short periods only the equipment may be:
 
(a)         Goods.
(b)         Inventory.
(c)         Subject to claims of the lessee's trustee in bankruptcy.
(d)         Repurchased by the vendor.

 
23.   If equipment is "inventory" which of the following is true:
 
(a)                You need to check UCC records.
(b)               Your normal UCC filings will not be adequate.
(c)                A party purchasing the equipment may take free of your interest if the lease is a $1 out lease.
(d)               A party purchasing the equipment may take free of your interest even if the lease is a true lease.
(e)                All of the above.
 
24.        You cannot obtain a purchase money security interest in which of the following:
 
(a)                Equipment purchased on a sale and leaseback.
(b)         Equipment purchased from the vendor if the lessee had possession for more than twenty (20) days.
(c)              Equipment purchased from the vendor if the lessee paid for the equipment and is being reimbursed by your financing.
(d)               Inventory unless we take special procedures.
(e)                None of the above.
(f)                 All of the above.
 
25.     It is not necessary to file a UCC financing statement with respect to which of the following types of equipment (although it is a best practice to do so just-in-case!)

(a)         Titled Vehicles
(b)         Railcars
(c)         Aircraft
(d)         All of the Above
(e)                Only items (b) and (c) above
(f)                 None of the above
 
 
26.       The property/casualty insurance certificate should designate you as
 
(a)                Insured
(b)               Assignee
(c)                Loss Payee
(d)               Lender Loss Payee

 
27.        A provision under which property pledged to secure a borrower's obligations under one agreement also secures borrower's obligations under another agreement is called what kind of clause?:
 
(a)                Cross Default.
(b)               Cross Collateralization.
(c)                Incorporation clause.
(d)               Parent guaranty.
(e)                Integration Clause.
 
 
28.        Which of the following is likely not a true lease for purposes of state law.
 
(a)                Lease with fixed price purchase option of 20%.
(b)               Twenty year lease of standard laptops with FMV purchase option.
(c)                Lease where lessee must purchase equipment at the end of term.
(d)               TRAC Lease.
(e)                Both (b) and (c) above.
(f)                 None of the above.
 
 
29.        If your customer leases (or subleases) equipment to one or more third parties you're your credit department requires assignment of the sublease, which of the following is advisable?:
 
(a)                Obtain copy of the third party lease
(b)               Obtain legal review of third party lease
(c)                Obtain copy of board resolution from third party lessee
(d)               Obtain possession of sole original of third party lease
(e)                Have lessee execute a form of sublease/lease assignment
(f)                 Have third part lessee execute acknowledgment of assignment
(g)                All of the Above
(h)                All of the Above except (b) and (c)
 
 
II.          True/False
 

1.  If the parties agree that a transaction is a lease it will be treated as a lease for federal income tax purposes by the IRS. (False)

 

2.  If the parties agree that a transaction is a lease it will be treated as a lease by the Bankruptcy Court. (False)

 

3.  If the parties agree in the lease documents that a transaction is a lease it will be treated as a lease by State Court. (False)

 
4.  A lease with a $1 purchase option is never a true lease. (True)
 

5.  A lease with a $1 purchase option is treated as a secured loan for most legal purposes. (True)

 

6.  A lease with a $1 purchase option is always treated as a loan for state sales and property tax purposes. (False)

 

7.  The lessee's right to quiet enjoyment is protected by Article 2A in a UCC Finance Lease. (True)

 

8.  The lessor's hell or high water assurance and disclaimer of implied warranties are automatically protected in a finance lease under UCC Article 2A. (True)

 

9.  Article 2A provides that the lessee in a finance lease has the benefit of the supplier's warranties. (True)

 

10.  A cure period is time a lessee has to perform obligations before it is in default. (True)

 

11.  A lease with a fair market value purchase option is always a true lease for legal and tax purposes. (False)

 

12.  A TRAC lease is always a true lease. (False)

 

13.  A lease with a fair market value purchase option is always an "operating lease" for accounting purposes. (False)

 

14.  A true lease for tax purposes is always an operating lease for accounting purposes. (False)

 

15.  An operating lease for accounting purposes only qualifies as a true lease for tax purposes. (False)

 

16.  There is more risk of liability for damaged caused by leased equipment in a true lease than a lease with a $1 purchase option. (True)

 

17.  Proof of property insurance is required for all transactions, unless there is a credit exception. (True)

 

18.  Proof of liability insurance is required for all transactions, unless there is a credit exception. (False)

 

19.  The law provides that the lessor never has risk of environmental spills or damage caused by leased equipment. (False)

 

20.  Negligence and gross negligence are the same thing. (False)

 

21.  Leases and guaranties must generally be in writing to be enforceable. (True)

 

22.  Financial Covenants are uniform (e.g. all Debt Service Coverage Ratios are the same). (False)

 

23.  The additional precautions necessary when leased or financed equipment is "inventory" is never necessary with titled vehicles. (False)

 

24.  The UCC does not apply to liens against titled vehicles when leased or financed equipment is "inventory" . (False)

 

25.  If a broker represents to his funder that the Equipment has been delivered and it turns out that the deal was a fraud (no Equipment) the broker will have breached his agreement even if he did not know about the fraud (True).

 

26.  Same question as Number 25 but the representation was made "to broker's best knowledge". (True)

 

27.  If a broker makes no representations regarding a deal it will never be responsible for lessee/vendor fraud. (False)

 

28.  In order to prove fraud it is always necessary to prove that the guilty party knew that he or she was making untrue statements. (False)

 

29.  If a broker breaches a representation to his or her funder he will always do better under an indemnity then a buy-back requirement. (False)

 

30.  Generally, n order to sell leases in any state a broker must be qualified to do business with a Secretary of State. (False)

 

31.  Generally, in order for a broker to have an office in a state the broker must be "qualified to do business" with a Secretary of State. (True)

 

32.  An oral agreement is never enforceable. (False)

 

33.  An oral agreement can never change the terms of a written agreement. (False)
34.   All lawyers are 
(a) necessary evils       (c) just evil
(b) unnecessary evils   (d)  nice people if raised by good mothers (that's for your mom)
 

400 Century Park South
Suite 100
Birmingham, AL 35226
(205) 251-8301

Direct Mail To: 
P.O. Box 11386
Birmingham, AL 35202
 
Barry S. Marks   
Direct:  205.251.8303 │ [email protected]
 
Matthew D. Evans   
Direct:  205.251.8302  │ [email protected]
 


___________________________________
 
The  material in  our newsletter s and on  our web site is for informational purposes only and is not legal advice.  Neither your review or use of any of such  materials  nor any correspondence which does not expressly confirm an attorney-client relationship create s an attorney-client relationship between you and  our firm or any of  our attorneys. You should not act upon any  information  in any of our newsletters or on our web site without seeking advice from a qualified attorney, accountant or other professional. Please note that you should not send  us any confidential information until you have received written agreement from  one of our attorneys to perform legal services. Unless you have received such  a written agreement, we will not consider any information you send us as confidential. No representation is made that the quality of the legal services to be performed  by our firm or any of our attorneys is greater than the quality of legal services performed by other lawyers.