Common Equipment Lease Agreement Traps
Enterprises that enter into an equipment lease agreement without a clear understanding of the risks involved almost always end up paying more than they should. Equipment leasing companies are well aware of how to increase their potential revenue by structuring an equipment lease agreement to increase lessee risk. To protect themselves, enterprises need to understand what these risky lease agreement terms are.
- Uncapped interim rent.
- Fees for non-compliance.
- Easy default.
- Lease extensions.
- Poorly defined fair market value at end of lease.
Most equipment lease agreements allow the lessor to charge rent for equipment that’s delivered and accepted before the official commencement date of the lease. Usually this rent is at the full rate (pro-rated for days used). The problem for lessees occurs when they fail to cap the amount of this interim rent. Without such a cap, equipment leasing companies can collect substantial additional rent without any adjustment to the amount of regular term rent owed.
Equipment leasing companies frequently include provisions that are difficult for lessees to meet, leading to additional costs. For example, equipment condition and packaging requirements (for damages, inspection prior to return, etc.) can sometimes be so stringent that non-compliance is likely. Lessees need to carefully examine any lease agreement for such overly burdensome requirements that can lead to penalties, and these clauses should be resisted.
Defaulting under an equipment lease agreement gives lessors a tremendous amount of leverage in future negotiations. For this reason, it’s imperative for lessees to structure any lease agreement so that the risk of default is minimized. If there’s any proposed lease agreement language that would allow default to happen “by accident” or by circumstances that could easily occur during normal operations, clauses that can trigger default, such as “failure to meet any obligation under the lease,” should be eliminated.
Lessors usually prefer that lessees extend leases rather than return equipment. One way that they typically accomplish this within an equipment lease agreement is to include an “all-but-not-less-than-all” provision for equipment return. This means that the equipment leasing company can continue charging full rent for an entire schedule until every single piece of equipment (serial-number specific) on that schedule is returned. This can be a very difficult, if not impossible task for lessees particularly when leasing distributed assets such as technology equipment. The threat of default can also be used to encourage lease extensions.
Many equipment lease agreements will allow the lessee to buy the equipment at fair market value (FMV) at the end of the lease, as opposed to returning the equipment (which often isn’t practical) or extending the lease. But if the lease agreement essentially allows the equipment leasing company to determine the FMV, then it can effectively take the purchasing option off the table for the lessee. If the equipment can’t be returned, the lessee is left with no recourse but to extend the lease, unless it’s willing to pay the inflated FMV.
Lessees can seek to limit this risk by insisting on mutual agreement on FMV. But this process of mutual agreement must be clearly spelled out and limited in time length, or else the lessee will probably still end up paying lease extensions that it didn’t figure into its equipment cost projections. Because the lessee will continue paying rent while negotiations proceed, the lessor has no incentive to reach an agreement.
Conclusion
These are just a few of the risks that lessees face when entering into equipment lease agreements. To adequately review a lease agreement, an enterprise needs to have in-house leasing expertise or contract with an equipment lease specialist. The resulting cost savings from a thorough, informed review of lease agreements can be considerable.