Fair Market Value at End of Lease
Equipment “fair market value” (FMV) is an ambiguous term that only finds definition within the terms of the equipment lease agreement. So it’s a mistake to assume that simply because a lease allows purchase or extension for “fair market value” that the value is mutually understood without further definition.
To understand the specific meaning of “fair market value” for each contract, enterprises need to evaluate their lease agreements to identify how the following elements are defined and structured.
The contract should define the marketplace—the type of buyer and the market segment—to be used for the valuation of the equipment. This conception of the marketplace should be reasonable and not slanted in favor of the lessor’s interests.
It’s best for the lessee if the lease agreement is as precise as possible about how a particular piece of equipment will be evaluated for wear and tear and how its fair market valuation will be adjusted accordingly.
There’s also the matter of “in use and in place” versus “de-installed” valuation. If the contract specifies that the valuation is for “…in use and in place,” or “…in continuous and uninterrupted use,” then the fair market valuation will be higher because the value of the equipment to the business is higher than the value of de-installed equipment on the open market.
Time Value of Money
Whether the fair market value is agreed upon at end of lease but financed over future periods, or the purchase price is paid in cash but represents upfront payment of a capped extend to own set up, the time value of money should be taken into account.
The Decider of Fair Market Value
Even with some contractual definition of fair market value, many lease agreements give great leeway to lessors in determining the value. If lease agreements are not adequately reviewed and understood by lessees, lessors often retain sole discretion in setting the fair market value within the parameters of the contract.
Even when mutual agreement on FMV is required, lessors can still have an advantage in determining fair market value because most leases continue until agreement is reached. During that time, rent payments continue — a situation that usually makes the lessor more willing than the lessee to extend negotiations, giving negotiating leverage to the lessor.
To protect themselves, lessees can ensure that each lease agreement spells out the specifics, including timetable, of how a valuation will be determined. A third-party appraisal to settle disputes is good option, but it’s important for the contract to dictate how the appraiser will be chosen, whether multiple appraisers will be used, the time frame for the appraisal and also who pays for the appraisal costs.
In their lease agreements, lessees should negotiate terms that clearly spell out how fair market value is determined at the end of lease. Failure to do so cedes control of the valuation process to lessors—almost always escalating the total costs of leasing for the lessee.