Lease Myth Busting: Going into default on a lease shifts the risk to the lessor

While it is true that IT and other assets experience such a steep reduction in value that repossession is less attractive to the lessor than other options in the case of client default, virtually all equipment leases contain numerous attractive options, and combinations of options in addition to repossession, for the lessor in the event of default. In addition “cross default” provisions create additional risks of default the implications of which are not commonly appreciated.

This topic often comes up during an end of lease negotiation of an “open-ended” lease (Fair Market Value/operating). At the end of lease the clock works against the lessee. The lessee is obligated to continue to make payments until the lease has come to conclusion. The lessor does not typically have any reason to rapidly collect all the equipment and stop the payment obligation. The incentive is quite the opposite. The responsibility is typically the lessee’s to return the equipment so the lease can come to conclusion and the lease payments can be stopped. If the lessee fails to make payments just about every equipment lease in existence throws the lessee into default with expensive results for the lessee. That the lessee holds the cards because the lessee can simply stop paying and the lessor must try and collect equipment is the kind of misinformed balderdash that pushes clients into expensive avoidable default situations. In addition many equipment leases are structured so that a lessee may fall into default but be unaware of their default status. This is because many leases do not require that the lessee be informed in a timely manner that any particular event – such as being late on a payment – is an event of default. For all these reasons gaining a thorough appreciation of default and its implications in the context of each firm’s equipment leasing contracts is important.

Other important issues in default include “cross-default” provisions (Lessee defaulting on any other material financial obligation triggering a lease default), whether Lessor has to notify the company that they are in default, and the length of the cure period.

Example: The following are examples of default, notice and extension provisions which create a material risk for the Lessee and are slightly modified examples of real language from various contracts.

– Cross Default would kick in if “Lessee defaults under or otherwise has accelerated any material obligation, credit agreement, loan agreement, conditional sales contract, lease, indenture or debentures;”

Other provisions which trigger Default in the same set of lease documents from various Lessors included examples like the following:

– Lessee fails to pay any Rent or other amount due under any Lease within five days after it becomes due and payable;

– Lessee fails to perform any other covenant, condition, or agreement made by it under any Lease, and such failure continues for 20 days;

Nothing in the above requires the Lessor provide the Lessee notice of a Default event AT ALL, including at the time of the infraction. That notice can be made at any time – even an inconvenient time like end of day December 24th. And when notice of the event is provided the Lessor is not obligated to highlight that the event triggers Default.

The results of Default are usually substantial and allow the Lessor to “pursue and enforce, alternatively, successively and/or concurrently…” many of the following:

  • Accrued and unpaid Lease charges due and owing
  • Lease Charges as and when becoming due
  • Accelerate all Lease Charges and other amounts due and/or likely to become due from the date of default to the end of the lease term (sometimes using a discount rate)
  • Cause to become immediately due and payable and recover from Lessee the Casualty Loss Value
  • Terminate any or all of the Lessee’s rights, but not its obligations
  • Retake possession of the equipment without terminating the Lease Schedule
  • Require Lessee to deliver the Equipment
  • Proceed by court action
  • Pursue any other remedy

Conclusion: Always pay the rents as due and satisfy other contractual obligations related to leasing. Under no circumstances does it make sense to not pursue options that will put you at risk for being placed in default. The best approach to negotiating with a lessor is to do an analysis of the all-in cost of leasing with the vendor so that you can understand the full cost of the program and the sources of that cost, and use this information as leverage during the negotiation on the items which can be negotiated such as Fair Market Value etc..