Leasing Law

Question 1

Statutory Law

Answer 1

Includes law enacted by legislative bodies such as state legislatures and U.S. Congress.
The Uniform Commercial Code “UCC” is a body of state statutory law

Question 2

Case Law

Answer 2

Often referred to as “common law”; case that apply/interpret statutory law or prior case law precedents to particular sets of facts.

Question 3

Regulatory Law

Answer 3

Consists of regulations adopted by public bodies (ex: IRS or SEC)

Question 4

Federal Law

Answer 4

Includes laws adopted by U.S. Congress such as the Internal Revenue Code and the Bankruptcy Code

Question 5

State Law

Answer 5

Includes laws adopted by individual state legislatures (ex: UCC, sales tax and property tax in each state)

Question 6

Conflicts of Law

Answer 6

Refers to inconsistencies in laws between states. The Lessor can include in their documents a “choice of law” provision, in which the lease states the law which will be applied in any dispute regarding the lease.

Question 7

Contract Law

Answer 7

Laws regarding a voluntary arrangement between 2 or more parties (“contract”); generally, a matter of state law, but case law is also important.

Question 8

Requirements of an enforceable contract:

Answer 8

1. An offer and acceptance evidencing a mutual agreement on principal terms and considerations, or something of value, given or promised by each party.
2. Capacity- each of the parties is legally able to enter into the contract
3. Legality- Often used to prohibit enforcements of secured financings that exceed the legal usury (Rate) limit, but also available to prohibit leases of equipment used in illegal activities, such as gambling, where it is not permitted by applicable law
4. Statute of Frauds- requirement that certain types of contracts be memorialized in writing; Under UCC Article 2A-201, a lease contract in excess of $1,000 in unenforceable unless in writing

Question 9

The Uniform Commercial Code (“UCC”)

Answer 9

A body of laws proposed by the National Conference of Commissioners of Uniform State Laws and the American Law Institue. Specific articles of the UCCs cover a variety of legal topics including negotiable instruments, bank deposits and collections, letters of credit and investment securities. All fifty states have adopted at least some of the Articles. There are 3 important

Question 10

Article 2 (UCC)

Answer 10

• It deals exclusively with the sales of goods, which are defined as tangible personal property.
• “Implied Warranties” - a merchant who sells goods “the Lessor” is deemed to warrant that they are merchantable (i.e. for ordinary purposes and in overall good condition) and fit for the particular use that the Lessee/buyer contemplates.

Question 11

Article 9 (UCC)

Answer 11

**Deals exclusively with the creation of security interests in personal property, only for secured transactions or secured financings, including loans secured by goods as collateral and leases intended as security
** NOT applicable for True Leases
**Failure to file creates a strong incentive for competing parties to examine the nature of the transaction.
** A purchase money security interest (PMSI) is given a grace period of 20 days under the state law to file a standard financing statement. **Must be filed in the state where the Lessee is incorporated organized. For fixture financing statements (equipment affixed to real estate), the filing is done in the local county real estate records.
** The UCC doesn’t cover all types of claims and equipment (i.e. air craft, vessels).
**Financing statements are not used to perfect interests in motor vehicles and other properties covered by certificate of title, **unless such items are held as inventory.
**Uses the term “secured party” for the Lender and the term “debtor” for the borrower.
**A “secured interest” refers to the interest granted to the lender/lessor and is analogous to a lien or other encumbrance.

Question 12

Article 2A (Deals only with “true leases” aka “finance leases”- FMV)

Answer 12

**A finance lease is a true lease including the following characteristics:
– The Lessor is not the manufacturer or vendor (the “supplier” in UCC terms) of the leased personal property
– The Lessor makes sure that the Lessee is appraised of its rights against the supplier with respect to warranties
–All warranties provided by the supplier are automatically deemed assigned to the Lessee, the Lessor is absolved of any responsibility with respect to equipment malfunction or failure to meet the Lessee’s expectations
<3 “The Hell or High Water Clause” is automatically made part of the lease. The Lessee must make rental payments for the equipment irrespective of any claim it may have against the Lessor and without setoff.
–There are no UCC filing requirements

Question 13

Legal Definition of a Lease (or what is not a lease)

Answer 13

Different rules exist for the definition of a “LEASE” between legal, federal income tax and accounting standards.

Question 14

The “legal” definition of what is NOT a lease under UCC

Answer 14

(i.e. when a SECURITY INTERST is created) includes the following elements:

The agreement is not subject to termination by the customer/lessee; AND:

1) The term of the agreement equals or exceeds the economic life of the equipment OR
2) The customer/lessee is required to buy the equipment or has the option to buy it for a nominal amount or automatically owns the equipment OR
3) The customer/lessee is required to renew the agreement or has the option to renew it for a nominal amount, if the renewal will cause the term of the agreement to equal or exceed the economic life of the equipment.

**SIMPLE SUMMARY:
If the lessee has all the benefits and risks of ownership and the lessor has no realistic residual value risk or benefit, the transaction is the same as a loan for all practical and economic purposes.

**Courts tend to focus primarily on the “Lessor’s residual position” when determining whether a transaction is a properly characterized as a lease or a secured loan creating a security interest. Other criteria for evaluation include length of term compared to economic life of equipment, lessee’s responsibility to pay taxes and other expenses related to the equipment, and who has the benefits and burdens of ownership (lessor = true lease, lessee = secured loan/financing).

Question 15

Bankruptcy

Answer 15

A lessor under a True Lease has better rights to uncover the equipment in the event of a Lessee default because the Lessor is the owner of the equipment

Question 16

Interest/Usury

Answer 16

Interest is charged in a secured loan but not in a true lease. True leases do not charge “interest”. True Leases are rental agreements.

– In a true lease, the Lessee pays all or a significant portion of the cost of the equipment to the Lessor together with an implicit interest factor or “rent factor.”

– In a secured loan which is structured as a lease, the “rent” is actually principal & interest expressed as a single payment.

Question 17

Collateral

Answer 17

It is technically incorrect to refer to leased equipment as collateral, although the term is entirely appropriate to secured financings.

Question 18

Liability

Answer 18

There is more exposure to the Lessor under a true lease for liability to third parties cause by faulty or improperly maintained equipment because the Lessor is the owner of the equipment

Question 19

UCC Rights

Answer 19

A true lease is governed by UCC Article 2A (Lessor owns the equipment), secured loans are governed by UCC Article 9 (Lendor/Lessor has security interest in equipment).

Question 20

Filing/Title- Perfecting Security Interests:

Answer 20

A Lessor is NOT required to file a UCC-1 financing statement under Article 9 to protect its interest in a true lease because they are NOT governed under Article 9 and there are no filing requirements under Article 2A.

Question 21

Residual Value

Answer 21

*A Lessor expects a profit from the combination of the portion of the rents and residual value

*A Lender looks only to the interest (or interest factor in the “rent”) during the term