eLease Equipment Leasing

Proposed FASB Legal Differences

In addition to the new differences between accounting for leases and the income tax rules (IRS), there also will be differences between a lease for the Uniform Commercial Code (UCC) and the new accounting rules under proposed FASB changes. Leasing contracts will have to amend several of its “paragraphs.” The announcement of the changes perhaps will come as early as Tuesday effecting an estimated $1.2 trillion in leased assets.

In addition to accounting changes, it will also center around the legal requirements of what the lease contract must say to be considered a legal lease (Article 2A) versus a “disguised conditional sales contract” or “a lease for security purposes” (Article 9).

This is column is a synopsis. It is best to consult your attorney and accountant who have experience in equipment leasing and finance to discuss how the new changes will affect your leasing contract once they are expected to be announced this week as “adopted.”

It may be that “operating leases” or “true leases” will be for shorter time periods and/or more transactions will be “capital leases.” It certainly will result in major changes on the balance sheet and in sales presentations as well as tax consequences.

To find what the UCC defines as a legal lease (true lease) you must go to Article 1 General Definitions and go to Par.1-201 (37) to find the definition of a “security interest” and there you will find that a lease is an exception to a security interest. It begins:

“Whether a transaction creates a lease or security interest is determined by the facts of each case; however, a transaction creates a security interest if the consideration the lessee is to pay to the lessor for the right to possession and use of the goods is an obligation for the term of the lease not subject to termination by the lessee…”

This paragraph is interpreted as the requirement that a true lease must be non-cancelable for the lease term. This requirement is not found in income tax requirements or accounting rules. It is very important to understand this not only in the contract, but for the salesperson making the presentation to understand what he is actually presenting.

The additional requirements must be read in the “negative” because these are what make the lease a lease intended as a security and it will become an article 9 conditional sales contract:

1. The original term of the lease is equal to or greater than the remaining economic life of the goods (it is prudent to limit your lease term to 80% of the economic life to avoid this rule)
2. The lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods.
3. The lease has an option to become the owner of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement, or
4. The lessee has an option to become the owner of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement.

A transaction does not create a security interest merely because it provides that:

1. The present value of the consideration the lessee is obligated to pay the lessor for the right to possession and use of the goods is substantially equal to or is greater than the fair market value of the goods at the time the lease is entered into.
2. The lessee assumes risk of loss of the goods, or agrees to pay taxes, insurance, filing, recording, or registration fees, or service or maintenance costs with respect to the goods.
3. The lessee has an option to renew the lease or to become the owner of the goods.
4. The lessee has an option to renew the lease for a fixed rent that is equal to or greater than the reasonably predictable fair market rent for the use of the goods for the term of the renewal at the time the option is to be performed, or
5. The lessee has an option to become the owner of the goods for a fixed price that is equal to or greater than the reasonably predictable fair market value of the goods at the time the option is to be performed.

For purposes of this subsection (37):

(x) Additional consideration is not nominal if (i) when the option to renew the lease is granted to the lessee the rent is stated to be the fair market rent for the use of the goods for the term of the renewal determined at the time the option is to be performed, or (ii) when the option to become the owner of the goods is granted to the lessee the price stated to be the fair market value of the goods determined at the time the option is to be performed. Additional consideration is nominal if it is less than the lessee’s reasonably predictable cost of performing under the lease agreement if the option is not exercised.

(y) “Reasonably predictable” and “remaining economic life of the goods” are to be determined with reference to the facts and circumstances at the time the transaction is entered into; and

(z) “Present value” means the amount as of a date certain of one or more sums payable in the future, discounted to the date certain. The discount is determined by the interest rate specified by the parties if the rate is not manifestly unreasonable at the time the transaction is entered into: otherwise, the discount id determined by a commercially reasonable rate that takes into account the facts and circumstances of each case at the time the transaction was entered into.

In addition Article 2A creates two types of leases; two party leases and three party (finance leases):

A two party lease is a lease between the supplier of the goods and the user of the goods. In this type of lease the supplier becomes the lessor and is “responsible” for the equipments performance.

A three party lease called a finance lease has an equipment supplier (vendor), a lessor, and an equipment user (lessee).

In order for the lessor to eliminate the risk of equipment performance, the lessor must pass the warrantees and guarantees called the “supply contract” from the vendor to the lessee (after informing the vendor to this in a purchase order). In addition the lease must carry a quite enjoyment clause.

Failure of any or all of these rules places the lease under Article 9 and is considered a conditional sales contract requiring the filing of a UCC 1 lien statement to protect the lessor. In certain states, usury may be addressed, as well as the party(ies) involved are not licensed by the state where the lessee is located.

The legal rules are very different from tax or accounting and need to be followed and understood to prevail in a court of law!

Mr. Terry Winders, CLP, has been a teacher, consultant, expert witness for the leasing industry for thirty years and can be reached at leaseconsulting@msn.com or 502-327-8666.

He invites your questions and queries.

Why are so many businesses installing surveillance systems in their offices? The main reason is TO SAVE MONEY. Companies that invest in surveillance equipment are likely to save money in a number of ways:
Insurance (workers comp) - Every year American businesses pay out millions if not billions of dollars to their employees for workers compensation for accidents that aren’t work related. Employment law in the United States heavily favors the employee and for good reason. But without a way to prove your employee wasn’t hurt on the job, businesses are extremely vulnerable to abuses of the system. By installing surveillance cameras companies can monitor their stores, production lines or any work place and have photographic evidence of specific injuries or accidents. Additionally, by seeing accidents first hand, business owners can take preventative measures to minimize future injuries.

Theft - All businesses have problems with theft from grocery stores to banks. By installing surveillance cameras not only can you abate theft from outsiders, but you can curb internal theft.

Productivity - Wonder what your employees are doing all day? With surveillance cameras you can track productivity of your workers and work on improving the efficiency of your business.

The other reason companies get a surveillance system for their business is to have PEACE OF MIND.

Internet Viewable - Surveillance systems today allow the business owner to
view their business operations from another location. The owner could be on a business trip in China and still keep an eye on his business.

Multiple Locations - Some business owners have more than one location and can only be present at one location at a time. With security cameras, owners can monitor locations simultaneously.

No how do business owners pay for their new surveillance system?

There are many different ways to pay for equipment for your business. The first and most obvious is paying cash. Not all business owners have the budget to pay cash for a surveillance system. This brings us to financing:

Financing your security system is a great way to acquire your equipment without having to seriously impact your cash flow. Traditional loans with banks can be good when considering an interest rate. You will typically have to put down anywhere from 10%– 20%. Along with the hefty down payment, banks place a blanket lien on all company assets.

What if a business owner could get that brand new surveillance system to save money in the long run and for peace of mind at the same time not giving up interest in assets or having to put down a bunch of money? Equipment leasing is the solution. Equipment leasing is a way to finance your surveillance system 100% only having to put down the first and last payment upfront. The leasing company only holds a lien on the particular equipment you are acquiring not all assets of the company.

The top 5 reasons to lease the new surveillance system:

1. Cash Flow - Making monthly payments are much easier than coming out of pocket thousands of dollars. Let the equipment pay for itself instead of waiting years before you break-even.
2. Low Down Payment (100% financing) - Paying your first and last payment upfront is much easier than having to come out of pocket 10% or 20% for a traditional loan from a bank.
3. Service contracts for the surveillance system can be bundled into a lease so you have one low monthly payment.
4. Upgrading - Adding equipment to your lease agreement is extremely easy. All it takes is a one-page contract added to the original agreement.
5. Leasing allows “Up Selling” - Having a leasing company pay for equipment allows customers to get EVERYTHING that they need without having to take certain items out because they can not afford them. Adding additional equipment to the lease will not change the monthly payment significantly allowing it to stay within customers’ budget.

Sometimes examples help illustrate abstract concepts like leasing. We are working with a film production company that has about 4 years in business and is trying to expand. The economics of their business provides a clear example of how leasing can help any business grow.

In the video production industry equipment doesn’t come cheap. Professional cameras range from tens of thousand of dollars to hundreds of thousands of dollars and with each piece of equipment there are necessary accessories which always end up costing thousands of dollars. And that is just the beginning. You need professional monitors, decks, expensive editing software and lighting packages.

This particular client has several projects happening at the same time and they wanted to increase their productivity by expanding their editing capabilities. They didn’t have enough capital to purchase the editing equipment required and were at a standstill.

When I ran the numbers for the client it made their decision easy. The equipment cost about 10,000 and it would take them months, if not years, to have enough money to purchase the equipment with revenues from the business. Their clients usually pay 60 days after the work is completed and they had a limited amount of work they could do given their existing infrastructure.

These clients bill their customers about $750 a day for editing and were not able to bill more because they only had one editing system to work on. You can lease $10,000 of equipment for as low as 225 dollars a month, far less than one day of editing. The numbers made their decision easy. By leasing the editing equipment they can spend less than half a day a month paying for their system and the rest of the month is profit to the company. The question for the business owner was clear: will you have use for the editing system for more than one day a month moving forward. The answer was naturally yes and leasing the editing system allowed them to remove a bottleneck of their production line and expand their business exponentially.

People occasionally ask if eLease.com can finance software and the answer is yes. As long as the software is coming from a manufacturer we can verify and the software is critical to your business.   eLease works with over 100 software firms to provide leasing services to their customers.

It is hard for a lot of business owners to wrap their minds around the concept of leasing software since it is not a physical piece of equipment. For leasing companies, software is riskier investment because there is nothing to resell if a company is unable to make its payments.

Every year CFOs find a larger and larger portion of their budget being allocated for software. It is an integral part of doing business these days and can be quite costly. Leasing or financing software is worth considering because it allows businesses to get the full versions of certain programs they would otherwise not be able afford. eLease.com can also finance the support and annual contracts to sweeten the deal.   With products like Great Plains software eLease.com is able to finance specific modules with just a one-page addendum.

For example, eLease.com just funded a lease for a web services company for $30,000 of Foundry Network equipment. This particular company has been in business for 4 years and wanted to structure their financing for 24 months with a Fair Market Value Option buyout.  We were able to get the software funded in just 2 days. This is the 12 lease we have funded for this customer who continues to grow and use leasing and financing to build their business.

Why do I like the small lease for the small business?   Today’s economy is all about impressive big numbers. Everywhere you turn there is always someone throwing around a big number. What I think some people forget is that a lot of smaller #’s create those bigger numbers.

We funded a transaction for an entrepreneur today who had been using an old telephone system for over 2 years that was completed outdated. Like most business owners, he was concerned about cash flow. We financed his $3,595.00 system the same day with payment of $126.00 per month on our Equipment Finance Agreement program.

The business was very small but had big plans and I like to think we are part of his future success.

The Definition of the Equipment Finance Agreement

An EFA is a fixed-term obligation with equal monthly payments, where the borrower is the owner of the equipment and the lender has a security interest in the equipment. The borrower deducts as a business expense both the depreciation on the equipment and the interest portion of the monthly payment.    A lessor may use an EFA, and act as the lender, when the borrower has already taken delivery of, and has paid for, the equipment.

We started offering EFAs in 2005 and we have had tremendous success with them over the last 2 years. I consider the EFA as a $1.00 lease on steroids because it is giving you the same tax benefits as a normal lease but has more flexibly to pay it off early. When we finance equipment for our office we use this type of financing.

Let us know if you have any questions on this type of agreement.