The inherent risk in equipment financing is often under appreciated by enterprises as they conduct a lease vs. buy analysis, as well as when they compare lessors.
Understanding these risks not only provides an enterprise with a realistic foundation for evaluating its options, it empowers the enterprise to lower the risk and cost through astute contract negotiations and performance monitoring.
The risks involved in equipment financing—even capital leasing—are many and varied, but these are five that should be on every lessee’s radar as they consider equipment financing:
1. Unlimited interim rent.
Lease agreements will specify under what conditions the lease commences, but they also usually allow the lessor to charge rent for equipment provided before that commencement date. If this interim rent isn’t well defined and capped in the contract, the lessee is at risk of additional rent payments that can throw off the cost analysis of equipment financing and result in costly equipment programs.
2. Lease schedules that alter the master lease agreement.
Lessees often think that they have covered all their bases if they’ve negotiated master lease agreements that limit risk. But risk is often contained within the individual lease schedules and amendments / riders, which can override terms in the master lease agreement or add terms not included. Therefore, lease schedules should be monitored and negotiated as intently as the master agreement — both upfront and throughout the life of the lease as new lease schedules are developed.
3. Burdensome notice requirements.
Lease agreements require lessees to provide notice for certain events, such as if and when the equipment may be returned, when equipment is damaged or destroyed, or when equipment is moved. These notice requirements are often onerous, requiring the notice to be provided in narrow time frames by extremely specific methods, etc. If the notice requirements aren’t fulfilled, the result is often additional costs or possibly even default.
To limit this risk, lessees must pay close attention to the probability of non-compliance with the requirements as specified in the lessor’s proposed lease terms and alter those terms.
4. "All-but-not-less-than-all" and substitution clauses that make compliant return nearly impossible.
With an "all-but-not-less-than-all" provision in the lease agreement, lessors can be permitted to continue charging full rent until every piece of equipment in a lease schedule population (as defined by the lease agreement) is returned. Lessees should not count on being able to fulfill this return requirement for all equipment and so should seek to negotiate terms that don’t place them in a disadvantageous position if "all-but-not-less-than-all" can’t be achieved.
"All-or-any" language allows for partial return and substitution clauses ("like-for-like") for replacement of equipment can limit the lessee’s risk, but they too should be examined closely. Substitution clauses are often confining and require the replacement equipment to be of greater value and utility.
5. Ambiguous definitions of fair market value.
At the end of the lease, many lease agreements give the lessee the option to buy the equipment at “fair market value (FMV),” extend the lease, or return the equipment. In situations where return is unfeasible or undesirable, the lessee must decide to purchase or extend the lease—but that decision is often virtually made for them by lease terms that in effect allow the lessor to set FMV.
Even in cases where mutual agreement on FMV is required, the lessor is in position of strength because the rent continues while negotiation over FMV occurs.
Without a comprehensive knowledge of the equipment finance industry, a lessee can put itself at great risk when negotiating lease contracts. An equipment leasing expert can help lessees avoid these and other common mistakes and minimize the lessee's all-in leasing costs.
