Rembrandt/Not Rembrandt: Finding the Win-Win in Your Firm's Technology Leases

About 20 years ago, the Metropolitan Museum of Art in New York City organized an unusual exhibit titled “Rembrandt/Not Rembrandt.” The exhibition included about 55 paintings in the Met's collection by Rembrandt, his pupils and followers, plus X-rays, autoradiographs and other technical evidence that was used to see under the surface of the paintings to help scholars and other experts determine the authorship of each of the pieces in the show. Previously, about 630 paintings had been attributed to the famous Dutch painter; but after the review of experts and the tools on display at the Met Museum, it turned out that only about 300 of those paintings were authentically Rembrandts, and the others were imitations by his pupils, followers, etc. It took about 300 years and several major technical advancements (including the invention of electricity) to be able to
ferret out the imposters. At the end of the day, however, an accurate and credible process for assessment was brought to bear on a long debate, and the results were impressive.

Which is to say, sometimes you need an expert and their expert tools in order to gauge value.

For law firms, it is a kind of “exhibit” time of year when ALM's The American Lawyer releases the 2012 law firm profitability results. Good financial statistics help law firms attract merger partners, and law firms need to show year-over-year gains in revenue per lawyer and profits per partner to lure prospective laterals while simultaneously keeping their own attorneys under roof.

Putting these two together, when it comes to your firm's technology and equipment, leasing is a strategic financial option that a firm can utilize to provide a monthly expense versus a total cost purchase. Leasing also beneficially cuts the out-of-pocket costs for technology upgrades, while still enabling new projects on the budget. If your lessor has been a strategic and unbiased partner in your firm's technology and equipment leasing and the lessor has done its job well, then it has provided your firm with the financial benefits of leasing your firm's technology and equipment, as well as the expertise and tools to understand the structure and true cost of the firm's lease. Below we describe some of the key steps in the process to achieve that win-win.

An Accurate and Credible Process, a Few Expert Tools

The first step of an accurate and credible process is an upfront and clear understanding of the Master Lease Agreement. The Master Lease Agreement (“MLA”), Schedule and related documents (collectively, the Lease Documents) determine all of the terms and conditions for your technology and equipment leases; however, one thing firms should realize is that terminology with effectively the same meaning may be given different language in Lease Documents.

“Software” is a primary example of this and may appear in the lessor's agreement(s) as: “Software will be deemed Equipment under the Lease.” Since lessors can only lease and not finance the software to lessee, there should be specific language in the Lease Documents regarding the fact that fair market value purchase and renewal options do not apply to any equipment that is designated as software or soft costs, and that there are no further charges for software or soft costs at the end of the lease term. Lessees should also look out for any language regarding damages owed by the firm if the firm continues to use the software at the end of the lease term. This potential “damages” verbiage can be found in the Remedies section of the Master Lease Agreement as well as any Amendment or Modification to the Lease Documents.

Leasing software can be very advantageous; however, it is important to accurately assess the meaning of software terms and conditions as detailed in your MLA, and that may require a set of expert eyes. For instance, the following describes a few scenarios we have seen when there has been a misunderstanding of the software terminology in a firm's MLA.

Software: The Right to Use

This medium-size firm received a lease proposal where the firm was provided one lease rate factor for the upgrade of the firm's accounting system, network and other related technology for the 48-month lease term. The total project cost was $1.8 million, and the software portion was around $600,000, not including the soft costs.

The lease rate factor was very attractive, and the firm had the following end-of-term options: purchase the equipment for fair market value, extend the equipment at the fair market value or return the equipment at the expiration of the lease term. After the proposal was reviewed, the firm assumed that there was no value in software and the FMV would only involve the hardware. This firm was not clear and was not educated on the consequences of the terms, and relied heavily on the language in the proposal.

During the review, the firm noted that the Master Lease Agreement stated that the firm did not retain the right of use to the software at the end of its lease. The contract also required that the firm stop using and destroy any copies of the software at the end of the lease schedule's termination date if the software was not extended or purchased for FMV. Where the real issue comes into play here is the fact that the definition of “Equipment” included both the hardware and the software, which in turn would mean that if the firm were to purchase the “Equipment” at the end of the lease, the firm would be paying for software it could not purchase. Also included in the Master Lease was the representation that if the firm was found to be using the software without paying the fair market value ' (which value could be as high as the cost of the latest version of that software), the firm would be required to pay up to two times the original software costs in damages. In addition, there was nothing in the Master Lease Agreement that allowed for the firm to get a free version of the software from the vendor or any option to replace the software for the equal value.

The firm was very upset with the leasing company because the leasing company had not been upfront and clear about the restrictions as to the rights to use the software, which then resulted in a much larger financial exposure than the firm anticipated on software that was mission critical. The firm originally did not add the cost of paying for the software twice into its lease comparison. Fortunately, the firm discovered the software language in time and decided to work with an alternative leasing company that used separate lease rate factors for hardware and software/soft costs. Fair market value only pertained to the hardware at the end of the lease, and the firm continued to use the software without any fair market value purchases or renewals.

Defined installation costs for software are not the problem; the problem is the manner of disclosure and definition as part of a total solution. This firm, for instance, had the exposure of paying up to an additional $600,000 (FMV for the latest version of that software) if the firm had not done its due diligence.

Pro Rata/Interim Rent

Often a lessor can help keep your monthly rental payments lower by the collection of the pro rata/pre-term rental income charges prior to the commencement of the lease. The pro rata rent charges help offset the cost of funds and interest expenses that are incurred from vendor payment remittance made prior to the commencement of the lease when the first monthly rental payment would be due and payable. It is a win-win for both the lessee and the lessor since the lessee's payments are kept low (freeing up cash) and the lessor's profit is no different from if the transaction were priced with higher rent payments and no pre-term/pro rata rent. Nothing is hidden here, and it works well for both parties. What you will want to watch out for, however, are hidden or excessive pro rata rent charges.

First, pro rata/interim rent may appear in your firm's lease documents as: “Interim rent for each Unit shall mean the rent payable with respect to any Interim, Term which shall be equal to one-thirtieth of the Monthly Rent,” or “In addition to regular rentals, Lessee shall pay to Lessor Interim rent, which shall be a pro-rata portion of the monthly rental charges based on a daily rental charge of one-thirtieth (1/30th) of the monthly rental calculated from the date on which the Equipment is accepted by the Lessee until final delivery and acceptance of all the equipment,” or “If the installation Date does not fall on the first day of a month, the Lessee charge for the period from the installation Date to the Commencement Date shall be an amount equal to the Monthly Lease Charge divided by (30) and multiplied by the number of days from and including the Installation Date to The Commencement Date,” etc.

What is key when reviewing the Master Lease Agreement, however, is to fully comprehend the total cost of ownership (“TCO”). We saw a medium-size firm upgrading its network along with its desktops and other related hardware in the amount of $1.2 million on a 36-month lease term. The firm wanted the ability to refresh the hardware with a similar monthly expense at the end of its lease term, so it decided to get lease quotes. The projects would take at least six months to install. The leasing companies were contacted and provided with the types of equipment along with the hardware, software and services breakdown, and the projected installation period which was over six months. The firm received a couple of very aggressive lease proposals that had very low lease rate factors; two were lower than the other proposals. The firm decided to move forward with the leasing company with the lowest lease rate factor.

The thought was that the attorneys would review the lease and negotiate the best possible lease terms. The proposal mentioned the firm would be charged at 1/30 a day rent for any money dispersed until the entire project was completed. The focus, of course, was on the low lease rate factor and other terms and conditions, not the pro rata language. The other leasing company with the lower lease rate had a similar type of language. The third lowest lease rate lessor included language in the lease proposal that defined the installation at 45 days of rent due at the end of each 90-day period. The lessor with the highest lease rate factor had installation language that offered interest expense at 5% for all money dispersed over the installation period with no mention of a 90-day installation period.

After due diligence, the firm realized that the pro rata 1/30 a day rent option was much more expensive and open-ended than the two proposals with higher lease rate factors. This was due to the extra amount of interim rent it would be paying until all the equipment was installed and the lease schedule commenced for its 36-month term. The firm, however, had a relationship with one of the leasing companies that had provided the lowest lease rate factor with the pro-rata 1/30 provision and the 90-day installation. The firm asked the leasing company to provide the same 90-day installation option but with 45 days for rent due at the end of the installation. The firm had to increase the lease rate factor, but still awarded the business to that lessor. Unfortunately, months later, the person handling the leases was no longer with the firm.

A couple years later, the firm found that during the confusion of employee turnover, the leasing company stopped providing the 90-day installation periods with the set 45 days of interim and went back to the more expensive 1/30 a day pro rata payments, and kept adding more equipment to keep the leases open for more than six months. The firm was very upset when it discovered the change and selected the leasing company that initially had provided the best overall solution.

The firm paid around $90,000 more under the pro rata 1/30 a day rent scenario, and the 36-month lease term did not start until after the six-month plus installation period. Make sure the total costs are defined during the installation period; there is nothing wrong with installation costs if they are defined and lower the lease rates to be comparable in total cost to a monthly lease rate without interim rent.

The Original Rembrandt

Leasing your firm's technology and equipment is an excellent and strategic solution not only to bolster your PPP but also to allow your firm to establish a monthly expense where the partner costs are spread out over the life of the hardware or software project, conserve cash reserves, keep bank lines of credit open for short-term use, allow your firm to expense lease payments rather than depreciate equipment, and avoid potential losses on the sale of equipment. Many law firm decision makers in the AmLaw 100/200 and more turn to leasing equipment and technology for their firm as a competitively advantageous way of performing in the new business model landscape.

Just make sure when you are reviewing your Master Lease Agreement, that you are, in fact, looking at a Rembrandt, that you have brought expert tools, accuracy and credible processes to bear upon the lease document, and that you understand the full meaning of its terminology. Make sure at least one of the lease options in the field can show upfront the total cost of ownership of the MLA with the actual language and terminology of the MLA. The true benefits of a lease structure are not determined by the glitter of the lowest lease rate factor, but viewed as a composite whole.

Our firm provides a lease analyzer that helps determine the total cost of the different economic language of any firm's equipment and technology lease document ' upfront ' and can do so determining the variables of such language as described above. It's one of the ways to determine true value ' with accuracy and credibility.

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Scott McFetters, a member of this newsletter's Board of Editors, is president and Mike Henderson is regional manager for CoreTech Leasing, Inc. Founded in 2008, CoreTech is an independent leasing company working in partnership with more than 100 of the nation's law firms. For more information visit www.coretechleasing.com.

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About 20 years ago, the Metropolitan Museum of Art in New York City organized an unusual exhibit titled “Rembrandt/Not Rembrandt.” The exhibition included about 55 paintings in the Met's collection by Rembrandt, his pupils and followers, plus X-rays, autoradiographs and other technical evidence that was used to see under the surface of the paintings to help scholars and other experts determine the authorship of each of the pieces in the show. Previously, about 630 paintings had been attributed to the famous Dutch painter; but after the review of experts and the tools on display at the Met Museum, it turned out that only about 300 of those paintings were authentically Rembrandts, and the others were imitations by his pupils, followers, etc. It took about 300 years and several major technical advancements (including the invention of electricity) to be able to
ferret out the imposters. At the end of the day, however, an accurate and credible process for assessment was brought to bear on a long debate, and the results were impressive.

Which is to say, sometimes you need an expert and their expert tools in order to gauge value.

For law firms, it is a kind of “exhibit” time of year when ALM's The American Lawyer releases the 2012 law firm profitability results. Good financial statistics help law firms attract merger partners, and law firms need to show year-over-year gains in revenue per lawyer and profits per partner to lure prospective laterals while simultaneously keeping their own attorneys under roof.

Putting these two together, when it comes to your firm's technology and equipment, leasing is a strategic financial option that a firm can utilize to provide a monthly expense versus a total cost purchase. Leasing also beneficially cuts the out-of-pocket costs for technology upgrades, while still enabling new projects on the budget. If your lessor has been a strategic and unbiased partner in your firm's technology and equipment leasing and the lessor has done its job well, then it has provided your firm with the financial benefits of leasing your firm's technology and equipment, as well as the expertise and tools to understand the structure and true cost of the firm's lease. Below we describe some of the key steps in the process to achieve that win-win.

An Accurate and Credible Process, a Few Expert Tools

The first step of an accurate and credible process is an upfront and clear understanding of the Master Lease Agreement. The Master Lease Agreement (“MLA”), Schedule and related documents (collectively, the Lease Documents) determine all of the terms and conditions for your technology and equipment leases; however, one thing firms should realize is that terminology with effectively the same meaning may be given different language in Lease Documents.

“Software” is a primary example of this and may appear in the lessor's agreement(s) as: “Software will be deemed Equipment under the Lease.” Since lessors can only lease and not finance the software to lessee, there should be specific language in the Lease Documents regarding the fact that fair market value purchase and renewal options do not apply to any equipment that is designated as software or soft costs, and that there are no further charges for software or soft costs at the end of the lease term. Lessees should also look out for any language regarding damages owed by the firm if the firm continues to use the software at the end of the lease term. This potential “damages” verbiage can be found in the Remedies section of the Master Lease Agreement as well as any Amendment or Modification to the Lease Documents.

Leasing software can be very advantageous; however, it is important to accurately assess the meaning of software terms and conditions as detailed in your MLA, and that may require a set of expert eyes. For instance, the following describes a few scenarios we have seen when there has been a misunderstanding of the software terminology in a firm's MLA.

Software: The Right to Use

This medium-size firm received a lease proposal where the firm was provided one lease rate factor for the upgrade of the firm's accounting system, network and other related technology for the 48-month lease term. The total project cost was $1.8 million, and the software portion was around $600,000, not including the soft costs.

The lease rate factor was very attractive, and the firm had the following end-of-term options: purchase the equipment for fair market value, extend the equipment at the fair market value or return the equipment at the expiration of the lease term. After the proposal was reviewed, the firm assumed that there was no value in software and the FMV would only involve the hardware. This firm was not clear and was not educated on the consequences of the terms, and relied heavily on the language in the proposal.

During the review, the firm noted that the Master Lease Agreement stated that the firm did not retain the right of use to the software at the end of its lease. The contract also required that the firm stop using and destroy any copies of the software at the end of the lease schedule's termination date if the software was not extended or purchased for FMV. Where the real issue comes into play here is the fact that the definition of “Equipment” included both the hardware and the software, which in turn would mean that if the firm were to purchase the “Equipment” at the end of the lease, the firm would be paying for software it could not purchase. Also included in the Master Lease was the representation that if the firm was found to be using the software without paying the fair market value ' (which value could be as high as the cost of the latest version of that software), the firm would be required to pay up to two times the original software costs in damages. In addition, there was nothing in the Master Lease Agreement that allowed for the firm to get a free version of the software from the vendor or any option to replace the software for the equal value.

The firm was very upset with the leasing company because the leasing company had not been upfront and clear about the restrictions as to the rights to use the software, which then resulted in a much larger financial exposure than the firm anticipated on software that was mission critical. The firm originally did not add the cost of paying for the software twice into its lease comparison. Fortunately, the firm discovered the software language in time and decided to work with an alternative leasing company that used separate lease rate factors for hardware and software/soft costs. Fair market value only pertained to the hardware at the end of the lease, and the firm continued to use the software without any fair market value purchases or renewals.

Defined installation costs for software are not the problem; the problem is the manner of disclosure and definition as part of a total solution. This firm, for instance, had the exposure of paying up to an additional $600,000 (FMV for the latest version of that software) if the firm had not done its due diligence.

Pro Rata/Interim Rent

Often a lessor can help keep your monthly rental payments lower by the collection of the pro rata/pre-term rental income charges prior to the commencement of the lease. The pro rata rent charges help offset the cost of funds and interest expenses that are incurred from vendor payment remittance made prior to the commencement of the lease when the first monthly rental payment would be due and payable. It is a win-win for both the lessee and the lessor since the lessee's payments are kept low (freeing up cash) and the lessor's profit is no different from if the transaction were priced with higher rent payments and no pre-term/pro rata rent. Nothing is hidden here, and it works well for both parties. What you will want to watch out for, however, are hidden or excessive pro rata rent charges.

First, pro rata/interim rent may appear in your firm's lease documents as: “Interim rent for each Unit shall mean the rent payable with respect to any Interim, Term which shall be equal to one-thirtieth of the Monthly Rent,” or “In addition to regular rentals, Lessee shall pay to Lessor Interim rent, which shall be a pro-rata portion of the monthly rental charges based on a daily rental charge of one-thirtieth (1/30th) of the monthly rental calculated from the date on which the Equipment is accepted by the Lessee until final delivery and acceptance of all the equipment,” or “If the installation Date does not fall on the first day of a month, the Lessee charge for the period from the installation Date to the Commencement Date shall be an amount equal to the Monthly Lease Charge divided by (30) and multiplied by the number of days from and including the Installation Date to The Commencement Date,” etc.

What is key when reviewing the Master Lease Agreement, however, is to fully comprehend the total cost of ownership (“TCO”). We saw a medium-size firm upgrading its network along with its desktops and other related hardware in the amount of $1.2 million on a 36-month lease term. The firm wanted the ability to refresh the hardware with a similar monthly expense at the end of its lease term, so it decided to get lease quotes. The projects would take at least six months to install. The leasing companies were contacted and provided with the types of equipment along with the hardware, software and services breakdown, and the projected installation period which was over six months. The firm received a couple of very aggressive lease proposals that had very low lease rate factors; two were lower than the other proposals. The firm decided to move forward with the leasing company with the lowest lease rate factor.

The thought was that the attorneys would review the lease and negotiate the best possible lease terms. The proposal mentioned the firm would be charged at 1/30 a day rent for any money dispersed until the entire project was completed. The focus, of course, was on the low lease rate factor and other terms and conditions, not the pro rata language. The other leasing company with the lower lease rate had a similar type of language. The third lowest lease rate lessor included language in the lease proposal that defined the installation at 45 days of rent due at the end of each 90-day period. The lessor with the highest lease rate factor had installation language that offered interest expense at 5% for all money dispersed over the installation period with no mention of a 90-day installation period.

After due diligence, the firm realized that the pro rata 1/30 a day rent option was much more expensive and open-ended than the two proposals with higher lease rate factors. This was due to the extra amount of interim rent it would be paying until all the equipment was installed and the lease schedule commenced for its 36-month term. The firm, however, had a relationship with one of the leasing companies that had provided the lowest lease rate factor with the pro-rata 1/30 provision and the 90-day installation. The firm asked the leasing company to provide the same 90-day installation option but with 45 days for rent due at the end of the installation. The firm had to increase the lease rate factor, but still awarded the business to that lessor. Unfortunately, months later, the person handling the leases was no longer with the firm.

A couple years later, the firm found that during the confusion of employee turnover, the leasing company stopped providing the 90-day installation periods with the set 45 days of interim and went back to the more expensive 1/30 a day pro rata payments, and kept adding more equipment to keep the leases open for more than six months. The firm was very upset when it discovered the change and selected the leasing company that initially had provided the best overall solution.

The firm paid around $90,000 more under the pro rata 1/30 a day rent scenario, and the 36-month lease term did not start until after the six-month plus installation period. Make sure the total costs are defined during the installation period; there is nothing wrong with installation costs if they are defined and lower the lease rates to be comparable in total cost to a monthly lease rate without interim rent.

The Original Rembrandt

Leasing your firm's technology and equipment is an excellent and strategic solution not only to bolster your PPP but also to allow your firm to establish a monthly expense where the partner costs are spread out over the life of the hardware or software project, conserve cash reserves, keep bank lines of credit open for short-term use, allow your firm to expense lease payments rather than depreciate equipment, and avoid potential losses on the sale of equipment. Many law firm decision makers in the AmLaw 100/200 and more turn to leasing equipment and technology for their firm as a competitively advantageous way of performing in the new business model landscape.

Just make sure when you are reviewing your Master Lease Agreement, that you are, in fact, looking at a Rembrandt, that you have brought expert tools, accuracy and credible processes to bear upon the lease document, and that you understand the full meaning of its terminology. Make sure at least one of the lease options in the field can show upfront the total cost of ownership of the MLA with the actual language and terminology of the MLA. The true benefits of a lease structure are not determined by the glitter of the lowest lease rate factor, but viewed as a composite whole.

Our firm provides a lease analyzer that helps determine the total cost of the different economic language of any firm's equipment and technology lease document ' upfront ' and can do so determining the variables of such language as described above. It's one of the ways to determine true value ' with accuracy and credibility.

'

Scott McFetters, a member of this newsletter's Board of Editors, is president and Mike Henderson is regional manager for CoreTech Leasing, Inc. Founded in 2008, CoreTech is an independent leasing company working in partnership with more than 100 of the nation's law firms. For more information visit www.coretechleasing.com.

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