The Irresistible Force Paradox in Play in the Middle Market

Editor's Note: This article is the first in a continuing series on resolving contentious issues in sophisticated lease transactions.

If you had a philosophy course in college, you likely know the story of the craftsman from the ancient Chinese state of Chu who sold spears and shields in the marketplace. Boasting, he claimed that his shields were so solid that no spear could pierce them; that his spears were so strong, they could pierce through anything. This, of course, was immediately met with laughter when the wise guy in the crowd commented, “What if I stab your shield with your spear?” It is said the craftsman had no response.

This story, of course, illustrates the paradox involving the unstoppable force meeting the immovable object. The problem has endured throughout time to describe the clash of strong-willed, unyielding participants in any endeavor. In the area of contract negotiations, however, the paradox plays out a bit differently. It is different because the end game is different. Everyone participating knows and understands that everyone else participating wants to complete a deal that in fact benefits everyone. As more time and energy is invested in negotiating that deal to a hopeful conclusion, the urgency to complete the deal, and the likelihood of deal fatigue, accelerates as frustration builds and everyone's stake in assuring the beneficial use of the participants' time, energy, reputations, personal capital, or whatever other personal reason might exist to propel the deal to finality, mushrooms.

Typically, staunch initial opposition to certain deal terms lessens, making compromise more likely, as greater time and effort is invested in a successful outcome. Although the justification given to the opposite side for such compromise may revolve around a claim that contract provisions have now been adequately explained, in fact, compromise is reached when an adequate explanation is provided to the other negotiator. This explanation can now be used by that negotiator to convince stakeholders to abandon a traditional hard-line position on an issue that has become contentious. It is not the explanation itself that results in compromise. It is that the explanation, plus the price of failure to agree, arms the negotiator with the necessary” ammunition needed to champion a reversal of the prior opposition of stakeholders. Recall that we started with the assumption that everyone wants to conclude a deal, so that by the time deal fatigue starts, everyone is scrambling to find adequate explanations to justify compromise and the completion of contract negotiations. The purpose of this continuing series of articles is to examine those deal points that first seem incapable of resolution and compare them with what was finally negotiated after protracted discussion and a realization of the price of failure.

A Hypothetical

The continuing hypothetical situation this article addresses is the syndication of a multimillion-dollar rolling stock equipment lease of tractors, trailers or both. Assume the parties are: 1) one or more well-known national banks with offices in many, if not all, states (collectively “Lender”) who will take an assignment of a particular Schedule to a Master Lease Agreement; 2) lessor, the broker or syndicator (“Lessor”) and; 3) a large non-public subsidiary of a Fortune 500 company with a need or a desire to lease its rolling stock fleet of vehicles (“Lessee”). This is, and in all respects is intended to be, a typical Article 2A finance lease.

As indicated earlier, the negotiations are complicated by the fact that there are various stakeholders for all parties and that each stakeholder may have an agenda that may or may not coincide with that of the parties' principal contract negotiators in this deal; the business team and the legal team. Stakeholders may consist of the treasury and tax departments of the Lender and Lessee, finance personnel, risk managers, business unit personnel, credit underwriters, asset managers, regulatory managers, bank branch or line officers, salespersons, servicing personnel, portfolio managers and documentation specialists, among others. With rolling stock, the deal may well be further complicated by the Lessor's use of a titling trust that will also be addressed in future articles.

This first article in the series examines both the anti-assignment provision and the financial statement provision, both of which can be found in most equipment leases.

The Anti-Assignment Provisions

It is quite common for the operative Master Lease Agreement to contain a provision relating to Lessee's inability to assign the lease. Typically, the Lessor will reserve the right to unconditionally assign its rights under the Master Lease Agreement and Schedules while simultaneously attempting to deny the Lessee's right to assign. The Lessor's right to assign will be examined in a future article.

A typical anti-assignment provision prohibiting a Lessee assignment, the breach of which is enforced as an Event of Default, might read:

Notwithstanding anything that may be contained in this Agreement or Schedule to the contrary, Lessee agrees not to assign its interest in this agreement and any subsequent schedule or to sublease the equipment. If any such assignment or sublease occurs without the express written consent of Lessor, or its assigns, which consent may be withheld in Lessor's sole, absolute and unconditional discretion, Lessee shall remain fully liable hereunder as though such assignment or sublease had not been made. Lessee agrees that any third party's use or possession of the Equipment will substantially impair the value of this Agreement and any Schedule to Lessor.

'

Financial Statements Provision

A typical financial statement provision might read:

Financial Statements. Lessee shall provide Lessor with ' financial statements ' and (iii) such other information as Lessor may reasonably request ' . If this Agreement and any Schedule is guaranteed by Lessee's corporate parent, for as long as such guaranty continues, the furnishing of such financial statements shall also relate to said parent-guarantor. In lieu of such statements, for as long as the Lessee (or its parent-guarantor) is required to file annual and quarterly financial reports on Forms 10K and 10Q with the United States Securities and Exchange Commission, such reports as filed and sent to Lessor, may satisfy the financial statements provisions of this subsection for the entity so reporting.

In negotiating the Master Lease provisions in this arena, Lessor's counsel, at the outset, must have an understanding of how much risk the Lender will tolerate. Lessor and Lender likely have a long-standing relationship evidenced by a heavily negotiated Program Agreement that typically includes a form Master Lease Agreement attached as an exhibit. Negotiating changes to that Master Lease Agreement with a proposed Lessee is fraught with peril for the unwary unless Lessor's counsel has a fairly well-developed sense of where a Lender will and will not compromise.

Changes to the Anti-assignment and Financial Statement provisions are not conventionally thought to be likely candidates for such compromise. Lender's have well-grounded reasons why each of these clauses must remain intact. Consideration must be given to the literal wording itself, the object sought to be obtained, why it is important for the Lessor, Lessee, and Lender to have the provision at all, how the clause may be crafted to conform to the needs of all concerned with the deal, what the parties need to have in the document and what they can do without. What are possible resolutions by way of language or otherwise to satisfy the needs of the Lessor, the Lessee and the Lender?

The Issues

At the outset of recently concluded negotiations in a $25 million lease syndication, in-house legal counsel for the non-public rolling stock equipment subsidiary of the Fortune 500 company speed-dialed Lessor's counsel and stated, “We cannot provide financial statements, we are not a public company. Our results are reported to our publicly held parent. If this is important to you, download our parent's 10K and 10Q filings. Additionally, since we cannot accept 95% of your Anti-Assignment Clause, we see no purpose in going further unless you delete that provision.” To which Lessor's counsel, having heard these exact words dozens of times before, replied, “Send me the assignment provision you can live with and we'll try to work something out and let's arrange a conference call to include our respective business people so we can address the financial statement issue and why we must have financial information from the Lessee to make credit decisions.”

In response, Lessee's counsel will claim that since the guarantor is a large public company, its publicly filed statements will suffice. Welcome to the world of high-stakes equipment leasing negotiation, which of necessity now involves redlining pertinent previously non-negotiable clauses from the Lessor's proposed, and Lender pre-approved, Master Lease.

From a review of the now-received excessively redlined Master Lease Agreement a few things become abundantly clear:

1. Lessee does not realize or comprehend that the lease, or a particular Schedule, will be syndicated to a large bank lender, perhaps one with which Lessee, or its parent, already has a business relationship; and
2. Because, or perhaps in spite, of that fact, Lessee wants to throw around its significant bargaining power.

In a conference call without clients, Lessor's counsel informs Lessee's in-house counsel of both the facts of lease syndication and the governing provisions of Article 2A of the UCC, subjects that Lessor's counsel knows will be put to good use later when Lessee's in-house counsel is discussing these issues with various objecting company stakeholders. Supplying financial statements is explained as at least a credit underwriting requirement of Lessor that cannot be waived. Moreover, from a regulatory and audit standpoint, copies of pertinent financial statements must be maintained in the Lessee's file.

Now firmly realizing that a regulated bank is the ultimate assignee, a fact that may have been overlooked or ignored earlier, some understanding of the issue involved in refusing to provide financial statements is acknowledged. Notwithstanding that acknowledgment, other stakeholders,' usually the treasury personnel, nevertheless steadfastly refuse to part with sensitive financial information that may not be separately reported by the parent in its public filings. Continued refusal to supply any financial information by these objecting stakeholders would obviously terminate further discussions.

One solution to this problem that may eventually occur to everyone is that the subsidiary has, or had in the past, a credit facility with the same Lender (perhaps a line of credit or a real estate loan). Although different stakeholders of the subsidiary may be involved, at least it can be demonstrated that financial statements had to have been supplied in the past and this is merely a continuation of that precedent.

Once it is determined that Lessee has prior credit relationships with Lender and that Lender is in receipt of earlier financial statements, it is not unusual for Lessee to then insist on a limitation of Lessor's unfettered right to assign, preferring only those Lenders that have such a prior history with Lessee. Thus, a compromise can be reached where Lessor limits the assignment to specific Lenders or at least identifies the Lender for each Schedule early in the process, essentially providing Lessee with a veto.

If there is no prior credit relationship with the current Lender, an effort can be made to convince the Lessee that this same information has been afforded to its other bank lenders. This allows the Lessee's business and legal teams to attempt to pacify the various stakeholders who object to the disclosure of any financial information reporting the results of a non-public subsidiary. Eventually, everyone realizes the point made in the Introduction, that everyone want to close the deal but that the deal cannot close without the Lender's credit underwriting department having sufficient information on which to base its funding decision.

The reasons for the prohibition on assignment are several-fold, including not only creditworthiness, but also such factors as risk exposure and concentration and prior or current litigation experience. This, in response to the redline that offered language that the assignment by Lessee would be only to an entity with comparable creditworthiness as Lessee.

Conclusion

Putting aside the issue of substituting the Lessee's criteria of creditworthiness for that of the Lender's, Lender also needs to be assured that the proposed assignee of Lessee will not expose Lender to the risk of too much credit concentration with the proposed assignee or too much exposure to a particular industry or endeavor. These are answers that the Lessee will not know before an assignee is identified, and even if identified, will not know unless the information is shared by the Lender. Moreover, it would be embarrassing, to say the least, if Lessee assigned its obligations to a company embroiled in litigation with the Lender. Consequently, Lender has very legitimate reasons to prohibit assignments.

In a future article, we will explore additional objections to Lessor's unfettered right to assign and the compromises reached to secure the assignment rights necessary in any lease syndication. In other future articles, we will undertake an examination of such other contentious issues like the Material Adverse Change clause, both as a representation and warranty and as an Event of Default, servicing obligations separate and apart from the syndication model, waiver of defenses issues, forum selection issues, finance lease issues, including the differing definitions of that term depending on who you are speaking with, and insurance issues, including a discussion about self-insurance typically encountered in this arena, and finally, a number of issues related to a parent guarantee.

Anthony L. Lamm and Stephen Levin are partners in the law firm of Lamm Rubenstone LLC with offices in Philadelphia and Trevose, PA and Cherry Hill, NJ. Lamm, the firm's managing partner and a member of this newsletter's Board of Editors, is admitted in Pennsylvania. Levin is admitted in Pennsylvania and New York. They may be reached at [email protected] and [email protected], respectively.

Editor's Note: This article is the first in a continuing series on resolving contentious issues in sophisticated lease transactions.

If you had a philosophy course in college, you likely know the story of the craftsman from the ancient Chinese state of Chu who sold spears and shields in the marketplace. Boasting, he claimed that his shields were so solid that no spear could pierce them; that his spears were so strong, they could pierce through anything. This, of course, was immediately met with laughter when the wise guy in the crowd commented, “What if I stab your shield with your spear?” It is said the craftsman had no response.

This story, of course, illustrates the paradox involving the unstoppable force meeting the immovable object. The problem has endured throughout time to describe the clash of strong-willed, unyielding participants in any endeavor. In the area of contract negotiations, however, the paradox plays out a bit differently. It is different because the end game is different. Everyone participating knows and understands that everyone else participating wants to complete a deal that in fact benefits everyone. As more time and energy is invested in negotiating that deal to a hopeful conclusion, the urgency to complete the deal, and the likelihood of deal fatigue, accelerates as frustration builds and everyone's stake in assuring the beneficial use of the participants' time, energy, reputations, personal capital, or whatever other personal reason might exist to propel the deal to finality, mushrooms.

Typically, staunch initial opposition to certain deal terms lessens, making compromise more likely, as greater time and effort is invested in a successful outcome. Although the justification given to the opposite side for such compromise may revolve around a claim that contract provisions have now been adequately explained, in fact, compromise is reached when an adequate explanation is provided to the other negotiator. This explanation can now be used by that negotiator to convince stakeholders to abandon a traditional hard-line position on an issue that has become contentious. It is not the explanation itself that results in compromise. It is that the explanation, plus the price of failure to agree, arms the negotiator with the necessary” ammunition needed to champion a reversal of the prior opposition of stakeholders. Recall that we started with the assumption that everyone wants to conclude a deal, so that by the time deal fatigue starts, everyone is scrambling to find adequate explanations to justify compromise and the completion of contract negotiations. The purpose of this continuing series of articles is to examine those deal points that first seem incapable of resolution and compare them with what was finally negotiated after protracted discussion and a realization of the price of failure.

A Hypothetical

The continuing hypothetical situation this article addresses is the syndication of a multimillion-dollar rolling stock equipment lease of tractors, trailers or both. Assume the parties are: 1) one or more well-known national banks with offices in many, if not all, states (collectively “Lender”) who will take an assignment of a particular Schedule to a Master Lease Agreement; 2) lessor, the broker or syndicator (“Lessor”) and; 3) a large non-public subsidiary of a Fortune 500 company with a need or a desire to lease its rolling stock fleet of vehicles (“Lessee”). This is, and in all respects is intended to be, a typical Article 2A finance lease.

As indicated earlier, the negotiations are complicated by the fact that there are various stakeholders for all parties and that each stakeholder may have an agenda that may or may not coincide with that of the parties' principal contract negotiators in this deal; the business team and the legal team. Stakeholders may consist of the treasury and tax departments of the Lender and Lessee, finance personnel, risk managers, business unit personnel, credit underwriters, asset managers, regulatory managers, bank branch or line officers, salespersons, servicing personnel, portfolio managers and documentation specialists, among others. With rolling stock, the deal may well be further complicated by the Lessor's use of a titling trust that will also be addressed in future articles.

This first article in the series examines both the anti-assignment provision and the financial statement provision, both of which can be found in most equipment leases.

The Anti-Assignment Provisions

It is quite common for the operative Master Lease Agreement to contain a provision relating to Lessee's inability to assign the lease. Typically, the Lessor will reserve the right to unconditionally assign its rights under the Master Lease Agreement and Schedules while simultaneously attempting to deny the Lessee's right to assign. The Lessor's right to assign will be examined in a future article.

A typical anti-assignment provision prohibiting a Lessee assignment, the breach of which is enforced as an Event of Default, might read:

Notwithstanding anything that may be contained in this Agreement or Schedule to the contrary, Lessee agrees not to assign its interest in this agreement and any subsequent schedule or to sublease the equipment. If any such assignment or sublease occurs without the express written consent of Lessor, or its assigns, which consent may be withheld in Lessor's sole, absolute and unconditional discretion, Lessee shall remain fully liable hereunder as though such assignment or sublease had not been made. Lessee agrees that any third party's use or possession of the Equipment will substantially impair the value of this Agreement and any Schedule to Lessor.

'

Financial Statements Provision

A typical financial statement provision might read:

Financial Statements. Lessee shall provide Lessor with ' financial statements ' and (iii) such other information as Lessor may reasonably request ' . If this Agreement and any Schedule is guaranteed by Lessee's corporate parent, for as long as such guaranty continues, the furnishing of such financial statements shall also relate to said parent-guarantor. In lieu of such statements, for as long as the Lessee (or its parent-guarantor) is required to file annual and quarterly financial reports on Forms 10K and 10Q with the United States Securities and Exchange Commission, such reports as filed and sent to Lessor, may satisfy the financial statements provisions of this subsection for the entity so reporting.

In negotiating the Master Lease provisions in this arena, Lessor's counsel, at the outset, must have an understanding of how much risk the Lender will tolerate. Lessor and Lender likely have a long-standing relationship evidenced by a heavily negotiated Program Agreement that typically includes a form Master Lease Agreement attached as an exhibit. Negotiating changes to that Master Lease Agreement with a proposed Lessee is fraught with peril for the unwary unless Lessor's counsel has a fairly well-developed sense of where a Lender will and will not compromise.

Changes to the Anti-assignment and Financial Statement provisions are not conventionally thought to be likely candidates for such compromise. Lender's have well-grounded reasons why each of these clauses must remain intact. Consideration must be given to the literal wording itself, the object sought to be obtained, why it is important for the Lessor, Lessee, and Lender to have the provision at all, how the clause may be crafted to conform to the needs of all concerned with the deal, what the parties need to have in the document and what they can do without. What are possible resolutions by way of language or otherwise to satisfy the needs of the Lessor, the Lessee and the Lender?

The Issues

At the outset of recently concluded negotiations in a $25 million lease syndication, in-house legal counsel for the non-public rolling stock equipment subsidiary of the Fortune 500 company speed-dialed Lessor's counsel and stated, “We cannot provide financial statements, we are not a public company. Our results are reported to our publicly held parent. If this is important to you, download our parent's 10K and 10Q filings. Additionally, since we cannot accept 95% of your Anti-Assignment Clause, we see no purpose in going further unless you delete that provision.” To which Lessor's counsel, having heard these exact words dozens of times before, replied, “Send me the assignment provision you can live with and we'll try to work something out and let's arrange a conference call to include our respective business people so we can address the financial statement issue and why we must have financial information from the Lessee to make credit decisions.”

In response, Lessee's counsel will claim that since the guarantor is a large public company, its publicly filed statements will suffice. Welcome to the world of high-stakes equipment leasing negotiation, which of necessity now involves redlining pertinent previously non-negotiable clauses from the Lessor's proposed, and Lender pre-approved, Master Lease.

From a review of the now-received excessively redlined Master Lease Agreement a few things become abundantly clear:

1. Lessee does not realize or comprehend that the lease, or a particular Schedule, will be syndicated to a large bank lender, perhaps one with which Lessee, or its parent, already has a business relationship; and
2. Because, or perhaps in spite, of that fact, Lessee wants to throw around its significant bargaining power.

In a conference call without clients, Lessor's counsel informs Lessee's in-house counsel of both the facts of lease syndication and the governing provisions of Article 2A of the UCC, subjects that Lessor's counsel knows will be put to good use later when Lessee's in-house counsel is discussing these issues with various objecting company stakeholders. Supplying financial statements is explained as at least a credit underwriting requirement of Lessor that cannot be waived. Moreover, from a regulatory and audit standpoint, copies of pertinent financial statements must be maintained in the Lessee's file.

Now firmly realizing that a regulated bank is the ultimate assignee, a fact that may have been overlooked or ignored earlier, some understanding of the issue involved in refusing to provide financial statements is acknowledged. Notwithstanding that acknowledgment, other stakeholders,' usually the treasury personnel, nevertheless steadfastly refuse to part with sensitive financial information that may not be separately reported by the parent in its public filings. Continued refusal to supply any financial information by these objecting stakeholders would obviously terminate further discussions.

One solution to this problem that may eventually occur to everyone is that the subsidiary has, or had in the past, a credit facility with the same Lender (perhaps a line of credit or a real estate loan). Although different stakeholders of the subsidiary may be involved, at least it can be demonstrated that financial statements had to have been supplied in the past and this is merely a continuation of that precedent.

Once it is determined that Lessee has prior credit relationships with Lender and that Lender is in receipt of earlier financial statements, it is not unusual for Lessee to then insist on a limitation of Lessor's unfettered right to assign, preferring only those Lenders that have such a prior history with Lessee. Thus, a compromise can be reached where Lessor limits the assignment to specific Lenders or at least identifies the Lender for each Schedule early in the process, essentially providing Lessee with a veto.

If there is no prior credit relationship with the current Lender, an effort can be made to convince the Lessee that this same information has been afforded to its other bank lenders. This allows the Lessee's business and legal teams to attempt to pacify the various stakeholders who object to the disclosure of any financial information reporting the results of a non-public subsidiary. Eventually, everyone realizes the point made in the Introduction, that everyone want to close the deal but that the deal cannot close without the Lender's credit underwriting department having sufficient information on which to base its funding decision.

The reasons for the prohibition on assignment are several-fold, including not only creditworthiness, but also such factors as risk exposure and concentration and prior or current litigation experience. This, in response to the redline that offered language that the assignment by Lessee would be only to an entity with comparable creditworthiness as Lessee.

Conclusion

Putting aside the issue of substituting the Lessee's criteria of creditworthiness for that of the Lender's, Lender also needs to be assured that the proposed assignee of Lessee will not expose Lender to the risk of too much credit concentration with the proposed assignee or too much exposure to a particular industry or endeavor. These are answers that the Lessee will not know before an assignee is identified, and even if identified, will not know unless the information is shared by the Lender. Moreover, it would be embarrassing, to say the least, if Lessee assigned its obligations to a company embroiled in litigation with the Lender. Consequently, Lender has very legitimate reasons to prohibit assignments.

In a future article, we will explore additional objections to Lessor's unfettered right to assign and the compromises reached to secure the assignment rights necessary in any lease syndication. In other future articles, we will undertake an examination of such other contentious issues like the Material Adverse Change clause, both as a representation and warranty and as an Event of Default, servicing obligations separate and apart from the syndication model, waiver of defenses issues, forum selection issues, finance lease issues, including the differing definitions of that term depending on who you are speaking with, and insurance issues, including a discussion about self-insurance typically encountered in this arena, and finally, a number of issues related to a parent guarantee.

Anthony L. Lamm and Stephen Levin are partners in the law firm of Lamm Rubenstone LLC with offices in Philadelphia and Trevose, PA and Cherry Hill, NJ. Lamm, the firm's managing partner and a member of this newsletter's Board of Editors, is admitted in Pennsylvania. Levin is admitted in Pennsylvania and New York. They may be reached at [email protected] and [email protected], respectively.