Ubi Sunt, Buck-Out Lease?

For those who didn't take a survey course in English lit, ubi sunt means “where are they?” and was used by Beowulf-era poets to mourn the passing of people and things.

The list of the gone-but-not-forgotten in the equipment finance business include the TBT lease, the wrap lease and several other variations. The popularity of the equipment finance agreement or “EFA” as a replacement for “leases” that are, in fact, financing arrangements would seem to signal the end of these “leases.” Despite predictions in several quarters, the so-called buck-out lease appears alive and healthy, if not as robust as it once was.

Background

As is widely known, the Uniform Commercial Code (UCC) provides that a lease with a “nominal” purchase option is a secured financing and not a true lease. UCC ' 1-203 (formerly, 1-102(37)) provides that a lease in which the lessee may acquire the leased property at the end of the term for nominal consideration is actually a security interest. Section 1-203 includes other types of transactions that fall within the definition of security interests, but leases providing that the lessee may purchase the equipment for $1.00 at the end of the lease term are the most popular.

At one time, it was estimated that as many as three-quarters of the leases entered into in the United States were leases of this type. As a result, few financial products have had such a wide range of names, a few of which are listed below:

• $1 Purchase Option Lease;
• $1-out Lease;
• ALIAS (a lease intended as security);
• Buck-out Lease;
• Capital Lease (often incorrect usage ' this is an accounting term);
• Collateral Lease;
• Conditional Sale Lease;
• Direct Finance Lease (which potentially applies to a number of types of leases);
• Dirty Lease;
• Disguised Lease;
• FAS Thirteen Finance Lease;
• Finance Agreement;
• Finance Lease (old usage);
• Financing Arrangement;
• Financing Lease;
• Full-payout Lease (which is misleading as these leases can contain FMV purchase options in which case they may or may not be true leases);
• Higher Purchase (Canada British-influenced companies ' thanks Jonathan Fleisher);
• Installment Sale Lease;
• Lease Intended as Security (often called “ALIAS”);
• Lease-Purchase;
• Mandatory Purchase Lease;
• Money-over-money Lease;
• Nominal Lease (which we will use for purposes of this article);
• Nominal Option Lease;
• Non-true Lease;
• Not-true Lease;
• Put Lease;
• Sales Finance Lease; and
• Synthetic Lease (which is largely accounting-driven and a much more complex matter).

Significant Issues

Amid all this popularity and confusion, several significant issues have arisen with nominal leases. State tax authorities are easily (and perhaps deliberately) confused by nominal leases and often insist on taxing the rent stream, including the finance charge/imputed interest rather than taxing the purchase price of the equipment. To add to the confusion, the states are not uniform as to whether the sales tax on the purchase price must be paid up front or may be paid over the life of the lease.

Where the lessee enjoys some form of tax exemption from the state, the use of a nominal lease can result in frustrating conversations with taxing authorities and angry customers. This is often true in the case of municipal leases in which the dollar purchase option is used to facilitate federal tax treatment similar to bond issues.

Troubling issues have resulted from the use of true lease documentation in nominal leases transactions. Unlike true leases remedies for nominal lease defaults would normally be expected to mirror the payoff of a level-payment loan: payments discounted to present value at the implicit interest rate of the deal, possibly with a prepayment premium factored in. Many lease forms refer to a casualty value table or calculation formula in calculating damages for lessee default. Where the table uses the implicit rate or something close to it, or the casualty formula mirrors the implicit rate discounting, these forms are not problematic. Where the damages are significantly above the return the lessor would reasonably expect were the lease to run to term without default, the lessor runs the risk of seeing his liquidated damage remedy thrown out by the court as an unenforceable penalty.

Other remedies and language throughout the lease might suffer from the inclusion of leasing language, such as citations to UCC Article 2A or the use of words such as “repossess” or “return.” A particular problem is the automatic renewal or “evergreen” provision or any language that, on its face or in practice, could result in the lessee paying “principal” in excess of the purchase price of the equipment or an implicit rate well in excess of prevailing usury limits. The same can be true of interim rent provisions. In short, putting a dollar purchase option in a lease does not always cleanly turn it into a financing and the results could be surprising.

Legal Precedent

Equipment finance agreements are clearly safer with respect to lessor liability. There is long-standing legal precedent against imposing liability for damage caused by equipment collateral. Marks, “Lessor Liability”, Chapter 19, Equipment Leasing-Leveraged Leasing (PLI 2012). Some courts have been unwilling to recognize that nominal leases are loans for purposes of determining ownership of the financed equipment and have imposed liability on the lessor as if it were the owner. Amba-An v. Arias-Turecious, 704 So.2d 1093 (Fla. App. 4 DCA. 1997).

On the other hand, there is much to recommend continued use of the nominal lease. There are lessees who would send a $1 million line of credit to their counsel for review, but would sign a $2 million nominal lease without batting an eye. Some executives who do not believe they have authority to borrow money are willing to do just that through nominal lease transactions. Nominal leases are at least arguably immune from usury concerns because payments are styled as “rent” for use of equipment.

Conclusion

In some states, the failure to state the rate of interest used to calculate EFA payments, or at least to provide ample information for the borrower/lessee to calculate the rate, can subject the lender to liability. This may be true with respect to the much-discussed “stated interest” statutory exception to Georgia's usury law and in states whose deceptive practices acts may be applied to commercial as well as consumer transactions. Whether these same laws apply to rent under nominal leases is at least debatable.

Some of these concerns are ameliorated by including a specific statement in the lease document to the effect that the transaction intended is a financing, title to the equipment is vested in the lessee and each payment constitutes principal reduction plus an implicit interest rate factor.

The nominal lease, however denoted or described, has been with us for over half a century. Only time will tell whether it is a buffalo that will lumber into the next few decades diminished in numbers but hardly extinct or a passenger pigeon about to fly into memory.

Barry Marks is a founding shareholder with Marks & Associates, P.C., whose practice centers on equipment leasing and finance. A member of this newsletter's Board of Editors, he has over 30 years' experience, including a wide range of financing structures. He may be reached at [email protected].

For those who didn't take a survey course in English lit, ubi sunt means “where are they?” and was used by Beowulf-era poets to mourn the passing of people and things.

The list of the gone-but-not-forgotten in the equipment finance business include the TBT lease, the wrap lease and several other variations. The popularity of the equipment finance agreement or “EFA” as a replacement for “leases” that are, in fact, financing arrangements would seem to signal the end of these “leases.” Despite predictions in several quarters, the so-called buck-out lease appears alive and healthy, if not as robust as it once was.

Background

As is widely known, the Uniform Commercial Code (UCC) provides that a lease with a “nominal” purchase option is a secured financing and not a true lease. UCC ' 1-203 (formerly, 1-102(37)) provides that a lease in which the lessee may acquire the leased property at the end of the term for nominal consideration is actually a security interest. Section 1-203 includes other types of transactions that fall within the definition of security interests, but leases providing that the lessee may purchase the equipment for $1.00 at the end of the lease term are the most popular.

At one time, it was estimated that as many as three-quarters of the leases entered into in the United States were leases of this type. As a result, few financial products have had such a wide range of names, a few of which are listed below:

• $1 Purchase Option Lease;
• $1-out Lease;
• ALIAS (a lease intended as security);
• Buck-out Lease;
• Capital Lease (often incorrect usage ' this is an accounting term);
• Collateral Lease;
• Conditional Sale Lease;
• Direct Finance Lease (which potentially applies to a number of types of leases);
• Dirty Lease;
• Disguised Lease;
• FAS Thirteen Finance Lease;
• Finance Agreement;
• Finance Lease (old usage);
• Financing Arrangement;
• Financing Lease;
• Full-payout Lease (which is misleading as these leases can contain FMV purchase options in which case they may or may not be true leases);
• Higher Purchase (Canada British-influenced companies ' thanks Jonathan Fleisher);
• Installment Sale Lease;
• Lease Intended as Security (often called “ALIAS”);
• Lease-Purchase;
• Mandatory Purchase Lease;
• Money-over-money Lease;
• Nominal Lease (which we will use for purposes of this article);
• Nominal Option Lease;
• Non-true Lease;
• Not-true Lease;
• Put Lease;
• Sales Finance Lease; and
• Synthetic Lease (which is largely accounting-driven and a much more complex matter).

Significant Issues

Amid all this popularity and confusion, several significant issues have arisen with nominal leases. State tax authorities are easily (and perhaps deliberately) confused by nominal leases and often insist on taxing the rent stream, including the finance charge/imputed interest rather than taxing the purchase price of the equipment. To add to the confusion, the states are not uniform as to whether the sales tax on the purchase price must be paid up front or may be paid over the life of the lease.

Where the lessee enjoys some form of tax exemption from the state, the use of a nominal lease can result in frustrating conversations with taxing authorities and angry customers. This is often true in the case of municipal leases in which the dollar purchase option is used to facilitate federal tax treatment similar to bond issues.

Troubling issues have resulted from the use of true lease documentation in nominal leases transactions. Unlike true leases remedies for nominal lease defaults would normally be expected to mirror the payoff of a level-payment loan: payments discounted to present value at the implicit interest rate of the deal, possibly with a prepayment premium factored in. Many lease forms refer to a casualty value table or calculation formula in calculating damages for lessee default. Where the table uses the implicit rate or something close to it, or the casualty formula mirrors the implicit rate discounting, these forms are not problematic. Where the damages are significantly above the return the lessor would reasonably expect were the lease to run to term without default, the lessor runs the risk of seeing his liquidated damage remedy thrown out by the court as an unenforceable penalty.

Other remedies and language throughout the lease might suffer from the inclusion of leasing language, such as citations to UCC Article 2A or the use of words such as “repossess” or “return.” A particular problem is the automatic renewal or “evergreen” provision or any language that, on its face or in practice, could result in the lessee paying “principal” in excess of the purchase price of the equipment or an implicit rate well in excess of prevailing usury limits. The same can be true of interim rent provisions. In short, putting a dollar purchase option in a lease does not always cleanly turn it into a financing and the results could be surprising.

Legal Precedent

Equipment finance agreements are clearly safer with respect to lessor liability. There is long-standing legal precedent against imposing liability for damage caused by equipment collateral. Marks, “Lessor Liability”, Chapter 19, Equipment Leasing-Leveraged Leasing (PLI 2012). Some courts have been unwilling to recognize that nominal leases are loans for purposes of determining ownership of the financed equipment and have imposed liability on the lessor as if it were the owner. Amba-An v. Arias-Turecious , 704 So.2d 1093 (Fla. App. 4 DCA. 1997).

On the other hand, there is much to recommend continued use of the nominal lease. There are lessees who would send a $1 million line of credit to their counsel for review, but would sign a $2 million nominal lease without batting an eye. Some executives who do not believe they have authority to borrow money are willing to do just that through nominal lease transactions. Nominal leases are at least arguably immune from usury concerns because payments are styled as “rent” for use of equipment.

Conclusion

In some states, the failure to state the rate of interest used to calculate EFA payments, or at least to provide ample information for the borrower/lessee to calculate the rate, can subject the lender to liability. This may be true with respect to the much-discussed “stated interest” statutory exception to Georgia's usury law and in states whose deceptive practices acts may be applied to commercial as well as consumer transactions. Whether these same laws apply to rent under nominal leases is at least debatable.

Some of these concerns are ameliorated by including a specific statement in the lease document to the effect that the transaction intended is a financing, title to the equipment is vested in the lessee and each payment constitutes principal reduction plus an implicit interest rate factor.

The nominal lease, however denoted or described, has been with us for over half a century. Only time will tell whether it is a buffalo that will lumber into the next few decades diminished in numbers but hardly extinct or a passenger pigeon about to fly into memory.

Barry Marks is a founding shareholder with Marks & Associates, P.C., whose practice centers on equipment leasing and finance. A member of this newsletter's Board of Editors, he has over 30 years' experience, including a wide range of financing structures. He may be reached at [email protected].