Principles of Lease Documentation

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1 Principles of Lease Documentation A presentation made to The 2003 ELA Lease Accountants Conference Edward K. Gross Ober, Kaler, Grimes & Shriver ekgross@ober ober.com

2 Introduction Lessor s Motivations Maximize Profit Rent (portion of amount advanced, plus interest) Tax/Depreciation Benefits Residual Value Avoid Liability Avoid Administrative and Other Burdens of Ownership

3 Introduction Lessee s Motivations Obtain Use and Possession of Capital Equipment at Cheapest Cost to Lessee Address Accounting, Regulatory, Contractual and Other Considerations (if any) Flexibility Use Purchase

4 The Law Generally Commercial Tort Tax User/Equipment Specific Other

5 The Law Uniform Commercial Code Article 1 General Article 2 Sales Article 2A Leases Article 9 Secured Transactions

6 The Law Uniform Commercial Code Lease/Security Interest ( Non-True Lease ) Lease ( True Lease ) UCC Sec. 2A-103(j) Finance Lease ( Finance Lease ) UCC Sec. 2A-103(g)

7 Article 2A Leases Freedom of Contract Finance Lease Concept Covers Consumer Leases Validates Sale-Leasebacks Implied Representations and Warranties Enforceability and Remedies Fixtures

8 Article 2A Leases True Lease UCC Sec (37) 1 What are the economic realities of the transaction? Does the Lessor have a reasonable expectation that at lease expiration or termination it will either receive more than nominal compensation for the equipment or recover equipment that has more than nominal residual value? Consider Options Useful Life

9 Article 2A Leases Benefits and Detriments of Characterization True Lease Lessor is Owner UCC-2A Bankruptcy Advantages Non-True Lease Seller/Lender/ Secured Party UCC-2/ UCC-9 Liability Avoidance Tax Advantages

10 Finance Lease UCC Sec. 2A-103(g) Prerequisites Lessor does not select, manufacture or supply the goods Lessor acquires the equipment to lease it to Lessee under that lease Prior to leasing, Lessee gets a copy of, or is otherwise made familiar with, supplier and supply contract

11 Significant Advantages of Finance Lease Automatically Hell or High Water Implied Warranties automatically disclaimed Risk of loss automatically passes to Lessee Lessee gets automatic pass-through of Supplier s warranties

12 Assignment of Leases Under Article 2A (UCC Sec. 2A-303) Restrictions on transfers may not be enforceable Non-breaching party may have other remedies If by Lessee, is it transferring use and possession? If by Lessor,, is it materially increasing Lessee s burdens or risks?

13 UCC Article 9 Secured Transactions

14 Security Interest in Equipment Creation and attachment of the security interest Perfection Priority of the security interest

15 Bankruptcy Basic Elements of a Bankruptcy Proceeding Automatic Stay/Relief Proof of Claim Lease Assumption or Rejection Plan (Chapter 11) Ipso Facto Clauses

16 Bankruptcy Basic Elements of a Bankruptcy Proceeding Automatic Stay, 11 U.S.C. Sec. 362(a) Essentially an Injunction Against Debtor or Property of Its Estate So Lessor Cannot Cancel Lease Send Demand Letters (or call) File Suit to Collect Money Repossess the Equipment Dispose of the Equipment

17 Bankruptcy Proof of Claim 11 U.S.C. Sec. 501 Must file within court-determined deadline If Chapter 11, only have to file if claim is described in Debtor s schedules as disputed, contingent or unliquidated or is inaccurately scheduled Most Lessors file as a matter of course

18 Bankruptcy Relief from Stay 11 U.S.C. Sec. 362(d) Lessor may seek an order vacating the stay, for cause, including: failure to provide Lessor with adequate protection absence of equity in leased equipment (non-true leases)

19 Bankruptcy Assumption or Rejection 11 U.S.C. Sec. 365 (only true leases) Lessee Required to Assume or Reject Within 60 Days of Filing if Chapter 7 Not Later Than Confirmation of Plan if Chapter 11 Right to Compel assumption or rejection of lease 11 U.S.C. Sec. 365(d)(2)

20 Bankruptcy Assumption or Rejection (continued) Assumption Cure or Provide Adequate Assurance of Prompt Cure of Pre- and Post-Petition Petition Defaults (Except Penalties and/or Non-Monetary Defaults... Maybe) Administrative Claim for Pre- and Post-Damages if Breached or Rejected Assume and Assign Rejection Business Judgment Rule (case law) Unsecured Claim for Damages

21 Bankruptcy No Free Ride Rule 11 U.S.C. Sec. 365(d)(10) True Leases Only Lessee Must Perform All Obligations Arising From or After 60 Days After Filing (Other Than Penalties) Unless Court Orders Otherwise, Based on Equities of Case Administrative Claim for Damages Due to Breach

22 Bankruptcy Plan of Reorganization 11 U.S.C. Sec Will Finally Address Assumption or Rejection (if not Already Addressed) Will Finally Address Treatment and Manner of Distribution with Respect to Claim

23 Bankruptcy Ipso Facto Claims 11 U.S.C. Sec. 365(b)(2) Cannot enforce clauses that are triggered by insolvency.

24 Bankruptcy Treatment in Bankruptcy (Chapter 11) True Lease Assumption (and/or Assignment) or Rejection No Free Ride Ownership Return of Equipment or Assumption of Lease/ Administrative Claim Non-True Lease Relief from Stay Adequate Protection Collateral Issues: Secured Claim: Lower of Amount of Debt or Value of Collateral Unsecured Claim for Deficiency

25 Basic Lease Documentation Generally, Substance Similar but Form Different Small ticket Middle Market Big Ticket

26 Basic Lease Documentation Proposal and Commitment Letter Proposal Proposes Financing Under Proposed Terms and Conditions Not binding

27 Basic Lease Documentation Proposal and Commitment Letter Commitment Letter Both Parties Commit to Enter into Financing Transaction After Credit Approval and Before Documentation Binding Should Address All Credit Committee Requirements

28 Basic Lease Documentation Master Lease Agreement Basic Terms and Conditions Negotiate Once Contemplates takedowns by Lease Schedule(s)

29 Basic Lease Documentation Master Equipment Lease Basic Provisions Include: Rent and Manner of Payment Late Charges Term of Lease and Any Options Net Lease/ Hell or High Water Ownership Conditions Precedent to Funding Delivery and Acceptance Maintenance/Return and Inspection Insurance Indemnification Tax (General and Income) General Disclaimers Lessee s Representations Default and Remedies Financials, etc. Governing Law and Choice of Forum Boilerplate

30 Basic Lease Documentation Lease Schedule Each a Separate Instrument of Lease Incorporates Master Lease Provisions Chattel Paper Economic Terms Equipment Description Term of Lease Commencement and Expiration Rent Amounts and Periodicity Acceptance Acknowledgements Riders as to Options or Flexibility Points

31 Basic Lease Documentation Acceptance Certificates Signed by Lessee After Inspecting Equipment Acknowledge Final Acceptance Establish Effective Date of Lease Schedule/Commencement Date of Lease Absolute Condition Precedent to Funding

32 Basic Lease Documentation Options End of Term Purchase Renewal Return During Term Terminate Purchase (Rider or in Lease)

33 Basic Lease Documentation Options End of Term Purchase Option Price Stipulated Fixed and/or Fair Market Sales Value Conditions Notice No Default All or Designated Units of Equipment

34 Basic Lease Documentation Options End of Term Renewal Option Length of Term(s) Maximum Number of Term(s) Rent Stipulated Fixed and/or Fair Market Rental Value Conditions Notice Credit All or Designated Units of Equipment

35 Basic Lease Documentation Options Terminal Rent Adjustment Clause (TRAC) IRC 7701(h) Lessee Risk/Compensation Split Risk

36 Basic Lease Documentation Options During Term Options Early Termination or Purchase Option When Exercisable Stipulated Amount if EBO, Fixed and/or Fair Market Sales Value Conditions Notice No Default All or Designated Units of Equipment

37 Basic Lease Documentation Guaranty Unconditional, Primary and Absolute Payment and Not Collection Waiver of Suretyship Defenses Ability to Assume Choice of Law, etc.

38 Basic Lease Documentation Certificates of Insurance Types of Coverage Liability Additional Insured Casualty Loss Payee Minimum Levels of Coverage Maximum Deductibles or Levels of Self- Insurance Exclusions from Coverage Endorsements Breach of Warranty Clause Written Notice 30 Days Prior to Cancellation or Charge Expiration Dates

39 Basic Lease Documentation Other Credit Support Security Deposit Collateral Economic Enforcement Letter of Credit Third-Party Obligation (Bankruptcy Proof) Lessor s Form Limited, Clear Drawing Rights Breach Bankruptcy Failure to Replace LC Replacement Prior to Expiration or Defaults

40 Basic Lease Documentation Other Credit Support Additional Collateral Warrants Blanket Lien Vendor Support

41 Basic Lease Documentation UCC-1 1 Financing Statements UCC Sec for True Leases Correct Legal Name of Debtor Appropriate Locations for Filing Adequate Description of Equipment Timely Filing

42 Basic Lease Documentation Other Closing Documents Lessee and any Guarantor or Other Obligor Corporate Certificate Certified Resolutions Incumbency Opinions Corporate or Other Legal Status/Authority Compliance with Legal and Contractual Requirements Enforceability Litigation Other

43 Basic Lease Documentation Purchase Documents Who is the Purchaser? Purchase Order Purchase Agreement Invoice Third-Party Agreements Purchase Order/Agreement Assignment Assignment of Warranties

44 Basic Lease Documentation Purchase Documents (continued) Bills of Sale Title Who Holds Title? Has Equipment Been Delivered?

45 Basic Lease Documentation Vendor Support Documents Remarketing Put to Vendor (full or limited) Credit Support

46 Basic Lease Documentation Intercreditor Agreements Subordination Agreement How Deep? Assignment of Subleases Who gets rent? How soon? Real Property Waivers Landlord Mortgagee Owner

Credit Underwriting, Lease Structures and Documentation Provisions

Credit Underwriting, Lease Structures and Documentation Provisions Presenters John Azzopardi Chief Financial Officer TIP Capital Anthony L. Lamm, Esquire Managing Partner Lamm Rubenstone Lesavoy Butz &