It’s never [well, maybe not usually] too late to lease. That’s right, even if a proposed lessee has already purchased and paid for equipment, leasing may still make sense. Sale and leaseback transactions are done frequently for the benefit of both lessor and lessee.
While the technique is usually utilized shortly after equipment deployment, there is no inherent reason why it cannot be utilized for more “seasoned” equipment which has been in service for a while. In some cases, leasing is contemplated but the paperwork is a bit out of sync with the business’ intention. So the equipment is delivered and paid for shortly before a lease is put in place. In other cases where significant time passes between equipment delivery and lease inception, the lessee is induced to lease -- despite its original intention to buy -- by an attractive leasing proposal which it did not originally believe to be available. In still others, the lessee decides as a result of a change of circumstances, to lease to better manage its cash position and/or shift residual risk, and “liquefy” illiquid assets which have been on its balance sheet. Or perhaps the lessee simply changes its philosophy to favor leasing instead of buying.
Even after acquiring title, if interested in such a transaction, the lessee can and should conduct a lease versus buy analysis the same way it would have at an earlier date. The “buy” part should reflect simply holding the assets and foregoing the cash obtainable from a transaction.
One consideration which should never motivate such transactions is federal income tax savings. While circumstances may have been different twenty plus years ago, changes in tax law make it impossible to effect tax savings today from this approach. Parties are urged to consult with tax advisors to determine tax implications in each specific case.
For the most part, the legal issues around sale/leasebacks are the same as those around other leases in which the lessor acquires the equipment from the vendor. For example, whether a deal is classified as a true lease or a security arrangement is governed by the same authority. Similarly, the need for a specific description of the leased items is the same.
In any case where the deal makes economic sense, there are certain legal considerations unique to the sale/leaseback arrangement to which both lessor and lessee must be alert. If the lessee has a credit facility, it must ensure that the proposed sale of the assets to the lessor is not prohibited by the terms of the facility documentation or other applicable agreement (e.g. with equity investors) or, if it is, that it obtains an appropriate waiver from the creditor(s)/investor(s). Of course, the proposed transaction should be evaluated with the same legal and financial analysis as a more conventional transaction not involving a sale/leaseback.
On what should the lessor focus? In addition to its customary legal, product and financial review, the lessor must ensure that it is getting clear title to the asset(s). In the first instance, this involves obtaining proof of payment to the vendor so as to avoid purchase money security interests. More importantly, it must conduct a full UCC lien search to ensure that the assets – once titled to the lessee – are not subject to a blanket lien in favor of a financial institution or other third party claim such as tax liens. This requires a thorough lien search and review of both pertinent security documentation and UCC-1 financing statements.
If the lessee has granted a financial institution a broad lien on all of its assets, including “after acquired” property, as is often the case, then the instant the lessee comes into title, the lien attaches and would relegate the lessor to a second position absent a waiver. The author has had personal experience with such a situation resulting in a seven figure loss to a lessor when its UCC search failed to note the blanket lien and the lessee then filed for bankruptcy, notwithstanding the lessor paying the lessee for the items.
In cases where equipment has been in service for any length of time, the lessor should take into account in its pricing analysis whether the lessee’s desire to do the sale/leaseback reflects a new intention to replace the equipment at fixed term expiration – i.e. lower anticipated in-place value. To the extent that this appears to be the case, the lessor should factor into its rate, the additional remarketing risk. This may mean reduced willingness to enter into an operating lease. The lessee should be realistic about the prospects for obtaining the same pricing that would have been available if the deal was done at time of equipment delivery.
It is also suggested that to avoid disputes over equipment performance, the lease documentation should expressly contain the lessee’s acknowledgment that the equipment has been in service, the lessee is familiar with its performance and is entitled to only the balance of the manufacturer warranty.
Additionally, it is also suggested that lessors that have not done a great deal of such leases ensure their own warehouse line or other credit facility permit such transactions. To the extent that the definition of “eligible equipment” or “eligible receivable” or standalone covenants restricts the use of used equipment, this will be problematic.
Lastly, lessors accustomed to collection of interim rent should not anticipate that it will be available in these situations, since there is no gap between vendor payment and lease commencement.
The recent declaration by FASB of its intention to require lessee balance sheet provisions for leases by 2019 should have no impact on the desirability of a sale/leaseback. The cash flow considerations remain the same for the lessor and lessee. Footnote disclosure of such obligations has always been required, and the delayed effectiveness of the change allows plenty of time for loan documentation and compliance practices to catch up with reality.
Sale/leasebacks often allow lessees a beneficial “do-over”while also providing lessors access to advantageous financing opportunities that would have been missed. However, both parties need to take a few special precautions to make the deals work.