By Jared Nusbaum
Many small businesses rely on equipment financing contracts and equipment leases to obtain office equipment, software or tools of the trade. Although equipment financing and/or leasing can enable businesses to meet their equipment needs immediately, certain risks accompany it. Here are some key items to be aware of if your company is going to purchase the equipment through financing with a third party (or directly with the equipment vendor), or if your company will be leasing equipment.
Inspections and repairs
Equipment should always be inspected prior to signing the contract. Most equipment leases and financing contracts will contain, at the least, a clause that indicates the receiving party has had a full chance to inspect the equipment. Many contracts will require that the receiving party sign a certificate indicating that the party has inspected the equipment and that the equipment is in good working order.
Once that chance to inspect has been given and the transaction moves further, if the equipment stops working or malfunctions for any reason, it is unlikely that the receiving party will be able to go back to the leasing company or equipment vendor to request repairs. Almost all contracts put the responsibility for repairs of business equipment on the business itself. Companies may be willing to negotiate warranty periods, but that is something that would need to be negotiated upfront and put in the contract.
Read the contract
Although this may seem like common sense to some, do not equate entering into a consumer lease or financing agreement with a business lease or financing agreement. The company requesting the equipment must read the contract carefully. Business contracts are generally form contracts that have been worked on by lawyers for many hours. They are almost always more beneficial to the vendor or third party financing company. Business contracts can usually be negotiated, so if there are terms in the contract that are worrisome, talk to the vendor or have your attorney negotiate terms.
Understand the term
Make sure you know everything about the term of the lease or financing contract, including the length, timing of each payment (weekly, bi-weekly, semi-monthly, monthly, or annually), etc. An often-overlooked part of the term is determining when the first payment is actually due under the contract. Some contracts allow float periods where the first payment is not due for 30, 60 or 90 days after the contract commencement date. Make sure to heed the commencement date as defined in the contract to confirm that you are in compliance with all payment dates.
Finance amount can change
Equipment financing or leasing is like any other security agreement: the equipment you purchase is secured by a loan; the vendor provides the equipment (and sometimes the lease or loan) and the lender provides a loan. If you fail to repay the loan, the lender can repossess the collateral and sue the business for any deficiency balance on the loan. The lender may reserve the right to adjust the amount financed - or your monthly payment level - to match the equipment cost and/or to cover any unexpected delivery costs. A huge adjustment is unlikely (for example, the contract may cap the adjustment rate at 10%), but it’s good to be aware of this possibility. Additionally, make sure you know your interest rate. Increases in payments may occur if you do not have a fixed-rate loan or if your lease payments increase after certain amounts of time.
All your equipment might be collateral
Many businesses finance multiple pieces of equipment from the same lender. This allows lenders to engage in cross-collateralization, meaning that in addition to the specific piece of equipment for which a particular loan is granted, the lender may require that all or some equipment that your company owns can be collateralized as a condition of issuing the loan. For example, say you purchase a forklift through a financing company. Buried in that company’s financing agreement is a cross-collateralization clause indicating that the loan the finance company is giving your company for the forklift not only allows the financing company to repossess the forklift if a default should occur, but also allows them to repossess your heavy plows and other equipment until the loan amount is paid off. This is the danger of a cross-collateralization clause in a contract.
Make sure to determine if there is a cross-collateralization clause in your contract. If it is present, I would recommend contacting an attorney to provide guidance.
Early termination options
In a commercial equipment lease, a lessee can often negotiate an early termination option. This allows the lessee to get out of the lease early, either by returning the equipment to lessor and paying a certain difference in valuation of the depreciated equipment or by selling the equipment and paying the lessor the current market value of the equipment. This can be beneficial for a business that runs into a situation where the lease payments are simply too high.
Jump start solutions
- Inspect all equipment before signing the contract.
- Make sure you understand the terms and any penalties before signing the contract.
- Defaulting on payments could result in repossession of additional assets.
- Consider early termination options in the event you need to get out a lease early.
Jared Nusbaum is an attorney with Zlimen & McGuiness, PLLC. His practice focuses on employment law, litigation, bankruptcy, and appeals. Learn more at www.zmattorneys.com.