deposit account control agreements account control agreements r. marshall grodner 14th floor, one...
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DEPOSIT ACCOUNT CONTROL AGREEMENTS
R. Marshall Grodner
14th Floor, One American PlaceBaton Rouge LA 70825
Telephone: (225) 383-9000Facsimile: (225) 343-3076
Direct Dial: (225) 382-3651E-Mail: [email protected]
INTRODUCTION
Until 2001, a security interest/lien in deposit accounts was governed by common law in most statesRevised Article 9, effective July 1, 2001, brought security interests in deposit accounts under Article 9 of the UCC.
DEFINITION
9-102(a)(29):“Deposit Account” means a demand, time,
savings, passbook, or similar account, maintained with a bank. The term does not include investment property or accounts evidenced by an instrument.
DEFINITION (CONT.)
Important Exclusions:Does not include investment property – i.e. a securities accountDoes not include accounts evidenced by an instrument –i.e. potentially a certificate of deposit evidenced by a writing.
Important Inclusion: A certificate of deposit that is not an instrument is a deposit account
ATTACHMENT
9-203 – becomes enforceable against the Debtor.Requirements:
Value has been givenDebtor has rights in the deposit accountSecured party has control pursuant to debtor’s security agreement.
ATTACHMENT (CONT.)
Debtor’s Security AgreementNo requirement of a writing or an authenticated recordEvidentiary Standard.
Recommendation – Always have a written security agreement signed by the debtor (or a record authenticated by the debtor)
PERFECTION
Concept of Control9-104 – Control of Deposit Account
Secured party is depository bankSecured party becomes bank’s customer – i.e. the deposit account is in the name of the secured partyControl agreement between depository bank, debtor and secured party
PERFECTION (CONT.)
Requirement for Control AgreementAuthenticated record (Signed writing)Depository bank’s and debtor’s agreement that the depository bank will comply with the instruction of the secured party regarding disposition of the funds without further consent of debtor
Note: Secured party has control even if debtor retains some rights regarding disposition of the funds on deposit
PRIORITY
9-327Secured party having control ranks ahead of another secured party not having control.
Importance – Secured party having control will outrank another secured party claiming the deposit account as identifiable cash proceeds of its collateral (i.e. accounts or inventory)
PRIORITY (CONT.)
Secured parties (other than the depository bank) having control rank according to the time at which they obtained controlWith regard to the depository bank’s lien, a non-depository secured party only takes priority if:
It gets control by becoming the depository bank’s customerThe depository bank has consensually subordinated its lien
ISSUES
Rights of Withdrawal by DebtorSection 2.1 of the Control Ag. and Section 6 of the Sec. Ag.Notice by Secured party
Depository bank’s right to charge the deposit account
Section 2.2 of the Control Ag.
ISSUES (CONT.)
Right to Renew on maturity – C.D.Length of RenewalPayment of InterestSee Article 5 of Control Ag.
Limits of Indemnity of depository bank by secured party
Co-extensive with debtorLimited to following secured party’s instructionsSee Article 9 of Control Agreement
GENERAL ISSUES
Deposit Account v. Investment PropertyWhen is a C.D. a Deposit AccountOther new Credit Enhancement Vehicles under Revised Article 9
Letter of Credit RightsCommodity Accounts
CONCLUSION
R. Marshall Grodner
14th Floor, One American PlaceBaton Rouge LA 70825
Telephone: (225) 383-9000Facsimile: (225) 343-3076
Direct Dial: (225) 382-3651E-Mail: [email protected]
DEPOSIT ACCOUNT SECURITY AGREEMENT (INDIVIDUAL ACCOUNT)
Dated: As of ________, 20_____ Debtor: __________________________ __________________________ __________________________ Secured Party: ___________________________ ___________________________ ___________________________
The Debtor listed above, whether one or more, are collectively, hereinafter, “Debtor”. The Secured Party listed above, whether one or more, are collectively, hereinafter, “Secured Party”. Unless otherwise indicated herein, capitalized terms shall have the meanings assigned to them in the Uniform Commercial Code as adopted in the State of [ ], as in effect from time to time, unless otherwise defined in the Equipment Lease referred to in the next paragraph.
Debtors [or , (“Lessee”)] and Secured Party have entered into that certain [_______] Agreement dated as of ___________ dated ________________, 20____(as amended from time to time, the “Equipment Lease”), and in consideration of the Equipment Lease other good and valuable consideration, receipt of which is acknowledged, the undersigned Debtor agrees as follows: 1. SECURITY INTEREST. Debtor hereby grants to Secured Party, a continuing security
interest (“Security Interest”) in that certain deposit account owned by Debtor maintained at _____________________, Account Number: ___________, together with any cash balances from time to time credited to such accounts and any and all substitutions and replacements thereof and any and all proceeds of any of the foregoing, whether now or hereafter existing or arising (collectively, “Collateral”).
2. INDEBTEDNESS SECURED. The Security Interest granted by Debtor secures
payment of any and all obligations of [Debtor/Lessee] under the Equipment Lease (“Indebtedness”).
3. REPRESENTATIONS AND WARRANTIES OF DEBTOR. Debtor represents and
warrants, and so long as any Indebtedness remains unpaid shall be deemed continuously
to represent and warrant, that:
a. Debtor is the owner of the Collateral free of all security interests or other encumbrances, except the Security Interest;
b. Debtor is duly organized and validly existing under the laws of the state of its
organization; and
c. Debtor is duly authorized to enter into this Security Agreement and the execution, delivery and performance of this Agreement by Debtor will not violate, or be in contravention of, the Debtor’s certificate of incorporation, by-laws, or other corporate documents or any indenture, agreement or undertaking to which the Debtor is a party or by which the Debtor may be bound.
4. COVENANTS OF DEBTORS. So long as any Indebtedness remains unpaid, Debtor:
a. Will defend the Collateral against the claims and demands of all other parties including, without limitation, defenses, setoffs, claims and counterclaims asserted by any financial institution which holds the Collateral against a Debtor and/or Secured Party, will keep the Collateral free from all security interests or other encumbrances, except for the Security Interest; and, will not close or rename the Collateral; and
b. Will cooperate with Secured Party in obtaining control of its Collateral and cause
to be delivered to Secured Party a fully executed Control Agreement (in the form attached hereto as Schedule 2) for the Collateral.
5. OWNER OF DEPOSIT ACCOUNTS. The Debtor authorizes Secured Party to transfer the Collateral or any part thereof into its own name or that of its nominee so that Secured Party or its nominee may appear on record as the sole owner thereof; provided that so long as no Event of Default has occurred, Secured Party shall deliver promptly to the Debtor all notices, statements or other communications received by it or its nominee. After the occurrence of any Event of Default, the Debtor waives all rights to be advised of or to receive any notices, statements or communications received by Secured Party or its nominee as such record owner.
6. RIGHTS WITH RESPECT TO THE EXISTING ACCOUNTS. The Debtor will not withdraw or transfer any funds from the Collateral, and Secured Party may direct the disposition of the Collateral and give any other instructions relating to the Collateral.
7. EVENTS OF DEFAULT.
a. The occurrence of an Event of Default under the Equipment Lease or a breach of any term or provision hereof or any representation or warranty herein becoming
incomplete or untrue shall constitute an Event of Default hereunder.
b. Upon the happening of any Event of Default, Secured Party’s rights and remedies with respect to the Collateral shall be those of a Secured Party under the Uniform Commercial Code and under any other applicable law, as the same may from time to time be in effect, in addition to those rights granted herein and in any other agreement now or hereafter in effect between Debtor and Secured Party.
c. Without in any way requiring notice to be given in the following manner, Debtor
agrees that any notice by Secured Party of sale, disposition or other intended action hereunder or in connection herewith, whether required by the Uniform Commercial Code or otherwise, shall constitute reasonable notice to Debtor if such notice is mailed by express mail, postage prepaid, at least ten (10) days prior to such action, to the address opposite Debtor’s signature or to any other address which Debtor has specified in writing to Secured Party as the address to which notices hereunder shall be given to Debtor.
d. Debtor agrees to pay on demand all reasonable costs and expenses incurred by
Secured Party in enforcing this Security Agreement in realizing upon or protecting any Collateral and in enforcing and collecting any Indebtedness any guaranty thereof, including, without limitation, reasonable accountants’ and appraisers’ fees and expenses, and if Secured Party retains counsel for advice, suit, insolvency proceedings or any of the above purposes, the reasonable attorneys’ fees and expenses incurred by Secured Party.
8. MISCELLANEOUS.
a. Upon Debtor’s failure to perform any of its duties hereunder, Secured Party may, but shall not be obligated to, perform any or all such duties in any reasonable manner, and Debtor shall pay an amount equal to the expense thereof to Secured Party forthwith upon written demand by Secured Party.
b. No course of dealing and no delay or omission by Secured Party in exercising any
right or remedy hereunder or with respect to any Indebtedness shall operate as a waiver thereof or of any other right or remedy, and no single or partial exercise thereof shall preclude any other or further exercise thereof or the exercise of any other right or remedy. Secured Party may remedy any default by Debtor hereunder or with respect to any Indebtedness in any reasonable manner without waiving the default remedied and without waiving any other prior or subsequent default by Debtor. All rights and remedies of Secured party hereunder are cumulative.
c. The rights and benefits of Secured Party hereunder shall inure to any party
acquiring any interest in the Indebtedness or any part thereof.
d. Secured Party and Debtor as used herein shall include the heirs, executors or
administrators, or successors or assigns, of those parties.
e. If more than one Debtor executes this Security Agreement, the term “Debtor” shall include each as well as all of them and their obligations, warranties and representations shall be joint and several.
f. No modification, rescission, waiver, release or amendment of any provision of
this Security Agreement shall be binding except by a written agreement subscribed by Debtor or otherwise authenticated by Debtor and by a duly authorized officer of Secured Party.
g. This Security Agreement is made under, and shall be governed by and construed
under the laws of the State of [ ] without giving effect to choice of law principles of the State of [ ].
h. This Security Agreement is and is intended to be a continuing Security Agreement
and shall remain in full force and effect until all of the Indebtedness shall be finally and irrevocably paid in full.
[SIGNATURE PAGE TO FOLLOW]
The foregoing is established by the following signatures of Debtors. Debtors Name By: By:
160897.1
Deposit Account Control Agreement Page 1
DEPOSIT ACCOUNT CONTROL AGREEMENT
THIS DEPOSIT ACCOUNT CONTROL AGREEMENT (the “Agreement”) is made as of , 20 (the “Effective Date”) by and between , (the “Debtor”); , (the “Secured Party”) and (the “Bank”) on the following terms and conditions:
W I T N E S S E T H:
WHEREAS, [Debtor/Lessee] [Note if Debtor and Lessee are different, add (the “Lessee”)] and Secured Party entered into that certain [Equipment Lease] dated as of , 20 (as amended, the “Equipment Lease”); WHEREAS, in order to secure the obligations of [Debtor/Lessee] under, the Equipment Lease, Debtor has granted (and does hereby grant) a security interest in favor of Secured Party in that certain Account No. , maintained by Debtor with Bank (the “Deposit Account”); WHEREAS, Secured Party desires to perfect its security interest in such Deposit Account by obtaining control of the Deposit Account; WHEREAS, Bank desires to allow Secured Party to obtain control of the Deposit Account on the following terms and conditions; NOW, THEREFORE, in consideration of the premises, for the mutual covenants, conditions and agreements contained in this Agreement, for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties to this Agreement agree as follows:
ARTICLE 1 CONTROL; DEBTOR’S RIGHTS
Section 1.1 Control. Notwithstanding anything in the any agreement between the Bank and Debtor governing the Deposit Account to the contrary, Bank will comply with instructions originated by Secured Party pertaining to the withdrawal or other disposition of funds in the Deposit Account, all without further consent of the Debtor.
Section 1.2 Debtor’s Rights. Debtor shall not be entitled to, and Bank agrees to prevent Debtor from, making any withdrawals from or otherwise directing the disposition of funds from the Deposit Account, unless and until Bank has received instructions from the Secured Party to the contrary.
ARTICLE 2 BANK’S RIGHTS AND RESPONSIBILITIES
Section 2.1 Rights of Setoff. Except as provided in Section 2.2, Bank agrees that it shall not offset, charge, deduct or otherwise withdraw funds from the Deposit Account as long as this Agreement remains in effect. Bank agrees that all such rights and/or its banker’s lien
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and/or any other rights or liens in the Deposit Account are subordinate to Secured Party’s security interest.
Section 2.2 Notwithstanding Section 2.1, Bank is allowed to charge the Deposit Account:
(a) for Bank’s usual and customary charges for services rendered in connection with the Deposit Account and this Agreement;
(b) in the event any item deposited in the Deposit Account is returned unpaid for any reason;
(c) for claims for breach of warranties of presentment or transfer under the applicable provisions of the Uniform Commercial Code.
ARTICLE 3 CUSTOMER’S RESPONSIBILITIES
Section 3.1 Fees. If the balances in the Deposit Account are not sufficient to compensate Bank for its customary fees and charges, Debtor agrees to pay such deficiency on demand.
Section 3.2 Returned Items. If the balances in the Deposit Account are not sufficient to compensate Bank for any returned item, Debtor agrees to pay such deficiency on demand.
Section 3.3 Other Accounts. Debtor authorizes Bank to charge any other account of Debtor maintained with Bank for the amount or amounts due under Sections 3.1 and 3.2.
ARTICLE 4 INFORMATION REGARDING THE ACCOUNT
Section 4.1 Account Statements. In addition to the original account statement for the Deposit Account sent to the Debtor, Bank will send a duplicate statement to Secured Party.
Section 4.2 Deposit Advices. In addition to sending information to the Debtor regarding deposits to the Deposit Account to Debtor, Bank will send a copy of each deposit advice to Secured Party.
Section 4.3 Other Information. Debtor authorizes Bank to provide Secured Party with any additional information regarding the Deposit Account without the further consent of Debtor.
ARTICLE 5 DEPOSIT ACCOUNT RENEWAL
Upon maturity, if any, of the Deposit Account and upon each subsequent maturity, if any, Bank may act upon the instructions of Debtor only to the extent such instructions advise Bank on
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the term of renewal selected by Debtor, which term shall not be greater than the original term of the Deposit Account, and do not contradict any other instructions to Bank from the Secured Party or the terms hereof.
ARTICLE 6 REPRESENTATIONS AND WARRANTIES
Each party represents and warrants to the other parties that (i) this Agreement constitutes its duly authorized, legal, valid, binding and enforceable obligation; (ii) the performance of its obligations under this Agreement and the consummation of the transactions contemplated hereunder will not (A) constitute or result in a breach of its certificate or articles of incorporation, by-laws or partnership agreement, as applicable, or the provisions of any material contract to which it is a party or by which it is bound or (B) result in the violation of any law, regulation, judgment, decree or governmental order applicable to it; and (iii) all approvals and authorizations required to permit the execution, delivery, performance and consummation of this Agreement and the transactions contemplated hereunder have been obtained.
ARTICLE 7 REPRESENTATIONS, WARRANTIES AND COVENANTS OF BANK
Section 7.1 Bank represents and warrants to the Secured Party that Bank has not received any notice of any currently effective security interest, lien, other encumbrance or other claim to the Deposit Account.
Section 7.2 Bank represents and warrants that it has not, and covenants with the Secured Party that it will not, enter into any agreement with any other person or entity by which such person or entity is granted control over the Deposit Account or obligating the Bank to follow instructions of such person or entity with regard to the disposition of funds in the Deposit Account.
Section 7.3 Bank will use commercially reasonable efforts to give the Secured Party notice of any claim made with respect to the Deposit Account.
ARTICLE 8 BANK’S LIMITATION OF LIABILITY
Section 8.1 Bank will not be liable to Debtor or Secured Party for any expense, claim, loss, damage or cost ("Damages") arising out of or relating to its performance under this Agreement other than those Damages which result directly from its acts or omissions constituting negligence or intentional misconduct.
Section 8.2 In no event will Bank be liable for any special, indirect, exemplary or consequential damages, including but not limited to lost profits.
Section 8.3 Bank will be excused from failing to act or delay in acting, and no such failure or delay shall constitute a breach of this Agreement or otherwise give rise to any liability of Bank, if (i) such failure or delay is caused by circumstances beyond Bank's reasonable control, including but not limited to legal constraint, emergency conditions, action or inaction of governmental, civil or military authority, fire, strike, lockout or other labor dispute, war, riot, theft, flood, earthquake or other natural disaster, breakdown of public or private or
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common carrier communications or transmission facilities, equipment failure, or negligence or default of Company or Lender or (ii) such failure or delay resulted from Bank's reasonable belief that the action would have violated any guideline, rule or regulation of any governmental authority.
Section 8.4 Bank shall have no duty to inquire or determine whether Debtor’s obligations to Secured Party are in default. Bank may rely on notices and communications it believes in good faith to be genuine and given by the appropriate party.
Section 8.5 Notwithstanding any of the other provisions in this Agreement, in the event of the commencement of a case pursuant to Title 11, United States Code, filed by or against Debtor, or in the event of the commencement of any similar case under then applicable federal or state law providing for the relief of debtors or the protection of creditors by or against Debtor, Bank may act as Bank deems necessary to comply with all applicable provisions of governing statutes and shall not be in violation of this Agreement as a result.
Section 8.6 Bank shall be permitted to comply with any writ, levy order or other similar judicial or regulatory order or process concerning the Account or any items and shall not be in violation of this Agreement for so doing.
ARTICLE 9 INDEMNITY
Section 9.1 Debtor and Secured Party shall jointly and severally indemnify Bank against, and hold it harmless from, any and all liabilities, claims, costs, expenses and damages of any nature (including but not limited to allocated costs of staff counsel, other reasonable attorney's fees and any fees and expenses) in any way arising out of or relating to disputes or legal actions concerning Bank's provision of the services described in this Agreement. This section does not apply to any cost or damage attributable to the gross negligence or intentional misconduct of Bank. Debtor’s and Secured Party’s obligations under this section shall survive termination of this Agreement.
Section 9.2 Debtor and Secured Party shall jointly and severally pay to Bank, upon receipt of Bank's invoice, all costs, expenses and attorneys' fees (including allocated costs for in-house legal services) incurred by Bank in connection with the enforcement of this Agreement and any instrument or agreement required hereunder, including but not limited to any such costs, expenses and fees arising out of the resolution of any conflict, dispute, motion regarding entitlement to rights or rights of action, or other action to enforce Bank's rights in a case arising under Title 11, United States Code.
Section 9.3 Debtor agrees to pay Bank, upon receipt of Bank's invoice, all costs, expenses and attorneys' fees (including allocated costs for in-house legal services) incurred by Bank in the preparation and administration of this Agreement (including any amendments hereto or instruments or agreements required hereunder).
ARTICLE 10 TERMINATION
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Section 10.1 Secured Party may terminate this Agreement by providing notice to Debtor and Bank that all of Debtor’s obligations which are secured by the Deposit Account are paid in full. Secured Party may also terminate or it may assign this Agreement upon [ ] day's prior written notice to Debtor and Bank. Bank may terminate this Agreement upon [ ] days’ prior written notice to Debtor and Secured Party. Debtor may not terminate this Agreement except with the written consent of Secured Party and upon prior written notice to Bank.
ARTICLE 11 GOVERNING LAW
This Agreement shall be governed by and construed in accordance with the law of the State of [ ______________ ]. The parties agree that [ ____________ ] is the "bank’s jurisdiction" for purposes of the Uniform Commercial Code.
ARTICLE 12 MISCELLANEOUS
Section 12.1 In the event of a conflict between this Agreement and any agreement between the Bank and the Debtor, the terms of this Agreement will prevail; provided, however, that this Agreement shall not alter any mandatory arbitration provision currently in effect between Bank and Debtor pursuant to a separate agreement.
Section 12.2 This Agreement may be amended only by a writing signed by Debtor, Secured Party and Bank; except that Bank's charges are subject to change by Bank upon [ ] days' prior written notice to Company.
Section 12.3 This Agreement may be executed in counterparts; all such counterparts shall constitute but one and the same agreement.
Section 12.4 This Agreement controls in the event of any conflict between this Agreement and any other document or written or oral statement. This Agreement supersedes all prior understandings, writings, proposals, representations and communications, oral or written, of any party relating to the subject matter hereof.
Section 12.5 Any written notice or other written communication to be given under this Agreement shall be addressed to each party at its address set forth on the signature page of this Agreement or to such other address as a party may specify in writing. Except as otherwise expressly provided herein, any such notice shall be effective upon receipt.
Section 12.6 Nothing contained in the Agreement shall create any agency, fiduciary, joint venture or partnership relationship between Bank and Debtor or Secured Party.
Deposit Account Control Agreement Page 6
In Witness Whereof, the parties hereto have executed this Agreement by their duly authorized officers as of the day and year first above written. ("Debtor")
By: Name: Title:
Address for notices:
("Secured Party")
By: Name: Title:
Address for notices:
("Bank")
By: Name: Title:
Address for notices:
160707.1
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ELA Legal Forum
May 2 – 4, 2004
The Ritz Carlton Hotel
New Orleans, Louisiana
BASIC LEASING ISSUES: TRANSACTIONAL APPLICATIONS
Leasing Computer Hardware and Software
Douglas A. Beimfohr Partner
Windels Marx Lane & Mittendorf, LLP 120 Albany Street Plaza
New Brunswick, New Jersey 08901
(t) (732) 448-2524 (f) (732) 843-3189
{40131323:1}
2004 ELA LEGAL FORUM
BASIC LEASING ISSUES: TRANSACTIONAL APPLICATIONS
1. Issue Spotting for High-Tech Equipment Leasing1
Standard lease form language needs to be reconsidered when leasing smaller and
portable items of high tech equipment. One size will not fit all. An “off-the-rack” lease
will need to be tailored because of the unique characteristics of computer hardware and
software. Several lease provisions from the Master Lease are affected because of the
property being financed. Small computer equipment is subject to fairly rapid
obsolescence; which raises a number of issues: What value does the equipment have in
the lessor’s risk assessment? Does transaction pricing assume high residual value? How
are upgrades and accessions to be handled? How will the mobility of the equipment be
addressed? What about maintenance and return conditions? Will the lessee have
substitution rights, purchase option rights, etc.?
A. Reliance on Collateral and Residual Values
At the outset, the lessor should decide whether provisions in the lease form
designed to protect the value of the leased equipment are meaningful. If the lessee’s
creditworthiness is the key factor, rather than the equipment as collateral, then the lessor
may be willing to relax some of the standard lease form’s maintenance and return
conditions.
1 Please note that much of what follows is paraphrased from the Imperfect Fit article noted in the Reference Materials section at the end hereof.
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On the other hand, many small computer equipment deals are placed with
technology companies or development stage lessees whose credit may be less than
investment grade at the time. With lessees of lesser creditworthiness, the collateral value
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of the equipment obviously becomes more important. Even though the resale market for
desktop computers may not be that attractive, and many computer lessors may be tempted
to not put much stock in the residual value of their collateral, most lessors will still want
to pay some attention to maintenance of collateral values in order to protect against lessee
defaults.
Another important consideration is the determination and use of residual values in
pricing small computer equipment transactions, as well as determining return conditions
and events of loss. Many technology lessors have used higher (and some would say
unrealistic) residual value assumptions in an effort to keep rental rates lower in the
competitive marketplace. These same lessors seek to create return standards which
would make it extremely unlikely that the lessee could comply with such provisions.
These provisions are designed to compel a higher purchase price from the lessee, and to
assert a claim of breach and seek a casualty value remedy when equipment is not returned
in perfect condition. Examples of impossible return standards include requiring (i) all
(but not less than all) equipment be returned, (ii) no repair, functional or cosmetic
damage, no missing cables or manuals and (iii) all equipment be returned in its original
packaging. To date, these efforts have resulted in mixed success.
B. Nature of Equipment; Upgrades
High tech equipment lends itself to frequent upgrading in order to maintain
cutting-edge technology. Still, even “reasonable” residual value assumptions may be
eviscerated if rapid technology advances occur.
Lessors will frequently permit lessees the flexibility of upgrading the equipment
or even replacing existing equipment with a new and improved model (a so called
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“substituted item”). Should a lessor insist on mandatory upgrades or substitutions, with
or without rent increases to protect or enhance the value of its assets? What if the change
occurs during the last year of the term? Can the parties distinguish between
modifications that benefit the lessee but adversely affect the remarketability of the
equipment? Many lessees will want to upgrade during the lease term and not simply at
lease expiry. If the lessee adds the upgrade to the lessor’s property but the incumbent
lessor does not finance the upgrade, it is unlikely the lessee will get financing from
someone else of an upgrade to another lessor’s underlying asset. On the other hand,
blanket assurances of financing do not protect the lessor from deterioration in the lessee’s
creditworthiness over time.
If a lessor commits to finance upgrades on “mutually agreeable” terms, can the
lessee be assured they will be on commercially reasonable terms or is this merely
illusory? Many experienced lessees believe the “mutually agreeable” upgrade terms do
not mean much.
C. Mobility
The physical characteristics of the equipment need to be considered as well.
Desktops, notebooks and other soft collateral items are susceptible to loss, theft and
disappearance. Also, movement of equipment to jurisdictions where the lessor does not
routinely transact business may create administrative burdens for a lessor.
Lessees will point to lease language prohibiting movement of equipment being
drafted based on former Article 9 of the UCC, requiring a filing where the equipment was
located. Under Revised Article 9, for registered organizations organized under state law,
the filing is made in the jurisdiction where the lessee is organized and therefore no new
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filing is required when equipment is moved. Still, knowledge of location of the
equipment is essential for repossession and end of term planning. In addition, the
analysis of state sales/use and property tax may be subject to change when equipment is
moved across state lines.
D. Casualty Losses and Cures
(i) Damage versus Destruction
As noted, because small computers are highly mobile, they are more likely to be
lost or destroyed than a mainframe. The lessor’s ability to inspect may be significantly
reduced and hopes of tracking all items of notebook computers are often lost at the outset.
The difference in the burden on a lessor to inspect 10,000 notebook computers in 40
locations versus one mainframe is considerable.
What about the distinction between “damage” and “destruction”? What if a
computer continues to function properly but is so badly damaged that it would cost more
to repair it than it is worth – has it been destroyed?
Is there a difference between “damaged beyond repair” and “damaged beyond
economical repair”? Suppose a unit suffers damage, casualty value is $1000, fair market
value is $400 and cost to repair is $500. Has the unit been destroyed? It depends on your
lease language. If the lease says damaged beyond repair, then the unit has not been
destroyed because it can be repaired. On the other hand, an argument could be made that
the unit has been damaged beyond economical repair since the value of the unit is only
$400.
Also, many lessees seek special rights with regard to “consumables” (mouses,
keyboards, manuals, cables and other peripheral items) that are most likely to be lost or
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destroyed during the term. If they are lost, when do they need to be replaced – during the
term or only at the end or should they be covered by a casualty value or not to exceed
value? Some lessees have been getting “best efforts” to return these items, but no
contractual liability if some of these items are not returned.
(ii) Replacement Rights
Often when items of equipment are lost, stolen or destroyed, the lease will have
“like kind” replacement language, speaking in terms of replacement with items of
equipment of the same make, model, type and configuration. In the case of small
computer equipment, lessors might do well to consider modifying the like-kind language,
should they be willing to permit it to begin with. For example, may the lessee replace an
item with an “improved” item that is less marketable at lease termination? Does the
substituted unit have to be from the original manufacturer – even if said manufacturer no
longer makes such equipment? If the original model has been discontinued, should the
lessor require replacement with the improved model? We have been seeing more “if”
lists being pursued by larger, creditworthy lessees on this issue. They seek language
permitting equipment replacement from the same manufacturer if available and of the
same configuration if available. If neither can be complied with, then equipment of at
least comparable functionality, equipment manufactured by another same tier vendor and
so forth.
Also pay attention to the event of loss section. The usual provision requires the
lessee to notify the lessor in the event of loss and to elect promptly to either replace the
property or pay the casualty value. Lessees are likely to say that they may not have
knowledge of loss of small computer equipment and seek to limit the notice obligation to
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knowledge of senior people or knowledge at the end of term. While this may seem
reasonable, the lessor is open to the lessee’s discovering the loss of equipment on the last
day of the term, resulting in a de facto purchase option allowing lessee to pay casualty
value for “lost” items or replace the item at the end of the term.
Casualty values at the end of term should be high enough to fully cover the
lessor’s anticipated residual, even if higher than the projected market value. Lessors
usually book a lower residual than they expect to realize to avoid a loss at lease end or
avoid writing down lower residual values during the lease term. If the lessee does not
produce all units at lease expiry, the lessor has lost its ability to realize the value it
originally expected to have in the residual. One would expect the end-of-lease casualty
value to exceed residual value booked by the lessor. That said, higher is not always
better. Casualty values set unreasonably high may be construed as a penalty and not be
enforceable. Suppose equipment has a casualty value of $900 but a fair market value of
$300. Items are returned with damage which allows the lessor to seek casualty value for
such items as an express remedy. Some would argue that the economic reality is that
under such circumstances paying casualty value is a penalty.
E. Maintenance and Alteration
Many leases of small computer equipment require the lessee obtain a maintenance
contract from the manufacturer or other approved organization. Does this make sense
particularly where the warranty on such equipment may extend for the entire lease term?
Should the lessor nevertheless leave the standard “good operating condition” language
during the term but assure the lessee that it will not be a problem if a few items are not
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maintained in such condition? Lessors should be careful that acknowledging that a
provision will not be enforced could affect a court’s construction thereof down the road.
Also, embedded software and certain hardware functions may result in significant
warranty rights or payments. These rights may effect residual value as well as functional
value of the equipment during the term. Many form leases state that so long as no default
exists, the lessee has the right to all warranty recoveries. A representative provision in
this regard states: “Lessor hereby appoints Lessee as Lessor’s agent to assert, during the
term of the applicable Equipment Schedule, any right Lessor may have to enforce the
manufacturer’s warranties, if any, provided, however, that Lessee shall indemnify and
hold Lessor or its assignee harmless from and against any and all claims, costs, expenses,
damages, losses and liabilities incurred or suffered by Lessor as a result of or incident to
any action by Lessee in connection therewith.”.
Conversely, should the lessee be able to drop off equipment at the local computer
store for maintenance? Not surprisingly, the contract requirements for maintenance will
be influenced by considerations of the lessee’s creditworthiness and the value and nature
of the collateral.
F. Software Issues
Form agreements for nontechnology equipment rarely address software issues.
Many agreements used by technology lessors only address “alterations, modifications or
accessions” which are likely not to address the issues of most concern to technology
lessors. Relevant considerations include these: Who owns the software? Is it licensed to
lessor or to lessee? Is it clear that all software necessary to maintain the value of the
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equipment must remain on the equipment? Should the lessee be required to remove the
software at the end of the lease term?
(i) Collateral Value of Software
Most everyone who leases computer equipment must also lease copyrighted
software as well as other soft costs including cabling, installation, training, etc. It goes
part and parcel with the business of leasing technology.
Many lessors see little or no residual value for software with some residual value
for hardware and may look to the underlying credit to get paid. In marginal credits, the
purpose and value of software to the lessee/borrower might influence the credit decision
if loss of software would put the lessee/borrower under pressure. Lessors note a subtle
difference between leasing soft costs versus proprietary software with proprietary
software being more valuable. Some lessors think that intellectual property may have
better value than hard assets because it usually does not depreciate and may in fact grow
in value. I am sidestepping leasing and/or financing issues related to leasing of patents,
copyrights, trademarks and service marks, and trade secrets as being beyond the scope of
this presentation.
Lessors vary as to their comfort level of using software as collateral. Difficulties
in selling used software stem partly from the newness of software leasing. In the last 15
years, software has gone from 10% of the typical software/hardware package to 25% to
100% and now the reality is that software is often more valuable to the customer. The
key for software lessors in valuing software as collateral is focusing on the mission
criticality of the software to the lessee because that makes it easier to use it as a “stick” in
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a default situation, unlike hardware which is a commodity that may depreciate rapidly
and can be replaced.
G. Return of Equipment
No issue is more vexing for either lessors or lessees of small computer equipment
then the end-of-term situation. In many cases, the lessor hopes the lessee will exercise its
purchase option instead of returning the equipment. At the same time, as early as the
proposal stage, lessees are pushing for additional options and rights at the end of the lease
term.
(i) Perfect Return
Some lessees demand a clear definition of what “reasonable wear and tear
excepted” means. Lessees focus on the ability of the equipment to function in the desired
manner, but that may mean computers with broken hinges, cracked screens or other
cosmetic defects. Note here also the interplay of the maintenance requirement, the
definition of “destruction/damage” and “reasonable wear and tear” for return purposes.
From the lessor’s standpoint as well, reasonable wear and tear language may be
unacceptable.
Return provisions may also require that all items be returned at the same time.
This raises issues of extensions of term and what happens if some, but not all, of the
equipment requires substantial repairs or modification to either qualify for maintenance
recertification or simply be in good operating condition. Does the entire lease (or
schedule) extend? Does lessee pay a per diem only for equipment that needs repair?
Does an automatic renewal term kick in if all units are not properly returned at lease end?
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(ii) Substitution of Like-Kind Equipment Lessees will often negotiate rights to substitute equipment during the term.
Unlimited substitution rights may be viewed by many lessors as unworkable. Often
lessors will provide that the lessee may not substitute any item of equipment having a
capitalized lessor’s cost in excess of 10% of the aggregate capitalized lessor’s cost of all
equipment at any time leased under the lease.
Lessees will also seek the right to return similar small computer equipment if the
one they leased is lost at the end of the term or if the return is simply inconvenient. Some
lessors will insist on being paid casualty value if equipment cannot be located at the end
of the lease. Is the lessee required to pay a casualty value for units that are not properly
returned or for all units because the compliance with the return provision was not perfect?
Some lessors may insist on complete returns or all items being purchased under the lease.
Depending upon how event-of-loss language is drafted, the lessee may have the
right to replace or pay casualty value for individual items of equipment even if the
language does not appear as an alternative to a proper return. Also, some leases may
permit return of items of equipment from different schedules to satisfy the return
provision for a specific schedule coming to term. Of course, with these additional return
options, lessors will need to be aware of the potential for a lessee cherry-picking its
leased portfolio.
H. Toward a More Workable Lease Contract
We have, by design, raised more questions than we have answered. Most of the
issues addressed here require negotiation between fully informed lessors and lessees
willing to break from the standard form lease provisions to craft creative solutions. One
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size clearly does not fit all and much of the language in traditional equipment lease forms
should be rethought when leasing notebooks, desktops and other small computer
equipment.
In addressing these issues, lessors should consider the following alternatives to
standard lease language:
1. Offer reasonable upgrade or substitution options that permit reexamination
of the lessee’s credit and valuation of new or upgraded equipment, as well as adjustments
for the market conditions at the time of the upgrade.
2. Review and revise language for equipment location. Allow reasonable
movement, usually within a geographic area acceptable to lessor, keeping in mind the
possibility of default or early return.
3. Decide whether it is essential to residual assumptions that maintenance
criteria be specified, during the term, upon return or both, keeping in mind the credit
quality of your lessee.
4. Review casualty definition and consider how “minor” damage might
affect residual value.
5. Consider the effects of replacements, substitutions, returns, purchase
options and other end-of-term rights commonly requested by technology lessees.
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Reference Materials
1. In re: Pillowtex, Inc., 2002 WL 32332071 (Bankr. D. Del. 2002), aff’d
349 F.3d 711 (3d. Cir. 2003) where the Third Circuit Court of Appeals held that
agreement under which seller of energy-saving equipment installed at no cost to buyer in
exchange for monthly payments of buyer’s energy savings for eight years, though
intended by parties to be a lease, was in fact a secured financing arrangement, based on
an economic realities analysis.
2. Ethan Shaw and Clive D. Moon v. Toshiba American Information
Systems et al., 1:99 CV0120, U.S. District Court for the Eastern Division of Texas,
Beaumont Division.
3. “Intellectual Property: The Leasing Industry’s Future” by Richard D.
Crawford, Journal of Equipment Lease Financing, Vol. 20, No. 2 (Fall 2002), pp 18 – 27.
4. “The Imperfect Fit: Making Form Leases Work for High-tech Equipment”
by Barry S. Marks and James M. Johnson, Ph.D., Journal of Equipment Lease Financing,
Vol. 22, No. 1 (Spring 2004), pp. 9-17.
5. “Forecasting Residual Value of Computer Hardware” by Robert J. Zises
and Rainer Mueller, Journal of Equipment Lease Financing, Vol. 18, No. 2 (Fall 2000),
pp. 2-6.
6. “Software Financing: You Don’t Have to Pay Twice” by Gregg F.
Carpene and Michael J. Crofton, Equipment Leasing Today, Vol. ___ (August 2001), pp
8-12.