17 Things to Consider Before Signing an Equipment Lease
Mark Cohen, J.D.. LL.M.
PO Box 19192
Boulder, CO 80308
Equipment leasing can grow a business without large out of pocket expenses because it allows the lessee to spread the cost over the term of the lease. Too often, though, contractors sign a lease without reading it. Often those who read it do not understand some provisions or dismiss them as “legal mumbo jumbo.” Equipment suppliers can be equally negligent; some may deliver equipment without a written lease at all while others may rely for years on a questionable template plucked from the Internet.
The failure to use a well-written lease can be disastrous. The parties may think they are in agreement when, in fact, they are not. They may not discover that their understandings conflict until an event weeks or months later. Only then do they call their lawyers, and the money they pay lawyers to resolve the dispute always exceeds the amount they would have paid for legal guidance in drafting the lease. This purpose of this article is to help lessors and lessees understand 17 legal issues they should consider before entering into an equipment lease.
1. The Equipment. What is being leased? Some machines can be equipped a certain way to accomplish a specific objective. For example, a user can fit a screener with screens of a certain size to produce the desired product. Are the screens part of the leased equipment or does the lessor charge separately for them?
2. The Term. What is term of the lease in weeks or months? Generally, the lessor benefits by requiring a minimum term as opposed to renting the machine out on a week-to-week or month-to-month basis.
3. The Rent. How much will the lessee pay to use the equipment? Do not confuse the amount of rent with the timing of rental payments. If the lease term is three months and the rent for the term is $6,000.00, the parties must agree on how that $6,000.00 will be paid. They may agree to three monthly payments of $2,000.00 or they may agree to some other schedule.
4. Sales and Use Taxes. If the jurisdiction imposes a sales or use tax, the lease should specify who will pay that tax (usually the lessee) and make clear that the tax charges are in addition to the rent.
5. Hours. Even when the parties agree on the lease term the lessor will want assurance that the lessee will not cause excessive wear by operating the equipment 24 hours a day. Thus, many leases provide that operation of a machine for more than a specified number of hours in a week or month will result in additional rent charges for each hour the lessee uses the machine beyond the specified number.
6. Insurance. Does the lease require the lessee to insure the equipment at the lessee’s cost? If so, what coverage is required?
7. Place of Installation. Where will the lessee use the equipment? Who will set it up if it requires specialized setup? The lessor must know where and how the lessee will use the equipment in case the lessor later needs to take possession of it or file a mechanic’s lien.
8. Transportation Costs. Who will pay the cost of transporting the equipment? In a lease the term “F.O.B.” generally specifies which party will pay for transportation of the equipment. If the equipment is "FOB shipping point" the lessee pays the transportation costs.
9. Maintenance and Repairs. The lease should specify who will be responsible for maintaining and repairing the equipment. If the lease requires the lessee to pay for replacement parts it should specify whether the charge for the parts will be the lessor’s cost or the lessor’s retail price.
10. Ordinary Wear and Tear. A lease almost always requires the lessee to return the equipment in good condition, “ordinary wear and tear excepted.” For this reason the lessor should establish a procedure to document the condition of the equipment before it leaves and upon its return.
11. Warranties. What warranties, if any, has the lessor made? If the lessor has made warranties the lease should describe that nature and extent of them. Certain warranties exist as a matter of law unless the lessor disclaims them; the lessor should make sure the lease disclaims such warranties unless the lessor intends to be by bound by them.
12. Default. What constitutes a default by the lessee and what remedies may the lessor exercise in the event of default. The most common default is failure to make a required rental payment. The lessor will want the lease to allow the lessor to immediately take possession of the equipment in the event of a default.
13. The “Merger” or “Integration” Clause. A good lease will contain what lawyers call a “merger” or “integration” clause. The purpose of this is to prevent the parties from later claiming that the lease does not reflect their entire understanding or was changed by a subsequent oral agreement. For example, a merger clause can protect a lessor from a lessee’s claim that the lessor represented that the equipment would perform to a specific standard.
14. Governing Law. Where the lessor and lessee are in different states, which state’s laws will govern the lease transaction?
15. Dispute Resolution. Sometimes the parties can resolve their dispute by talking to each other, but when that fails a dispute may be resolved by mediation, arbitration or litigation.
Mediation is a non-binding process in which a neutral mediator helps the parties reach a mutually agreeable resolution. Most mediation clauses provide that the parties will share the costs of mediation equally. The lease should specify how a mediator will be selected if the parties are unable to agree on one. The advantages of mediation are that it is relatively inexpensive, it may lead to a quick resolution, and it sometimes helps preserve good relations between the parties so they can do business together in the future.
In arbitration a neutral arbiter acts like a judge; the arbiter may hear testimony, review evidence, and enter binding rulings. Once an arbiter makes a final award, the prevailing party may file that award in the District Court and convert it to a judgment. Arbitration sometimes leads to resolution sooner than a lawsuit would. Another advantage of arbitration may be the opportunity to select an arbiter who has specialized knowledge. For instance, in a construction dispute the parties might choose an arbiter with experience in construction law. There may be disadvantages to arbitration. First, arbitration may be as expensive as litigation because most arbiters charge $250-$350 per hour. Second, the right to engage in discovery (take depositions and issue subpoenas) may be quite limited. Third, unless the lease is drafted properly the parties may end up with an arbiter with little expertise in the relevant area of law. Fourth, it is virtually impossible to seek review of an arbiter’s decision; in many states a court may not overturn an arbiter’s decision merely because the arbiter did not properly apply the law to the facts of the case.
Litigation, of course, is the filing of a lawsuit. Litigation is expensive, but it may offer several advantages. First, litigation is governed by established rules of law, procedure, and evidence. Knowing these rules ahead of time helps the attorneys for the litigants evaluate the strengths and weaknesses of their respective cases. Second, litigation allows a party to engage in discovery that may be necessary to find relevant evidence and/or to obtain information from non-parties that do not want to become involved. Third, litigants may opt for a jury trial, and there may be cases in which a jury trial is advantageous. Finally, a party that wishes to may appeal the trial court’s decisions on matters of law to a higher court.
Mediation and litigation are not mutually exclusive. We often draft contracts that require the parties to participate in mediation, but that allow any party to file suit if mediation is not successful.
16. Venue. If there is litigation between the parties, what court will host that litigation? No party wants to be hauled into court in a distant county or state. We encourage lessors to insist that their lease forms contain a clause mandating that the exclusive venue for any litigation will be in the county where the lessor has its principal place of business.
17. Attorney’s Fees and Costs. In most states a party to a lawsuit pays its own attorney’s fees and costs – even if it wins. However, the parties can alter that rule by including a clause providing that the prevailing party in any lawsuit will be entitled to collect its attorney’s fees and costs from the other party.
When others learn I am a lawyer they often ask whether I do transactional work or litigation. In equipment leasing this distinction is artificial; lease litigation is almost always the result of a poorly drafted lease or a negotiation that failed to consider all the “what if” contingencies. The good news is that the parties to an equipment lease can greatly reduce the risk of misunderstandings and costly litigation by taking the time to make certain the lease is both unambiguous and complete.