There is a good deal of pressure in the marketplace for lessors to offer non-standardized financing. This topic was discussed in greater detail in a recent article authored by Brian Madison, "Non-Standard Financing:  Switching Gears to Meet Customers’ Demands."  In many cases, non-standard financing agreements include offering a bundled package of leasing, equipment maintenance and other services.

While this may open new or keep open existing sales and marketing doors for lessors and their affiliates, it does have potential legal implications which should be considered as well. These implications do not mean that funding sources should refrain from financing such leases or that lessors should refrain from writing them.  As noted below,in the following discussion,  they do mean that both should be mindful of the available techniques for reducing these risks in a customer-friendly manner, and making the leases more "fundable."

Legal Concerns

Combining lease financing with services on the same contract may impact the enforceability of the lease payment obligation. Under the law which governs equipment leasing in virtually all states, Article 2A of the Uniform Commercial Code [‘2A’], it is highly desirable and usually essential for lessors to have their leases qualify as statutory "finance leases" under 2A. Such status has nothing to do with lease characterization for financial accounting purposes, but when applicable, a particular section of 2A makes the payment obligation irrevocable and non-cancelable. That is, the rent payments are due "come hell or high water," the traditional sine qua non of the leasing industry.

This is obviously critical for a lessor expending cash to purchase the item, as well as anyone financing the corresponding lease. It is one thing for a lessor or its financing source to assume the credit risk associated with a transaction when the underlying obligation is legally unassailable. It is quite another to assume both risks.

In order to be a finance lease, a contract must be a "lease" covering movable "goods." Services, by definition are not in this category. For a lease to be a statutory finance lease, among other things, “the lessor does not select, manufacture or supply the goods.” Where the lessor is providing services pertaining to the goods, particularly where the lessor provides the goods as part of a bundled offering in which the lessor does select the goods in connection with its provision of consulting or integration services, it is questionable if this criterion is met. Even where the lessor does not select the item but otherwise provides services to the lessee pursuant to a bundled offering and rate, it is questionable if the entire contract qualifies as a finance lease.

While it is not entirely clear what ensues if a lease does not qualify as a statutory finance lease, it is clear that the door is opened for the lessee to assert various defenses to its payment obligation if it is unhappy with the items and/or services. For example, if the lease is a finance lease, the payment obligation is NOT subject to "cancellation, termination, modification, repudiation, excuse or substitution," meaning that other, non-finance leases are subject to such things.

Mitigation Techniques

The legal risk can be mitigated, if not eliminated, if the two offerings are documented in different agreements. Even if the two agreements are both schedules pursuant to the same master lease, if the "pure" goods transaction is on one schedule by itself, that schedule should be a statutory finance lease (if it otherwise meets the definition) with an irrevocable payment obligation. Any legal problems should be confined to the other schedule. Inclusion on the goods schedule of de minimus (relative to the cost of the goods being financed) amounts for maintenance, training, consulting, taxes, freight and the like is customary and presents little or no problem in the marketplace.

As the percentage of the total amount on one schedule financed represented by services increases, so does the legal risk. Prudent funders should look at the"equipment description" when conducting due diligence and question schedules which appear to involve a substantial percentage of "soft" costs. In some cases, with a high proportion of such costs, funders may want to refrain from financing the deal or insist upon special indemnities and/or put options from the lessor which come into play if there is a dispute with the lessee.

If a lessor does not intend to seek (or can live without) external financing of such transactions, but will hold it in its own portfolio, the risk is mitigated, since there is no concern over reaction of a third party, although the lessor may face complications in connection with its own enforcement efforts if any should become necessary. In such cases, the lessor should pay close attention to the nature of its relationship with the lessee and nature/history of the equipment. If there is a long, clean history with both, the risk is probably quite low. If the lessee is not familiar and/or the equipment is susceptible to breakdowns or an unknown quantity, this should give pause to the lessor.

Lessors should anticipate increased lessee focus on this topic of leases being combined with agreements for other things. The Big 4 accounting firm PriceWaterhouse Coopers has addressed the topic from the opposite perspective in its March 2016 report titled, “Are leases embedded in your contracts?”

Mr. Madison is correct in his observations regarding the role these deals play in the marketplace and the actual and perceived value which they add. However, all concerned should make educated decisions as to whether this model or any particular transactions are suitable for their own circumstances.

In all events, lessors should educate their sales forces and pricing teams as to legal risk associated with bundled deals and when they are most appropriate. Mr. Madison is also correct in his observations regarding the role these deals play in the marketplace and the actual and perceived value which they add. However, all concerned should make educated decisions as to whether this model or any particular transactions are suitable for their own circumstances.