Wednesday, April 25, 2012

What Constitutes a Legal Lease?

What is a Legal Lease?
The documentation of an equipment lease must follow the requirements of the Uniform Commercial Code (UCC). Perhaps the most important thing to understand is that two parties may enter into a contract to do just about anything. So long as the agreement does not cross any legal barriers both parties are expected to live up to the requirements of the contract. When a breach occurs (one or both parties fail to honor the contract) and a civil court action is required to settle the dispute, the contract, as written and signed, will be used by the judge to determine corrective action or penalties.
The contract must clearly state "do’s and don’ts," if the contract does not prohibit something, it is assumed the lessee has the right to do it. If the contract contains provisions that conflict with existing laws, it is said to be “unenforceable” An example: If a contract claims to be governed by Article 2A, of the UCC, and then contains a provision that excludes it from 2A then the provision claiming to be governed by 2A is unenforceable (not illegal).
The UCC, for Commercial transactions, is divided into Articles with each Article defining a type of business activity. Article 9 defines the requirements for money lending or secured lending. This Article acknowledges the borrower as the legal owner of the equipment and the lender as a lien holder. To “perfect,” or record a lien, the lender must file a recording document called a UCC-1. This UCC-1 must be filed in the State where the borrower has incorporated or registered to do business. If the borrower has an existing “blanket lien” (a lien on everything owned by the borrower) the new lender is restricted from having a first position and would be regulated to a secondary lien position in the case of a default. However, if the equipment is a new purchase and the lender has loaned the money to purchase it ,then Article 9 allows for a “purchase money lien filing” that will have first lien position in front of the blanket lien holder providing the purchase money filing is filed within twenty days of the borrower taking possession. This twenty-day requirement starts with customer possession—not the date of the signatures on loan documents. Therefore some record of delivery date needs to be retained in case of a court challenge in default.
Article 2A is for equipment leasing that is not a lending activity governed by Article 9. To distinguish the differences, the definition of an Article 2A transaction was published as an exception to a secured transaction and is found under the definition of a “Security Interest” as section (37). The reason for this article on leasing is to establish the rights of the lessor as the legal owner of the equipment. In the case of a third party lessor, it establishes procedures for the lessor to pass on to the lessee the supply contract; a term for the usual equipment performance guarantees and the warrantees from the vendor, seller. This limits the third party lessor from responsibility for equipment performance or liability for non-performance, or injury, from malfunction.
To qualify as an Article 2A lease and be judged by the contents of 2A the lease transaction must meet the definition or the qualifications in section (37). If the transaction fails then it is considered an Article 9 secured transaction and the lessor must contend with the lien filing requirements of this article to maintain their lien position. Most Lessors’ file a lien-filing document called a financing statement also called a UCC-1 as a precautionary measure because under the law the filling of a UCC-1 cannot be used as evidence the Lessor considered the transaction to be a loan. There is no requirement for a lien filing in Article 2A because the lessor is considered the legal owner. One difficulty presents itself when leasing non-titled equipment (personal or tangible property:) Without a lien filing, there is no location for a lessor to post a notice that the lessee is in possession of equipment that the lessee does not own. A potential purchaser finding no liens may assume the business asset is free and clear of all liens and the lessee has rights to sell it. This is one of the reasons for filing a UCC-1 or as some Lessor’s do, put labels or notices on the asset itself, stating “ This equipment is owned by ABC Leasing and may not be removed from this location without our permission. PH 123-456-7891.” Still, in many cases when assets are sold without the lessor’s knowledge and the buyers name is not recorded, many Lessor’s have little recourse in default situations except to take the Lessee to court for selling non owned assets.
Mr. Terry Winders, CLP, has been a teacher, consultant, expert witness for the leasing industry for thirty-five years and can be reached at