Ten Essential Lease Provisions

Words matter. But which words should be in the contracts leasing attorneys pour over, passionately debate and… sometimes lose sleep over?

Other than describing the term length, addressing economic provisions for rent payments and identifying a signature or similar acknowledgment confirming a lessee is bound by the documents, leases come in a wide variety of forms. Various considerations arise between legal, operations and sales personnel regarding how long a lease should be, what it should cover and what provisions it should include.

From a lessor’s standpoint, an ideal lease should achieve two goals: (1) protect the lessor’s economic interest—revenue stream and residual interest and (2) limit the lessor’s liability. Here are 10 essential provisions that are “must haves” and a few other “nice to haves.”

Must Haves

1. Indemnity – A lessor typically does not have visibility into how a lessee uses or operates equipment. Additionally, a lessor usually does not select the equipment or maintain it. In most transactions, a lessor merely finances the equipment’s acquisition and holds title (or minimally a first-priority security interest). Consequently, it’s essential that the lessor be indemnified by the lessee and held harmless for damages, claims or other losses arising from the condition, operation, performance or maintenance of the equipment. The lease should provide that the lessee’s indemnification obligations survive the expiration, termination, cancellation or assignment of the lease. In some cases, government-related lessees are statutorily prohibited from being subject to third-party indemnification obligations.
   
   
2. Hell or High Water – The lease should provide that the lessee’s payment obligations shall not be reduced, delayed, abated or discontinued for any reason, including equipment failure, the lessee’s dissatisfaction with the equipment’s functions or damage/destruction of the equipment. Lessors (and assignees) rely on the payment stream and the lease should state that payment obligations shall not cease for any reason.
   
   
3. Acceptance – This seems simple, but without an acknowledgment in the lease (or in a separate document ancillary to the lease) it can be difficult to determine when the lease term commences or whether the equipment has been delivered and fully installed. An acceptance certificate also fulfills another important function: to confirm that the lessee inspected the equipment and has determined it is in place and suitable for the lessee’s needs. This can be extremely important to the extent the lessee later claims the equipment was not fully delivered or did not function as intended (I’d recommend a separate lessee signature on an acceptance certificate confirming these items).
   
   
4. Disclaimer of Warranties/Waiver of Defenses – The lessor should disclaim express and implied warranties, including the warranties of merchantability and fitness for a particular purpose. Warranty disclaimers should be clear, unequivocal and, as required in some jurisdictions, conspicuous (in all caps). Include language that the equipment is being leased “as-is” and “with all faults.” The lease should specifically disclaim any lessor liability for lessee damages or specific performance in connection with the lease. If the lessor plans to assign to a funder, consider providing that the lessee is not entitled to assert any claims, defenses, setoffs or counterclaims against the assignee that might be raised against the lessor.
   
   
5. Risk of Loss/Insurance – The lessee should be solely responsible for, and otherwise bear the entire risk of, damage, loss, theft and destruction of the equipment for any reason. Provide that to the extent of damage to, or partial loss of, the equipment lessee is obligated to repair and restore it. To the extent of theft or complete destruction of the equipment, the lessee should be responsible for replacement or for a stipulated loss/casualty value payment to compensate the lessor and its residual interest. Require the lessee to insure the equipment for its replacement cost (naming the lessor as an additional loss payee) and to obtain liability insurance (naming the lessor as an additional insured). The amount of liability insurance necessary is asset and industry dependent. Require that the lessor receive 30 days written notice from the insurer prior to cancellation. If the equipment stores data, consider additional coverages for data loss and misuse scenarios.
   
   
6. Default and Remedies – Defaults and remedies could be the subject of an entire article; however, the lease should minimally provide that the lessee’s failure to make timely payments constitutes an event of default. Also, the lessee’s failure to adhere to non-monetary obligations, and its furnishing of false or misleading information to the lessor, should constitute events of default. Consider whether to require a written default notice and a cure opportunity prior to exercising the lessor’s remedies, or whether to empower the lessor to pursue remedies without notice. Remedies should minimally include rights to: (a) terminate the lessee’s rights under the lease, but not its obligations; (b) recover all accrued and unpaid lease payments as of the default date; (c) accelerate and cause to become immediately due the present value of future amounts due under the lease; (d) authorize the lessor to retake possession of the equipment; and (e) pursue remedies available at law, equity or pursuant to any statute.
   
   
7. Grant of Security Interest/Authorization to file UCC-1 – Provide that notwithstanding the transaction is intended to be a true lease, the lessee grants a security interest in the equipment (with language also addressing proceeds, accessions, replacements, etc.) and authorizes the lessor to file a UCC-1 Financing Statement. This offers protection for lessors if the transaction is later determined to be a disguised security agreement.
   
   
8. Late Fees – To cover the lessor’s administrative and operational expenses to address slow payers, consider language entitling the lessor to recover a late fee if the lessee fails to timely pay. Five percent of the amount due is popular in the industry, but consider whether the transaction is a true lease, whether the lessee is an entity or an individual, applicable state law and customer relationships.
   
   
9. Recovery of Expenses/Net Lease – Many items fall into this category, including recovery of attorneys’ fees, personal property taxes, license and registration fees, assessments, delivery and freight costs, installation expenses, etc. Regarding attorneys’ fees, use broad language encompassing litigation expenses, fees incurred in asserting the lessor’s rights in bankruptcy, expenses incurred in government investigations and expenses incurred whenever the lessor is required to assert rights and pursue lease remedies.
   
   
10. End of Lease Options – Unless the lease is a simple rental agreement, at the end of the term, the lessee will be required to return the equipment or exercise a purchase option. Many leases provide that unless the lessee returns the equipment or exercises an option, the lease automatically renews. The equipment’s economic life and the amount of the purchase option may impact whether the transaction is a true lease. Additionally, some states employ strict requirements to enforce automatic renewals. The lessor should be thoughtful in drafting these provisions.

Nice to Haves

1. Assignment/Sublease Language – The lessor should have the right to assign the lease to a funder. The lessee should not have the right to assign the lease without consent.
   
   
2. Choice of Law and Venue – Considerations include where the lessor maintains operations and/or personnel, equipment deployment locations and whether the equipment is fixed or moveable.
   
   
3. Waiver of Jury Trial – Equipment leasing concepts are often challenging to explain to judges, much less juries. Jury waivers are not enforceable in some jurisdictions.
   
   
4. Equipment Maintenance – To preserve the lessor’s residual, require the lessee to adhere to applicable manufacturer’s specifications. Depending on the type of equipment leased, maintenance provisions can be very robust and specific.
   
   
5. Lessee Representations and Warranties – Among others, representations from the lessee that it: (a) is duly organized and authorized to conduct business; (b) is empowered and authorized to enter into the lease; (c) holds all licenses and permits to conduct business; and (d) has paid all taxes can be powerful lessor tools in the event that facts later emerge to challenge the legitimacy of the transaction or imperil the equipment.
   
   
6. Landlord/Mortgagee Waiver – Usually set forth in a separate document rather than a provision, if the equipment will be installed on mortgaged or leased property, this can assist a lessor in avoiding fights with other lenders and landlords regarding lien priority, and it may assist a lessor in gaining access to the equipment in the event of a default and/or abandonment without having to pay the landlord.
   
   
7. No Alterations – Be clear that the lessee may not alter equipment without the lessor’s consent. Include language that if the lessee does so, the alterations become property of the lessor.
   
   
8. Inspection Rights – This can be an important tool, as the lessor owns the equipment. A must-have for mid- and large-ticket lessors.

Some will disagree whether the above “must haves” are all indeed necessary, or whether some “nice to haves” should be mandatory. There is certainly room for differences of opinion, debate and discussion depending on, among other things, an organization’s customer base, portfolio makeup and risk profile.