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1. Bankruptcy Reform Favors Leasing, But Poses New Challenges For Lessors For over eight years, Congress has struggled to pass comprehensive bankruptcy law reform of the current federal Bankruptcy Code (Code). On April 20, 2005, Congress finally succeeded when President Bush signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (Public Law No. 109-8) (Act). Although the Act addresses numerous issues concerning individuals and small businesses, the 500 page bill also makes some significant changes affecting real and personal property leasing. All of the provisions discussed in this article, as well as most of the provisions in the Act, will take effect October 17, 2005. It appears that, like other creditors, lessors will generally benefit from the revisions to the Code. Debtors will have to tow the line more often by paying more of their debts, more of the time, rather than shielding themselves with the Code’s special protections against creditors. *Terms to Know: When a lessee files a petition in bankruptcy, it becomes the "debtor". As such, the Code gives the debtor special powers with respect to its lease agreements. The debtor has the power to "assume," "assume and assign" under Section 365(f) of the Code or "reject" its leases, subject to varying deadlines. "Assuming" a lease means agreeing to maintain a lease arrangement in accordance with its terms. To assume a lease, a party must cure all defaults, or demonstrate that it will cure them promptly (that is, provide adequate assurances that it will perform its obligations in the future). To "assume and assign" a lease means that the debtor assumes the lease and then assigns it to another party that takes over the lease obligations. Finally, "rejection" of a lease refers to the debtor’s unilateral right to effectively terminate a lease regardless of the length of the remaining term of the unexpired lease. The lessor then generally has the right to retake its leased property and assert an unsecured claim in the debtor’s bankruptcy for pre-petition obligations and an "administrative claim" (higher value, higher priority payment rights) for post-petition obligations. See: Section 365(b)(1), (f) and (g) of the Code. A "Chapter 7" filing under the Code refers to the liquidation of the assets in the debtor’s estate, but a "Chapter 11" filing involves the reorganization of the debtor’s assets and liabilities. See: Leasing 101: What is Chapter 11 of the Federal Bankruptcy Code? The ability to assume, assume and assign, or reject a lease in bankruptcy gives the debtor substantial power in its lease relationships with lessors. See: Leasing 101: What Does It Mean to "Assume" or "Reject" a Lease in Bankruptcy? by David G. Mayer, Business Leasing News (May 2002). Section 365(b) Reformed—Cure All Non-Monetary Defaults to Assume The Act requires the debtor-lessee (or trustee in possession of the debtor-lessee’s estate) to cure and perform all non-monetary and monetary obligations before the debtor may assume or assume and assign the affected lease. The Equipment Leasing Association (ELA) worked hard over several congressional sessions to correct Section 365(b) of the Code that contained ambiguous language leading some courts to provide relief only for monetary obligations. Congress made the primary correction in Section 365(b)(2)(D) of the Code by adding the word "penalty" before the word provision, clarifying that only a "penalty rate or penalty provision" relating to a non-monetary default did not have to be cured before assumption. Previously, courts have reached inconsistent decisions on whether a lessee must cure non-monetary provisions before assumption under that section of the Code. See: BLN Case & Comment: BankVest Assumes Lease, Ignoring Non-Monetary Defaults, by David G. Mayer, Business Leasing News (Sept. 2004). Real property lessors receive two changes from this general rule in the new Act in Section 365(b)(1)(A) of the Code. If a non-monetary default is not curable (such as a past operational problem), the Act requires that a debtor-lessee must be in current compliance at the time it assumes the affected non-residential real property lease. In addition, a non-residential real estate lessor will then be entitled to monetary cure damages if it has suffered a monetary loss from the past non-monetary breach. *Warning: Congress did not amend Section 365(d)(10) of the Code (other than renumbering it as 365(d)(5)). Section 365(d)(10) of the Code (now (d)(5)) requires the debtor to perform all obligations under a lease after 60 days from the date the lessee files its petition in a Chapter 11 case. Although the Act now requires a lessee to cure all obligations when it assumes a lease, the Act did not clarify lessee’s payment or performance obligation incurred before it rejects the lease. Lessors should closely monitor payments and diligently require a debtor-lessee to make lease payments after the first 60 days. If not timely paid, lessors should be prepared to face the possibility that they might not be allowed a claim at all. However, most federal courts allow a lessor an administrative expense claim for all obligations incurred after the first 60 days and through the date the lessee rejects the lease. A few courts do not allow any claim for all obligations incurred before the lessee rejects a lease. On May 2, 2005, in CIT Communications Fin. Corp. v. Midway Airlines Corp. et al., (In re Midway Airlines Corp.), 04-1502 (4th Cir. 2005), the court allowed CIT to make an administrative claim for all obligations that came due 60 days after filing bankruptcy and before the lessee rejected the lease. In light of the recent changes to Section 365(b) of the Code, case law may now require a debtor to take responsibility for all lease obligations incurred before assumption or rejection. *Tip: Lessors should still ensure that a court’s order regarding assumption (or assumption and assignment) does not limit the lessee’s obligations to curing monetary defaults only. Lessors should require clear language in any relevant federal Bankruptcy Court order that the lessee must cure all known or unknown monetary and non-monetary breaches as part of assumption or cure of any unknown defaults in the future. Otherwise, a lessor might not be able to assert a pre-assumption default against a debtor or assignee if it was not listed in the assumption order. See In re Diamond Manufacturing Co., 164 B.R. 189, at paragraphs 37, 53 and 54 (Bankr. S.D. Ga. 1994) (failure to raise environmental indemnity in assumption order barred pre-assumption cleanup claims post-assumption). New Rules on Assumption and Rejection of Leases A new provision under Section 305 of the Act adds Code Section 365(p) providing two new protections for lessors. First, Code Section 365(p)(1) clarifies that if a Chapter 7 trustee either rejects a lease or fails to assume a lease within 60 days of a Chapter 7 filing, the leased property is no longer property of the estate and the automatic stay is terminated. Consequently, lessors may recover their property without further court order. Second, Code Section 365(p)(2) provides that an individual debtor who files liquidation bankruptcy (Chapter 7) may not assume a personal property lease unless the lessor expressly consents. This right is in addition to the bankruptcy trustee’s right to assume a lease. The new laws permit a lessee-debtor to notify the lessor of his intention to assume the personal property lease. The lessor then has the option to withhold consent of the assumption, or consent and demand that all outstanding defaults be cured pursuant to the lease terms. If the debtor assumes the lease, the lessee-debtor becomes obligated on that lease outside of the bankruptcy process. In other words, the debtor can no longer retain the leased property and pay on the lease without a complete assumption of the contractual obligations or prevent the lessor from terminating the lease. See new 11 U.S.C. § 365(p) and old § 365. Similarly, Section 404 of the Act makes favorable changes for lessors in the real estate arena by changing the period during which any debtor or trustee may assume or reject a non-residential real property lease. Under the old law, a lessee-debtor had only 60 days from its bankruptcy filing to assume or reject a non-residential real property lease, unless the court extended the period. Despite the 60-day limitation, courts routinely granted nearly unlimited extensions. Such extensions frustrated lessors because the lessee-debtors usually did not pay pre-bankruptcy unpaid rent or taxes during the period leading up to the assumption and rejection of the lease. In reorganization bankruptcy cases (Chapter 11), lessee-debtors routinely extend the rejection period for many months, or even years, while they cobble together a reorganization plan. The new bankruptcy law amends the assumption period in a balanced fashion by extending the debtor’s initial rejection period, while limiting the debtor’s ability to obtain extensions. The new law provides that a debtor has 120 days from its bankruptcy filing to assume or reject a non-residential real property lease. The bankruptcy court may extend that 120-day period once for 90 additional days if the debtor shows sufficient cause. But unlike the old law, no further extensions are permitted without the prior written consent of the lessor. See 11 U.S.C. § 365(c)(4). *Warning: In non-residential real property cases, lessees may try to negotiate a lease provision that permits unlimited extensions of the rejection period described in new Section 365(c)(4) in the event either party files bankruptcy. Lessors, on the other hand, should be on the lookout for such provisions, and should generally avoid them whenever possible. See: 11 U.S.C. § 365(c)(4) (as amended). Preference Defenses Expanded Creditors of bankrupt debtors often view preference claims against creditors as the most unjust provision of the Code. Section 547 of the Code allows a debtor or trustee to recover payments: (1) to a creditor; (2) on account of a debt previously incurred; (3) while the debtor was insolvent; (4) within 90 days of the bankruptcy filing (for non-insiders, up to 1 year for insiders); and (5) allowing the creditor to receive more than it would have received in a Chapter 7 bankruptcy. Such payments can be recovered even though the debts paid were legitimate debts. Congress has now given creditors two stronger defenses. First, Section 409 of the Act requires that the total of all payments in the 90 days must be $5,000 or more before the debtor or trustee can bring a lawsuit against a creditor. By establishing a minimum threshold, Congress has reduced the likelihood that a debtor or trustee can file litigation that settles for nuisance value because the cost of hiring an attorney to assert any legitimate defenses exceeds the settlement cost. Second, lessees that expect to file in bankruptcy often stop paying rent or paying it regularly, especially in the 90-day period prior to a filing. By creating an irregular pattern of payments from the contractual arrangements under a lease, the lessee sets up its lessor as a target of preference payments. Under the old provisions of the Code, to defend a preference a creditor had to prove it incurred the debt under ordinary business terms and then that it was paid in the ordinary course of business between the debtor and creditor and was paid according to ordinary business terms. The courts have determined that the last factor is whether the payment was made according to the terms of the relevant industry. Often, the courts would require proof not only of what was normal between the debtor and creditor, but also expert testimony of what was normal in the industry. However, Section 409 of the Act revises Section 547 of the Code so that a creditor may defend a payment that was paid in the ordinary course of business between the debtor or creditor or paid according to ordinary business terms. This change significantly lowers a creditor’s burden by requiring proof of only one, but not both, ordinary course payment terms. *Tip: The new provision does not relieve lessors of the burden of closely monitoring its lessee’s financial condition and regularly asserting its right to full payments. Should lessors determine they face a risk of a filing, the lessor should still evaluate whether to put the lessee in default and terminate the lease to avoid allowing the lease to become subject to the bankruptcy proceedings. Once a lease is terminated, it cannot become part of the debtor’s estate. Tax Collection: State and Local Government Rights Strengthened State and local governments gained a provision to help collect taxes due from debtors, especially property taxes (also called ad valorem taxes). New Section 701 amends Section 724 of the Code to enhance collections subject to property tax liens. Previously in a Chapter 7 bankruptcy case, the Chapter 7 trustee could subordinate (put in lower priority in rights of payment) these taxes to the unsecured claims of administering the Chapter 7 bankruptcy. The Act now requires that property tax liens on real and personal property may only be subordinated to employee benefit plans and wage claims. Further, Chapter 7 trustees must dispose of all other unencumbered assets of the debtor’s estate and recover cost and expenses of preserving and disposing of the property before a tax lien may be subordinated. *Warning: Lessors should closely monitor and, if feasible, pay property taxes for lessees and charge the lessees a pro rated portion of the taxes as part of a scheduled rental payment. By doing so, lessors should pay taxes on time to prevent the statutory lien for taxes from arising that may, if unpaid, result in a lien for state and local property taxes priming the lessor’s rights in the affected asset. For example, if a lessee of aircraft fails to pay property taxes, the lessor will often be required to pay those taxes for the lessee. After the lessor recovers the aircraft, it might then only hold an unsecured claim in a bankruptcy case for the paid taxes. Most of the reforms in the Act favor creditors. Practically all of the amendments affecting leasing curtail the rights of lessee-debtors and enhance the rights of lessor/creditors. It is now the job of the courts to interpret these important amendments in the context of actual business leasing arrangements. Thanks to Jeff LeForce and Nathan Galbreath in the Patton Boggs Bankruptcy and Restructuring and Corporate Finance Groups for writing this article. 2. Do You Have Attributes of the Most Respected CEOs? Do you exemplify the most important attributes of a successful leader and CEO? Do you have a clear view about the character and skills you should develop to enjoy the success of some of the top business leaders today? In late March, Barron’s took its first crack at identifying the top 30 CEOs in the world. Some of the attributes of the leaders Barron’s selected provide insights into the best and most successful ways to run a business. See: The Most Respected CEOs, Barron’s at p. 1 (March 28, 2005). Admitting it used a subjective process, Barron’s identified corporate leaders based fundamentally on earnings growth during the CEO’s tenure. It picked CEOs who exhibited leadership strength, industry stature and such "keen and beneficial influence on their organizations… that stock prices probably would decline if they abruptly departed." In some cases, the article included salient business methods, attributes of success and elements of personal style of these CEOs. Some CEOs on the list will surprise no one. For example, Warren E. Buffett, at age 74, made the list for obvious reasons: Berkshire Hathaway has $40 billion in cash and a stock price that has risen over 40 years from $15 to $87,000 per share (and that’s no typo). Some of Buffett’s most defining characteristics include that "he hates meetings, makes quick decisions and refuses to court Wall Street." Despite recent skirmishes regarding American International Group, Buffett remains the "conscience of American business" according to the survey. Lexmark is giving Hewlett-Packard fits in the printer business. Lexmark has increased its share of the printer business from 19 percent in 1999 to 32.5 percent currently. It’s leader, Paul J. Curlander, is "sharp, disciplined and tireless" with technical knowledge as an MIT electrical engineer. He also puts a strong focus on generating cash flow. The stock price has risen 16.99 percent since he has been CEO. Kenneth I. Chenault leads American Express in a way that inspires behavior that you might find surprising or rare in the executive suite. As implied by a report in USA Today, Chenault, an African American, could easily exude arrogance and bravado. He graduated from Harvard Law School and has served as a college professor. Barron’s reports that AMEX trades at 16 times estimated 2005 earnings compared to a price/earnings ratio (P/E) of 12 for its peer group of credit card companies. What defines and distinguishes this man? He is a seasoned negotiator and honest broker, a fierce competitor, a speaker of truth even when it is unpleasant; yet he is also a balanced, reasonable guy without pretension. He regularly says that you must be pleasant and respectful of your colleagues and business partners to excel long-term. In short, he quips, "You can’t be a jerk and be successful" in the service business. See: ‘You can't be a jerk and be successful’ in service business, USA Today at page 1 and 3B (April 25, 2005). As the only women on Barron’s list, Anne M. Mulcahy epitomizes a tough fighter who has been under excruciating pressure to turn around Xerox. She has trimmed debt and overhead and driven up the stock price 90 percent since 2001. She pursues innovation and executes effectively, as illustrated by Xerox’s 30 percent market share of the color copier market In December 2004 Scoring a spot on Barron’s list, Jeffrey R. Immelt, 49, should win an award for great performance after taking on the unenviable role of following Jack Welch as CEO of General Electric. Welch has turned from CEO to leadership guru and best selling author four years after his retirement from GE in 2001. He just published his newest book called Winning (HarperBusiness, 384 pages) in which he extols the attributes of leadership. For example, he urges leaders relentlessly to upgrade their team, to live and breath the company vision, and to exude positive energy, optimism and candor while having the guts to make tough decisions. Called "Neutron Jack" by many people, Welch urges leaders to celebrate and encourage talent, believing that happy troops produce successful results. See: Welch shows the ‘Winning’ side of business for all, USA Today at page 5B (April 14, 2005). Immelt turned the Welch heat level down a bit and did not carry forward the "imperial" style for which Welch became well known. Although GE’s stock price has been flat since 2001, Immelt has rebalanced GE’s portfolio by focusing on the higher growth businesses such as medical imaging, while supporting the best in class businesses like power generation and aircraft engines. As anyone in financial services knows, GE has an enormous financial services business that pervades almost every market affecting leasing and equipment finance. *Comment: Many other stellar CEOs appeared on Barron’s list. The skills and attributes of those described in this article should provide guidance of how you, as a leader, at your particular level, can develop your own unique skills in leasing and finance, which increasingly are both a product and service business. 3. EU Ratchets Up Aviation Insurance Required of Non-EU Operators and Air Carriers U.S. and other non-EU aircraft operators and air carriers may be surprised that they won’t be permitted to fly to, in or over any of the 25 European Union Member States, until they ratchet up their insurance coverage to comply with new Regulation 785/2004 (Regulation). Put into effect on April 30, 2005, the Regulation enables Member States to impose potentially serious consequences on those who fail to comply with the insurance provisions contained in the Regulation. Objective of Regulation With insurance requirements based on aircraft weight and seating capacity, the objective of this Regulation is to establish minimum insurance coverage for air carriers and aircraft operators pertaining to passengers, baggage, cargo and third parties. See: Article 1(1). The Regulation applies regardless of other legal or contractual requirements imposed on the operator. See: Article 4(3). Additionally, the Regulation applies to aircraft registered outside EU member states. Operators of these aircraft must deposit with a Member State a certificate or other valid evidence of insurance coverage when they apply for landing or over-flight rights in the EU State. See: Regulation Text. Scope of Covered Risks and Affected Operators Under Article 4(1) of the Regulation, the insured risks include acts of war, terrorism, hijacking, acts of sabotage, unlawful seizure of aircraft and civil commotion. Air carriers and aircraft operators must provide insurance for each and every flight, regardless of whether the aircraft is operated through ownership or any form of lease agreement, or through joint or franchise operations, code-sharing or any other similar agreement. See: Article 4(2). *Technical Point: Under Article 2(2)(a), the Regulation does not apply to state aircraft. It also does not apply to the carriage of mail under Article 1(2). War risk and terrorism coverage does not apply to aircraft with a MTOW of less than 500kg (1,103 pounds) used for non-commercial purposes or flight instruction. Calculation of Coverage Third party liability must be insured under Article 7 at certain levels to satisfy the standards. Using a portion of a chart published by the Aircraft Owners and Pilots Association, maximum takeoff weight and insurance in U.S. Dollars are as follows:
MTOW/MTOM (kg) |
MTOW/MTOM (lb) |
SDRs |
U.S. Dollars U.S.$1.4399:1 SDR 4/19/05 Exchange Rate |
<500 |
<1,103 |
750,000 |
$1,135,275 |
<1,000 |
<2,205 |
1,500,000 |
$2,270,550 |
<2,700 |
<5,954 |
3,000,000 |
$4,541,100 |
<6,600 |
<14,553 |
7,000,000 |
$10,595,900 |
<12,000 |
<26,460 |
18,000,000 |
$27,246,600 |
<25,000 |
<55,125 |
80,000,000 |
$115,188,629 |
<50,000 |
<110,250 |
150,000,000 |
$215,978,679 | *Terms to Know: An "aircraft operator" means the person or entity, not being an air carrier, who has continual effective disposal of the use or operation of the aircraft; the natural or legal person in whose name the aircraft is registered shall be presumed to be the operator, unless that person can prove that another person is the operator. See: Article 3(c) (Definitions). "SDR" means a Special Drawing Right (valued based on a basket of international currencies) as defined by the International Monetary Fund. See: Article 3(e) (Definitions). "MTOM" means the Maximum Take Off Mass (also called MTOW above), which corresponds to a certified amount specific to all aircraft types, as stated in the certificate of airworthiness of the aircraft. See: Article 3(f). (Definitions). Article 6 of the Regulation also requires insurance of the following categories of risk with some exceptions: · Baggage - minimum insurance cover shall be 1,000 SDRs per passenger in commercial operations. · Passengers - minimum 250,000 SDRs per passenger and potentially less for non-commercial operators of aircraft with a MTOM of 2,700 kg or less. · Cargo - minimum insurance cover shall be 17 SDRs per kilogram in commercial operations. These insurance levels do no apply with respect to flights over a Member State by non-Community air carriers and by aircraft operators, such as U.S. registered aircraft, which land in or take-off from, such territory. An article published online on April 4, 2005 by the National Business Aviation Association (NBAA) gave this example of how the insurance adds up based on the number of passengers and the weight of aircraft: The Regulation would require a Citation X, Falcon 50 and Hawker 800 each to carry $118,788,269 calculated as follows: · $115,188,629 (MTOW)+ $3,599,640 ($359,964 x 10 passenger seats) = $118,788,269 As a further illustration, consider large cabin jets. A Gulfstream G-450 has a MTOW of 73,900 pounds/33,521kg and carries 12-16 passengers. Assuming 12 passengers, the insurance should be: · $215,978,679 + $4,319,568 ($359,964 x 12 passenger seats) = $220,298,247 A Gulfstream G-500 has an MTOW of 85,100 pounds/38,601kg and carries 14-18 people should be the same calculation plus six more passengers (for a total of 18 passengers) at $359,964 each for a total of $222,458,031 of liability coverage. A mid-sized aircraft like the Bombardier Learjet 60 has a MTOW of 23,500 pounds/10,659kg and carries up to 8 passengers. Its coverage should be calculated the same as the Citation X, but with two fewer passengers ($359,946 x 2 = $719,928) for a total insurance requirement of $118,068,341. *Warning: These insurance levels may exceed what is currently required by your lease or loan documents, and immediate changes may be necessary to comply with the coverage rules. Further, many U.S. business jet operators do not carry terrorism coverage because it lacks value for the perceived risk. The Regulation may now force operators and air carriers to purchase terrorism and other liability insurance to engage in flights to the EU even though they don’t need or want it in the U.S. As a result, costs of insurance may increase for flights in the EU. To keep your compliance efforts even more interesting, watch out for the exchange rate changes in the U.S. Dollar as compared with the currencies used to compute SDRs. Keep a margin above the required amount in this era of the weak U.S. Dollar. Sanctions for Failing to Comply Failure to comply with the Regulation can result in sanctions that the EU intends to be "effective, proportional and dissuasive". Community air carriers may lose their operating license, but Member States may refuse to allow non-Community air carriers and aircraft operators using aircraft registered outside the European Community to land on its territory or to take off until the operator evidences the mandated insurance coverage. See: Article 8(6) (landing) and Article 8(7) (takeoff). Member States have enforcement powers under Article 5(3), including a right to demand evidence of insurance and arrange for inspections to prove the existence of insurance. Changing Market Conditions The Commission intends to monitor the types and amounts of insurance required from time to time. The Regulation contemplates that insurance, such as terrorism coverage, may not always be available at reasonable rates. Accordingly, the Regulation contemplates the need for periodic adjustments. On the whole, the Regulation seems to place greater strictures on air carriers than private operators. Private operators will still encounter new scrutiny and enforcement for failing to carry required levels of insurance. *Action Item: Although these changes affect flights to the European Union, as a non-EU lessor, owner, lender or operator with interests in aircraft used in international travel, you should immediately review your insurance coverage. You should ensure compliance with the Regulation. Your documents should contain a covenant to comply with all applicable law, and you may be able to rely in the absence of a specific insurance provision. Consider modifying your new documents to refer to the insurance requirements in the EU. Insist on a written certification of appropriate coverage in all existing and new evidence of insurance covering any aircraft that travels in or to the European Community. The certification should provide a statement, based on advice of your counsel and insurance underwriters, to the following effect: "It is certified that the amounts and types of insurance set forth above comply with the minimum insurance requirements in EU Regulation No. 785/2004, effective April 30, 2005, based on exchange rates used to calculate Special Drawing Rights as of the date of this certificate. The limits and types of insurance may require revision from time to time to reflect changing coverage required or permitted by such Regulation and variations in exchange rates during the policy period. The coverage at inception includes passenger liability, third party liability, cargo liability, baggage liability as well as insurance for acts of war, terrorism, hijacking, acts of sabotage, unlawful seizure of aircraft, civil commotion and allied perils." It has been a year since the Regulation began its gestation period toward effectiveness. With the effective date of April 30, 2005, it’s critical to comply with the Regulation immediately for those who fly to the European Union. Otherwise, you may find that your trip to the EU either doesn’t happen at all or lasts long enough for you to buy and evidence required insurance while your aircraft is grounded in a place far from your home base. 4. Leasing 101: What is an "Additional Insured"? An "additional insured" refers to a person to whom an owner of a liability insurance policy, called the "named insured," extends protection under that policy. To add a person as an additional insured, the named insured, who pays the premiums for the coverage, must cause his insurance carrier to endorse the name of the additional insured on the policy. *Warning: As an additional insured, you should always obtain binding evidence of insurance. A certificate of insurance may describe coverage, but it may not suffice to create a binding obligation of the insurance carrier to provide the insurance to you under the named insured’s policy. If a certificate fails to evidence coverage properly, you could end up with no coverage at all despite having an original certificate of insurance in your hands. See: Certificate of Insurance Fails to Protect Lessor, by David G. Mayer, Business Leasing News (Dec. 2003). A named insured provides coverage to an additional insured in leasing and financing transactions to provide and share its own right to be indemnified and insured against liability to third parties. For example, in aircraft loans, the lender will require that the borrower provide insurance coverage, including comprehensive general liability insurance, against liability from buying, operating and maintaining the aircraft. The same would be true for a printing press, a tractor-trailer or power plant. A lender or lessor will always want its borrower or lessee to protect it from liability with appropriate insurance coverage. When an additional insured receives liability coverage, it shares the total coverage with the named insured and possibly other additional insureds. For example, if an aircraft or crane operator has $50 million of liability insurance, and has three additional insureds that are its lenders, all four entities share the $50 million of coverage. The coverage does not equal $200 million ($50 million each). However, if the coverage is a "per occurrence" coverage, the $50 million limit would apply each time a liability event occurs up to any specified aggregate insurance limit or total amount an insurance company will pay under the agreement of insurance with the named insured.
5. BLN Case & Comment: Fraud Washes Out Hell or High Water Clause in Eureka Broadband Case The "hell or high water " clause in a lease assures a lessor that it will be paid rent. That remains true even if the lessor allegedly breaches its obligations. The lessor’s wrongful act is treated as a separate and independent event and does not affect the lessee’s obligation to perform under the lease. This extremely important clause turns leases into financial assets that lessors can assign to other financial institutions. Leasing 101: The "Hell-or-High Water" Clause: A Critical Provision in Leasing, by David G. Mayer, Business Leasing News (July 2002). In most cases, the courts respect these rights found in contractual language and in Article 2A of the Uniform Commercial Code". See: BLN Case & Comment: Hell or High Water Clause Rises Again, Business Leasing News (July 2004). But, in a recent case, Eureka Broadband Corporation, Plaintiff, Appellee, v. Wentworth Leasing Corporation, No. 04-1577, Defendant, Appellant, the facts produced a different result. BACKGROUND: Plaintiff-appellee, Eureka Broadband Corporation, installs fiber optic systems in large office buildings and generates revenues by charging access fees to commercial carriers desirous of providing telecommunication services to tenants. In June of 2000, Eureka decided and selected certain equipment for its business and financed the equipment under two leases with Defendant-appellant, Wentworth Leasing Corporation. Although the selection and installation of the equipment seemed to proceed normally, the Defendant, lessor, did not have the capability or intention to pay for the equipment to two vendors. However, the lessor did take rents and deposits from Eureka as part of the lease transactions. When the lessor failed to pay the vendors, they pursued Eureka. Eureka returned the equipment, settled the vendor claims and pursued the lessor for damages equal to all the rent Eureka had paid as lessee plus expenses. ISSUE: Will the hell or high water clause operate independently from, and require rent payment by a lessee in spite of, fraudulent misrepresentations by a lessor? OUTCOME: No. The hell or high water clause will not be enforceable under Massachusetts law when a lessee successfully asserts that a lessor fraudulently misrepresents its ability and intention to pay for equipment to be leased. The lessor had to repay all rent and expenses of enforcement to lessee. LAW OF CASE: According to Appellate Court: "To prevail on a claim of fraudulent misrepresentation under Massachusetts law, the plaintiff must show that the defendant "made a false representation of a material fact with knowledge of its falsity for the purpose of inducing the plaintiff to act thereon, and that the plaintiff reasonably relied upon the representation as true and acted upon it to his damage." MA Section 2A-505(4) of the Uniform Commercial Code (UCC) provides that "[r]ights and remedies for material misrepresentation or fraud include all rights and remedies available under this Article for default." The UCC provides that in cases of fraud or misrepresentation, the injured party is entitled to the same remedies as are available in cases of default including the right to "cancel the lease contract" and to "recover so much of the rent and security as has been paid and is just under the circumstances." See: MA UCC § 2A-508(1). The failure to provide the lease financing that the lessee sought plainly constituted a material element of the interaction with the lessor. The lessee’s need to respond to the demands for payment by vendors and to defend against their claims (and in one instance, to defend litigation) established Eureka's detrimental reliance, as lessee, on Wentworth's fraudulent misrepresentation, as lessor. Therefore, the lessee did establish the fraudulent misrepresentation claim. *Comment: The bad acts of a few lessors can spoil the business for the rest of us. This lessor apparently had no intention of paying for the equipment that it purported to lease and duped the lessee into relying to the lessee’s detriment on the lessor’s intentional misstatements. It would not be surprising if other jurisdictions follow this precedent because the hell or high water clause should not be impermeable to clearly proven fraud perpetuated by lessors; otherwise, it should always hold water and require lessee’s to pay rent regardless of other disputes. This kind of precedent has the potential to open the floodgates to fraud allegations by lessees and undermine the value of the hell or high water clause in leasing. It also can cause lessees to require lessors to make payments to vendors before payment is otherwise due. An earlier payment may adversely affect a lessor’s economics. As a lessor, be ready to allay this concern of your lessee. *Remember: In every lease transaction, as a lessor, ask your counsel to include a lessee waiver of its rights and remedies under Article 2A of the UCC to minimize the potential that the lessee can disrupt the intended benefits of your lease transaction and minimize the potential for a lessee successfully challenging a hell or high water clause that should also be written into your lease. 6. About Patton Boggs LLP and My Law Practice; Recent Publications; Upcoming Speeches I am a member of the Patton Boggs LLP Corporate Finance Group in our Dallas office. Patton Boggs LLP is a law firm of more than 400 lawyers located in five offices in the United States and internationally in Doha, Qatar. The firm has extensive capabilities in over 50 distinct areas of legal practice that include leasing, secured transactions, personal property financing, corporate finance, syndications, power project regulatory, development and finance disciplines, mezzanine financing, bankruptcy, real estate, public policy, litigation, intellectual property and technology law, and much more. The leasing and secured transaction practices regularly involve the buying, selling, financing and leasing of real and personal property of all kinds, including business aircraft, energy, facility, production, power plant, technology and health care assets. We also structure, negotiate and close secured transactions of all kinds. We have fully integrated team that handle securitizations, tax-exempt and federal leasing arrangements, and corporate and portfolio acquisitions, among a full range of financing and acquisition transactions. Despite the improving economy, we continue to assist our clients with troubled deals and bankruptcies, including repossessions, lift stay actions, true lease contests, deficiency litigation, workouts and forbearance arrangements. Call me at 214.758.1545 or e-mail me at if Patton Boggs LLP can help you with your legal or business challenges. We welcome the opportunity to build a relationship with you! Recent Publications Here are a few feature articles published in January by David G. Mayer: · Norvergence Strikes Again – Problems With Forum Selection Clauses, by David G. Mayer, The Monitor at page 26-27 (May 2005). · Off Balance Sheet Leasing: Is the End in Sight?, by David G. Mayer, The Monitor (Jan. 2005). Mindy Berman of 42 North Structured Finance, Inc. commented on this article. · The Bright Side of Big Deficits, by David G. Mayer, Equipment Leasing Today (Jan. 2005) (on federal leasing). Michael Guiffre of Patton Boggs LLP edited this article. Upcoming Speeches On Sunday, May 15, 2005, Bob Downey of Caterpillar Financial Services Corporation and I will speak on Leasing to State and Federal Government: A Primer in Specialized Markets, at the 2005 Legal Forum sponsored by the Equipment Leasing Association, at the Loews Miami Beach Hotel, Miami, Florida. On Tuesday, May 17, 2005, Stephen T. Whelan of Thacher Profitt & Wood, LLC, and I will be conducting an interactive "Breakout Session" on Complex Transactions. Steve will address credit support issues in securitizations and I will talk about the fundamentals of The Cape Town Convention and related Aircraft Protocol. We will present at the 2005 Legal Forum sponsored by the Equipment Leasing Association, at the Loews Miami Beach Hotel, Miami, Florida.
7. A Message from the Founder, David G. Mayer House of Cards A recent article in BusinessWeek online sounds the alarm that some American manufacturers make money or survive only because they have operated successful financial services businesses. The article says: America is no longer a nation of manufacturers. But it isn't quite a health-care or even a tech economy, either. Instead, America is quietly and quickly becoming a nation of financiers. Finance supplies 30% of all U.S. company profits, as of last Sept. 30, up from 21% a decade ago, according to federal government data. And some of those profits don't come from banks or other financial companies, but from manufacturers and retailers that rely on their financial activities for a big chunk of their earnings. The article spins this situation as a negative with some interesting, but not surprising data points. Some major industrial companies receive substantial profits, if not all their profits, from their financial services functions. For example: · Deere & Co. (DE ), the farm-equipment company, finance produces nearly one-fourth of its earnings. · General Motors Corp. (GM ) has faced crisis from selling too few cars, but its financing operations earned $2.9 billion last year and will likely constitute GM’s only profitable segment in 2005. · General Electric Co.'s (GE ) finance and insurance units earned a whopping 49 percent of its $16.6 billion profit last year, up from 37 percent in 1995. Why is BusinessWeek so concerned that such performance is bad news? It suggests that a threat to companies exists from rising interest rates and the narrowing gap (spread) between long-term interest rates charged to the customers and short-term interest rates at which manufacturers borrow (representing their cost of funds), coupled with "less choosy" lending practices that will lead to defaults. To complicate matters, the writer thinks tougher accounting practices by regulators and auditors may "pose a risk to finance profits" as the auditors question financial reporting of the finance business earnings. Are these finance businesses building a house of cards that could collapse? While few people would venture an answer to that question today, the indisputable reality is that manufacturers and other non-financial services businesses do use their money to make money and will likely continue to do so. Consider that Dell is beefing up Dell Financial Services to more profitably deploy some of its $14.1 billion in available cash (measured at the end of January). See: Dell Puts Cash Flow to Work, by Gary McWilliams, The Wall Street Journal (SW Ed.), Page C:3, Col. 1 (April 25, 2005); Dell: Sales of non-PC products to rise in future, The Financial Express-net edition (April 11, 2005) Before the premise of the BusinessWeek article causes you to lose any sleep, it’s also worth noting a separate study called the "Future of Financial Services - Future Scenarios", presented a brighter picture of financial services. The April 19 study by Mercer Oliver Wyman, a financial services and risk management consulting firm, predicts big upward movements in financial transactions. The firm states that, by 2020, the financial services industry will represent 10 percent of the gross domestic product with revenue growth to $6 trillion. Even more interesting, the top 100 financial services providers will supply 85 percent of the market, compared with 65 percent in 2002. Perhaps the industrials should retool their core businesses or alter their business models to focus on finance. Regardless of the future of manufacturing, it escapes me why BusinessWeek thinks that the growth of financial services by industrials/manufacturers is bad news. From my perspective, the more financial services growth the better! Have a great month of May and thanks for reading Business Leasing News. |