Welcome to the September 2004 edition of Business Leasing News.

From: David G. Mayer, a business transactions partner of the law firm of Patton Boggs LLP and author of the book, Business Leasing for Dummies ® (BLFD). The book is out of print, but a few copies are still available; so if you want to find a copy, please search the web today! Thanks for buying my book for three years.

In this issue:

A Message From the Founder, David G. Mayer

1.  Tech Spending Improves Despite Doubts; Leasing Supports Its Growth

Despite optimism earlier this year for growth in the technology sector, some CEOs have become more concerned about the economy for the balance of 2004. They seem to be holding back on capital spending, though they haven’t cut their budgets. Stock prices of technology companies have been taking a beating, with a reprieve in the last week or so, as a result of this pause in spending on information technology (IT) assets. See: Tech Shares Approach Bear-Market Status, The Wall Street Journal (S.W. Ed.), Page C:1, Col. 2 (Aug. 16, 2004). Taking a far more optimistic view, chief information officers (CIOs) may yet loosen the purse strings and push back against the reluctance of their CEOs. In doing so, they may increase IT acquisitions by using leasing, which provides a flexibility and value to fuel their IT spending, and supports their capital expenditure budgets.

2. California Imposes New Use Taxes on Aircraft, Vehicles and Vessels

California’s Governor Arnold Schwarzenegger, the “Terminator”, signed a bill on August 16, 2004 to end a sales tax benefit for aircraft, vehicles and vessels for almost two years.

As part of California’s revenue-raising provisions in the tax law, SB1100 amends Section 6248 of the Revenue and Taxation Code to impose use tax on aircraft, vehicles and vessels. The law does so by shifting a presumption as to when purchasers pay use tax. The net effect is to raise taxes in California on the backs of lessors and other owners of these assets.

Under the old rule, if a purchaser acquired an aircraft, vehicle or vessel outside of California and did not transport or bring it into California within the first 90 days after purchase, California presumed that the owner would not store, use or otherwise consume the property in California. Accordingly, California would not subject the property to use tax. To raise revenue, the 90-day presumption will now become twelve-months. As stated in the Legislative Digest to SB1100:

This bill would, until July 1, 2006, expand this presumption to a vehicle, vessel, or aircraft, if that vehicle, vessel, or aircraft is (1) purchased by a California resident, (2) subject to California's registration or property tax laws during the first 12 months of ownership, or (3) used or stored in this state more than 1/2 of the time during the first 12 months of ownership. See: Section 2 of SB 1100.

*Technical Point: The presumption that a purchaser acquires an aircraft, vehicle or vessel for storage, use or consumption in California may be disproved by documents such as registration of that vehicle, vessel or aircraft with the proper authority outside of California.

Understanding the implication of the rule, in the past, aircraft owners, for example, stored their aircraft outside California for the first 90 days to avoid paying the use tax. Thereafter, the owners could hangar the aircraft in California without paying the use tax.

*Action Item: This new rule takes effect after October 1, 2004. See: Section 6248(f). Consequently, if you intend to purchase an aircraft as the owner-operator or owner-lessor, you should enter into a binding contract or purchase the aircraft on or before October 1, 2004 to avoid the new, longer presumption period of twelve months. Play it safe; don’t wait until October 1, 2004!

The new law will preserve exemptions from use tax when the purchaser uses the aircraft in interstate or foreign commerce for more than 50 percent of the period during the first 180 days after purchase of the aircraft. Further, the law will not apply to the repair, retrofit or modification of the aircraft or vessel and for up to 25 hours thereafter to leave California if the owner’s purpose is to deliver or return the property outside of California. See: Section 6248(e)(2).

*Warning: While the rules described here may seem straightforward, the tax laws affecting aircraft, vehicles and vessels are not, and the rules here have been generalized in some respects. You should seek advice of a qualified professional to assist you. Be aware that California is aggressively seeking revenue in general. As a result, property, sales and use tax collection efforts may change the cost of storing, using or consuming vehicles, vessels and aircraft in California. As a lessor, you should carefully monitor sales, use and property taxes of your lessees to avoid the imposition of a lien on your property by any government entity in California. A tax lien may diminish the value of your investment or cause a lease default.

California has little choice but to raise revenue to balance its budget. Owners of vehicles, vessels and aircraft will do their part by paying more use taxes, at least through the end of June 2006.

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3. Mediation Provides A Different Way to Address Defaults

When your lessee or secured borrower defaults midway through the lease/loan term, your first reaction may be to call in litigators and start preparing for a lawsuit on the obligation. This response may be especially true if a payment default occurs rather than merely a breach of covenant or other requirement under the lease or loan. Naturally, you expect that the sooner you foreclose and show the lessee or borrower you’re serious, the more likely it is that you’ll recover your investment in the deal.

But there may be a more effective way to address the problem. Bringing in a neutral third party to mediate a dispute over non-payment (or other default) may in certain cases prove to be more manageable, less time consuming, and ultimately much more financially beneficial to all parties.

A Time to Talk and a Time to Sue

Not every default situation is a good candidate for third party intervention. For example, sometimes the lessee, for whatever reason, decides it’s in its best interest just to stop paying rent. Sometimes the lessee refuses to talk with you or even to respond to your demands for payment. In these kinds of cases you may have little choice but to “lower the boom” and take serious legal action.

There are other situations, though, in which serious thought should be given to engaging a professional third party to step in and help resolve the dispute before it gets out of hand. Perhaps the lessee is experiencing other business or financial pressures, unbeknownst to you, that are affecting its ability to pay. Perhaps the lessee is part of a larger group of affiliated companies and is being directed to take actions that even its own management doesn’t approve. Perhaps the non-payment is triggered by one-time events that will soon be resolved, and the default cured.

A skilled, knowledgeable, and neutral mediator, meeting privately with all parties and drawing out such information, may often help the parties themselves craft a workable and cost-effective resolution of the issues at hand. Someone who is “at the table” with no agenda other than to work through the problems and help structure a mutually acceptable resolution may be the key to keeping you out of long, costly, and risky litigation.

Getting Beyond the Obvious

The most important benefit of third party mediation in financial disputes is the ability of the neutral mediator to meet privately and confidentially with each party to dig out what’s really going on with the deal. Often the lessee’s default, even if it’s simply a failure to pay rent, may involve more than meets the eye. An experienced mediator who specializes in these kinds of disputes can ask the right questions and dig out the underlying agendas and issues. This is usually done in confidential “caucuses,” allowing the parties to retain control of their own information while providing the mediator with the background essential to working out a solution that everyone can accept.

Armed with this confidential information, the mediator can form a view of the entire transaction – and of the dispute. This process analysis allows a full exploration with all parties of various options and alternative ways of resolving the issues, not just solutions that may be obvious at the outset. Using an iterative process of working through both the common and the private problems, an experienced mediator can often guide the parties to a settlement that would not have been possible without third party intervention.

How to Select a Mediator

To make this process work, it is essential to find a neutral mediator who understands the fundamental issues that arise in leasing or lending deals, who is experienced in mediating financial disputes, and who is knowledgeable in leasing and financing terminology and concepts. Using such a person will save everyone involved a great deal of time and frustration in having to educate the mediator before getting to the real issues.

There are providers of ADR (alternative dispute resolution) services in major cities throughout the U.S., in Europe, and elsewhere in the world. Many of the larger ADR providers include on their panels of neutral specialists in a variety of subject matter areas, often including business disputes and corporate finance. In addition, there are smaller mediation and consulting firms who provide experienced, neutral mediators specializing in very specific kinds of disputes – secured financing, leasing, business dissolutions, and various kinds of corporate financing transactions.

Although many professional mediators are also lawyers, it is not essential that you use a lawyer in this role. There are qualified and experienced non-lawyer mediators who can bring the benefit of their business experience and expertise to bear on even very difficult and complex financial disputes. A lawyer mediator may be able to help you (and your attorney) sort out some of the underlying legal issues. However, the most important attributes of a successful mediator include a strong knowledge of how leasing or equipment lending works and the ability to ferret out how the parties’ underlying agendas affect their positions at the negotiating table.

*Tip: Before engaging any third party mediator, you should:

• Ask for a complete resume and references that can be contacted regarding the mediator’s prior experience and working methods.

• Look not only for direct experience and knowledge in leasing, lending and corporate finance but also for indications of how well you think you will be able to work with the mediator.

• Require any prospective mediator describe how he or she intends to conduct the mediation. Every mediator approaches the task in a unique way, and not every approach may be successful in your situation. For example, ask (1) how the issues will be drawn out and analyzed, (2) how the parties will be expected to participate, and (3) what additional information (lease documents, spreadsheets, pricing runs, even statements from outside experts) will be requested or required during the mediation.

*Remember: In mediation (unlike arbitration or a court trial) the parties control the process. The mediator is there to serve you and all parties in helping to work out a mutually acceptable resolution of a dispute. Acting early in a problem may avoid bankruptcy or other adverse consequences that will cost you more and potentially produce far less return on your investment.

I would like to thank Paul Bent of the Alta Group for contributing this article. Paul is a lawyer and mediator with lengthy experience in leasing and finance. He works as a member of The Alta Group litigation support team.

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4. BLN Case & Comment: BankVest Assumes Lease, Ignoring Non-monetary Defaults

A lessor’s creditors put the lessor into an involuntary bankruptcy. During that case, the lessor wanted to collect $1 million of unpaid rent from its lessees. See: In re Bankvest Capital Corp., 360 F.3d 291, No. 03-9006, (First Cir., March 15, 2004).

Although BankVest committed some non-monetary defaults against these lessees, this case shows that such defaults don’t have to be cured (in certain jurisdictions) by a debtor-in-possession under the federal Bankruptcy Code (the lessor, BankVest, in this case), to assume leases and sue for certain back rents.

FACTS: BankVest Capital Corporation (BankVest) entered into separate lease agreements with Eagle Insurance Company and Newark Insurance Company (Lessees) covering 190 items of computer equipment. Due to production delays, the manufacturer, Nortel, could not deliver 20 of the 190 items until several months after the start of the lease term. To cover the gap period, BankVest provided the Lessees with “loaner” equipment.

On December 17, 1999, before BankVest could replace the loaner equipment, BankVest’s creditors filed an involuntary Chapter 11 petition against BankVest. BankVest proposed a plan of reorganization in bankruptcy that the bankruptcy court confirmed the plan on May 31, 2001. During the bankruptcy proceedings, the Lessees continued to use the leased property and loaner equipment, accumulating unpaid rent of approximately $1 million.

As the debtor-in-possession, BankVest wanted to assume the leases without first curing non-monetary defaults (the non-delivery of the 20 items of equipment). The Bankruptcy Court allowed the assumption. See: In re BankVest Capital Corp., 270 B.R. 541, 543 (Bankr. D. Mass. 2001). BankVest was not in default on any monetary provision -- given that BankVest was the lessor to which the Lessees made payments under the leases (as lessor, it made no payments). The court held that there were no cure claims that had to be satisfied before the assumption of the leases by BankVest. See page 544 (affirmed In re BankVest Capital Corp., 290 B.R. 443, 447-48 (B.A.P. 1st Cir. 2003). The Lessees timely appealed because they argued that all non-monetary defaults had to be cured before BankVest could assume the leases under 11 U.S.C. §365(b)(2)(D).

ISSUE: Does 11 U.S.C. §365(b)(2)(D) permit a debtor-in-possession to assume an unexpired lease without first curing non-monetary default?

LAW: Section 365(b)(1) of the federal Bankruptcy Code provides that if the debtor has defaulted on a contract prior to assumption, the debtor, cannot assume that contract unless it (1) cures the default; (2) compensates the non-debtor party for any actual pecuniary losses resulting from the default; and (3) provides adequate assurance of future performance under the contract. (BankVest's failure to replace the loaner equipment constituted such a default.). A relevant exception to this rule arises under Section 365(b)(2)(D)(2). That section states that no cure by the debtor is required for a breach of a provision relating to “(D) the satisfaction of any penalty rate or provision relating to a default arising from any failure by the debtor to perform non-monetary obligations under the executory contract or unexpired lease.”

In re Claremont Acquisition Corp., 113 F.3d 1029, 1034-35 (9th Cir. 1997), the Ninth Circuit held that non-monetary defaults must be cured before assumption.

OUTCOME: The answer to the issue presented is “yes.” The BankVest Court disagreed with and criticized Claremont. The Court, noting the overriding purpose to rehabilitate the debtors would not allow the Lessees to use a “historical fact” (the non-delivery of 20 items of computers equipment) to block the assumption of the leases. The Bankruptcy Court ruled that BankVest did not have to cure the default of failing to deliver the 20 items of equipment, which constituted a "quintessential example of a nonmonetary default" within the meaning of subparagraph (2)(D). See: 270 B.R. at 544. The decision cleared the way for BankVest to assume the leases and to file an action to collect the $1 million in outstanding rent. In that action, the Lessees could raise their defenses to payment and counterclaim for damages for any losses actually suffered through BankVest's alleged breach.

*Comment: On June 21, 2004, the U.S. Supreme Court denied certiorari in the BankVest case. It refused to decide the same issue on which the Claremont court in the Ninth Circuit and the BankVest court in the First Circuit reached opposite outcomes. Congress will have to fix the law to avoid further expensive and arguably unnecessary litigation.

In the meantime, as a lessor, you should heed the warning of the case and take certain actions to protect your interests against an adverse result of your lessee failing to cure non-monetary defaults while piling up rent and other defaults that damage, if not destroy, your lease investment. For example, you can:

• Improve your internal ratings systems for troubled leases so you take corrective actions sooner if your lessee’s credit deteriorates. Consider mediation, if necessary, as discussed in BLN’s article 3 above entitled Mediation Provides A Different Way to Address Defaults.

• Monitor non-monetary defaults closely and don’t assume that you cannot or should not exercise remedies against a lessee, even where no monetary defaults exist. Early action may save you from high bankruptcy court expenses and investment losses. For example, regularly inspect leased property for proper maintenance and confirm timely insurance renewals.

• Terminate your lease before your lessee files a petition for bankruptcy to argue that the lessee has no leasehold rights that it can assume, and seek the immediate return of your leased property.

*Tip: As a lessee, you too should be cognizant of the credit of your lessor, especially during the time that your lessor has commitments to pay for, or deliver, equipment to you. By doing so, you may avoid the fight that the Lessees in BankVest faced at high court costs and disruptive use of executive time.

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5. Leasing 101: What is "Utility Computing"?

Imagine that you don’t own your computer and can pay for it only as much as you actually use it. That idea is the essence of utility computing. As defined by IBM Global Services, “Utility computing is the on demand delivery of infrastructure, applications, and business processes in a security-rich, shared, scaleable, and standards-based environment over the Internet for a fee.” See: The utility business model and the future of computing services, IBM Systems Journal, Vol. 43, No. 1, at page 38 (2004).

While IBM’s definition is packed with meaning and industry jargon, IBM more simply explains that utility computing isn’t much different than the utilities business of providing water, power, heat and common carrier transportation. You pay for what you use as you use it. You don’t own the bus you ride or the power plant that generates your power. Likewise, the computer and network user doesn’t own the computer, network or its software, but pays only for the use, by appropriate metrics.

A cellular telephone combines a contrasting model that you can combine with the utility model--the “subscription” model. You can pay a base fee and then pay for minutes you use over your set allocation of minutes in each billing period.

Although utility computing isn’t intended to be a lease per se, the arrangement seems to fit the concept of an Article 2A “lease” to the extent the utility computing model covers goods, such as computer hardware (and software imbedded in the goods). A "lease" under Article 2A in part  means a transfer of the right to possession and use of goods for a term in return for consideration, but a sale, including a sale on approval or a sale or return, or retention or creation of a security interest is not a lease. In a utility computing arrangement, the user receives a transfer of the right to use and possess the system, but the user clearly does not intend to buy the system. Title always stays with the provider/owner of the system. The user has a right to possess the system and use it in return for paying fees or other consideration.

*Tip: Utility computing seems to fit the Article 2A definition of a lease. However, you generally don’t use lease terminology in utility computing arrangements, but should consider adding precautionary language and filings of financing statements under Section 9-505 of the Uniform Commercial Code in the event a court treats the arrangement as a lease. Some leases combine lease structures with utility computing prices. This approach results in a true lease for state and tax law purposes, but with variable rents under the utility computing pricing model.

Utility computing is an evolving method to put technology in the market for large and small companies. IBM, Hewlett-Packard, Sun Microsystems, Inc. and other vendors offer different utility computing options. See: IDC: SMB Next Big Utility Computing Market, NetworkWorldFusion (Jan. 9, 2004).

BLN’s Leasing 101 definition offers a start to understanding this growing method of acquiring, deploying and using of technology equipment and software, together with services, and pay for it as you go. See: Pay as You Go, InformationWeek (March 4, 2002).

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6. BLN Briefs: Biz Roundtable Ups CAPEX: Mexican Trucks in U.S.; CA Waste Law Update

Business Roundtable Plans Capital Expenditures. The September Economic Outlook Survey of the Business Roundtable indicates that 49 percent of the companies expect to increase capital spending in the next six months. Only 7 percent expected decreases while 45 percent expected no change. The 118 CEOs who responded represent $4 trillion of annual revenue and 10 million employees. Their sense that “America’s …economy is fundamentally healthy…” should bode well for equipment finance and leasing.

Mexican Trucks Roll on U.S. Roads. In Department of Transportation et al. v. Public Citizen et al., No. 03–358 (argued April 21, 2004 and decided June 7, 2004), the U.S. Supreme Court ruled that Mexican trucks can use U.S. highways without completion of environmental studies. It is unclear whether the ruling will prove to be a detriment or provide opportunity for lessors and lenders on rolling stock, especially in the southwestern part of the United States.

*Technical Point: This case rules, more specifically, that the Federal Motor Carrier Safety Administration (FMCSA) did not violate The National Environmental Policy Act of 1969 (NEPA) or the relevant regulations of the Council of Environmental Quality (CEQ) when it did not consider the environmental effect of the increase in cross-border operations of Mexican motor carriers in its limited environmental assessment. Nor did FMCSA act improperly by not performing, pursuant to The Clean Air Act (CAA) and relevant regulations, a full conformity review analysis for its proposed regulations.

ELA’s Amendment to Waste Bill is Trashed. The Equipment Leasing Association attempted to reduce the adverse impact of California Senate Bill 50, which requires lessors (and others) to collect fees for disposal of hazardous electronic devices. Unfortunately, the burden won’t be lifted just yet, if ever, as the legislature dumped the amendment on the Assembly floor on August 27, 2004 and sent it to Governor Schwarzenegger for signature on September 3, 2004.

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Reader Feedback

Thanks to all the readers of BLN for their comments about the August edition.

One reader e-mailed: “We met at last years’ ELA. Your newsletter is awesome….” Another reader said: “Great job, David!  I will look forward to seeing you at the ELA!” Offering a bit of humor and solace, a third reader observed: “Another great set of articles this month. I am sorry to hear that your book, Business Leasing for Dummies is going out of print. I assume from my receipt of BLN, that the movie rights have not sold and you still have to work for a living.”

Yes, indeed, I am working for a living as a practicing lawyer and welcome your contact and business!

Recent Publications

Here are two feature articles I wrote that were published last month:

• Beating True Lease Challenges: A Lessor’s Guide to Structuring and Defending True Leases, LNJ Leasing Newsletter, by David G. Mayer (August 2004).

• Bankruptcy Court Provides Guidance on True Leasing of Software, ELA ‘s Equipment Leasing Today, by David G. Mayer (August-September 2004).

Upcoming Speeches at ELA Annual Convention

On Tuesday, October 26, 2004, I will lead a panel at the 43rd Annual Equipment Leasing Association Convention, entitled "Back to the Future: True Lease Opportunities and Structuring." The panel is scheduled for 10:30am to 12:00 p.m. and is repeated from 2:00 p.m. - 4:00 p.m., October 26th. The Conference will be held from October 24 – 26th, at the Marriott Desert Springs Resort and Spa in Palm Desert, California. For more information and registration, click on ELA Convention.

Training - Substance the Easy Way!

To help improve your business operations, deal processing and risk management, I offer private training seminars tailored to your specific needs at your designated location. My interactive and informative training includes topics I cover in BLN. I customize the format and content for your specific training needs- no canned programs.

After one of my private training sessions, here’s what one of the company’s senior managers said: “David, thanks again for an excellent presentation. You helped us tackle a complex, but important topic. Your expertise is first-rate and you are an excellent teacher to boot -- that’s a rare combination.”

Feel free to call me at (214) 758-1545 to discuss the possibilities.

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A Message From the Founder, David G. Mayer

Lease Bashing

Just as the political season ramps up where candidates bash each other, the media has taken a negative shot at the leasing industry, with little basis, knowledge or justification. In an article entitled Let the Rent of Equipment Beware, New York Times (Aug. 12, 2004) New York Times writer Elizabeth Olson pens a diatribe of how leasing companies have taken advantage of small business, with rising complaints and court fights that follow. She says in part:

Add equipment-leasing deals to the list of financial pitfalls for small businesses. Last year, the number of complaints involving them at Better Business Bureaus across the country soared eightfold, to 772, from just 98 in 2002, according to the Council of Better Business Bureaus, an umbrella group. The surge placed questionable equipment-leasing practices high on the list of top problems at the group, based in Arlington, Va.

What Ms. Olson fails to mention is that the Better Business Bureaus have had massive increases in complaints generally. In fact, much of her research stems from Virginia, where the BBB also recently said:

U.S. BBBs processed 773,042 complaints in 2003, a 23.5 percent jump in the 626,081 complaints processed in 2002.

‘The growing complaint volume doesn’t necessarily indicate a decline in service by the business community; it’s more a reflection of the increased reliance on the BBB system and the tremendous effort BBB staff persons devote to helping resolve disputes that arise in the marketplace,’ Hunter said.

In another 964,666 instances, BBBs in the U.S. assisted the public by providing complaint counseling or referrals to appropriate agencies or organizations.

The complaints described by Ms. Olson for leasing represents less than one percent of the BBB complaints. Ms. Olson omitted to say that BBB has enhanced its online complaint system and fielded a wide variety of complaints from a host of businesses. See: BBB Services Nationwide Surged in 2003, BBB Services Nationwide Surged in 2003; Businesses Ranked by Inquiries and Complaints, BBB Current Alerts, May 4, 2004.

Ms. Olson’s observations suggest an area of concern for $208 billion per year leasing industry. But her analysis includes a misleading discussion of typical commitment fees and lacks any description of hell-or-high water clauses that may have caused lessors to stand on their rights. Further, she omits that about 80 percent of all businesses use leasing to acquire some or all of their equipment.

Perhaps Ms. Olson should take another closer look at this one narrow part of the leasing business and gain a more complete understanding of the value of leasing and the diversity of the industry so she can write a more balanced article next time. Her generalizations of apparent problems to the whole leasing industry and negative impact on small business lacks knowledge and appreciation for the value that leasing provides daily to small businesses worldwide.

Have a great September and a strong start to the fourth quarter.

Thanks to the BLN Staff

I extend a special thank you to my editors at Patton Boggs LLP for their comments on this edition, Adrian McCoy Sheila McCoy and our primary web site review partner, Jeff Turner. The technical team, consisting in part of George Barber and Winston Jackson, provides you the easy-to-use e-mail navigation and artistic appearance of BLN. Claire Campbell, our Chief Librarian provided research for BLN. Finally, in a special appearance, Anne Mayer, my spouse and a professional writer, edited BLN this month. Anne helped develop the original concept for BLN in January 2002.

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David G. Mayer
Founder
Business Leasing News
Patton Boggs LLP
2001 Ross Avenue
Suite 3000
Dallas, Texas 75201
(214) 758-1545 (phone)
(214) 758-1550 (fax)
E-Mail: dmayer@pattonboggs.com

© David G. Mayer 2005

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