EQUIPMENT FINANCE - THE BASICS Presented by:Kenneth B. Flowers, Partner M. Timothy Syer, Associate

Loan  Borrower has ownership  Borrower has possession  Lender takes a security interest or charge  Full disclosure on interest rates and cost of borrowing

Lease  Lessor has ownership  Lessee has possession for lease term  Lessor gets charge in addition to title  Little disclosure on cost of financing  May have purchase option  No automatic passage of title to Lessee

Conditional Sale Agreement  Conditional purchaser has possession  Conditional seller retains title until purchase price is paid in full  Title passes automatically upon payment in full  Conditional seller takes security interest or charge  Little disclosure on financing charges

Rental Agreement v Lease  No legal distinction between the two  Typically, “rental agreement” is short duration where most risks of ownership remain with Lessor eg. car rental agreement  Typically, “lease” is longer duration with many risks of ownership transferred to the Lessee  “lease” may have purchase option, “rental agreement” rarely does

“True” Lease v “Financing” Lease A.“True” Lease  Lessee has absolute right to return equipment at end of term and to return is not excessive  No bargain purchase option  Lease term does not exceed useful life of leased asset  Payments do not significantly exceed fair value of asset at the inception of the lease (cost of capital considered)  Leased equipment is not so specialized that only the Lessee can use it without major modifications

“True” Lease Cont’d  The purchase option is a true option  Qualifies for “off balance sheet” treatment  May not require registration if less than one year term – but advisable  Lessee does not guarantee the residual (ie. closed- end lease)  Lessor retains the surplus on sale B.“Financing” or “Capital” Leases  Does not qualify as an “operating” lease  Open-end lease (lessee guarantees residual value)  Sale Leaseback transactions  Lessee may continue lease after initial term for below market rent

Elements of a Lease  Creation of Lessor-Lessee relationship  Rent / late rent  “Hell or high Water” provisions / Non- cancellable  Term  Use  Equipment Acceptance

Elements of a Lease Cont’d  Ownership / markings / quiet enjoyment  Warranties – disclaimer / assignment  Indemnity in favour of Lessor  Maintenance and repairs  Insurance  Taxes

Elements of a Lease Cont’d  C.C.A. / Section 16.1 election  Registration Rights / PMSI  Return of Equipment  Default  Remedies  Assignment / Sublet  Option to Purchase

Breakage Cost The positive amount, if any, of the present value, at the date of default, of the aggregate of (i) all remaining payments under the lease; and (ii) [the purchase option price (being the estimated FMV of the equipment at the end of the lease term)] [the estimated FMV if the equipment at the end of the lease term less the purchase option price] discounted [on an annual basis using the Prime Rate in effect on the date of default] [at the then Government of Canada Bond yield for a bond with a term similar to the remaining lease term].

Vendor Programs  Keeps manufacturers out of finance business  Can be simple referral arrangements or complex structures on a “recourse” or “non- recourse” basis  Ultimate net-loss pools  Remarketing arrangements

Emerging Issues A.Service Agreement  Lessor leases and services equipment  Use different entity for service than leasing  Use separate service agreements or at least separate lease payment from service payment  Lessor merely acts as collection agent for services  Failure to segregate may impact absolute obligation to pay

Emerging Issues Cont’d B.Vicarious Liability  Lessors have been held liable for vehicle injury claims  In Nunavut title holders are deemed to be the owners under the Motor Vehicle Act (NU)  Liability in ON/AB/BC capped at $1,000,000  Lessors excluded from vicarious liability in USA

Special Leases A.Software  Software is licensed to end user, not sold  Support (ie. service) after included for a period of time  Software leases often use standard forms, however, Title clause is changed and insurance, risk of loss and maintenance are removed Use restrictions and update requirements are enhanced Remedy would include termination of license  Installment Payment Agreement structure often used

Special Leases Cont’d  IPA contains “Hell or High Water” clause regardless of whether software functions or support is provided  Tri-party agreement re: payment default under IPA will terminate license and support  May be an assignment of license to permit finance to remarket End User Software Vendor Finance Co. license agreement license payments IPA finance payments

Special Leases Cont’d B.Aircraft  Aircraft are a series of time limited parts  Aircraft are the ultimate mobile asset  Watch for hot zones on insurance coverage  Highly regulated by government  Register as a serial numbered good under PPSA and, if applicable, Capetown Convention  May have maintenance fund  Snap-on and pooling arrangements  May allow “wet” leases (lessee supplies maintenance and aircrew) or “dry” leases (sub- lessee supplies own maintenance and aircrew)

Special Leases Cont’d C.Energy Management  Often take advantage of government grants  Payments based on energy savings based on engineering studies  Used to require backstop for assumptions by engineering companies, no longer the case  Key is the purchase option rights

Special Leases Cont’d D. Use based Leases  Photocopiers sometimes use this type of lease  Usually include a service component or availability guarantee  Rent based on number of copies made with a minimum  Energy service companies have also used this approach eg: compression equipment supplies  Rent based on horsepower used with minimum rents and right to “swap out” equipment

Presentation By: Kenneth B. Flowers, Partner M. Timothy Syer, Associate © 2016, Lawson Lundell LLP. All rights reserved. Lawson Lundell LLP is a British Columbia Limited Liability Partnership