Businesses lease equipment instead of buying it because no purchase price payment is needed and the payments are fully deductible. The purchase price of equipment is not deductible. Instead it must be amortized, generally over the life of the equipment with deductions for depreciation taken over that period. Depreciation deductions are sometimes limited by the alternative minimum tax.

Disadvantages of leasing equipment are that the lessee usually cannot sell the equipment and the lessee does not get the benefit in any increase in value of the equipment. Additionally the lessee must compensate the lessor for its participation.

The purchase of equipment can be financed, either by the seller of the equipment or a third party lender. These transactions have some characteristics of an equipment lease in that the lessee gets the equipment in return for payments over a period of time. There are differences however, such as the effect on the lessee's financial statements and credit rating. Equipment purchased on credit results in the equipment value being shown as an asset on the buyer's balance sheet and the loan being shown as a debt. Leased equipment is not shown as an asset and the lease obligation or part of it may or may not appear as a liability depending on the accounting rules used.

There are a variety of types of equipment leases:

a) Operating lease. This is usually for a small part of the equipment's useful life and the lessor usually maintains the equipment. The lessee does not usually guaranty the residual value.

b) Capital lease. This is usually for most of the equipment's useful life and the lessee usually acquires title at the end of the lease.

c) Finance lease. The lessor is not the manufacturer or supplier of the equipment. The lessor merely is putting up the money.

d) Leveraged lease. This is the same as a finance lease, but the lessor borrows much of the cost of the equipment, sometimes on a non-recourse basis (if not paid, the lender can take the equipment, but it cannot hold the lessor personally liable).

e) Guideline lease. IRS has guidelines for distinguishing a lease from a conditional sale (sale on credit). There are different tax consequences for each type of transaction. The guideline lease meets the IRS criteria for lease treatment.

f) Sale-leaseback. In this type of transaction the owner of equipment sells it to a lessor and then leases it back. The reason for doing so can be to get different tax and financial statement treatment, but the reason is usually to generate cash from the sale to be paid back over time in rent.

g) Lease for security. In case the lessee goes bankrupt the lessor is sometimes in a better position to recover the leased property than it would be if it had sold the equipment to the lessee and retained a security interest.

Equipment leases are often forms meant for continuing use between a lessor and a lessee. The different equipment packages and their terms are added by schedules.

Equipment leases should cover the following:

a) Description of the equipment.

b) Who maintains the equipment and provides updates.

c) Who selects the equipment if it is going to be acquired from a third party.

d) Who pays for delivery and installation.

e) Term of lease and any right to renew.

f) Rights to terminate.

g) Rent.

h) Provision intended to protect lessor's ownership interest as against third parties.

i) Restriction's on lessee's use and prohibiting sale of the equipment. Sometimes elaborate restrictions on the lessee's conduct of its business are imposed similar to restrictions a lender imposes on a borrower.

j) Disclaimers of warranties and representations by the lessor.

k) Representations and warranties by the lessee.

l) Who will insure the equipment and who bears the risk of loss in case of fire or other damage.

m) Who pays taxes and fees.

n) Provisions regarding return of the equipment at the end of the lease.

o) Lessee's option to purchase the equipment, when and for how much.

p) What happens on default, for instance, if the lessee doesn't pay rent or fails to maintain insurance on the equipment.

q) Provision allowing the lessor, but not the lessee, to assign the lease.

The Uniform Commercial Code has provisions covering equipment leases and their provisions which deal with warranties, indemnity and remedies must be consulted when preparing equipment leases.

The Uniform Code also contains provisions applicable to sales of equipment on credit. It is important to make sure than equipment lease will not be treated as a sale under the applicable laws because the rights of the lessor against third parties are different in each case. The seller of equipment on credit no longer owns it. The seller can retain a security interest in the equipment so that the seller can take it back if the required purchase price payments are not made. This security interest is not valid against third parties unless the seller files a financing statement with the Secretary of State of the buyer's state. This financing statement gives notice of the seller's interest.

A lessor does no have to do this. The lessor owns the equipment to begin with. It is usually advisable to have the lessor's ownership markings on the equipment, but this is not required by any statute. If the lessee goes bankrupt, the equipment does not go to the lessee's creditors because it is not the lessee's property.

If, however, the lease is drafted so that it is treated as a sale, the lessee is treated as the owner, the lessor has not filed a financing statement, and the lessee's creditors get the equipment.

Donald M. Thompson * Illinois Equipment Leasing - 55 W. Monroe #3950; Chicago, IL 60603
Ph: 312-782-0844 * Fax: 312-201-1436 * Email: donthompsonlaw@sbcglobal.net