3 Reasons for an Equipment Lease Agreement

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What is an Equipment Lease Agreement?

An equipment lease agreement, or equipment hire agreement, is a written agreement between two businesses where one business (the lessor), leases or rents equipment to another business (the lessee) for a fee (rental).

Businesses whose business model involve:

  • Hiring out equipment for a fee; or
  • Offering their customers a paid trial of equipment, with an option to purchase the equipment during the lease period,

should have a well-written equipment lease agreement, for 3 important reasons which we will explain below.

Business Outcomes of an Equipment Lease Agreement

The hiring or leasing of equipment is a common business practice, as it allows capital-intensive businesses to:

  • Conserve cash and control cash-flow
  • Test expensive equipment to see if it fits with its business needs
  • Upgrade outdated equipment or provide access to new technology
  • Maintain a more attractive balance sheet
  • Enjoy tax benefits

The equipment leasing model is used in many industries, and involves the leasing or hiring of equipment ranging from coffee machines, aircraft, ships, photocopiers, pool tables, kitchen equipment and heavy machinery to vehicles.

From the perspective of the lessor, the equipment is rented out and generates revenue for the lessor.

Since ownership of the equipment stays with the equipment owner or lessor, it is free to re-sell the equipment at the end of the lease period or rent it out to another party, so that the equipment continues to generate revenue for it.

It is common for equipment leases to come with an option to purchase the equipment.

3 Reasons Why Lessors Need an Equipment Lease Agreement

Many equipment hirers or lessors operate their business without a written equipment lease or hire agreement, and rely on verbal agreements or simple quotations or purchase orders.

This is a major mistake, as written equipment lease agreements can help hirers in the following 3 areas:

1. Protect against bankruptcy or insolvency of the lessee or hirer

By stating clearly that the ownership of the equipment stays with the equipment lessor, the equipment lessor is protected against the insolvency of the equipment lessee or hirer.

On the insolvency of the equipment hirer, there is a risk that the hirer’s creditor will seize the equipment of the hirer. A well-written equipment lease agreement gives the equipment hirer a right to take back the equipment, and prove that the creditor of the hirer cannot take over that equipment.

2. Have the right to charge late payment interest

Having the right to charge interest on late payments is a powerful tool to encourage prompt rental payments, as well as improve the cashflow of equipment lessors.

However, late payment interest is not enforceable if the interest is too high and is arguably a “penalty”, so equipment lessors need to be careful in how the late payment interest clause is written.

3. Right to Enter Premises and Seize Equipment

We have been approached by several equipment lessors to help them sue their equipment lessees for late payment. In several of these cases, the equipment lessor simply “disappeared” after failing to pay rent for many months.

Had they come to us contracted based on a properly-written equipment lease agreement, they would have been advised to insert in the agreement:

  • The right to enter the equipment lessee’s premises to more actively monitor the lessee’s payments; and
  • To seize the equipment if the lessee failed to pay rent.

This would have maximised their ability to recover the equipment early, and to reduce the trouble of having to locate their equipment, especially from lessees in financial trouble.

Key Terms to Include in an Equipment Lease Agreement

Apart from the 3 key matters mentioned above, equipment lessors need to make sure that the following key terms are included in their equipment lease agreement template:

1. Lessor is entitled to inspect the equipment

This term ensures that the lessor is able to observe that the equipment is used and maintained by the lessee in a manner that does not breach the terms of the equipment lease agreement.

2. Lessee is restricted to using the equipment at a particular location

This term ensures that the lessor knows where the equipment is. This enables the lessor to exercise his right to:

  • Inspect the equipment;
  • Seize the equipment; or
  • Take the equipment back at the end of the rental period.

3. Lessor is entitled to rental as set out in a payment schedule

This protects the lessor’s right to timely payment of rental by making it clear when and in what amounts of rent that the lessor is entitled to.

4. Lessor is entitled to a security deposit from the lessee

A security deposit which is paid to the lessor by the lessee at the beginning of the lease or hire period protects the lessor against unpaid rental payments and loss or damage to the equipment.

Unpaid rental amounts or costs of repairing the equipment may be deducted from the security deposit for use by the lessor.

5. Lessee is under a duty to maintain the equipment in a good and usable condition

This protects the lessor in ensuring that the equipment returned at the end of the lease is in a good and usable condition, so that the equipment is still commercially valuable to the lessor.

Where this term is breached, the lessor may deduct the equipment repair costs from the security deposit.

6. Lessee must indemnify the lessor for third-party claims

As the owner of the equipment, a lessor may find itself facing claims from third-parties arising from the use of the leased asset by the lessee.

This may potentially expose the lessor to financial losses and legal expenses, which it will want the lessee to be responsible for, since it is most likely that it is the lessee’s actions that resulted in the claims.

Having an indemnity provision makes it clear that the lessee is legally responsible for these third-party claims, and must compensate the lessor for any losses and expenses it incurs.

How I.R.B. Law Can Help Your Business

Our lawyers at I.R.B. Law are experienced in the commercial and legal aspects of equipment leases, and would be glad to assist your business:

  • In preparing the right equipment lease agreement based on your business model;
  • Perform due diligence on potential equipment lessees; and
  • Enforcing equipment lease agreements and recovering unpaid rent and equipment,

to help you maximise your cashflow and profits, and arm you with remedies and solutions against defaulting or uncreditworthy equipment lessees.

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