Whether in these tougher economic times or under more normal conditions, furnishing your business with the necessary equipment can be a difficult decision. First, there is the business decision of whether you need the equipment. After that comes another question – how should I acquire the equipment. There are three basic options – buying it, leasing it or leasing it under a so-called “finance lease.” For a variety of reasons the option chosen can make a significant financial difference.
Buying the equipment is the most straightforward of the options. Your purchase gives you ownership of the equipment and, from a legal standpoint, this option gives you important legal rights. Unfortunately you also probably have debt that will be secured against the equipment and you will have paid the vendor the full purchase price for the equipment so you have no payments to “set off” if the equipment malfunctions.
Conversely, a lease of the equipment does not give you ownership of the equipment, but it does provide certain other benefits. For example, if the equipment malfunctions, you, as lessee, have some leverage over the lessor in that you can simply stop paying (although, presumably, a lawsuit will soon follow); you would not have to borrow the purchase price or make the large initial outlay of money that accompanies a significant purchase.
The third basic form of transaction is the “finance lease,” also known as the “Article 2A lease” because it arises under Article 2A of the Uniform Commercial Code. This lease transaction is essentially a triangle among three parties, the vendor, a leasing company and yourself. In rough outline, you pick the equipment, the leasing company buys it from the vendor and you make periodic payments to the leasing company for use and possession of the equipment. You then take delivery of the equipment, sign many papers, including an “acceptance” of the equipment, and begin paying monthly payments to the leasing company.
As long as the equipment works, everything is fine – a finance lease is very much like a true lease. However, if the equipment does not work, your problems have just started. Regardless of how well or badly the equipment works, you have to pay the leasing company for equipment acquired under a finance lease. Under the “hell or high water” clause of 2A407 of the Uniform Commercial Code, your promise to pay becomes “irrevocable” and “independent” – meaning you can’t take it back and you must pay whether or not the equipment works. You can bring a lawsuit against the vendor of the equipment, if you have succeeded to the rights of the leasing company under the many documents you signed. However, you have no warranties or other rights to enforce against the leasing company. Moreover, even if you sue the vendor you have to keep paying the leasing company. As between you and the leasing company, a finance lease is not a lease, it is a loan, and you should expect to pay it.
This is a rough outline of the relevant legal framework. The reality is that the question of what a lessee or buyer’s legal rights are can become very complex and the distinctions between the transactions often blur. Some transactions that call themselves “leases” may be viewed as “disguised sales” by a judge. To complicate this, some transactions that are leases in the eyes of a state court judge may be a sale in the eyes of the Bankruptcy Court judge.
Finally, there are tax considerations. The details of these go beyond the scope of this article, however, depending on the size of the acquisition, and the type of equipment, it can be better to lease than to buy for deductibility reasons. With that said, thanks to the Economic Stimulus Act of 2008 a purchase of “qualifying property” can result in a tax deduction of up to $250,000.00, and if the equipment is placed in service in 2008, the taxpayer may take a depreciation deduction of up to 50% of the taxpayer’s basis in that property. That could be a good deal even if the economy is currently stalled.
A lot can go wrong when acquiring equipment. Most equipment salespeople, whether from a manufacturer or a leasing company, are paid on commission. Many of them give elaborate financial analysis and advice, and many of them are entirely honest. However, their incentive is to close the transaction. In the event that you are pitched a lease or a finance lease for a significant piece of equipment, it may be beneficial to discuss the transaction with your accountant and/or lawyer before signing.
– Rod Fluck