Leasing Nuts and Bolts

So an agency wants to lease 10 of your systems rather than buy them. How do you arrange for leasing your products? How do you figure your quote for leasing as opposed to purchase? What if the agency wants a lease with an option to purchase?

Vendors marketing to government agencies are being faced with these questions more and more. Leasing has returned as a viable option when selling to the government. Vendors need to understand the basics of lease transactions in order to respond to agencies seeking to compare the costs of purchase against leasing. Equally important, vendors need to prepare a leasing strategy to keep up with those competitors offering leasing as an alternative vehicle.

Let’s first discuss the players and terminology of a lease transaction. There’s the company leasing the equipment, called the “lessor.” The lessor can be a manufacturer or a dealer. The agency leasing the equipment is called the “lessee.” (In law, the suffix “or” refers to the party who is doing something to another party, with the recipient having the suffix “ee” to show for it.) The “term” refers to the length of the lease, which usually is anywhere from two to five years. A “purchase option” enables the lessee to buy the equipment short of the full term, usually by applying a specified “purchase option credit” calculated as a percentage of the lease payments to date.

In the simplest lease transaction, a manufacturer leases its systems to an agency for a fixed monthly sum over a set year term. The monthly lease charge comprises the purchase price of the system, plus an interest charge to recoup the cost of getting the sales price over time rather than up front, and an administrative charge to cover the monthly cost of handling the lease billing and annual cost of renewals. A maintenance charge may also be bundled together with the monthly lease payment.

Despite its relative simplicity, many manufacturers dislike this kind of lease scenario for several reasons. First, manufacturers usually like to get paid in full for their products at the beginning of the deal and not over time. Manufacturers don’t want to be put in the position of a bank lending money to the lessee. Second, the administration of a lease requires a staff that bills the lessee monthly, keeps good records, follows up on late payments, and annually obtains the lease renewal. It can be costly, however, to assemble and pay for the staff able to administer leases.

Enter the lease finance company. The lease finance company buys the equipment from the manufacturer when the lease is first entered into, and administers the lease over the term. The lease finance company makes its money on the interest and administrative charges built into the monthly lease payments it collects.

Leases for big, expensive systems are often sold to lease finance companies on a deal-by-deal basis, with the manufacturer shopping among finance companies for the most competitive rate. For less expensive items that are sold in greater quantities, a manufacturer may enter into a long term lease finance arrangement under which the manufacturer sells its leased equipment to the lease finance company as leases arise.

Documenting a lease deal takes quite a bit of paper. The manufacturer must enter into a contract selling the equipment to the lease finance company. That contract includes an Assignment clause assigning payments under the lease to the lease finance company, and a Notice of Assignment directing the government to send its lease payments to the lease finance company rather than to the contractor.

Federal and state government leases have quirks that make life interesting for both the lessor and lease finance company. Unlike commercial lessees entering into “hell or high water” leases that are near impossible to break, the government has several outs during the lease term. First, the government can terminate the lease for its convenience if, for example, it no longer needs the equipment. Second, government leases must be renewed annually. This is because appropriation laws prohibit the government from entering into most contracts beyond the September 30 end of the government’s fiscal year. As a result, either the contractor or the lease finance company, as the case may be, must actively seek to obtain renewals for each lease held, or risk lapsing the lease. Also, an agency that wants to get out of a lease can use annual funding as a reason to decline to renew the lease.

All of which leads to what happens if the lease is, in fact, terminated before the full lease term is up. Upon early termination, the equipment comes back to the contractor before the agency has paid sufficient lease payments to cover the purchase cost of the equipment, let alone interest and administrative costs. If the parties are fortunate and the equipment is not obsolete, the contractor or finance company will be able to refurbish the equipment and either sell it or lease it again. If the equipment has been passed over by newer technology, it may be impossible to unload the equipment.

The risks of non-renewal, termination for convenience, and remarketing are usually covered in the lease finance agreement. It is up to the contractor and the lease finance company to decide which party will bear or share these risks.

There you have it in a nutshell. It’s not a simple area, and there are a few traps for the unwary along the way. But with leasing on the rebound and the government seeking even more ways to work efficiently, vendors need to understand leasing as an alternative to purchase.