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Kit Menkin


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Lease Buy-Outs 

In the movie "Ronin", Robert De Niro’s first consideration is how can he "back out safely." He wants a "back-up plan." You should also do this in considering a lease contract. Perhaps a going out of business plan is pessimistic, but it could happen. More than likely someone may offer you a price you cannot refuse for your company to incorporate into theirs or maybe join as a partner or investor. You may not even be looking. It may be when you least expect it. Your company may merge with your competitor or a larger company on the other coast who wants to enter this marketplace. We have seen this happen to all size companies.

The recent trend has been toward company consolidations. There are some notable exceptions, such as Hewlett-Packard and RJ Nabisco, but for the last two years larger companies have been buying out smaller companies and consolidating operations.  We have at least two dozen lessees who have become millionaires after "selling" their company; Cofer, Contempo Realty, FST, Bishop-Hawk, Production Metal Products, to name just a recent few. Often the owner stays on as a "consultant" or on a "contract basis" in an executive capacity.

In a related article, Lease Assumptions:

The issue of personal guarantees were covered. It is strongly recommended that your lease either be formally transferred before the "merger". It has been our experience that when this request starts after the event, the transfers are never completed. In ALL our experience in twenty-eight years, not one of the lease transfers were concluded before the sales were ever formally completed. Be aware that almost all operating and finance leases are non-cancelable. It is rare that your contract will have a written early termination option.

First Consideration

There are two aspects to the buy-out of a lease. The first, and easiest, is the "purchase option." If the dollar amount is stated and agreed upon at the signing of the lease, this then is the amount agreed upon. If it is "fair market value" or the most common used: higher ten percent or "fair market value, whichever is higher" , this may present economic obstacles to an early termination.

If the lessor, leasing company, is treating the lease as an "operating lease," where you as the lessee are deducting "rent," and they are taking "depreciation," the early termination may trigger the purchase not to be "ten percent" expected at the end of the lease contract, but the "fair market value" at early termination. Often the leasing company needs help in determining the value. While many may want to spend the money to hire a professional appraiser, it is my experience this is almost always to the benefit of the leasing company. It also may trigger locked positions where negotiations are costly to both parties.

I first recommend the opinion of several dealers of the equipment, especially used equipment dealers, who know the real world. Both parties may approve the choice of the dealer(s).

Do not think because there is labor or installation, such as in a telephone system or computer network, that this is worth zero. At the end of the lease, it may well be, but not in an early termination the lease contract dollar amount is the "total cost to the lessor." The leasing company must abide by the accounting and tax rules. And if your lease has been sold once or twice, you are far removed from the original transaction ( everything the lessor paid; total cost to lessor ). It is always best to deal with any company where you know them personally and you are comfortable they will be in business during the course of your lease. You cannot only get advice, often verbal agreements override written agreements, especially here in California. There will be many attorneys who will disagree with this statement, but as a recognized "Legal Expert" on leasing matters in California courts, let me tell you otherwise. The reason we have so many attorneys and judges is the written law does not work as written or intended by the legislators. *

You may think you can "negotiate" with the lessor about the purchase price, but often it is not a "profit motive," but a "tax motive" that drives the price. If you can help the lessor prove the equipment is only worth ten percent, wholesale, after commissions, repairs after reasonable and working condition ( the lessee pays for shipping as you did when the equipment was purchased, by the way ), that may be more important than a come and get it bluff.

Remaining Payments

Included in remaining payments are personal property tax, sales tax in California ( the early purchase of the lease contract is considered a "sale" in California, and sales/use tax is applied on the "early purchase" ), late charges, and often an early termination fee. This is rarely covered in lease contracts. It definitely would be costly to the lessee to have such an early termination clause, and may also invalidate the nature of a "true lease" also known as an "operating lease.". Many leasing companies, and most of the large ones, never put in an early termination clause or even have a side agreement regarding "discounting" the remaining lease payments. Some even keep the security deposit due to the language in the lease contract. Unless your accounting department is tracking the lease payments, you may be charged for extra payments. I have seen some very large leasing companies do this on a routine basis. They legally can, they have told me. I have never seen this issue challenged. In all the instances I have been involved, I have helped lessees get this money back, as again, the actual practice often overrides what is "legal" ( I have been specifically told by the funding source their position is "legal" ) and "written and signed by both parties." I am also talking about some large banks. Don’t assume because you are dealing with a large bank or financial institution, they will treat you properly. Wells has been sued and lost cases regarding purchase options, late fees ,and interest charges. We were involved in a case as lessee with a large national bank, along with many others, and it does happen. While they may have their side to the story, don’t assume because it is a large financial institution, they will treat you "right".

I go back to my premise, know who you are dealing with as they should protect you. There are many good insurance companies, and many just as bad, so the agent you choose is more important than the company that writes the policy. This is true in most businesses. It is relationships. It is the person who wants your continued business who will protect you and hopefully keep earning the right for your continued business. To everyone else, you are just a "number." The first thing you need to obtain when you get a "pay-off," is the break down. You need to see the purchase option, the late charges, etc., so you can "agree" with them. When you get the "remaining payments," use your common sense and look at when the lease started, then figure out if the remaining payments are accurate. If they are not, ask for a computerized payment history.

Every leasing company has this. They don’t like to give it out. Many leasing companies will not give you a "discount" on early termination. Do not be surprised to not see a discount on the remaining payments. Sometimes this can be to your advantage, as sometimes you may want to pay the remaining payments rather than take a discount. If you pay the remaining payments in the State of California, this is not an early termination, and therefore there is no sale that would trigger "sales/use tax."

Often when the early termination is figured, and the sales/use tax added, it is cheaper to pay the remaining payments. If you are paying the sales/use tax monthly, then the discounted payments are to your advantage. It is most common in equipment leases that sales tax is paid to the seller of the equipment rather than is charged monthly, which is common in vehicle leases.

How is the "discount" determined? Most companies will "present value" the remaining payments. Once you have agreed what the real remaining payments are and that it is cheaper to pay the sales tax on the "pay off," determine if there is a "present value" basis. This is a little more complicated, because each leasing company uses a different interest rate ( prime, prime plus two, the wholesale or retail interest rate, 18%---there is no common "present value rate".) In an accountants mind or as published in the Wall Street Journal, there may be one prevailing discount rate. In reality, each leasing company calculates it a little differently.

Let me also make a final generalization: as a rule of thumb, it is best to "buy-out" of the lease when you are approximately half way through it. If you are in the first "third," you have paid more interest than principal. The lease contract is particularly not designed to be "bought out" in the first year. It is not like a ninety day or one year bank note. When you are two-thirds through the lease, there is little economic reason to purchase the remaining payments, unless you are doing it to eliminate your personal liability because you are selling your company. If you have been deducting lease payments, you may also have to recapture some tax deductions, too. We utilize an internal form and you may want to copy it in case you find yourself in the position that you would like to have a "back-up". **

*( my attorney would rather me say: the law doesn’t work well all the time, is open to interpretations, precedents, negotiations, amendments, specifics, history

( as I thought we were all equal but the Supreme Court did not agree with that until the 1950’s ) and each circumstance has its own circumstance ).

Click to see payoff form

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