Beware Automatic Renewals
Other lease terms, too, burden lessees with requirements that seem onerous or subjective. Some lessors, for instance, require the use of the original boxes for returns, or designate a return location far from the lessee. Leasing companies may set tough standards for determining “normal wear and tear” for returned items, or add steep charges in the case of missing parts, even if those parts are superfluous.
Lessees also may find that the up-front deposit isn’t applied to the last month’s payment, as they expect. Sometimes deposits go for such things as restocking instead — offsetting the lessor’s cost.
“To understand the full costs, you need to load up the lease, operational, and financing costs,” says Ecologic’s Keeler.
“Make sure you have control over the management of leases so you don’t go into automatic renewals,” adds Michael Caglarcan, CEO of Captara, a provider of enterprise lease management services, in San Francisco. “In our experience, 20 to 30 percent of existing leases are in evergreen state. You pay through the nose as soon as you renew.”
Lease terms usually call for buyout prices to be based on fair market value at the end of the lease, with values agreed on by lessor and lessee. Lessees, however, are often in a vulnerable negotiating position — especially if alternatives to buying the leased equipment are limited. Lessors may make matters worse by foot-dragging in negotiations, leading to continued uneconomic lease payments, or perhaps triggering automatic lease renewals.
“Lost (Track of) Our Lease”
Joseph C. Lane, chairman of the Equipment Leasing and Finance Foundation and former chairman of the ELA, agrees that lessors plan to profit from the back end of leases. Echoing the ELA’s Fleming, he argues that they deserve to benefit to offset their risks as equipment owners. To qualify for operating lease accounting, the present value of a lessee’s committed payments may not be greater than 90 percent of the original equipment cost. So the lessor must plan to recover at least 10 percent of the original equipment cost by remarketing the assets at the end of the lease simply to recover the initial investment. While it plans to make more than that, the lessor also bears the risk that the value will not be there in the future.
“On any playground there are kids that play badly,” says Lane. “In this industry, there have been some that have intentionally dragged their feet in negotiations in order to get rent payments for an extended negotiation period. And, there have been those who have found 42 scratches on a bulldozer after a three-year lease and defined 26 scratches as normal wear and tear.” But, he adds, “nearly all [lessors] try to conduct themselves in a fair way, because they are driven by repeat business.”
Unlike most leasing companies, many lessees manage their process through decentralized operations. They lack systems for monitoring deadlines, or lose track during personnel changes or mergers. Such complications make lease-related errors, like missing a notification deadline, as common as they are expensive.