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Deathgrip Leasing And acts of Unethical Behavior
Deathgrip Leasing And acts of Unethical Behavior
Deathgrip Leasing And acts of Unethical Behavior
Deathgrip Leasing And acts of Unethical Behavior
Deathgrip Leasing And acts of Unethical Behavior
Deathgrip Leasing And acts of Unethical Behavior
Deathgrip Leasing And acts of Unethical Behavior
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Deathgrip Leasing And acts of Unethical Behavior

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  • 1. Predatory Leasing Practices: The Case of the DeathGrip Lease By James M. Johnson, Ph.D. Graduate School of Business Northern Illinois University Principal, Mark Financial Services 630.365.9004 fax 630.365.5602 jamesmjohnsonphdleasing@worldnet.att.netCopyright © James M. Johnson 1999. James M. Johnson, Ph.D. is professor of finance in the GraduateSchool at Northern Illinois University and is Principal of Mark Financial Services. Johnson has been aconsultant/advisor/educator to both lessors and lessees for more than 20 years. He is author of the industrystandard text on structuring titled Fundamentals of Finance for Equipment Lessors published by theEquipment Leasing Association, is on the Board of Directors of the Foundation for Leasing Education, anda member of the board of editors of the Journal of Equipment Lease Financing. Spring, 19991
  • 2. Predatory Leasing Practices: The Case of the DeathGrip Lease Leasing has become a very big business, and justifiably so. It servesmany important business needs. However, leasing is an unregulatedindustry in large part. As with any such industry, it is difficult to gain thecooperation of all lessors to follow to a code of fair and ethical practices.Although legitimate differences concerning fair and unfair practices do exist,a handful of practices are truly nothing short of predatory in nature. Thegood news is that most lessors do not practice them. The bad news is thatthey exist at all, and can be a career-altering experience for a professionalthat falls prey to one. Predatory leasing practices are difficult to learn about. Companieswho discover they have unwittingly signed a predatory leasing contract areunderstandably not eager to share their experience. It is critical to realizethat these practices are not reserved for unsophisticated businesses. Theyare attempted (successfully enough to continue the practice) on AAA-ratedorganizations as well. A recent seminar for a major financial institutionrevealed that the firm had received a leasing proposal. The officers involvedin the workshop were not aware it was a predatory lease, since they had littleexperience with technology leasing. Once the terms and conditions of theagreement were analyzed, however, the officers were understandablyfloored—especially since the leasing company involved was a customer oftheir institution! The purpose of this article is to outline the worst provisions of apredatory lease agreement, discuss how it is marketed, and offer somestrategies to reduce the odds of signing such an agreement. The discussionwill remain relatively general, since there are a number of purveyors of thistype of lease, each with their own unique spins and variations.The DeathGrip Lease It may be difficult to imagine that the lease outlined here is, in fact,real. Unfortunately, it is. There are many variations of what is dubbed hereas the DeathGrip Lease, but they have one very important commoningredient—their end-of-lease provisions. A “normal” lease is thought of as providing the lessee with thetemporary use and possession of someone else’s property for a contractuallyagreed upon period of time. At the end of the specified lease term, and2
  • 3. subject to the notification period defined, the lessee’s obligation is fulfilled.Notification periods generally run from 30 days to 90 days prior to the endof the lease term. Notification simply means that the lessee is giving noticeto the leasing company that it wishes to return the equipment at leaseexpiration. Alternatively, a lease may permit the lessee at lease end to eitherpurchase the equipment or extend the lease term. The key point in all this isthat the lessee has the option but not the obligation to purchase theequipment, extend the lease, or return the equipment at lease expiration. For the uninitiated, the DeathGrip end of lease provision may notseem problematic, and in fact may appear to offer quite flexible options atthe end of the lease (hereafter EOL). Generally, lessees tend to understandhow confining the DeathGrip lease is onlt when the end of their DeathGriplease term approaches, and after they have been in contact with the involvedleasing company to be informed as to what they are really required to do. We will paraphrase the EOL language found in DeathGrip leases andthen explain the real import of each provision. At the expiration of the lease term…or at the expiration of an extention term…lessee must (1)purchase the leased property at a mutually agreeable price; (2) return the leased property…and leasereplacement property which has a cost at least equal to the original cost of the returned property; or (3)extend the lease for an additional year at the lease rate prevailing in the expiring lease. Regarding options(a) and (b), lessor and lessee shall agree to terms or not agree to terms in their sole discretion. Let’s put each of the three options under scrutiny. The first optionsays that the equipment under lease can be purchased at a mutually agreedupon price. Such wording has the look and feel of civility—we willnegotiate in good faith and arrive at an agreeable price. It is easy to readintent into this wording, but to do so ignores the reality of how the provisionis enforced. Mutually agreeable does not mean or imply “reasonable,” or“market value,” or “fair market value.” Mutually agreeable means twoparties either agree on a price or they don’t. Notice that language goes on tosay that lessor and lessee will either mutually agree or not in their solediscretion. This means that if they cannot arrive at a striking price, there isno requirement for arbitration or any other form of dispute resolution. Thereis no contractual obligation for the DeathGrip lessor to behave in acommercially reasonable manner. The second EOL option permits the lessee to return the equipmentunder lease and enter into a new agreement to lease equipment with a valueequal to or greater than the original cost of the equipment currently underlease. The bad news of this provision lies in what it does not say. Let’s puta trailer on the language of this provision to clearly see the problem:3
  • 4. “Lessee may return the equipment and enter into a new lease agreement forequipment of equal or greater value than the existing lease at terms andconditions to be decided when we get there.” This agreement says nothingregarding the lease rate or other pertinent terms and conditions that will beoffered on the replacement lease! To further aggravate the problem, theDeathGrip lessor and lessee will attempt to negotiate the terms of thereplacement lease in their sole discretion. As with the first option, there isno mechanism for dispute resolution. In essence, option (b) means thatlessor and lessee must mutually agree to the terms and conditions of thereplacement lease in their absolute discretion. Once again, there is nocontractual obligation for the DeathGrip to negotiate in a commerciallyreasonable manner or to subject the process to third party dispute resolution. The third option is very clear—continue to pay rent at the same ratefor an additional year. Even though the open market value of the equipmentmay be only ten percent of its original cost at the end of the term, rentpayments continue on at the full rate in effect on day one. The DeathGriplessor has no obligation to reduce the rental rate during the extension periodto a fair market rental rate. Notice the option that is missing—simply returning the equipment atthe end of the lease term. This is the distinguishing characteristic of theDeathGrip lease—at the end of the lease term, the lessee’s contractualobligation is not fulfilled—the lessee still owes more money. This is simplynot a lease in any meaningful sense of the word. It does not grant the lesseethe temporary possession of the leased property—it grants possession of theleased property to the lessee indefinitely, or until the lessor decides to allowthe lessee to get out, and how much it wants the lessee to pay for the exitprivilege. It gets worse. Notice that the beginning of the paraphrase states thelessee must choose one of these three options. Each of the three options isindeed an option, but the lessee has the contractual obligation to select oneof the three. The typical DeathGrip contract goes on to say that if the lessorand lessee cannot agree to the terms and conditions of either option (1) oroption (2), then option (3) will be exercised by default. It gets still worse. Read the beginning of the paraphrase once more.Note the language: “At the expiration of the lease term…or at the expirationof an extention term…lessee must...” Suppose a lessee has gone through itsfirst DeathGrip lease term, could not mutually agree on options (1) or (2),and was automatically kicked into a one-year renewal of the lease. At theend of the one-year renewal, what happens? One interpretation suggests thatthe lessee is left facing the same three options again. In Fortran4
  • 5. programming, this is called a “do-loop.” After each one-year extension, itappears that the EOL procedure must be cycled through once again. How can a DeathGrip lease be ended? In a word, money. Thepurchase price in practice is usually set at an additional year’s rental income,plus the DeathGrip lessor’s originally booked residual value--at a minimum.The new lease terms and conditions will be whatever the lessor can get thelessee to agree to. Of course, the DeathGrip lessor’s worst-case scenario isanother year’s rental income at the same rate they have been charging.Since these leases are predominantly in the technology arena, imagine howlucrative it is to enjoy two or three renewals on equipment that has eroded invalue to three dollars a pound.The Marketing of DeathGrip Leases DeathGrip leases are typically marketed in one of two ways, oftendepending upon the perceived sophistication of the lessee. The firstapproach is called the We’re Your Lease Flexibility Partners approach. Thecontract in this approach is expected to be given a cursory review, withsignificant reliance placed upon the representations of the DeathGrip salesrep. If the lease in question is for technology equipment, which themajority of DeathGrip leases are, one would normally expect to need theequipment under lease--or “technology refreshed” equipment--for theindefinite future. In such a case, the sales rep indicates that this leaseaffords all options the lessee could possibly want—to purchase equipmentat EOL, migrate to new equipment if desired, or renew the existingequipment lease for an additional year. What greater flexibility could alessee possibly require? The second approach is labeled the Parade of Documents approach.This strategy is employed for the more sophisticated lessee. The prospect isexpected to demand a copy of the lease contract in advance of negotiating adeal, read it in full, understand it, and attempt to negotiate desired changes tothe lease. Since the DeathGrip provisions will be detected by anexperienced lessee, the DeathGrip provision will not appear in theequipment lease or master lease agreement—it will appear in a subsequentdocument—a schedule, an addendum, an exhibit, a supplement, anassignment document or other document that has not been carefullyexamined. Since these documents are equipment specific, they are notgenerally expected to be provided before a specific transaction is undernegotiation. Understandably, a lessee that has carefully scrutinized andnegotiated changes to a master agreement is less likely to give subsequent5
  • 6. documents the same detailed examination, since the lessee may assume thatall significant terms and conditions have been settled. Unfortunately, thereis typically no contractual assurance that the deal cannot be significantlyaltered in subsequent documents, and this is the window through which theDeathGrip provision may slip undetected.A Summary of DeathGrip End of Lease Requirements Standard leases have end-of-lease options available to the lessee,among which is the right to simply return the leased equipment withoutfurther obligation. The DeathGrip lease, on the other hand, does not permitthe return of leased equipment without extracting significant additionalmonies from the lessee—the lessee cannot simply return the equipment. In atypical DeathGrip lease, the lessee will be on the hook to buy the leasedequipment for whatever amount the lessor chooses to agree to; enter into anew deal under terms and conditions the lessor controls; or renew theexisting lease for an addional year at the same lease rate that was paid duringthe initial lease term. Remember—the lessee is contractually obligated toexercise one of these three options. Further remember that if the lease isrenewed for a year due to an inability to negotiate a purchase or newequipment deal, the same three options are faced by the lessee at the end ofthe renewal term, and so on, and so on, and so on.How to Avoid DeathGrip Leases There are three ways to avoid becoming ensnared in a DeathGriplease: lessor scrutiny, contractual scrutiny and in-house documentdevelopment. The first avoidance tool—lessor scrutiny—simply meansperforming a due diligence investigation on lessors before deciding whichleasing firms to consider. Ask lessors for three references from existingcustomers, and three references from former lessee customers. Go to lessee-oriented seminars and conferences and use the power of networking. Asklegal counsel to assess the lessor’s litigation record—are they in courtenforcing end-of-lease provisions with regularity? This method should notbe considered a substitute for document scrutiny, but should be used inpartnership with the second and third methods discussed below. The second method involves bringing a healthy attitude of skepticismto each lease document that is offered for signature. Remember the Paradeof Documents strategy. Lessees have achieved considerable success byrequiring that each bidding lessor submit simultaneously the entire family ofdocuments the lessee will be asked to sign, and further require the lessor tostipulate that each and every document required has in fact been submitted.6
  • 7. The lessee can further require that should it be determined later that thestipulation was not adhered to, the lease and its terms and conditions are nulland void. The third method is the strategy that will spare lessees more money,aggravation, time and future headaches than any other: develop originallease documents. When a lessee puts forth its own lease documents as partof a leasing Request for Proposal, it becomes extremely difficult for aDeathGrip lessor to propose document changes that will not be immediatelydetected.Summary It is an unfortunate fact of life in the leasing industry that a handful ofpredators are making business difficult, both for lessees and for the lessorsthat compete against the predators. This unethical behavior needlesslytarnishes an important sector of corporate finance—the leasing industry. Absent any regulatory vehicle that could reign in lessor predators, it isessential that lessees develop an awareness of predatory leasing practicesand how to avoid them. The goal of this article has been to fulfill thatobjective.7

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