Dodging Leasing's Grim Reaper: Navigating a Payment Default

In her third Harry Potter novel, ‘The Prisoner of Azkaban’, J.K. Rowling introduces a silent mysterious clan of spiny, cloaked creatures capable of siphoning off happiness and all good thoughts from anyone in their presence. Extended exposure to these scabby grim reapers, called Dementors, resulted in madness or death for even the most joyful individuals. In the world of equipment leasing, the closest things to Dementors are lessors who lose confidence in defaulting lessees. If your firm faces imminent payment default, there are several actions you can take to improve your chances of navigating this unfortunate situation.

As in most situations that can spin out of control, effective communication between lessee and lessor is extremely important. At the start of the lease, you are primarily concerned with obtaining flexible, cost effective equipment financing. The lessor’s primarily objective is to originate a profitable lease transaction. Once a payment default is in the offing, the primary concerns of both parties change. You now focus on taking actions to guarantee survival, while the lessor seeks protection and recovery of the lease investment. That being said, it is very important that you appreciate the lessor’s concerns when you are planning a recovery and when communicating with the lessor.

As a first step, you should notify the lessor when a payment default seems unavoidable. No one wants to be blindsided by an unexplained delinquency as the first indication of a problem. Most lessors will appreciate your forthright candor in alerting them. Be prepared to give an explanation of the cause of the payment problem, a detailed account of your company’s financial condition, and your plan to correct the situation. If you are able to generate financial projections, they will prove helpful in convincing the lessor to allow you to execute your recovery plan.

Try to stay in compliance with all other terms and conditions of the lease. Most lessors will appreciate your diligence in adhering to the other lease provisions, especially those requiring periodic financial information. Frequent updates will give the lessor confidence that you are cooperating and working with him.

If appropriate, propose a rent reduction in an amount and for a term that will give you an opportunity to recover. Remember, the lessor is primarily interested in how the lease will be repaid and how he will realize the benefit of the bargain negotiated at the outset of the lease. Secondly, he is concerned about his collateral position. Now that a problem has surfaced, he will want protection from a loss on the transaction if your company fails or if equipment repossession becomes necessary. Offer cash flow projections to show how your firm will recover and when you will be able to resume making full rent payments.

If possible, be prepared to offer credit enhancements and an increase in the lease rate to entice the lessor to accommodate you. Credit enhancements are intended to make the lessor feel more secure that he will recover his investment. You may offer additional collateral, a personal guarantee, a pledge of stock or other securities as credit enhancements. To compensate the lessor for the added risk of the defaulted transaction offer a rate adjustment. A rate adjustment might be accomplished by extending the lease term, stepping up the rental after resuming payments, or issuing warrants to purchase stock in your firm.

If you can’t determine the likely duration of the default, you should request a relatively short period of lower payments until you can better evaluated the situation. Be prepared to negotiate the length of the period, the amount of the reduced payments and credit enhancements.

If the default looks hopelessly incurable, you may proceed in number of ways. You can: 1) offer to return the equipment to the lessor and pay the lease balance over an extended time; 2) offer to find a suitable sublease arrangement for the equipment; or 3) see whether the lessor will allow you to keep the equipment and make reduced payments on a month to month basis until you or the lessor can re-market the equipment. If all else fails in working out an acceptable solution with the lessor, it may be time for you to get a skilled attorney involved.

If you are able to reach a mutually acceptable solution, some lessors might require a formal forbearance agreement covering the new understanding. These agreements can take the form of an informal letter of understanding or an extensive legal agreement. The agreement form may depend on the size of the transaction and the preference of the lessor. Most lessors ultimately expect to be compensated for forbearing via a one-time forbearance charge, penalty rental payments or other means. Also, expect to reimburse the lessor for any legal expenses incurred to document a forbearance arrangement.

Most lessors don’t want to take legal action or cause customers hardships that will interfere with recovering their lease investment. This preference is weighted against the prospect of realizing a larger eventual loss by allowing the customer to retain the equipment. It is usually more advantageous for lessors to work with customers if the situation seems salvageable. The less desirable alternative is to go through an expensive and lengthy legal process to foreclose on the lease and attempt to repossess the equipment. Many large lessors have individuals in-house that specialize in managing ‘work out’ transactions. These specialists usually have had experience with many lessee payment defaults. Their mandate is to get the quickest recapture of the lease investment possible, subject to protecting the investment. If it becomes clear at any time that the lessor plans to take legal action against your firm rather than try to work with you to realize a mutually acceptable solution, get a skilled attorney involved. The attorney can provide you with your legal alternatives and may be able to assist you in negotiating with the lessor.

When your company’s fortunes take a turn for the worst and you have to modify payment terms with your leasing company and other creditors, don’t panic. This is the time to redouble your efforts and to draw up plans to remedy the situation. Early aggressive actions by you to develop solutions will pay great dividends. Make every effort to create and propose plans mutually acceptable to all parties. However, always be prepared to seek legal help should grim reapers or Dementors show up at your door.