Be Equipped For Equipment Lease Automatic Renewals
November 9, 2012
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When negotiating and planning your equipment leasing needs, it is important to understand the ins and outs of automatic lease renewal provisions. All equipment leases have a fixed term (usually 36, 48 or 60 months) with payments due monthly or quarterly. However, many leases have a provision that allows the lease to “automatically renew” for an additional period (usually one year) with lease payments to be made monthly at the rate for the most recent month, unless the lessee notifies the lessor in writing of its intention to terminate the lease at the end of the lease term. While it sounds confusing and unmanageable, there are certain advantages which can be realized, and these terms may even afford the lessee additional flexibility.
Sometimes the automatic lease renewal provision can inure to the lessee’s benefit. If the leased equipment is still functioning properly, the equipment is still being used regularly in the course of the lessee’s business, and the cost of replacement equipment is similarly priced, a lessee may want to exercise the automatic renewal provision (by doing nothing, and merely allowing the lease term to expire). This will allow the lessee to continue using the equipment without: (i) any interruption to business operations, (ii) having to incur the expenditures in time and money to research new equipment and negotiate a new equipment lease, or (iii) having to expend efforts to return the old equipment, and install and acclimate to the new equipment[1]. However, often times the equipment is becoming obsolete by the natural end of the lease term, the old equipment is not functioning as expected, or the decreased cost/improved functionality of new equipment is desirable; in such cases it is critical that you make sure to terminate the lease and prevent the automatic renewal period from kicking in.
To better understand a real-world application of these considerations, let’s examine a single restaurateur who has executed separate five-year leases, one for a walk-in meat locker for his kitchen and the other for a photocopier machine for the office in the back of the restaurant. As the five-year lease term for the two leases starts winding down, the restaurateur must decide whether to let his equipment leases automatically renew, or return and release new equipment.[2] Given the facts that:
(1) removal and replacement of a walk-in meat locker would be disruptive to the continuing business operations of the restaurant;
(2) there is little variation in functionality of meat lockers from one year to the next such that a newer model would have desirable upgrades, and
(3) the restaurateur would incur great expense to uninstall and return the old meat locker and install the new meat locker
— the restaurateur may well elect to allow the automatic renewal to kick in, keep the old meat locker in place, and continue making lease payments to the finance company for the next twelve months.
— the restaurateur may well elect to allow the automatic renewal to kick in, keep the old meat locker in place, and continue making lease payments to the finance company for the next twelve months.
Alternatively, photocopier machines are notorious for becoming obsolete within minutes of being purchased! As with all electronics, five years is a veritable lifetime, and the newest models are undoubtedly more efficient, versatile and functional for the money than the old machine. In this case, the restaurateur would elect to terminate the automatic renewal provision, return the equipment, and enter into a new lease for a new photocopier machine.
Terminating the automatic renewal provision is simple, so long as the lessee is meticulous and diligent with complying with the lease requirements. Most automatic renewal clauses provide that the lease will automatically renew unless the lessee: (i) gives the lessor written notice between 60 and 120 days prior to the expiration of the lease that the lessee will return the equipment, and (ii) returns the equipment at the expiration of the lease. Unlike real estate leases, equipment leases are often simpler and do not enumerate a specific method as to where/when/how notice must be given; however, it is recommended that the notice be in writing and sent to the lessor via a method that allows you to prove that the notice was sent (i.e. overnight carrier, certified mail return receipt requested, etc.).
It is very important that you comply with the lease provisions and send a written notice to decline the automatic lease renewal within the proper time frame. Courts will enforce these automatic renewal provisions, and can be very rigid about the timelines; if you don’t send the proper notice within the proper time frame, you could be in the unenviable position of having the equipment repossessed and having to pay the lessor an entire year’s worth of renewal rents, interest, late fees and attorneys’ fees!
New York law does provide the lessee with a little bit of protection in the form of General Obligations Law § 5-901, which states that automatic lease renewal provisions are only enforceable if “the lessor, at least fifteen days and not more than thirty days previous to the time specified for the furnishing of such notice to him, shall give to the lessee written notice, served personally or by mail, calling the attention of the lessee to the existence of such provision in the lease.” Because most, if not all, leasing companies are aware of this provision, you will usually get a computer-generated letter from them 90-150 days prior to the expiration of the initial lease term. The letter may be cryptic, and make only a vague reference to a renewal provision in a specific paragraph of the lease. Unfortunately, courts have deemed this notice sufficient to comply with the statute. Further, many leasing companies will just include pre-printed language on your final 3-4 monthly invoices, which language refers you to the automatic renewal clause of the lease. Courts have also upheld this form of notice, so be sure to always read your monthly invoices very carefully!
Contrary to popular opinion, automatic lease renewal provisions are not all bad. If understood, and manipulated correctly, they can provide you with additional flexibility and leverage in structuring your commercial equipment acquisition. Just be sure to be vigilant and comply with all of the requisite notice provisions, so you will be better equipped to deal with automatic renewals.
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[1] Keep in mind that automatic lease renewal usually does not automatically renew the service contract. The service agreement for the equipment (if any) is almost always provided externally to the lease by a third-party. As such, it is important that you contact your service provider and negotiate a new service contract which coincides with the term of the new lease to ensure that the equipment will be properly maintained during the course of the renewal term.
[2] For the purposes of this example, we will assume that: (i) the restaurant maintains a viable business going into the sixth year; (ii) the restaurant still requires a meat locker and photocopier machine, and (iii) the restaurateur still prefers to lease these items rather than purchase them.
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