2. Predatory Leasing Practices:
The Case of the DeathGrip Lease
Leasing has become a very big business, and justifiably so. It serves
many important business needs. However, leasing is an unregulated
industry in large part. As with any such industry, it is difficult to gain the
cooperation 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. The
good news is that most lessors do not practice them. The bad news is that
they exist at all, and can be a career-altering experience for a professional
that falls prey to one.
Predatory leasing practices are difficult to learn about. Companies
who discover they have unwittingly signed a predatory leasing contract are
understandably not eager to share their experience. It is critical to realize
that these practices are not reserved for unsophisticated businesses. They
are attempted (successfully enough to continue the practice) on AAA-rated
organizations as well. A recent seminar for a major financial institution
revealed that the firm had received a leasing proposal. The officers involved
in the workshop were not aware it was a predatory lease, since they had little
experience with technology leasing. Once the terms and conditions of the
agreement were analyzed, however, the officers were understandably
floored—especially since the leasing company involved was a customer of
their institution!
The purpose of this article is to outline the worst provisions of a
predatory lease agreement, discuss how it is marketed, and offer some
strategies to reduce the odds of signing such an agreement. The discussion
will remain relatively general, since there are a number of purveyors of this
type 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 here
as the DeathGrip Lease, but they have one very important common
ingredient—their end-of-lease provisions.
A “normal” lease is thought of as providing the lessee with the
temporary use and possession of someone else’s property for a contractually
agreed upon period of time. At the end of the specified lease term, and
2
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 end
of the lease term. Notification simply means that the lessee is giving notice
to the leasing company that it wishes to return the equipment at lease
expiration. Alternatively, a lease may permit the lessee at lease end to either
purchase the equipment or extend the lease term. The key point in all this is
that the lessee has the option but not the obligation to purchase the
equipment, extend the lease, or return the equipment at lease expiration.
For the uninitiated, the DeathGrip end of lease provision may not
seem problematic, and in fact may appear to offer quite flexible options at
the end of the lease (hereafter EOL). Generally, lessees tend to understand
how confining the DeathGrip lease is onlt when the end of their DeathGrip
lease term approaches, and after they have been in contact with the involved
leasing company to be informed as to what they are really required to do.
We will paraphrase the EOL language found in DeathGrip leases and
then 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 lease
replacement 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 option
says that the equipment under lease can be purchased at a mutually agreed
upon price. Such wording has the look and feel of civility—we will
negotiate in good faith and arrive at an agreeable price. It is easy to read
intent into this wording, but to do so ignores the reality of how the provision
is enforced. Mutually agreeable does not mean or imply “reasonable,” or
“market value,” or “fair market value.” Mutually agreeable means two
parties either agree on a price or they don’t. Notice that language goes on to
say that lessor and lessee will either mutually agree or not in their sole
discretion. This means that if they cannot arrive at a striking price, there is
no requirement for arbitration or any other form of dispute resolution. There
is no contractual obligation for the DeathGrip lessor to behave in a
commercially reasonable manner.
The second EOL option permits the lessee to return the equipment
under lease and enter into a new agreement to lease equipment with a value
equal to or greater than the original cost of the equipment currently under
lease. The bad news of this provision lies in what it does not say. Let’s put
a 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 for
equipment of equal or greater value than the existing lease at terms and
conditions to be decided when we get there.” This agreement says nothing
regarding the lease rate or other pertinent terms and conditions that will be
offered on the replacement lease! To further aggravate the problem, the
DeathGrip lessor and lessee will attempt to negotiate the terms of the
replacement lease in their sole discretion. As with the first option, there is
no mechanism for dispute resolution. In essence, option (b) means that
lessor and lessee must mutually agree to the terms and conditions of the
replacement lease in their absolute discretion. Once again, there is no
contractual obligation for the DeathGrip to negotiate in a commercially
reasonable manner or to subject the process to third party dispute resolution.
The third option is very clear—continue to pay rent at the same rate
for an additional year. Even though the open market value of the equipment
may be only ten percent of its original cost at the end of the term, rent
payments continue on at the full rate in effect on day one. The DeathGrip
lessor has no obligation to reduce the rental rate during the extension period
to a fair market rental rate.
Notice the option that is missing—simply returning the equipment at
the end of the lease term. This is the distinguishing characteristic of the
DeathGrip lease—at the end of the lease term, the lessee’s contractual
obligation is not fulfilled—the lessee still owes more money. This is simply
not a lease in any meaningful sense of the word. It does not grant the lessee
the temporary possession of the leased property—it grants possession of the
leased property to the lessee indefinitely, or until the lessor decides to allow
the lessee to get out, and how much it wants the lessee to pay for the exit
privilege.
It gets worse. Notice that the beginning of the paraphrase states the
lessee must choose one of these three options. Each of the three options is
indeed an option, but the lessee has the contractual obligation to select one
of the three. The typical DeathGrip contract goes on to say that if the lessor
and lessee cannot agree to the terms and conditions of either option (1) or
option (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 expiration
of an extention term…lessee must...” Suppose a lessee has gone through its
first 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 the
end of the one-year renewal, what happens? One interpretation suggests that
the lessee is left facing the same three options again. In Fortran
4
5. programming, this is called a “do-loop.” After each one-year extension, it
appears that the EOL procedure must be cycled through once again.
How can a DeathGrip lease be ended? In a word, money. The
purchase 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 the
lessee to agree to. Of course, the DeathGrip lessor’s worst-case scenario is
another year’s rental income at the same rate they have been charging.
Since these leases are predominantly in the technology arena, imagine how
lucrative it is to enjoy two or three renewals on equipment that has eroded in
value to three dollars a pound.
The Marketing of DeathGrip Leases
DeathGrip leases are typically marketed in one of two ways, often
depending upon the perceived sophistication of the lessee. The first
approach is called the We’re Your Lease Flexibility Partners approach. The
contract in this approach is expected to be given a cursory review, with
significant reliance placed upon the representations of the DeathGrip sales
rep.
If the lease in question is for technology equipment, which the
majority of DeathGrip leases are, one would normally expect to need the
equipment under lease--or “technology refreshed” equipment--for the
indefinite future. In such a case, the sales rep indicates that this lease
affords all options the lessee could possibly want—to purchase equipment
at EOL, migrate to new equipment if desired, or renew the existing
equipment lease for an additional year. What greater flexibility could a
lessee possibly require?
The second approach is labeled the Parade of Documents approach.
This strategy is employed for the more sophisticated lessee. The prospect is
expected to demand a copy of the lease contract in advance of negotiating a
deal, read it in full, understand it, and attempt to negotiate desired changes to
the lease. Since the DeathGrip provisions will be detected by an
experienced lessee, the DeathGrip provision will not appear in the
equipment lease or master lease agreement—it will appear in a subsequent
document—a schedule, an addendum, an exhibit, a supplement, an
assignment document or other document that has not been carefully
examined. Since these documents are equipment specific, they are not
generally expected to be provided before a specific transaction is under
negotiation. Understandably, a lessee that has carefully scrutinized and
negotiated changes to a master agreement is less likely to give subsequent
5
6. documents the same detailed examination, since the lessee may assume that
all significant terms and conditions have been settled. Unfortunately, there
is typically no contractual assurance that the deal cannot be significantly
altered in subsequent documents, and this is the window through which the
DeathGrip 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 without
further obligation. The DeathGrip lease, on the other hand, does not permit
the return of leased equipment without extracting significant additional
monies from the lessee—the lessee cannot simply return the equipment. In a
typical DeathGrip lease, the lessee will be on the hook to buy the leased
equipment for whatever amount the lessor chooses to agree to; enter into a
new deal under terms and conditions the lessor controls; or renew the
existing lease for an addional year at the same lease rate that was paid during
the initial lease term. Remember—the lessee is contractually obligated to
exercise one of these three options. Further remember that if the lease is
renewed for a year due to an inability to negotiate a purchase or new
equipment deal, the same three options are faced by the lessee at the end of
the 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 DeathGrip
lease: lessor scrutiny, contractual scrutiny and in-house document
development. The first avoidance tool—lessor scrutiny—simply means
performing a due diligence investigation on lessors before deciding which
leasing firms to consider. Ask lessors for three references from existing
customers, and three references from former lessee customers. Go to lessee-
oriented seminars and conferences and use the power of networking. Ask
legal counsel to assess the lessor’s litigation record—are they in court
enforcing end-of-lease provisions with regularity? This method should not
be considered a substitute for document scrutiny, but should be used in
partnership with the second and third methods discussed below.
The second method involves bringing a healthy attitude of skepticism
to each lease document that is offered for signature. Remember the Parade
of Documents strategy. Lessees have achieved considerable success by
requiring that each bidding lessor submit simultaneously the entire family of
documents the lessee will be asked to sign, and further require the lessor to
stipulate 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 the
stipulation was not adhered to, the lease and its terms and conditions are null
and void.
The third method is the strategy that will spare lessees more money,
aggravation, time and future headaches than any other: develop original
lease documents. When a lessee puts forth its own lease documents as part
of a leasing Request for Proposal, it becomes extremely difficult for a
DeathGrip lessor to propose document changes that will not be immediately
detected.
Summary
It is an unfortunate fact of life in the leasing industry that a handful of
predators are making business difficult, both for lessees and for the lessors
that compete against the predators. This unethical behavior needlessly
tarnishes an important sector of corporate finance—the leasing industry.
Absent any regulatory vehicle that could reign in lessor predators, it is
essential that lessees develop an awareness of predatory leasing practices
and how to avoid them. The goal of this article has been to fulfill that
objective.
7