Joseph K. has operated a lawn mowing service since he was in his early twenties. Jennifer J. has run a successful photography studio for many years. Timothy V. has spent decades as a trainer in the fitness center he owns. All three are retiring and closing their operations this year. Each has decided to lease their equipment instead of selling it outright.  Many retirees face this situation. What do they need to know about equipment leases in Texas?

Structure of Equipment Lease as a Security Interest of a True Lease

            Any person leasing equipment (Lessor) must determine whether to structure the lease as a true lease or as a security interest. The Texas Uniform Commercial Code (T.U.C.C.), rather than the title of the agreement, determines which it will be. 

            A true lease gives the Lessee the right to use the equipment for a time period that is shorter than the economic life of the equipment. For example, suppose Jennifer’s photographic equipment is worth $50,000.00 and she leased that equipment for $1,500.00 a month for 12 months, with an option to the Lessee to purchase the equipment at the end of the lease. Lessee must pay more than a nominal amount to purchase the equipment in addition to lease payments, for the lease to qualify as a true lease.  Jennifer’s lease qualified. The lease provided that the Lessee could purchase the property at the end of the lease for $50,000.00 with all of the lease payments applied toward the purchase price. At the end of the lease, the Lessee exercising the option would pay $32,000.00 to own the equipment.

            The equipment lease will be judged a security interest if it contains certain provisions. First, the Lessee cannot terminate the lease during its term. Also, one of the following must apply to the agreement: (1) the original term of the lease is equal to or greater than the remaining economic life of the equipment; (2) the Lessee is obligated to renew the lease for the remaining economic life of the equipment or to become its owner; (3) the Lessee is obligated to renew the lease for the remaining economic value of the lease for either no or nominal additional payment; (4) the Lessee has the option to become owner of the equipment for either no or nominal additional payment.

            However, the U.C.C. complicates the issue of whether a lease is a true lease or security interest by providing that the agreement is not a security interest just because these factors exist: (1) the present value of the amount the Lessee must pay under the lease is substantially equal to or greater than the fair market value (FMV) of the equipment; (2) Lessee assumes risk of loss; (3) Lessee pays taxes, insurance, filing and recording fees and/or maintenance costs; (4) Lessee has option to renew lease or purchase equipment, even if for fixed rental equal to or greater than predictable FMV of equipment at the time of renewal or purchase.

 Consequences of True Lease Versus Security Agreement

            The equipment lease that is actually a security agreement is the equivalent of a loan. Therefore, it is subject to the usury statutes under state law. These laws limit the amount of interest that the Lessor can charge if the Lessee defaults in payment. The true lease is not subject to these rules.

            If Joseph decides on a true lease, he can set the interest rate at whatever figure he and the Lessee can agree upon. Another option would be for Joseph to refrain from giving a precise interest rate but state it as “the maximum rate allowed by law.” In that case, he can charge up to 18% annual interest. This is the rate allowed prejudgment and post-judgment when a court enters judgment in a litigated case under the Texas Finance Code §§304.002 and 304.003. 

            If Joseph decides to use the security interest type equipment lease, he will need to consult an attorney to make certain that the amount of interest charged does not violate any usury laws. Interest rates charged over certain amounts can even lead to criminal charges. The amount of interest allowed can differ in accordance with the amount of the loan. Higher amounts require lower interest rates than lower amounts.

Leasing Equipment an Attractive Option for Retirees When Care is Taken

            The leasing of equipment may offer an attractive option for retirees to produce added monthly income if care is taken in creating the lease. In addition to the issues outlined above, the creation of a lease must deal with who is response for repair and maintenance, liability, insurance and what happens in case of default. It is folly for an individual to prepare an equipment lease on his or her own or to use a generic form downloaded from the internet. The retiree considering a lease arrangement for equipment should consult a knowledgeable attorney to assist in the process.  

 Sandra W. Reed is an attorney with Katten & Benson, an Elder Law firm in Fort Worth. She lives in beautiful Somervell County, near Chalk Mountain.