A business leases may not be a true lease but rather recharacterized as a secured purchase, giving you significant power over the creditor.
Our blog post a week ago was titled “Leases that Are Actually Secured Purchases.” Sometimes a transaction labeled a lease is legally not truly a lease but is really a disguised purchase. Leases give the lessor/creditor a lot of leverage over you, the lessee/debtor. If you can persuade your bankruptcy court to recharacterize the “lease” as a secured purchase, you are usually in a much better position.
Last week’s post reviewed this from a consumer perspective. Today’s focus is on business leases, using an equipment lease as an example.
Disadvantages of True Leases in Bankruptcy
As a lessee, such as on a business equipment lease, very soon after filing bankruptcy you must choose between “assuming” or “rejecting” the lease. You “reject” the lease if you are not keeping the leased equipment. If you want to keep the equipment, you “assume” the lease.
That comes with the following disadvantages.
- If the lease has below-market payments, the bankruptcy trustee may “assume” the lease ahead of you. The trustee does this to sell the lease rights to another party and then pay the proceeds to your creditors. So you could lose equipment you need to operate your business.
- If you were behind on your lease payments when filing the bankruptcy case, you must cure any missed payments quickly.
- If you fell behind after filing bankruptcy while deciding whether to assume the lease, you have to catch up on those as well.
- You have to make the full regular lease payments going forward, with no break in price.
- At the end of the lease you return the leased equipment. That’s true unless the agreement allows you to renew the lease or to purchase the equipment. You’re stuck with whatever the lease provides.
In contrast, if the equipment lease is recharacterized as a disguised purchase:
- A trustee may under limited circumstances have some say about keeping the equipment. But generally, if your business needs the equipment and you meet some basic requirement, the trustee can’t take it away from you.
- If you qualify for “cramdown,” you don’t have to pay any missed payments. As long as you entered into the transaction more than a year ago, and the equipment is now worth less than the remaining balance, you qualify for “cramdown.”
- With “cramdown,” your monthly payment is reduced, as well as the total you pay for the equipment. The balance owed is divided between secured and unsecured portions. The secured portion matches the amount of the value of the equipment. The unsecured portion is the rest, the portion not covered by the equipment’s value. The monthly payments are reduced because they are based on only the secured portion. They are also often stretched over a longer period, possibly at a lower interest rate. You pay the unsecured portion only to the extent that you have available funds to do so.
- At the end of the payment period, you own the equipment free and clear.
Our next blog post will get into the special business-oriented factors the bankruptcy courts use to determine whether a lease is a true lease and so deserves the benefits that gives to the lessor.