When a Good Lease Goes Bad: What Should You Do?
Lessee Defaults: An Outline for Action

By:William L. (Bill) Phillips, III

I. PREPARATION:

A. Review your documentation.

1. Verify that your file is complete with original, signed documents.

2. Verify that you are in the lien position that you expect and that you have properly perfected the lien under the UCC or that you have the Certificate of Title on titled collateral. You do not want to repossess collateral only to realize later that you can’t sell it or all of the proceeds should go to another creditor.

If you do not have a “clean” file your counsel may advise that you hold off on calling the default until you can get better documentation.

3. Check your remedies section of the lease. Know your options for collection and how to calculate the damages on default.

4. What does the lease say about notices? Make sure that you comply with these requirements and keep copies of any notice or other correspondence to or from the lessor.

5. Are there any guarantors? Have the guarantors pledged collateral?

The financial strength of the guarantor and value of any guarantor collateral may be the most important factors in deciding how to proceed.

B. Confirm there is a default.

1. Is there a dispute about application of payments or any other aspect of the lessee’s performance?

You may choose not to call a default that is not a clear violation of the contract to avoid possible lessee claims. You may also decide to file suit for possession of the collateral rather that using self-help repossession which could subject you to a claim for conversion of the property.

2. Check for non-monetary lessee defaults such as insurance lapse or unauthorized use or relocation of the collateral.

C. Check the collateral.

1. Where is it located?

2. When was the collateral last appraised or inspected? Do you know whether it has substantial value?

3. Is the collateral insured? Does the lessee have liability coverage if the collateral is in use?

4. What are the costs of repossessing and remarketing the collateral?

The answers to these and other collateral-related questions may determine whether you repossess the collateral or try to work out the default with the lessee.

D. Is the lease a consumer or non-consumer transaction?

1. If consumer: Consumer lease defaults can be tricky and require legal advice at an early stage.

2. If you believe it to be a non-consumer lease: Check to be sure: is proper language in the lease? Do you know how the lessee is using the equipment?

E. Is it a true lease or lease-purchase?

Your lawyer will need this information and it can be important in the event of a lessee bankruptcy.

F. Check on the lessee’s financial health.

If the lessee is likely to declare bankruptcy or hide/damage the collateral you may want to consider repossessing valuable collateral as soon as possible after any required notice of default and cure period.

G. Broker/Assignor Liability.

Review the broker agreement or assignment agreement to determine if the transaction was on a recourse basis or if the broker/assignor has breached any representation or condition that would enable you to require the broker/assignor to repurchase the lease.

II. ACTION:

A. Default Notice. Send default notice to lessees and guarantors including acceleration of debt. [Do you have a form of default notice that has been approved by counsel?]

B. Repossession:

1. Self-help repossession: Under Article 2- §2A-525 and Article 9 §9-609 a creditor may take possession of collateral. However you cannot do so if in repossessing the collateral you “breach the peace”.

2. Repossession sale. The sale can be a public or private sale. You must provide notice to the lessee and any other lienholders. Review your contract and the UCC for details. Be mindful that some contracts purport to give lessors/lenders greater rights than allowed under the UCC or other applicable law.

C. When to involve your lawyer

1. You can’t repossess the collateral without “breaching the peace”:
If you cannot repossess the collateral or cannot do so without breaching the peace, you will need to file suit for possession of the collateral. Under certain circumstances you will also have the remedy of court assisted repossession of the collateral before a judgment is entered.

2. Bankruptcy: Stop all normal collection action against party filing bankruptcy and participate in the bankruptcy case. Consider having your lawyer file, as appropriate, one or more of the following: Proof of Claim, Objection to Confirmation, Motion to Assume or Reject Lease and Motion for Relief from Automatic Stay. However, unless the debt is a consumer debt and the lessee is in chapter 13, you may still pursue collection from guarantors or co-debtors.

3. When you are ready to file suit against lessees and guarantors:

(a) Should you file suit?

(i) Is the lessee business still open? If it is a business entity and is closed with no assets, suit may not be productive.

(ii) Does the debtor have any assets or source of income?

(iii) Are there guarantors that may have assets or income?

(iv) What are the costs of filing suit, including attorney fees, court costs and other legal expenses, travel costs and lost productivity of your employees?

(v) Do you anticipate a counterclaim? Does it have merit?

(b) Preparing for Litigation.

(i) Compile all transaction documents, correspondence, notes and other records related to the transaction.

(ii) Take precautions to insure that electronic records related to the transaction will not be deleted.

(iii) Notify any collectors, account representatives or salespersons that may be negotiating with the lessees that you are about to file suit.

(c) When to file.

Once you have decided to that you cannot collect the debt without filing suit, the sooner you file suit, the better. If you delay, you will need to be aware of the statute of limitations for the state where you file suit. Generally speaking, the older the delinquency, the more difficult it is to collect.

(d) Where to file.

(i) Review the lease to determine if there is a forum selection clause. Is the forum provision mandatory for the lessor or do you have discretion.

(ii) If you have a forum clause that allows you to sue in your home state you should consider whether you want to do so and then domesticate the judgment in the lessee’s state or do you just want to file the suit in the lessee’s home state? The lessee is less likely to file an Answer or Counterclaim in your home state. However, a lawsuit in the lessee’s home state could be quicker and cheaper if you anticipate a default judgment.

(iii) If you do not have a forum selection clause, consult with your lawyer to discuss where you should file suit.

(iv) If the lease is a consumer debt the Fair Debt Collection Practices Act limits you to filing suit where the lessee signed the lease, where the lessee resides or where the real estate is located if you are enforcing an interest in real estate.

(e) Choosing a lawyer.

It is important to choose a lawyer that understands your case and can handle it most efficiently. Such a lawyer will have extensive knowledge of leasing law, creditor’s rights and commercial litigation. Lease Enforcement Attorney Network (LEAN) is a great recourse to find such lawyers.

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William L. (Bill) Phillips, III concentrates in the areas of equipment finance, creditors’ rights, real estate and bankruptcy law. Bill has been practicing law for fifteen years and is now with Marks and Weinberg, P.C. in Birmingham, Alabama. See www.leaselawyer.com for more information on this and other leasing related topics.

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