Typical Lease Financing Structure
The lease purchase agreement (LPA) is entered into between the municipality, as lessee, and a lender or other lessor. Under the LPA, the lessor leases the equipment to the lessee, and the lessee rents, leases and hires the equipment from the lessor. The term of the LPA is for one year and is subject to renewal and appropriation by the lessee. In some jurisdictions, a built-in evergreen provision might be added to provide for automatic renewals of the IPA unless the lessee takes action to “not” appropriate.
The lessee, on behalf of the lessor, orders the equipment and installs the equipment, and only then leases the equipment.
Under the IPA, the lessee promises to make rental payments only to the extent appropriated therefore. In the event of a nonappropriation, the IPA is deemed terminated, and the lessee is required to deliver the equipment to the lessor.
Upon acceptance of the equipment by the lessee, title to the equipment and any and all additions, repairs, replacements or modifications will vest in the lessor, subject to the lessee’s rights under the IPA. The lessee has no right, title or interest in the equipment except its leasehold interest therein.
The lessee commonly has a purchase option under which it may be allowed to purchase the equipment from the lessor.
Typical Installment Purchase Agreement Structure
The installment purchase agreement (IPA) is entered into between the municipality, as borrower, and the lender. Under the IPA, the lender makes a loan to the municipality. Usually, the loan proceeds are deposited to an escrow fund. The municipality, with the consent of the lender, may make a draw from the escrow fund from time to time to use the loan proceeds to purchase the equipment (or energy conservation measures). The lender does not operate, control or have “possession” of such equipment or measures. The municipality is responsible for selecting the equipment and using, maintaining, operating and storing the equipment.
In the IPA, the municipality promises to make loan payments to the lender during the loan term, usually based on a payment schedule attached to the IPA. A portion of the loan payment is separately identified as the interest component, which is eligible for tax-exempt treatment. The lender may assign the loan payments to another person.
During the loan term, legal title to and “ownership” (vs. possession) of all equipment and any and all repairs, replacements, substitutions and modifications thereto is in the lender, and the municipality must take all actions necessary to vest such title and ownership in the lender. For instance, the municipality may need to mark or otherwise label the equipment to identify the lender as the owner. Upon termination of the loan by prepayment in full by the municipality or through payment by the municipality of all loan payments and other amounts relating thereto, the lender must convey its ownership interest in the equipment thereby terminating the lender’s ownership of the equipment.
The municipality may permit the lender to file financing statements and amendments thereto describing the equipment in order to evidence the lender’s ownership interests in the equipment. Such financing statements should reflect the lender’s legal title to the equipment and be designated as “filed for notice purposes only.”
Upon failure by the municipality to pay, the lender may declare the outstanding balance immediately due and payable and may be able to enter the municipality’s premises to disable the equipment or retrieve the equipment.
In certain states, depending on state law and other pertinent circumstances, it may not be possible to structure an IPA as an annually appropriated financing that would not be considered a multiple fiscal year debt of the municipality.
What’s the Difference Between an LPA and IPA?
There isn’t really a difference. The LPA may be more acceptable in certain jurisdictions in which there is an express prohibition of multiple fiscal year obligations. The lease, as such, is more easily understood as a structure that provides for annual renewals. Unlike the IPA structure where the municipality is considered the borrower of the loan, the LPA refers to the municipality merely as lessee, and there is no “loan” – instead, the lessee purchases the equipment on behalf of the lessor, and then leases the equipment. In some jurisdictions, these distinctions may not matter. In others, they are significant reasons for why the lease structure is preferred.
It is questionable whether a “true lease” can be structured as a tax-exempt obligation given the federal tax law requirement that the lessee build up equity in the leased property. See Rev. Rul. 55-540 and PLRs 8235056 and 8347058. See discussion in Bond Attorneys Workshop materials from 2008.
True lease vs. financing lease? See “When Is a Lease Not a Lease? Seventh Circuit Adopts ‘Substance Over’ Form Test for True Lease Determination,” David A. Hatch and Mark G. Douglas, Jones Day, available online.