Navigating an Equipment Lease Agreement

Navigating an Equipment Lease Agreement

by Belle Wong, J.D., January 2019

One potential consequence of the growth of a small business is the need for new or upgraded equipment. However, purchasing such equipment may not be the best alternative as the capital required to do so might be put to better use elsewhere. In many cases, the rental of any required equipment can often be a better option.

The Basics of a Commercial Equipment Lease Agreement

It's important to carefully review the terms of the equipment lease agreement you sign, regardless of whether it's a simple equipment lease agreement, a standard-form contract, or a more specific type of rental lease, such as a heavy equipment agreement.

The basics of any commercial equipment rental lease are as follows:

  • The party that owns the equipment is known as the lessor.
  • The party leasing the equipment is called the lessee.
  • The lessor gives the lessee the right to use its property for a set amount of time.
  • In exchange for this right to use the property, the lessee must make regular rental payments to the lessor.

Specific Equipment Rental Terms and Conditions

Even though most rental companies use a standard equipment lease agreement, you should still carefully review the document's terms and conditions. If there are any clauses in the agreement that you're concerned about, you may be able to negotiate better terms for yourself.

Important terms and conditions in any equipment rental contract include the following:

  • The lease of the equipment and the term of the lease. This identifies the equipment to be rented and the time period during which the lessee will lease the equipment from the lessor.
  • Rental payments. The amount the lessee is required to pay each month and the due date should be clearly stated.
  • Ownership of the equipment. This provision states that the equipment belongs to the lessor, even if it is installed on the lessee's property. Legal ownership of the equipment is not transferred from the lessor to the lessee. The exception to this is a lease-to-own agreement, which is described in more detail below.
  • Lessee's responsibilities. These often include the equipment's care and maintenance and its proper use.
  • Lessor's representations and warranties. The lessor sets out what they promise under the lease. For example, a typical clause in this section is the lessor's warranty that they own the equipment in question and have the right to lease it.
  • Lessee's representations and warranties. A common clause in this section is a statement that the lessee finds the equipment being rented to be in good condition, that she wants to rent the equipment, and that she will use it in her business.
  • Insurance. The lease may state that the lessee is responsible for obtaining insurance on the equipment, even if the lessor already has coverage. Most lease documents state that the lessee's insurance will provide the main coverage for the equipment. The lessor might also require the lessee to provide proof of the coverage obtained.
  • Liability. This section deals with the lessee's liability if the equipment being leased is lost, stolen, or damaged while in the lessee's care. For example, the lessee might be required to pay the lessor the fair market value of any equipment that has been damaged. Alternately, the section might state that the lessee is required to pay a portion of the original cost of the equipment plus any additional rental payments owing for the remainder of the term of the lease.
  • Default. "Events of default" describe any actions by the lessee that are viewed as breaking the lease agreement. This section also outlines the consequences of default and the rights of the lessor if default occurs.
  • Return of the equipment. When the term of the lease expires, the lessee has to return the equipment, unless the lease is renewed.
  • Description of the equipment being leased. Usually titled "Exhibit A," this section includes a detailed description of the equipment, including any serial and model numbers.

Optional Lease Agreement Provisions

In addition to the standard conditions contained in most equipment lease agreements, you may find some optional provisions, including:

  • Security deposit. Under this option, the lessee is required to pay a security deposit, which is then returned at the end of the lease, provided that the rental equipment is returned to the lessor in good condition.
  • Indemnity. The lessee promises to indemnify the lessor, or pay back any costs the lessor might incur as a result of the lessee's use of the leased equipment. For example, if the lessee damages the equipment, they would be responsible for the lessor's repair costs.
  • Right of inspection. The lessor usually has the right to inspect its equipment during normal business hours, although some leases might require the lessor to provide the lessee with a minimum period of notice.
  • Option to renew. At the end of the lease, the lessee is provided with the option to extend the lease terms.
  • Option to purchase. At the end of the lease, the lessee has the option to purchase the leased equipment, usually for its fair market value.

Lease-to-Own Agreement

In a lease-to-own agreement, also known as a capital lease, title to the leased property is transferred to the lessee at the end of the lease term. Such leases are actually an alternate way of financing the purchase of equipment, which means lease payments in such agreements are higher than in a standard equipment rental agreement because they factor in the eventual transfer of ownership to the lessee.

From an accounting perspective, the distinction between a lease-to-own agreement and a regular lease has particular significance because the lessee can claim the tax advantages of owning the leased equipment, such as depreciation.

Equipment rentals are often a good option for a small business in need of upgraded equipment or new equipment to handle an expansion of its services. Before you sign an equipment rental agreement, a thorough review of the document will give you a better understanding of your rights and responsibilities.