IT Lease Agreements – 6 Key Issues to Consider

7 September 2018

Choosing to lease IT equipment allows your business to be agile when it comes to rapid changes in technology, while at the same time managing limited capex budgets. Other than the obvious advantage on the balance sheet, leasing IT equipment should create the opportunity for flexibility and lower levels of lock-in to a particular technology or strategy.

It should also enable efficiency by ensuring that equipment remains current and does not impact on productivity. In our experience, and having reviewed many finance agreements for our clients, we have learned that their structure and content often undermines the intended benefits. Consider carefully the following six areas when concluding IT Lease Agreements:

• Termination

• Additional Hidden Costs

• Interest

• Equipment Warranties and Indemnities

• Automatic Renewal

• Maintenance 

1. Termination

Flexibility is key to ensuring that a lessee can optimise the benefits of the lease agreement. Understandably, lessors may attempt to protect their revenue stream and limit the lessee’s ability to terminate early or in part. However, limiting termination in whole or in part also limits the lessee’s ability to scale their environment up and down according to strategic directives. When negotiating flexible termination provisions, and associated termination costs or discounts against applicable termination fees, the lessee should consider:

• the swap costs incurred by the lessor, 

• whether the lease is a full value or residual value lease, 

• the currency and projected useful life of the equipment, 

• the ability of the lessor to redeploy or re-sell the equipment, and 

• the potential double recovery of any costs.   

2. Additional Hidden Costs 

Leases can be peppered with additional costs that are not part of the monthly lease fees. These impact the lessee’s overall cost case. They may consist of costs automatically payable by the lessee, such as ad hoc “administration fees”, or they may be hidden costs that affect the lessee’s business case, for example:

• the cost of decommissioning and transporting lease equipment to any location designated by the lessor at the end of the lease, 

• sweep clauses obliging the lessor to be liable for refurbishment of the equipment at the end of term, 

• rights of the lessor to procure insurance for the equipment on behalf of the lessee, or

• loss or damage terms that amount to double recovery.

3. Interest

A lease agreement may state that interest is payable on late payments and this is often widely accepted. However, the values can often be excessive compared to industry standard and should be reviewed. A recommended starting point would be 2% above a retail bank’s base rate.

4. Warranties and Indemnities

As the lessor is the title holder of the equipment, it is also the beneficiary of any indemnities and warranties under the original agreement in terms of which the equipment was supplied to the lessor. However, to better protect itself, the lessee (as the user of the equipment) should try to ensure that these warranties and indemnities are capable of being passed through to it by the lessor. If not, the lessee will not be afforded any protection under the supplier’s intellectual property indemnity if the lessee’s use of that equipment is the subject of an intellectual property claim. 

The warranty on new equipment usually applies to the title holder of the equipment, namely the lessor (see the discussion on ‘hell or high water’ clauses below). That lessor will then usually have ‘remediation remedies’ against the supplier. These require the supplier to remedy anything that hinders effective use of the equipment. However, where the equipment has been leased to a third-party lessee, the lessor will not be the party facilitating the remediation of any equipment failures. This would fall to the lessee. For this reason, the lessee should ensure that it has the ability to invoke remediation under the warranty directly with the supplier, even though the lessor, and not the lessee, is the title holder of the equipment.  

5. Automatic Renewal 

Be cautious of automatic renewal terms, as these are often drafted in 12-month cycles with protracted termination periods. As with termination, the ability to renew a lease schedule should provide for partial renewal, particularly where the schedule contains a mix of new and used equipment. The lessee should have the right to terminate at any time, on notice, during the renewal period.

The rental payments during any renewal period will not necessarily continue at the same rate as the initial term. This is particularly relevant where the full capital value was financed over the term of the initial lease period. If the capital value has been fully recovered in the initial term, there should be significant reduction in the rental payments, after the initial lease period, based on the committed term of any renewal period. 

6. Maintenance

A lessee is usually obliged to maintain the equipment in accordance with the original manufacturer specifications. The lease may contain sweeping restrictions on the lessee or any third party “accessing, modifying or altering the equipment”. For ‘out of warranty’ equipment, ensure that these restrictions do not contradict the lessee’s ability to maintain (or to have a third party maintain) the equipment in accordance with the maintenance terms. If the lessee enters into bulk equipment lease schedules, the deployment of the equipment may not run concurrently with the lease payment terms. In that case, the lessee should ensure, where possible, that the warranty period on any equipment commences on the date of deployment, and not the date of delivery.

So-called “hell or high water” clauses should be considered carefully. These provide, expressly, that the lessee’s payment obligations remain enforceable regardless of whether the equipment is functional or allows ‘productive use’ by the lessee. Remediation remedies may exist, but the enforcement of any remediation against the supplier usually remains under the supply agreement - and not under the finance terms. This means that the payment of rental payments will continue in full, regardless of any dispute around performance of the equipment. To address this, where the supplier of the equipment is also the lessor, the lessee should ensure sufficient delineation of remedies between supply terms and lease terms to ensure that, if equipment fails, the ‘hell or high water’ clause does not compromise the lessee’s ability to call on a warranty or other remedy under the supply terms. 

In conclusion, regardless of the reasons for entering into an IT equipment lease, the lessee should ensure that the terms meet the strategic or business drivers promoting the requirement. A collaborative finance partner should be open to the requirements of their clients and solutioning a lease agreement that satisfies these requirements. 

by Lighthouse Law

The information and views contained in this article does not constitute legal advice. If you do require legal advice, please contact us on hello@lighthouse.law.