LEASING LAW By Barry Marks and Bill Phillips Due Diligence for Municipal Lessors Know Your Lessee, Your Equipment and Your State Law ESSORS engaged in leasing to city, county and state governments are well aware that one of the principal distinctions between this type of government leasing and traditional private company leasing is the non-appropriation clause. State laws and constitutions place strict limits on the incurrence of debt in most states. Generally, issuances of debt require voter approval and in some locations, the acquisition of goods or services through the issuance of public debt is subject to competitive bid laws. “Debt” for this purpose is a payment obligation that extends beyond the current fiscal year of the municipality. L In response, the municipal leasing industry (which is the term we will use to include leasing to governmental agencies and instrumental-ities generally, but excluding the federal government and its divisions) has developed leases that are terminable by the lessee annually. The most common of these structures are leases that contain non-appro-priation clauses. A typical non-appropriation clause provides that the lessee may terminate the lease at the end of any of its fiscal years if its governing body does not appropriate funds to pay the next year’s rents. Non-appropriation is distinguishable from an early termination clause seen in normal commercial lease contracts in several respects. Most notably, the clause does not, as a rule, provide any form of pen-alty for termination, such as payment of a termination value equal to discounted future rents, or require certifications as to the equipment being obsolete or uneconomical or that the lessee’s governing body has determined it surplus to the lessee’s needs. The lessee simply does not budget funds to pay rent, notifies the lessor and returns the equipment. In response to the obvious risk, creative lessor counsel have devel-oped language designed to ensure that the lessee is not acting arbitrarily or simply looking to arrange better financing. One such restriction is a good faith clause, requiring that the lessee make good faith efforts to secure appropriations permitting continued leasing. Another is for the lessee to certify that its present intention is to continue to appropriate funds to pay rentals for the full term of the lease. Some lessees are asked to represent that the equipment is not only currently essential to the les-see’s fulfillment of its governmental purpose and duties but also has been determined to continue to be essential in the remaining years of the lease. For many years, the most commonly used protection was a non-substitution clause. This clause provides that the lessee may not acquire equipment similar to the leased equipment within a stated period of time (often one year) after termination due to non-appropriation. In theory, a non-substitution clause addresses the temptation on the part of the lessee to terminate one lease and seek better terms for financing the same equipment from a competing lessor. While they may provide comfort, good faith clauses and other means of assuring the lessor that the lessee will at least attempt to se-cure funding are likely to run afoul of the argument that they interfere with the sovereignty of the municipality. This could render the clause unenforceable or, worse, indicate that the lease is actually debt. For example, the Texas Court of Appeals in City-County Waste Control Board v. Capital City Leasing 813 S.W.2d 705 (Tex. App.—Austin 1991) held that a requirement that the municipality seek in good faith to 34 NOVEMBER/DECEMBER 2015 EQUIPMENT LEASING & FINANCE MAGAZINE obtain appropriations for the lease for the entire term actually consti-tutes an obligation extending beyond one year. Consequently, the lease transaction was considered an unconstitutional debt. The non-substitution clause, in particular, has fallen out of favor fol-lowing adverse interpretation by state courts and attorneys general. As with other attempts to protect against non-appropriation, non-substi-tution clauses face the double risk of being unenforceable and nullifying the benefit of the non-appropriation clauses. The latter risk follows the lessee’s assurances that the equipment is, at least initially, essential: if essential equipment cannot be replaced for a given period of time, then the municipality cannot, as a practical matter, non-appropriate. See, for example, Frankenmuth v. Magaha 769 So.2d 1012 (Fla. 2000). Other State Laws Restricting Leasing Some states go further, actually showing hostility to municipal leasing altogether. For example, in South Carolina municipalities and school boards were using lease-purchase financing for major real estate expen-ditures to avoid the constitutional requirements of voter approval of debt. In response, the legislature passed a law that essentially categorizes many leases (even ones with non-appropriation clauses) as debt by adopting a broad definition of “financing agreement,” which effectively prohibits traditional lease financing (S.C. Code Ann. § 11-27-110). Other states require that leases be terminable not only for non-appropriation but for any reason that the government entities chooses. O.C.G.A. § 36-60-13 (2014) § 36-60-13. Multiyear lease, purchase, or lease-purchase contracts (a) Each county or municipality in this state shall be authorized to enter into multiyear lease, purchase, or lease-purchase contracts of all kinds for the acquisition of goods, materials, real and personal property, services, and supplies, provided that any such contract shall contain provisions for the following: (1) The contract shall terminate absolutely and without further obligation on the part of the county or municipality at the close of the calendar or fiscal year in which it was executed and at the close of each succeeding calendar or fiscal year for which it may be renewed as provided in this Code section; This Georgia statute not only seems to eliminate any requirement for the municipality to act in good faith to seek appropriations, it may be interpreted as requiring a separate right to terminate for convenience.