Watch Out For Equipment Leases (Your Risk is in The Fine Print)

We have clients who lease medical equipment without having the lease reviewed by an attorney until a problem occurs after the lease is signed. This is problematic for the lessee (the person who rents) because leases are contracts that should be treated as legally enforceable. To avoid unnecessary expense and frustration we would like to offer our clients the following.

Business owners, including medical practices, often choose to enter into equipment leases rather than purchase for a variety of reasons. Under a lease, the lessor continues to own the equipment while the lessee is only using the equipment during the term of the lease. Therefore, if the lease agreement is drafted properly, the lessee does not have the liabilities of an owner of the equipment. When considering when to enter into an equipment lease, businesses should attempt to protect themselves from legal pitfalls which can be very expensive and frustrating.

Leases allow businesses to obtain needed and often expensive equipment without borrowing money from a traditional lender which can require pledging collateral for the loan as well as alleviate repair costs, provide for upgrades as a part of the lease and, if provided for under the terms of the lease, allow the lessee to return equipment that it is no longer in need of at the end of the lease term.

Although there are many benefits to leasing equipment, equipment leases can contain unforeseen or unrecognized risks to the lessee. For instance, in some leases, lease payments do not stop for any reason, even if the equipment is not functioning properly. Some leases cannot be cancelled during their term for any reason, including whether the equipment is not performing as promised. Prohibiting a lessee from terminating the lease for any reason is common because the lessor is using the equipment as security for a loan and is depending on the lease payments to make its payments to a lender.

Many times, warranty provisions limit the remedies a lessee may have if the equipment does not function as represented and the lease may entirely “disclaim” warranties which may include what is known as the “warranty of merchantability” or “fitness for a particular purpose”. Although these disclaimers are most applicable to equipment purchases, many lessors insert these terms into their leases to avoid the loss of rents when equipment does not function as represented.  To assure that the equipment performs as represented, the lease agreement should state that the lease term commences when the lessee determines that the equipment is fully installed and operating properly. Lessees should be careful not to take the lessor’s word that the equipment is installed and operable.

Lessees should avoid lease terms that release lessors from liability if the use of the equipment leads to an adverse event, such as an injury to the lessee or a third party (e.g., a patient), and which is caused by the equipment at no fault of the lessee.

Lessees should carefully review the termination language. Some equipment leases have “evergreen” clauses which means that the lease will continue after the termination date unless the lessee gives the lessor notice that it wishes to terminate the lease. Equipment leases should terminate on a specific date but should also, for the benefit of the lessee, give the lessee the option to extend the lease for another period, generally and preferably one year.

The lease should state that, at the end of the lease, the lessor should remove the equipment (or if appropriate and practicable the lessee should return the equipment) at the expense of the lessor.

In equipment leases that provide for a purchase option, excessive costs for the disabling and returning of equipment could force a lessee to purchase unwanted or unneeded equipment rather than just return it at the end of the lease.  If the lease provides for a purchase option at the end of the lease, the purchase price, or at least a formula for determining the purchase price, should be set forth in the lease.

In addition to the business terms in a lease such as those described above, medical professionals should always keep in mind the legal requirements when the lessor and/or lessee is a provider of designated health services (DHS) as defined by the Stark Law. Those situations are most common where the lessor is a physician and the lessee is a hospital, or vice versa and the physician and hospital refer to patients to each other for DHS, the payment for which will be by a government payor such as Medicare or Medicaid. In those cases, equipment leases, like leases for office space, must comply with certain Stark requirements to avoid noncompliance and potential repayment issues. Those requirements include:

• The lease agreement must be in writing, signed by the parties and specific as to the equipment covered by the lease.
• The equipment leased does not exceed that which is reasonable and necessary for the legitimate purpose of the lease and the equipment is not used by or shared with the lessor.
• The lease is for a period of at least one year, and if terminated before the end of the first year of the lease, the parties cannot enter into another lease.
• The lease amount is set in advance, is consistent with fair market value and does not take into advance the volume or value of referrals.
• The lease would be commercially reasonable even if no referrals were made between the parties.

Although equipment leases create an opportunity for a business, including medical practices, to obtain expensive equipment without the risks of ownership, it is important that lease agreements not be signed blindly and that lessees know what they are signing and either attempt to renegotiate unfavorable terms or pass on leases that create unacceptable risks.

For further information contact us.