Be Careful How You Draft Them
If it's not set up carefully, a lease/purchase program can jeopardize the delicate balance between independent contractor and employee.
Patricia Smith
Senior Editor
Truck lease/purchase programs have become a popular offering for carriers trying to recruit owner-operators. If structured right, they can provide a good start for company drivers who want to take a first step to independence. They can also be a way for carriers to help cash-strapped owner-operators get into new equipment. They may even provide balance sheet and income benefits for the carriers themselves.
But owner-operator lease programs are not without risks, warns Dan Barney of Scopelitis, Garvin, Light & Hanson. For one thing, carrier-sponsored lease programs often attract individuals with minimal financial management experience or skill. If they have financial problems going in, they're likely to get much worse unless the carrier - or its leasing arm - is willing to nurture lessees through those first difficult months.
If not set up carefully, a lease/purchase program can jeopardize the delicate balance between independent contractor and employee - at least in the eyes of federal and state tax authorities.
Last but hardly least, lease/purchase programs over the past few years have been frequent targets of lawsuits claiming violations of federal leasing rules.
In Part Two of a three-part teleconference series on owner-operator issues sponsored by the Truckload Carrier Assn., Barney offered some advice regarding lease/purchase agreements and escrow funds. Following are some highlights.
FEDERAL LEASING REGULATIONS
In order to help shield the trucking operation from liability issues, it's wise to establish a separate entity to offer and administer equipment lease/purchase programs.
However, the courts have recently held non-carrier equipment affiliates to the same federal leasing regulations as carriers themselves (49 CFR Part 376). Thus if you want to avoid a lawsuit, independent contractor operating agreements and equipment lease/purchase agreements should follow those rules "to the letter."
CHARGES AND DEDUCTIONS
Any charge-backs or deductions from settlements related to the equipment lease must be clearly specified in the contract, including the method of computation. Barney said it's important to make clear, in the leasing agreement, that the lessee will be footing the bill for normal vehicle operating expenses, such as licenses, permits, maintenance and repairs. Otherwise, lessees may claim they thought those costs would be included in lease payments. Documentation of owner-operator financial obligations can also come in handy if their independent contractor status is questioned.
Barney said computations can be treated generically. For instance, you can generally indicate if you will or won't add a mark-up or administrative fee to charge-back items. Or the contract can specify which items will carry the extra charges. The contract should also address discounts, refunds or rebates you'll get as a result of contractor participation in a program. Will they be passed on to the contractors or retained by you?
Federal leasing regulations require that owner-operators be "afforded" copies of documents necessary to determine the validity of charges. Some argue that this means every charge-back item should be accompanied with a receipt or other proof of the expense. But Barney said the common understanding of "afforded" is that the documents will be provided at the owner-operator's request - and this has been affirmed in at least one court case.
Any changes in charge-back items should be documented with an addendum signed by both parties. Alternatively, you can use a "negative option" approach, notifying the lessee of a change and give them 30 days to respond before the change goes into effect. If you use the latter approach, lessees must have the option to terminate the lease if they are not willing to go along with the change.
MAINTENANCE AND REPAIRS
Lessees should inspect the vehicle before taking delivery and certify - in writing - that it meets minimum guidelines regarding condition of the equipment set forth in an addendum to the lease. Similar guidelines should be established for when the vehicle is returned.
The lease should set forth who will be responsible for maintenance and repairs. Barney suggested an addendum listing service items and required maintenance intervals. He also urged carriers to pass any warranty benefits to the owner-operators and to specify this in the lease.
"It's important to show fairness," he explained.
Escrow Funds
Several lawsuits have centered on escrow funds. More specifically, owner-operators have charged that carriers violated federal leasing rules by not returning unused funds within the required 45 days after termination of the contract. In many cases, they also charge that carriers deducted charges that were not specified in the contract.
Barney said contracts must list specific items to which the reserve funds will be applied. Wording such as "any amounts owed by contractor" is too general, he argued. "You need to be specific, but you need to have some flexibility." For example, you might specify sets of purposes for which reserves can be spent such as major maintenance items. He also cautioned against using the term "maintenance fund" because it's too specific.
The lessor must be given an accounting of reserve funds with each settlement or at least once a month, but the lessee may demand an accounting of transactions involving the escrow or reserve fund "at any time." Interest must be paid on escrow funds at least every quarter using a rate that can't be lower than the rate on 90-day Treasury Bills. Any unused funds, along with a full accounting, must be made within 45 days of termination of the contract.
The final accounting can include deductions for expenditures made in conjunction with termination of the vehicle lease. Examples: repairs needed to bring the vehicle back to pre-established minimum conditions, expenses involved in repossession of the truck and return it to the location specified in the lease, replacement of missing parts or accessories, and the cost of re-leasing the truck to another contractor.
However, there's a time limit on expenditures. For instance, the contract might specify that the lessee will pay rents until the truck can be re-leased if the contract is terminated early, but only rent for the current period can be deducted from the reserve.
INSURANCE
Barney recommended an insurance schedule as an addendum to the lease agreement specifying the lessee's insurance obligations. Care should be taken to make sure obligations and required coverage complies with federal leasing regulations and with any applicable state laws.
The carrier or leasing company can make insurance available to contractors leasing equipment, but it must be an option not a requirement. Barney suggested an addendum outlining the type of vehicle-related insurance offered with a space where lessees can indicate whether they accept or decline each type of coverage.
"It's a way to protect yourself from charges that you forced lessees to obtain insurance directly from you, which would be a violation of leasing regulations," he explained.
If insurance is provided through the leasing company or carrier, costs or charge-backs must be clearly specified in the contract. Barney said it's alright to add an administrative fee but the amount or the method of calculation must be disclosed. Alternatively, the agreement can specify an overall amount and indicate that it includes an administrative fee.
Any changes in costs or coverage should be done with an addendum signed by both parties, or with the previously discussed "negative option" approach. A lessee that buys insurance through the leasing company or carrier must receive a certificate of insurance. A new certificate should be issued whenever there's a change in premiums or coverage. Copies of the actual policy must be available on request.
If lessees buy insurance elsewhere, the leasing company or leasing carrier should be given proof of coverage. You can set standards regarding the quality of insurance, such as a minimum financial rating for the insurance company. You should require written notice at least 30 days in advance of cancellation and the leasing company or leasing carrier should be listed on the policy as an additional insured.
SUBLEASE
Many years ago, the Interstate Commerce Commission ruled that a carrier wasn't violating federal leasing regulations by prohibiting its lessees from subleasing to other carriers. But leases that bind owner-operators to affiliated carriers may open the door for lawsuits, or may jeopardize independent contractor status, Barney warned.
"My advice generally is to allow subleasing," he said, but with restrictions. For instance, the lease might require prior approval of the new operating agreement by the leasing entity. It might dictate that the new carrier meet specified minimum safety standards. It might even require that the new carrier meet certain financial standards in order to help assure that the lessee will be able to continue making lease payments. The leasing entity may even charge a fee for review of the new operating arrangement, if the fee is clearly specified in the lease contract.
Audio tapes of the conference, along with handout materials, can be ordered through the "products" section of www.truckload.org or by calling (800) 775-7654.
Ask for "Lease-Purchase Agreements and Escrow Funds." Part One of the series, "Charge-Backs, Fuel and Compensation" is also available. Part Three, "Insurance and Indemnification" will be held Nov. 19. For details, contact Virginia DeRoze at (703) 838-1950.
