The Potential Problems You Can Encounter At The End Of A Lease Agreement:
Whilst the benefits of lease agreements for lessees are numerous, the leasing industry hasn’t grown without there being plenty of benefits for the many lease providers available to choose from.
Whilst the lease agreement termly payments, and the turn on money built into them, are enticing enough for a lender to become a lease vendor and a great way to generate capital on a portfolio of marketable assets, other opportunities have been created as the industry has matured over the years.
To illustrate, if there were only two lease providers in one market and they had the same asset available for businesses to lease, whichever provider could survive on the lowest margin would win all the business.
At least that is until the second provider starts lowering their monthly payment terms in order to pinch enough business to stay operating. But, rather than run at a loss, the second provider then installs terms and conditions that mean, when all's said and done, and the agreement comes to an end, they have recouped their desired profit margins or perhaps even more.
These end of lease charges and fees, sometimes viewed as penalties are what put off many individuals and businesses from utilising lease agreements to acquire their assets.
Here’s an explanation of the most typical end of lease issues you need to avoid and an explanation of how to do so.
Penalty Fares & Payments
As the simple example above aims to show, the more favourable your monthly payment terms are the more likely it is that the penalty payments and potential extra charges will be less favourable.
For something such as leased company vehicles, a cheaper provider will likely be less forgiving when it comes to delayed payments due to cash flow issues or will demand tighter payment terms in the first instance.
Like most things in life, it’s fair to say you get what you pay for when it comes to quality of service from a lease provider. And that goes for the quality of the asset itself too: you wouldn’t expect to be able to lease your sales rep a Lamborghini for the same price as a Hyundai and not get caught out with some rather unfair penalty charges.
Whilst penalty payments incurred from late payments are to be expected and only fair, some providers might at least offer sliding scales of charges depending on the length of delay. Others do not.
The amount needed to meet penalty charges at the end of an agreement is also potentially huge and problematic if you have a poorly negotiated agreement.
Asset Return Conditions Damages
The lessor needs to protect the future value of the asset they own whenever they form an agreement with a lessee. The worse the condition that the asset is returned in makes the chances of finding a new lessee more difficult. Of course, the lessor can spend money restoring the asset - but why should they?
The lessee is obligated to maintain the condition of the asset and meet any predetermined maintenance schedules. This means company cars need to be serviced and looked after (no more putting the muddy Labrador on the back seat, Paul) or any accidental damage repaired before lease termination.
Granted, if you are in a strong negotiating position because you have large purchasing power or a long-lasting working relationship with your provider, you may get more leeway and benefit of the doubt when it comes to the condition of the asset on return – but such reward for loyalty and buying power will only survive if both parties benefit from this.
Most companies aren’t that fortunate, however. And this is especially true with less favourable lease agreements, from the lessee’s point of view.
Final Payments And A Cash Flow Oversight
If your business has only a handful of lease agreements, it’s easy enough to account for any increased final payments in your cash flow schedule. But when your lease portfolio has been developed over years and there are plenty of other pressure points on the company cash flow - late client payments, unexpected spend on overheads, tax miscalculations, not meeting financial targets - it can be easy for final payment amounts to catch you out.
It’s not uncommon for lease agreements to have double final payment amounts. This is a way of presenting a more attractive regular payment amount as a sales tactic, but it’s also a great way of encouraging lessees to extend their agreement. Signing up for another few months probably isn’t a bad thing after all, right?
In the long run, however, this is more costly than budgeting for the increased final payment.
Diverting Management Attention
When lease agreements come to an end, this saps valuable management attention away from other issues in two key ways:
- The manager needs to source replacement lease agreements and likely needs to go through a whole tender process to do so. This means researching the market, finding and comparing different providers, then processing all the paperwork associated with creating the agreement.
- The manager will be focused on negotiating an improved position in light of penalty charges or auto-renewals. Whilst lessors will issue pre-noted charges and amounts, there are plenty of grey areas in lease agreements. This is especially so when it comes to what constitutes “fair wear and tear” or what is the real market value of the asset at the end of the agreement. Anything which is in any degree subjective is a potential negotiating point and a potential cost if not handled properly and promptly. Lessors are business savvy after all. And they haven’t got where they are today without making the best of any financial situation.
But both of these issues pull an employee away from other tasks.
Your company may find itself with limited options at the end of a lease agreement. In an ideal world, every lease agreement on your lease portfolio will give you the full range of options: everything from being able to activate a reduced rate second term or send the asset back, to being able to act as a sales agent on the lessor’s behalf and securing any profit from the sale above their agreed figure.
But we don’t operate in an ideal world. Agreements could have been formed in a rush. The end of the lease agreement can be of least importance when your team is on site and needs the newly leased equipment in order not to activate exorbitant liquidated damages owed to the client.
The irony is that you are then facing more charges at the end of the poorly negotiated agreement or have limited options with where you can go once the lease terminates.
Last, but certainly not least, is the all too common instance of assets and agreements being neglected. This can result in automatic renewal clauses being activated or penalties being incurred for not serving the required notice of your intentions with regard to the asset or for not returning the asset when promised.
Whilst those with a good working relationship between lessor and lessee will more than likely be notified of the upcoming lease termination, not all providers will do this.
After all is said and done, lessors need to make a living too. A few months of enhanced rate payments to keep hold of an asset for a while or a penalty charge here and there are how they may operate.
But how can you protect your exposure to all of these issues? Automated lease management software is the answer.
How Lease Management Software Works & How It Helps
Lease management software is a web-based, secure and largely automated computer programme. It allows you to centralise and store all of your lease portfolio information in one secure place and where all your employees who need to can access it.
This access is afforded to all your relevant accounts team members, when the time comes to conduct lease accounting, and to your operations teams who may need to check information within the agreements.
All of the above charges and end of lease problems can be alleviated by using a piece of lease management software.
Software such as LOIS, Innervision’s lease management tool, will analyse your lease agreement information - across your entire portfolio - and highlight any potential issues, such as notifying you which agreements are coming close to completion.
Because the tool is developed by experts within the leasing industry, it can even assess your lease portfolio - both automatically and individually - by experienced professionals pointing out agreements which could be improved upon. This will give you benchmark data to compare against, from across the entire leasing industry, and will result in a better negotiating position when it comes to renewing agreements or starting a new.
This tool saves you time and money and gives your management team more flexibility to concentrate only on the leases which need their attention. But they can do so from a stronger, more informed position than if they were managing your lease portfolio manually.
If you want to continue reading about how lease management software helps you - including when it comes to complying with IFRS 16, the biggest change to lease accounting standards in a generation - then press the button below to check out our Digitising Lease Management guide.