From the Editor

Business Trust Enhances Flexibility In True Lease Transaction Syndications

Use A Synthetic Lease To Finance Equipment Under A Local Government Tax Incentive Program

Maryland Exempts Equipment from UCC Recordation Tax

Banking and Commercial Financing and Equipment Finance Groups
Alan J. Mogol, Editor
410-347-7332
ajmogol@ober.com

Business Trust Enhances Flexibility In True Lease Transaction Syndications

How can a lessor syndicate a fractional interest in a true lease transaction? In many cases, lessors will either (a) leverage deals (by seeking non-recourse debt), or (b) hold individual items of equipment in individual schedules, which can be assigned to various lessors. What about the situation in which the lessor wants to syndicate the equity position, and the equipment is not easily divided among individual schedules? In recent years, more and more lessors have turned to the use of business trust arrangements as a tool for syndication of such transactions. A business trust arrangement can also avoid potentially significant expenses in syndicating the true lease of titled motor vehicles. Conveying ownership of titled vehicles often involves a significant administrative burden and may also involve a significant expense if the titling jurisdiction requires payment of a sales or excise tax in connection with retitling those vehicles.

The use of a business trust may present an answer to both problems by creating a flexible and useful tool for syndication of lease transactions.

What is a Business Trust?
A number of states, including Delaware and Maryland, have enacted statutes providing for the creation of an alternative form of business entity: a business trust. In practical terms, a business trust is a special purpose vehicle which allows maximum flexibility to the holders of beneficial interests.

Under the Delaware Business Trust Act (Act) a business trust is "an unincorporated association which (i) is created by a governing instrument under which property is or will be held, managed, administered, controlled, invested, reinvested and/or operated, or business or professional activities for profit are carried on or will be carried on, by a trustee or trustees for the benefit of such person or persons as are or may become entitled to a beneficial interest in the trust property...." Del. Code Ann. tit. 12, §3801(a).

Advantages
Bankruptcy Remote Characteristics - The Act provides that a business trust is a legal entity separate and distinct from its owners and managers, and the Act provides that the rules governing the internal affairs of the trust are those agreed to by the parties. This combination of provisions bolsters the separation between the trust and its originator and reduces the risk of a bankruptcy court consolidating the assets and liabilities of the trust and the originator.

Maximum Flexibility - The stated policy of the Act is to "give maximum effect to the principle of freedom of contract and to the enforceability of governing instruments," and the Act is specifi-cally designed to allow flexibility in certain key areas:

1. Control by Beneficiaries - Under common law, the exercise of too much control by the beneficiaries might cause the trust to be deemed an agent of the beneficiary (thus subjecting the beneficiary to potential liability for obligations of the trust, or permitting a creditor of the beneficiary to disregard the trust and reach its assets). The Act gives beneficiaries limited liability similar to that extended to stockholders of corporations, and the Act specifically provides that a beneficiary may control the trustee (or even act as a trustee) without running any risk of personal liability or any risk that its creditors could reach trust assets.
   
   
2. Trustee Liability - Under the Act, the duties and liabilities of the trustee are governed entirely by the terms of the trust agreement and related governing documents, and a trustee has no liability for good faith reliance on such provisions.
   
   
3. Sub-Trusts - A trust created under the Act may provide for the creation of a series of sub-trusts or series trusts, each of which will contain such assets as may be allocated to it. The key advantages are that (a) different sub-trusts may contain different assets and have different trustees and beneficiaries, (b) different sub-trusts may be subject to different rules regarding the rights, powers, and obligations of the trustees and beneficiaries, and (c) the assets contained in a particular sub-trust are insulated from exposure to claims against the general trust assets or other sub-trust assets.
   
   
4. Conformity to Tax Regulations - The Act permits the parties to determine tax allocation and to conform the governing documents to any applicable Internal Revenue Code provisions.

Ease of Creation - A trust may be created, with the full advantages of the Act, simply by filing a certificate of trust with the Delaware Secretary of State. Because the trust agreement itself is not required to be filed, the details of the transaction do not become a matter of public record.

Servicing the Transaction - The Delaware Act permits multiple trustees. One of the additional trustees may agree to provide all servicing requirements for the trust, including the administration of the lease transactions comprising the trust's assets. The leasing company which originates the lease transactions may serve as one of the trustees and may agree to service those transactions for the trust.

No Change in Title to Assets - It is possible to structure a transaction so that the equipment to be leased is initially acquired directly by the trust and then allocated, at the instruction of the initial beneficiary, into a sub-trust. Since legal title to the asset remains in the trust, there is no need to retitle the asset and there is no conveyance of title to the asset which could give rise to the potential imposition of a sales or excise tax. The beneficial ownership interest in the sub-trust may be conveyed by the initial beneficiary to the investor. As an asset of the sub-trust, the trustee holds legal title to that asset for the benefit of the beneficiary or beneficiaries of the sub-trust and, if the trust and sub-trust are structured appropriately for tax purposes, the beneficiary or beneficiaries of the sub-trust should be entitled to the tax benefits of ownership of the asset.

Perpetual Existence - Under the Act, except as provided in the trust agreement, a trust has perpetual existence and may not be terminated or revoked by a beneficiary or otherwise terminated by the death, dissolution, termination of existence, or bankruptcy of a beneficiary. As to each of these features, the general provisions of the Act may be specifically overridden by the terms of the trust agreement. For example, it may be essential, in order to address certain potentially adverse tax ramifications, that the trust not have perpetual existence or that a beneficiary have the right to terminate or revoke the trust or to withdraw its assets from the trust.

Disadvantages
Although there are obvious benefits to using a business trust, there are some potential disadvantages as well:

Costs - The Delaware Act requires that at least one trustee be a Delaware resident. This Delaware resident does not have to be a financial institution but general practice has been to designate a Delaware financial institution experienced in trust matters as the Delaware resident trustee. There may be one or more non-Delaware trustees appointed, as well. The expenses of the Delaware resident trustee, including its counsel fees, must be factored into the cost of the transaction as well as the cost of drafting and negotiating the governing documents (which may be similar to the cost of drafting and negotiating participation agreements or assignment agreements in other types of syndications).

Tax Ramifications - Parties often use trusts in an effort to create a mechanism for splitting the depreciation benefits of ownership of equipment among the various parties to a transaction. Although this is certainly permitted under Delaware trust law, the parties are not always successful under IRS guidelines. In a transaction in which individual beneficiaries hold beneficial ownership of assets under sub-trusts, where the individual beneficiaries are given the ability to take action against their individual sub-trust assets without regard to actions taken by the beneficiaries of other sub-trusts and have the right to terminate the sub-trust, the sub-trust should qualify as a grantor trust under the provisions of Sections 671 through 679 of the Internal Revenue Code, with each beneficiary treated for tax purposes as the owner of the assets included in its sub-trust. In a transaction in which either (1) the assets are not easily divisible and each of the beneficiaries of a sub-trust holds an undivided interest in the same trust assets, or (2) the beneficiaries of a sub-trust agree to act in concert with respect to disposition of the assets or directions to the trustee, or (3) a beneficiary of a sub-trust is not permitted to withdraw its assets from the trust or otherwise terminate the sub-trust with respect to the assets which it owns, there is a risk that the IRS would contend that the trust should be classified for tax purposes as a partnership. If the trust is treated as a partnership, it may have an initial taxable year of less than 12 months, with a resulting reduction of tax benefits for the investors.

How Would a Typical Transaction be Structured?
In a simple transaction, the lessor with the original beneficial interest in the transaction would create the trust and convey to the trust either (a) the lease assets and the lease agreement or schedules, or (b) the right to enter into the lease agreement or schedules and to acquire the equipment directly from the vendor. A Delaware trust company would act as the required Delaware trustee, and the original lessor would act as the administrative trustee to administer the lease. Depending upon the structure of the transaction, the original beneficiary would instruct the trustee to allocate assets to a sub-trust and then would transfer beneficial interests in the sub-trust to other investors. Under the trust agreement, the parties holding the beneficial interests in the particular sub-trust would agree to allocate tax benefits and liabilities among themselves on an agreed pro rata basis. The day-to-day administration of the lease would be handled by the administrative trustee, on behalf of the trust, subject to such restrictions as might be contained in the servicing agreement. Later, at the discretion of the original beneficiary (and subject to the applicable provisions of the trust agreement), the original beneficiary might contribute additional assets to the trust, to be syndicated in the same way.

Conclusion
A business trust can be a very useful tool for syndication of a lease transaction, and because of the success and popularity of the Delaware Business Trust Act, certain other states, including Maryland, have recently adopted similar statutes. Anyone considering the use of a business trust as a syndication tool should, however, discuss the potential costs and implications of using such a structure with its tax and legal advisors.

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