Escrow accounts have long been a part of municipal and tax-exempt leasing agreements, but they are rarely used in financing commercial equipment. Lessors should think about using an escrow structure if a difficult transaction needs to be completed. The advantages and varieties of transaction structures are covered in this article.
Escrow accounts have long been a part of municipal and tax-exempt leasing agreements, but they are rarely used in financing commercial equipment. This specific piece of documentation will outline the various traditional and cutting-edge escrow techniques utilized in municipal and commercial transactions.
Escrows can be used for both municipal and commercial customers in addition to the conventional equipment acquisition fund, which is typically used in municipal transactions, to safeguard the lessor's security interest, facilitate equipment installation, testing, and acquisitions over time, and secure a stream of payments or hold funds to pay for things like security deposits, repair and maintenance, insurance, and other pre-paid expenses.
Background
Three parties—the lessor, the lessee, and the escrow agent—have an enforceable contract known as an escrow agreement. The escrow agreement controls both the procedure and each party's rights and obligations. In the beginning, the escrow agreement specifies how much money has been placed as well as where and how it will be invested. It is crucial to confirm that the investment vehicle is regarded as a qualified investment under the lessee's bylaws as many towns have stringent investment regulations.
Any associated fees, such as investment management fees, depository fees, and the escrow agent's fee, to mention a few, should be specified in the escrow agreement as well.
It is also desirable for both parties for commercial lessees to choose an investment strategy that guarantees principle preservation. Otherwise, there might not be enough money available to pay for the equipment.
BENEFITS OF USING AN ESCROW ACCOUNT
The most obvious advantage of an escrow transaction for a tax-exempt or municipal customer is that it enables them to hold aside funds allocated for in one year to be used in another year or years. Many towns have rules stating that approved funds (or debt) must be spent by the end of a fiscal year or they cannot be utilized at all. If the municipality cannot use the funds, the funds or debt must be approved again in the next fiscal year.
For instance, if a municipality appropriates money to buy a fire vehicle in the first year but the truck isn't delivered by the end of the fiscal year, the municipality would have to reappropriate the money for the purchase in the second year.
In essence, the municipality would be denied the chance to spend those monies in the first fiscal year and would then be required to reapprove the amount the following year. The town accepts a budgeted debt for that fiscal year by entering into a finance agreement for the fire truck.
The municipality can close on the lease transaction in the current fiscal year by funding it through an escrow account, effectively using the approved funds for the lease agreement's objectives.
When the fire truck is prepared to be delivered to and accepted by the municipality, the lessor will then place the money in an escrow account, where it can be utilized to purchase the vehicle in any succeeding fiscal year.
Additional Opportunities
Escrow deals might give the lessor more chances to earn money from fees and interest. The leasing business will be charged an escrow management fee5 by the escrow agent to keep the escrow account, but this fee can be passed on to the lessee and may even be increased because the lessor spends a lot of time overseeing the escrow account and authorizing the disbursements.
Commercial Transactions
Escrows are typically utilized in business settings when acceptance requires delivery, installation, and/or testing. As a result, the transaction can be fully booked by the lessor and lessee, and the equipment vendor and lessee can take their time installing and thoroughly testing the equipment. This enables the finance to be in place. The lessee agrees to a final acceptance and the monies are transferred to the vendor once they are happy with the vendor's work and have had a chance to test and certify the performance of the equipment.
TYPES OF TRANSACTION STRUCTURES
Less Common Equipment
Although the equipment mentioned above is more frequent, employing an escrow transaction structure also makes it possible to lease less frequent equipment.
For instance, equipment that often requires a lengthy build-out time, such as energy-saving equipment or municipal facilities finance (real estate and construction financing combined), typically requires progress payments and the build-out phase can last for many years. The escrow account can be used to release the progress payments when they become due and payable.
Reimbursements
A municipality may use reimbursements received through the escrow process in one of two ways. A municipality may first ask for compensation for any equipment bought in advance of the financing agreement. To be permitted, however, the lessee must have a resolution in place stating that it wants to finance that particular piece of equipment. This kind of reimbursement procedure is typically employed when the lessee has an immediate need for the equipment but has not yet had a chance to look for financing for that equipment.
Net-Funded Escrow Accounts
A net-funded escrow account is a different style of lease structure that uses an escrow account. In a net-funded transaction, less money is put into the escrow account than the overall cost of the equipment. When the money is deposited, it is known when the equipment will be delivered.
The interest is calculated in conjunction with the escrow account so that it covers the discrepancy between the financed amount and the total equipment cost.
Vendor Payable Accounts
A vendor payable account is another kind of escrow account; it gets its name from the fact that money is paid directly to the vendor. The fact that a vendor payable account is a noninterest-bearing escrow account distinguishes this type of account from others. The full deposit sum is paid to the vendor upon the lessee's acceptance of the equipment because there is no interest. These kinds of accounts can be used for short-term escrows when only a few last tasks need to be finished before the equipment can be delivered.
Unique Credit Requirements
Equipment finance frequently has certain credit standards that can make it challenging to fund a transaction right away. There may be extra credit restrictions that prevent the money from being paid right away, even after the equipment has been delivered and installed. An increasingly frequent requirement of this kind is a visual inspection by an equipment manager or assessor, which frequently causes funding to be delayed by several days or more.
Security Deposits and Other Uses
Although the most typical escrow account used in the equipment finance and leasing business is the equipment acquisition fund, escrow accounts can also be used to hold monies set aside for other purposes. Escrow accounts can be used to hold security deposits at the start of a lease term. It is advantageous to place a security deposit in an escrow account so that a third party, rather than the lessor or lessee directly or solely, has authority over it.
CONCLUSION
Escrow accounts can be applied in a variety of ways during equipment leasing and financing transactions. Lessees and lessors should feel sure that fiduciary obligations will be fulfilled and that their money will be kept safe when working with a professional escrow agent. There will always be novel and creative ways for lessees and lessors to use escrow accounts in a volatile and changing environment.
The next time you have a difficult deal, think about if an escrow structure could assist you finish it.
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