To finance a variety of governmental projects without incurring a “debt” or an “indebtedness” that is subject to the voter approval and debt limitation requirements contained in most state constitutions or otherwise required by statute;

To implement a flexible financing structure that best serves its’ particular needs and that is frequently not subject to certain restrictions that may be imposed under applicable law on other types of financing, such as public sale requirements;

To acquire all of the equipment that it presently needs and spread the cost of such equipment over time rather than basing the acquisition of equipment on the current year’s available revenue sources;

To take advantage of cost-effective financing for the acquisition of property over time rather than depleting existing and future cash reserves; or

To acquire essential equipment or fund capital projects that may be too expensive to purchase outright but that have a useful life to short to finance though long-term bond issues.

Lease-purchase financing represents a way for municipalities to conserve their cash and still acquire equipment or fund capital projects needed for governmental operations. There are laws in all 50 states which restrict the ability of municipalities to borrow money.  Conversely, there are very few restrictions on the ability of municipalities to enter into lease purchase agreements since they are not considered debt, and therefore not subject to the limitations placed on debt by state and local laws.  A municipal lease purchase represents a fiscal year-to-fiscal year commitment on the part of a municipality to make lease payments, and not a commitment to pay debt service.

A tax-exempt lease or lease-purchase agreement is an installment purchase, conditional sale or lease with an option to purchase for nominal value, usually $1.00. It is also referred to as a municipal lease.  It involves the purchase of an asset through periodic lease payments, which have principal and interest components. A tax-exempt lease allows a public organization to acquire an item of equipment or a group of equipment at relatively the same time. Tax-exempt leasing is a popular alternative to bond issues that provide a public organization with easy access to low-cost funds.

1. Equipment should be “capital” in nature whether expenditures for payments are made from an operating account or the capital account, and have a useful life at least as long as the financing term. For example, a year’s supply of printer toner cartridges for a network of computers might be material in cost but do not have a long enough life to qualify as a capital asset.

2. Equipment should be “repossessable”. Because lease obligations are not general obligations of the public organization, the lease payments are subject to annual appropriations. For this reason, the equipment should be of a nature where the possibility exists for the lender to “repossess” the equipment if the public organization doesn’t make the payments. For example, a photocopier can be financed; consulting fees can not.   This also means that certain elements which are pertinent to the installation and use of equipment (such as conduits, tubes, optic fibers, wires, etc.) are not suitable because they are likely to become fixtures and improvements to real property.  However, other components (such as switches, chassis, ports, memory, power supply, etc.) are suitable for lease-purchase financing because they generally are not permanently installed, and are removable without loss of value or damage to real property.

3. Equipment should be hard to “lose” or easily identifiable. Examples are computer and telecommunications hardware, photocopiers, printing press, audio/video equipment, laboratory equipment, etc. or items that are likely to have a serial number as opposed to small, light items like hand tools.

4. Equipment should be kept in good working condition at all times. The public organization must notify the Lender of any change in the equipment use or location. This includes any equipment returned to the equipment supplier, for any reason.

A government body, educational institution or quasi-governmental entity may qualify for tax-exempt leasing.  Such entities include a State or possession of the United States, the District of Columbia, or a political subdivision thereof.  Political subdivisions include cities, villages, towns, townships, counties and other municipalities.  They may include other public entities such as school districts, special purpose districts (fire, parks, utility, water, etc.), hospitals, agencies, authorities, boards and commissions.

State constitutions and statutes typically provide that obligations that exceed the revenues and receipts for the current fiscal period of the Government Body constitute “debt” and are, therefore, subject to voter approval requirements and limitations on the amount of debt that may be issued.   Municipal Leases are written with provisions which empower a Government Body to elect, through its periodic appropriations process, to renew or, not to renew its payment obligation at the inception of each fiscal period.  Lease payments that a Government Body makes for each fiscal period for which it has elected to continue a lease are deemed to be consideration for the use and enjoyment of the asset being financed during a particular fiscal period.  So long as such lease payments are within and made out of the current fiscal period’s revenues and, the Government Body has no obligation beyond the current fiscal period, in a majority of states such a lease will not constitute “debt” for purposes of state constitutional and statutory provisions.

The constitutional and statutory “debt” limitation issue is apparent in several provisions under a municipal lease which generally fall into one of two categories: a non-appropriation obligation or an abatement obligation.

Non-appropriation obligations are financial contracts that a municipal entity, in its sole discretion, can renew or terminate through its appropriations process at the beginning of each fiscal year.   The non-appropriation doctrine holds that a loan is not debt if the repayments are subject to the periodic appropriation of the legislative or governing body.

If a public organization’s governing body were to decline to make its budgetary appropriation for future lease payments, it would effectively be terminating the lease, and relinquishing its lease-hold interest in the assets to the Lessor.   While the cessation of payments under a non-appropriation obligation do not result in an event of default by the public organization, it is important to note that in certain instances, non-appropriation could result in a downgrading of a public organization’s overall credit rating.

Abatement lease obligations are financial contracts that allow a municipal entity to halt or reduce the amount for contractual lease payments if future conditions (such as non-completion, damage or destruction) restrict the municipal entity’s use or occupancy of the asset being financed. Because of this, lease payments are contingent upon the continued beneficial use and enjoyment of the asset being financed.  The cessation of payments under an abatement obligation, subject to the provisions just noted, does not result in an event of default by the municipal entity.

Lease-Purchase financing offers some unique attributes when compared to traditional bond financing, which include:

Periodic payment obligations that are treated as a current expense and not considered “debt” ;

Interest costs that are competitive with traditional debt financing;

Tax-exempt lease financings are less complex and can be completed in a much shorter time frame;

Lease terms are generally shorter than bonds and better match the useful life of the asset being financed;

The ability to acquire equipment at current cost rather than at higher costs in the future when cash might be available.

In deciding which acquisition or funding strategy will provide the lowest cost, a public organization should take both the stated interest rate and the transaction costs into account.  Adding transaction costs to a financing increases the ultimate cost above that indicated by the stated interest rate.

Lease financing is based on the legal concept that a governmental entity is making lease payments in consideration for the use and enjoyment of the leased property during each fiscal period.  The term of a lease may be extended up to 120% of the average reasonable, expected economic useful life of the property or project being financed.  However, a Lessor’s risk of non-appropriation increases if a financing term exceeds the useful life of the equipment, such that in practice, the term of a lease financing is usually not allowed to exceed the useful life of the financed property. 

Typically, this covers terms:

• Up to 10 years on Equipment
• Up to 20 years on Capital Projects

A tax-exempt lease is a "net lease," which means that the lessee is responsible for these types of expenses. However, the lessee may contract with the equipment supplier to provide maintenance and other services and, to a certain extent, these costs may be included in a municipal lease financing.

Title is usually passed to the lessee at the inception of the lease.  It may also be retained by the lessor until all payments have been received. In most cases, it is preferable to pass title at lease inception to avoid any potential tax issues.

As part of the Lease with Option to Purchase Agreement, amounts correlating to a Purchase Option Price are listed at each payment due date. The Purchase Option Price is provided so the Lease can be terminated early to save on future interest costs. Unlike issuing a bond, most municipal lease purchase agreements have no up front costs or fees. All of the Lessor's expenses of issuing the Lease are recaptured through the Lease Payments over the term of the lease, and not as an additional up front charge. Since these expenses have already been incurred once a lease has commenced, if the Lessee exercises the Purchase Option Price to terminate the Lease early, then the expenses that would have been recouped through the future Lease Payments must be recouped in the Purchase Option Price amount. The saving of future interest costs of paying off the Lease early is still realized by the Lessee, and the Lessor's costs of issuance are covered.

Certain used and refurbished equipment can be financed just like new equipment so as long as the financing period does not exceed the remaining useful life of the equipment.

The only required documents are:

• Financing Agreement
• Essential Use Declaration
• Certificate of Acceptance
• Insurance Policy or Self-Insurance Letter
• IRS Tax-Exempt Registration Form:      
  a) 8038-G for financings above $100,000 OR
  b) 8038-GC for financings below $100,000
• Amortization Schedule
• Borrowing Resolution
• Opinion of Issuer’s Legal Counsel
• Initial Invoice (if initial payment due under the financing is less than 60 days away)

Depending on the size or complexity of a financing, other closing documentation might include an Opinion of Bond Counsel.

Revenue Shortfall in a current fiscal year, with similar gaps expected for the upcoming two to three fiscal years

Public Organization is approaching its legal limit of maximum annual debt service

Substantial capital needs

Property tax levies are ultimately limited by statutory caps

Significant, ongoing capital needs remain which reflect an aged system

Possible future challenges in funding overall system’s increasing needs while desiring to preserve financial flexibility

Revenue Sources are billed and collected over extended periods such as quarterly or semi-annually.