Some months, nary a letter shows up in the mail. Other months, I get some of the most interesting questions. Below is an example of one of those interesting questions:

“Good afternoon, Tom. I am working with a lease form that your firm prepared. I’m pondering some questions and hope you can either direct me to where I need to go or help in some way. The question concerns the early payoff of a lease contract. The lease agreement states the following:

“‘We figure your adjusted lease balance, which is the balance subject to rent charge, using the ‘constant yield’ method. Constant yield method means the method of determining the rent charge part of each base periodic payment under which the rent charge for each period is earned in advance by multiplying the constant rate implicit in the lease with the balance subject to rent charge as it declines during the lease term. At any given time during the lease term, the balance subject to rent charge is the difference between the adjusted capitalized cost and the sum of: (i) all depreciation amounts accrued during the previous periods, and (ii) any base periodic payment amount paid at lease inception. The periodic rent charge calculations are based on the assumption that we will receive your periodic payments on their exact due dates and that the lease goes to its full term.’

“Does this imply that the lessee receives a rebate for the unearned rent charges on an early payoff? Also, are lessors forced to grant a rebate of the unearned rent charges on an early payoff or can they call for the entire contract to come due?”

This is how I replied: “Yes, a lessee under that formula is entitled to a rebate of unearned lease charges upon early termination. And, yes, lessors must rebate most of any unearned lease charges.” My reply was based on Section 183b of the federal Consumer Leasing Act (CLA), which requires that “penalties or other charges for delinquency, default or early termination may be specified in the lease, but only at an amount that is reasonable in light of the anticipated or actual harm caused by the delinquency, default or early termination, the difficulties of proof of loss and the inconvenience or nonfeasibility of otherwise obtaining an adequate remedy.”

Section 213.4 of the Federal Reserve Board’s Reg. M (a regulation issued under the CLA) requires that a penalty or charge for early termination must be reasonable. Article 2A of the Uniform Commercial Code (UCC) has a similar requirement.

Most lease lawyers will tell you that anything a lessor charges beyond an amount that will “clear the books” (the constant yield language quoted in the agreement is a clear-the-books formula) will be treated as a penalty or charge for early termination. They also will tell you that while a lessor may charge a fee or penalty for early termination, there haven’t been enough reported decisions discussing the amount permitted for lawyers to opine on the matter with any confidence.

The concept at work here is one we’ve dealt with for years. On precomputed loans and retail installment contracts, the customer has agreed to pay a given number of monthly payments in a specific amount. If, upon prepayment in full, some of the finance charge is unearned, the customer gets a rebate.

The inquiry caught my attention for a couple of reasons. First, I’m always worried a dealership or finance company will decide to go into leasing and will grab some leasing form like ours “off the shelf” and adopt it without first seeing whether the lease accounting system, the operations and collections manuals, and, for that matter, even the dealership’s or finance company’s pro formas for the business reflect what the form requires the dealer to do when there’s an early termination.

Second, the question illustrates a broader point: Even if federal lease laws or state UCC provisions did not require a rebate of unearned lease charges, the contractual language — a requirement under Reg. M that is derived from a Financial Accounting Standards Board rule — does. That means the lessor would be obliged by the terms of the lease contract to rebate unearned lease charges even if it’s not required by law.

So, make sure your lease matches your lease program. Also remember that, in addition to laws and regulations, your contract with your customer limits your rights and remedies.

Tom Hudson, Esq., is a partner in the law firm of Hudson Cook LLP and author of several books. For more on his books, visit www.counselorlibrary.com. Copyright CounselorLibrary.com 2010, all rights reserved. Based on an article from Spot Delivery. Single print publication rights only to F&I and Showroom. HC# 4831-0221-0055 (10/10).