Federal Leasing: A Lifeline in a Sea of Red Ink?
Anonymous. ELT. Arlington: Jan 2006.Vol.18, Iss. 1; pg. 10, 8 pgs
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Subjects: Equipment financing, Leasing, Federal government, Operating leases, Capital leases, Government agencies, Buy or lease decisions, Accounting policies, Private sector Equipment financing, Leasing, Federal government, Operating leases, Capital leases, Government agencies, Buy or lease decisions, Accounting policies, Private sector
Classification Codes 8110 Commercial banking services, 9550 Public sector, 9190 United States, 4120 Accounting policies & procedures
Locations: United States, US
Companies: Government Accountability Office (NAICS: 921130 ) , Office of Management & Budget (NAICS: 926110 ) , OMB (NAICS: 926110 )
Author(s): Anonymous
Document types: Feature
Section: Leasing Law
Publication title: ELT. Arlington: Jan 2006. Vol. 18, Iss. 1; pg. 10, 8 pgs
Source type: Periodical
ProQuest document ID: 981026971
Text Word Count 3563
Document URL: http://proquest.umi.com/pqdweb?did=981026971&sid=1&Fmt=4&clientId=2606&RQT=309&VName=PQD
Abstract (Document Summary)
Despite the huge budget deficit and constraints of the federal government, certain agencies interpret complex rules and guidelines to limit leasing or insist on terms, conditions and structures that undermine the viability of leasing transactions. Yet, in its proverbial sea of red ink, leasing could provide a lifeline to the federal government to fund many aspects of its vast bureaucracy. The guidelines, in part, distinguish between operating leases and capital leases, which is crucial in federal leasing. The reality is that in the last couple of years federal agencies have inhibited leasing by strictly enforcing accounting policies and applying other technical reasoning to bar operating leasing in favor of purchasing needed equipment and other assets. Many agencies simply do not understand leasing. If, for any reason, an agency cannot or will purchase or lease such assets, the agency will just forgo the operating assets. Federal leasing and finance is not for the faint of heart or the uninformed. Lessors should use knowledgeable counsel, accounting, government business and pricing professionals to assist in identifying, evaluating, structuring and closing of federal lease transactions.
Full Text (3563 words)
Copyright Equipment Leasing Association of America Jan 2006
Leasing occurs throughout the federal government, and is particularly useful when the government cannot or will not fund needed projects or assets out of its capital budget. The inability to fund government acquisitions has been especially acute lately due to the multi-billion dollar commitments of the federal government to the Iraq War and the recovery from the damage caused last year by hurricanes Katrina, Rita and Wilma. Despite the huge budget deficit and constraints of the federal government, certain agencies interpret complex rules and guidelines to limit leasing or insist on terms, conditions and structures that undermine the viability of leasing transactions. Yet, in its proverbial sea of red ink, leasing could provide as a lifeline to the federal government to fund many aspects of its vast bureaucracy.
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[Photograph]
The Federal Leasing Challenge
The federal government has long relied on leasing as a way to obtain the use of buildings, equipment and other forms of capital. The organizations most concerned with federal budgeting-the Congressional Budget Committees, the Office of Management and Budget (OMB), and the Congressional Budget Office (CBO)-have adopted guidelines for the budgetary treatment of leases. The guidelines, in part, distinguish between operating leases and capital leases, which is crucial in federal leasing.
Like purchases, capital leases of assets frequently require federal agencies to justify a long payback period on the investment and draw funding out of the nation's capital budget. In contrast, operating leases enable agencies to use operations and maintenance funds immediately to gain long-term benefits from assets they otherwise could not acquire.
Operating leasing can provide other significant benefits to the federal government. For example, an agency may need an enterprise computer system that could purchase over a three-year period of successive annual federal budgets. Rather than stage the acquisition under the capital budget, the agency could, instead, order and install the full project immediately by entering into an operating lease. In the operating lease transaction, the lessor could acquire the assets and the agency need only secure authority to pay rents on an annual basis. That authority could easily amount to a fraction of the purchase price for the same assets. The agency could thereby enhance its operational efficiency by obtaining the full system immediately, avoid a difficult and uncertain capital budgeting process, and gain the economic benefits from replacing out-of-date assets.
The reality is that in the last couple of years federal agencies have inhibited leasing by strictly enforcing accounting policies and applying other technical reasoning to bar operating leasing in favor of purchasing needed equipment and other assets. Many agencies simply do not understand leasing. If, for any reason, an agency cannot or will purchase or lease such assets, the agency will just forgo the operating assets. This result seems to occur even when the agency can make a good business case for leasing. It follows that, when the agency does not lease, willing funders (banks, trust companies or other financing institutions) correspondingly loose valuable transaction opportunities. The challenge, therefore, is to overcome these limitations and tap into the enormous potential for federal leasing.
The Lease-Buy Decision: Criteria and Structures
Federal leasing refers to the leasing of property (land, buildings, equipment and intellectual property) and services to the federal government. (see OMB Circular A-94, Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs.)
Two types of officials wield the power of leasing in federal agencies: a Program Manager and a Contracting Officer. After a decision is made to acquire a capital asset, the Contracting Officer completes a lease-buy analysis by applying the guidelines under section 13 of OMB Circular A-94. Section 13 does not apply to the initial decision to acquire the use of an asset and the associated cost-benefit analysis. Rather, after an agency decides to acquire the use of the asset, it then determines the economic impact of leasing versus purchasing, and assures appropriations or funding is available for the desired asset.
OMB, which sets the leasing policy, and the Government Accounting Office (GAO), which implements the policy of OMB, monitor or audit leasing transactions. OMB Circular A-94 covers procurements of capital assets, including goods, equipment, buildings, facilities, installations, and land. In determining whether to lease these assets, the Contracting Officer considers life cycle costs, economic life, purchase price, taxes, services, residual value, renewal options, and certain imputed costs such as property taxes and insurance. Section 33.4 of OMB Circular A-11 states that "leases of capital assets are preferable to direct government purchase and ownership in accordance with the policies contained in OMB Circular No. A-94." In any case, Section 300, Part 7 of OMB Circular A-11 establishes policy for planning, budgeting, acquisition and management of federal capital assets, and instructs federal employees that they must provide budget justification and meet reporting requirements for major acquisitions and major IT systems or projects.
The Contracting Officer will decide on the lease structure, which may be a:
* Lease to Ownership Program (LTOP)-An agency makes lease payments with automatic ownership at the end of the lease term;
* Lease with Option to Own (LWOO)-with a fixed purchase price option or a fair market value purchase price option in which an agency makes lease payments and retains the right to exercise an option to purchase the asset at the end of the lease term (also called a lease with option to purchase (LWOP)) or
* Lease or Rental-An agency leases or rents an asset for a fixed term and can either renew the lease or return the asset at the end of the lease term.
Federal leases typically require a funding reauthorization and/or lease renewal each budget year (October 1 to September 30). Further, federal agencies enjoy special powers under the Federal Acquisition Regulation (FAR), including rights to terminate lease transaction. The FAR also provides the rules used by agencies to acquire supplies and services with appropriated funds.
Termination Rights
The federal government implements its powers to terminate transactions through the rights:
* to terminate a transaction for the government's convenience, which allows the government to exercise its right to completely or partially terminate performance of work when it is in its own interest to do so;
* not to renew a lease, which usually lasts only one or two years between inception and renewal consistent with budget years unless authorized by federal legislation for a longer term;
* to terminate for the default of the prime contractor or other cause (a prime contractor may be a lessor or a vendor that provides property and services to the federal government); and
* to terminate as a result of the non-appropriation of funds by Congress for the expenses arising out of the lease transaction.
These rights can make or break your deal. To protect a lessor and its funders, it is imperative in each leasing transaction to perform substantial due diligence, create legal structures to protect the lessor/funder's interests and complete a thorough economic analysis of payments and effects of potential terminations by the government.
To finance or syndicate any lease arrangement, the lessor can assign the rights to rent payments to funders that qualify as an assignee under the Assignment of Claims Act of 1940, as amended, 31 U.S.C. § 3727 and 41 U.S.C. § 15. The transfer of the rent stream appeals to lenders and lessors because rents offer a reliable cash flow of a government credit subject to unique, but manageable, credit risks. In most transactions, the lessor will not experience a termination event, at least not without some offsetting compensation or rights to recover payments due to the termination. However, such a recovery process can take a lengthy period of time.
Federal leasing requires funders to exercise caution about the entity that contracts with the federal government. That entity, which also acts as the lessor, alone has privity with the government. Stated differently, the funder has no contractual relationship with the government and must therefore rely on and trust its government's prime contractor/lessor. The government, as lessee, is not required to, and generally will not, communicate with any entity in the transaction, including a funder, other than its prime contractor. If a prime contractor fails to perform, the government can terminate for default or not renew the lease (which must usually be renewed annually). The return of the asset due to a non-renewal or other termination can adversely impact the funder.
The variation in this approach may occur when prime contractors, including IT vendors and construction companies, enter into contractor team arrangements to meet the diverse needs of a project. FAR Subpart 9.6 provides for team arrangements relationships to satisfy the requirements of federal contracts. In teaming, the federal government will recognize more than one entity that brings required skills and/or resources to a single project. (see "Hurricane Relief Expands Opportunities for Federal Contractor Team Arrangements," by David G. Mayer, Business Leasing News, Nov. 2005).
Scoring Operating and Capital Leases
In structuring a federal lease transaction, contractors and funders must understand the distinction between an operating lease and a capital lease for several reasons, including budget scoring for capital and operating leases. "Budget scoring" or "budget scorekeeping" is a term that refers to the act of measuring federal spending obligations against amounts appropriated. It calculates the effect of government legislative and administrative actions on the deficit. Under the AntiDeficiency Act, no agency can obligate the federal government to pay more than the amount appropriated to it by Congress. The OMB, House and Senate Budget Committees, and CBO collaborate on the rules that govern this scoring process. OMB guidelines require that obligations be made for the "full economic cost" of an action at the time an obligation is made.
The distinction between a capital lease and an operating lease under federal law is every bit as it is under Financial Accounting Standards No. 13 (FAS 13) issued by the Financial Accounting Standards Board. In fact, the criteria used by the federal government in large part derive from FAS 13.
A federal capital lease is often structured as a lease intended primarily as a lease-purchase transaction (with and without significant ownership risks on the government), but an operating lease is treated as an expense for the use of an asset. Federal agencies view some leases as purchases of assets. General budget principles and authority require federal agencies to keep score at lease inception of an amount equal to the present value of lease payments over the life of such a lease. When an agency enters into a capital lease or lease-purchase under general authorities available to the agency, it must do so within the limits of the budgetary resources available to it and the constraints of the scorekeeping requirements.
The distinction between types of leases and related obligations can determine whether or not an agency can enter into a transaction. For a "capital lease," the federal agency must score the full costs of the commitment up front, at the time that budget authority is first provided and correspondingly record the obligation when the capital lease is signed. For those assets, the agency scores and records the obligations under its budget on an annual and, for some transactions, a two-year, basis rather than capitalizing the obligation at lease inception. Capital budgeting typically involves a demanding and lengthy process of calculating and submitting requests for budget authority each fiscal year (except where multi-year authority exists by statute).
In contrast, for "operating leases" the agency reflects that it is merely purchasing the services of an asset for a part of the asset's life without implying the risks of ownership. For an operating lease, the agency generally will use funds in its "bucket" for operations and maintenance as an "operating expenditure." Although these funds may be scarce, as noted earlier, an agency today may have an even more difficult task of obtaining funds from its capital budgets.
Annex B - Scoring Lease-Purchase and Leases of Capital Assets to OMB Circular A-Il contains six criteria that must be met for a lease to qualify as an operating lease (plus detailed explanations and methods for making the correct determination):
1. The asset must be a general-purpose asset, not for a special purpose of, or built to unique specifications for, the government;
2. There must be a private-sector market for the asset;
3. The present value of the lease payments cannot exceed 90 percent of the asset's fair market value at the start of the lease (90 percent test);
4. The lease cannot contain a bargain-price purchase option;
5. Ownership of the asset must remain with the lessor during the term of the lease and is not transferred to the government at or shortly after the end of the lease term; and
6. The lease term cannot exceed 75 percent of the asset's estimated economic life.
In addition, SFFAS No. 5, Accounting for Liabilities of the Federal Government (Paragraphs 43-36 and Appendix B - Glossary) and SFFAS No. 6, Accounting for Property, Plant and Equipment (Paragraphs 44 and Appendix E Glossary) define the criteria for a "capital leases" and "operating lease." Federal lessors must adhere to these standards.
OMB and GAO Restrictions
The GAO, by strictly construing or enforcing lease accounting guidelines in a manner that has restricted leasing, has at times constrained or questioned the funds flow to the federal government for leasing. On one hand, GAO's efforts maintain a firm grip on deficits by not allowing federal agencies, such as the General Services Administration (GSA), to treat capital transactions as operating leases. On the other hand, GAO's efforts may misinterpret existing federal guidelines in such a way as to cut off or limit a vital source of private funding to the federal government in a time of budgetary crisis.
OMB can skew the analysis against leasing by its choice of how to value the asset. Rather than using the cost the government would pay for an asset, as OMB has previously done, Section 13c of OMB Circular A-94 requires that the "price of the asset for purposes of the lease-purchase analysis is its fair market value, defined as the price a willing buyer could reasonably expect to pay a willing seller in a competitive market to acquire the asset." The price contemplated in section 13c will almost always be higher than the purchase price the government will pay because the federal government's buying power allows it to obtain big price discounts off of "fair market value" prices.
Leasing encounters a further disadvantage when the government uses its discounted purchase price instead of fair market value. Under the 90 percent test, the present value of the lease payments cannot exceed 90 percent of the asset's fair market value at the start of the lease. The higher the original value used for the calculation, therefore, the greater the likelihood that the discounted lease payments will not equal or exceed 90 percent of the fair market value. Correspondingly, if lessors must use the government's highly discounted price rather than fair market value, the less likely that the government can achieve operating lease treatment. OMB has insisted in transactions that the discounted price (instead of fair market value) is appropriate, as a way to block operating lease treatment.
To make operating lease treatment even more difficult for lessors to achieve, the government uses like-term (to the lease term) Treasury Rate to discount the rents under the 90 percent test. That Treasury Rate will always be lower than a lessor's required yield rate (rate of return). The lower the discount rate (that is, the Treasury Rate), the higher the present value of the rent. Under the operating lease calculations, the higher the present value of the rent, the more likely a lessor is to exceed 90 percent test limit (creating a capital lease under federal accounting guidelines).
The Right Pros
Federal leasing and finance is not for the faint of heart or the uninformed. Lessors should use knowledgeable counsel, accounting, government business and pricing professionals to assist in identifying, evaluating, structuring and closing of federal lease transactions. See Sidebar. As part of the legal and business due diligence, lessors should validate the authority of the federal agency to lease the subject assets and confirm the essential nature of the assets to the agency's functions. In this age of budget cuts, lessors may also wish to consider using advisors who, when conducting due diligence, can determine the status of legislation, leasing authority and agency intentions during the anticipated lease term. Lessors can argue for use of appropriate fair market values, discount rates and interpretations of the law and accounting rules. However, a change in laws and regulations may be required to significantly affect the federal government's thinking and process.
Still, amid war and crisis of nature, the federal government faces record deficits and budget cuts. If the government enhances it knowledge of leasing and lowers certain technical hurdles to lease transactions, it can greatly increase leasing as a significant financing tool. By leasing more assets, the federal government can stay within its budget restrictions, satisfy some of its immediate needs for assets, including software, and provide contractors and funders the opportunity to tap into the huge potential for federal leasing. However, regardless of the tact the government takes, federal leasing has been, and should remain, a valuable means for funders and contractors to invest private capital for the benefit of the federal government.
[Sidebar]
Recently federal agencies have inhibited leasing by strictly enforcing accounting policies and applying other technical reasoning to bar operating leasing in favor of purchasing.
The distinction between a capital lease and an operating lease under federal law is every bit as important as it is under FAS 13349975v13
[Sidebar]
Two Approaches to Federal Leasing
Most federal agencies have the authority to enter into leases for capital assets including real, personal and even intangible property (including certain IT assets). Two types of transactions merit special attention.
General Services Administration Schedule TransactionsThe GSA plays a major role in federal leasing today. The GSA established a program for leasing under long-term government contracts with commercial firms to provide access to more than four million commercial services and products. It lists these vendors as its GSA Schedule contractors, and GSA also refers to its lists as "Multiple Award Schedules" and "Federal Supply Schedules."
A federal agency or other eligible organization acts as a customer of the GSA and selects equipment or other items only from the GSA Schedule. Then the agency decides whether it gains advantageous pricing and budgeting by leasing or purchasing the equipment or other item. The Contracting Officer generally compares the leasing terms offered by leasing companies qualified to participate in the GSA Schedule as well as the pricing terms offered by other GSA Schedule sellers. If a lease is selected, the government then enters into lease documentation under the GSA schedule structure.
Enhanced Use Leasing Structure Transactions-Numerous federal agencies, including the Department of Defense (DoD), Department of Veterans Affairs (VA) and the Department of Energy (DoE), use the "enhanced use lease" (EUL) structure. Authorization for EUL reflects a federal policy that opportunities exist for public/private partnerships in financing, constructing and operating federal facilities. The premise of an "enhanced use" transaction is that there is embedded value in under-utilized federal assets that can be brought to bear for the benefit of the federal government by teaming with the private sector. These transactions are often structured using an "out-lease" of an existing asset to a special purpose entity. The entity participates in a securities or other project financing to access capital for improvements to the underutilized asset. The asset is then leased to the federal agency under an operating lease. If properly structured, an enhanced use leasing transaction can provide access to long-term capital at highly competitive rates.
For example, DoD uses the structure to fund capital projects designed to address the challenges of base reductions and closures, force redeployment and the Gulf Coast reconstruction. The VA has constructed hospitals, cogeneration facilities, clinics and senior living centers. One of the most active and progressive participants, the DoE, has engaged in building several laboratories and other facilities in its National Laboratory Programs. Enhanced use leasing maximizes underused assets, provides capital for new acquisitions and increases the commitment of the federal government to engage in public-private partnerships. Enhanced use leasing also has been recognized by the DoE as an important tool in its efforts to address deferred capital expenditures for mission-critical facilities.
Although further discussion of the structure and terms of UELs is beyond the scope of this article, lessors should understand that projects that use the EUL structure can provide significant opportunities to finance a single transaction with hundreds of millions of dollars of real, personal and intangible property.
[Sidebar]
GAO'S efforts may misinterpret existing federal guidelines in such a way as to cut off or limit a vital source of private funding to the federal government in a time of budgetary crisis.
[Sidebar]
If the government enhances it knowledge of leasing and lowers certain technical hurdles to lease transactions, it can greatly increase leasing as a significant financing tool.
[Sidebar]
ELT thanks David G. Mayer, a business transactions partner in the Dallas office of Ration Boggs LLP. The author would like to thank Michael Guiffre and Greg Johnson of the Patton Boggs LLP Federal Leasing Team, and Jack Helmly, President of GTSI Financial Services, for their comments on this article.
Anonymous. ELT. Arlington: Jan 2006.Vol.18, Iss. 1; pg. 10, 8 pgs
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Subjects: Equipment financing, Leasing, Federal government, Operating leases, Capital leases, Government agencies, Buy or lease decisions, Accounting policies, Private sector Equipment financing, Leasing, Federal government, Operating leases, Capital leases, Government agencies, Buy or lease decisions, Accounting policies, Private sector
Classification Codes 8110 Commercial banking services, 9550 Public sector, 9190 United States, 4120 Accounting policies & procedures
Locations: United States, US
Companies: Government Accountability Office (NAICS: 921130 ) , Office of Management & Budget (NAICS: 926110 ) , OMB (NAICS: 926110 )
Author(s): Anonymous
Document types: Feature
Section: Leasing Law
Publication title: ELT. Arlington: Jan 2006. Vol. 18, Iss. 1; pg. 10, 8 pgs
Source type: Periodical
ProQuest document ID: 981026971
Text Word Count 3563
Document URL: http://proquest.umi.com/pqdweb?did=981026971&sid=1&Fmt=4&clientId=2606&RQT=309&VName=PQD
Abstract (Document Summary)
Despite the huge budget deficit and constraints of the federal government, certain agencies interpret complex rules and guidelines to limit leasing or insist on terms, conditions and structures that undermine the viability of leasing transactions. Yet, in its proverbial sea of red ink, leasing could provide a lifeline to the federal government to fund many aspects of its vast bureaucracy. The guidelines, in part, distinguish between operating leases and capital leases, which is crucial in federal leasing. The reality is that in the last couple of years federal agencies have inhibited leasing by strictly enforcing accounting policies and applying other technical reasoning to bar operating leasing in favor of purchasing needed equipment and other assets. Many agencies simply do not understand leasing. If, for any reason, an agency cannot or will purchase or lease such assets, the agency will just forgo the operating assets. Federal leasing and finance is not for the faint of heart or the uninformed. Lessors should use knowledgeable counsel, accounting, government business and pricing professionals to assist in identifying, evaluating, structuring and closing of federal lease transactions.
Full Text (3563 words)
Copyright Equipment Leasing Association of America Jan 2006
Leasing occurs throughout the federal government, and is particularly useful when the government cannot or will not fund needed projects or assets out of its capital budget. The inability to fund government acquisitions has been especially acute lately due to the multi-billion dollar commitments of the federal government to the Iraq War and the recovery from the damage caused last year by hurricanes Katrina, Rita and Wilma. Despite the huge budget deficit and constraints of the federal government, certain agencies interpret complex rules and guidelines to limit leasing or insist on terms, conditions and structures that undermine the viability of leasing transactions. Yet, in its proverbial sea of red ink, leasing could provide as a lifeline to the federal government to fund many aspects of its vast bureaucracy.
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Enlarge 400%
[Photograph]
The Federal Leasing Challenge
The federal government has long relied on leasing as a way to obtain the use of buildings, equipment and other forms of capital. The organizations most concerned with federal budgeting-the Congressional Budget Committees, the Office of Management and Budget (OMB), and the Congressional Budget Office (CBO)-have adopted guidelines for the budgetary treatment of leases. The guidelines, in part, distinguish between operating leases and capital leases, which is crucial in federal leasing.
Like purchases, capital leases of assets frequently require federal agencies to justify a long payback period on the investment and draw funding out of the nation's capital budget. In contrast, operating leases enable agencies to use operations and maintenance funds immediately to gain long-term benefits from assets they otherwise could not acquire.
Operating leasing can provide other significant benefits to the federal government. For example, an agency may need an enterprise computer system that could purchase over a three-year period of successive annual federal budgets. Rather than stage the acquisition under the capital budget, the agency could, instead, order and install the full project immediately by entering into an operating lease. In the operating lease transaction, the lessor could acquire the assets and the agency need only secure authority to pay rents on an annual basis. That authority could easily amount to a fraction of the purchase price for the same assets. The agency could thereby enhance its operational efficiency by obtaining the full system immediately, avoid a difficult and uncertain capital budgeting process, and gain the economic benefits from replacing out-of-date assets.
The reality is that in the last couple of years federal agencies have inhibited leasing by strictly enforcing accounting policies and applying other technical reasoning to bar operating leasing in favor of purchasing needed equipment and other assets. Many agencies simply do not understand leasing. If, for any reason, an agency cannot or will purchase or lease such assets, the agency will just forgo the operating assets. This result seems to occur even when the agency can make a good business case for leasing. It follows that, when the agency does not lease, willing funders (banks, trust companies or other financing institutions) correspondingly loose valuable transaction opportunities. The challenge, therefore, is to overcome these limitations and tap into the enormous potential for federal leasing.
The Lease-Buy Decision: Criteria and Structures
Federal leasing refers to the leasing of property (land, buildings, equipment and intellectual property) and services to the federal government. (see OMB Circular A-94, Guidelines and Discount Rates for Benefit-Cost Analysis of Federal Programs.)
Two types of officials wield the power of leasing in federal agencies: a Program Manager and a Contracting Officer. After a decision is made to acquire a capital asset, the Contracting Officer completes a lease-buy analysis by applying the guidelines under section 13 of OMB Circular A-94. Section 13 does not apply to the initial decision to acquire the use of an asset and the associated cost-benefit analysis. Rather, after an agency decides to acquire the use of the asset, it then determines the economic impact of leasing versus purchasing, and assures appropriations or funding is available for the desired asset.
OMB, which sets the leasing policy, and the Government Accounting Office (GAO), which implements the policy of OMB, monitor or audit leasing transactions. OMB Circular A-94 covers procurements of capital assets, including goods, equipment, buildings, facilities, installations, and land. In determining whether to lease these assets, the Contracting Officer considers life cycle costs, economic life, purchase price, taxes, services, residual value, renewal options, and certain imputed costs such as property taxes and insurance. Section 33.4 of OMB Circular A-11 states that "leases of capital assets are preferable to direct government purchase and ownership in accordance with the policies contained in OMB Circular No. A-94." In any case, Section 300, Part 7 of OMB Circular A-11 establishes policy for planning, budgeting, acquisition and management of federal capital assets, and instructs federal employees that they must provide budget justification and meet reporting requirements for major acquisitions and major IT systems or projects.
The Contracting Officer will decide on the lease structure, which may be a:
* Lease to Ownership Program (LTOP)-An agency makes lease payments with automatic ownership at the end of the lease term;
* Lease with Option to Own (LWOO)-with a fixed purchase price option or a fair market value purchase price option in which an agency makes lease payments and retains the right to exercise an option to purchase the asset at the end of the lease term (also called a lease with option to purchase (LWOP)) or
* Lease or Rental-An agency leases or rents an asset for a fixed term and can either renew the lease or return the asset at the end of the lease term.
Federal leases typically require a funding reauthorization and/or lease renewal each budget year (October 1 to September 30). Further, federal agencies enjoy special powers under the Federal Acquisition Regulation (FAR), including rights to terminate lease transaction. The FAR also provides the rules used by agencies to acquire supplies and services with appropriated funds.
Termination Rights
The federal government implements its powers to terminate transactions through the rights:
* to terminate a transaction for the government's convenience, which allows the government to exercise its right to completely or partially terminate performance of work when it is in its own interest to do so;
* not to renew a lease, which usually lasts only one or two years between inception and renewal consistent with budget years unless authorized by federal legislation for a longer term;
* to terminate for the default of the prime contractor or other cause (a prime contractor may be a lessor or a vendor that provides property and services to the federal government); and
* to terminate as a result of the non-appropriation of funds by Congress for the expenses arising out of the lease transaction.
These rights can make or break your deal. To protect a lessor and its funders, it is imperative in each leasing transaction to perform substantial due diligence, create legal structures to protect the lessor/funder's interests and complete a thorough economic analysis of payments and effects of potential terminations by the government.
To finance or syndicate any lease arrangement, the lessor can assign the rights to rent payments to funders that qualify as an assignee under the Assignment of Claims Act of 1940, as amended, 31 U.S.C. § 3727 and 41 U.S.C. § 15. The transfer of the rent stream appeals to lenders and lessors because rents offer a reliable cash flow of a government credit subject to unique, but manageable, credit risks. In most transactions, the lessor will not experience a termination event, at least not without some offsetting compensation or rights to recover payments due to the termination. However, such a recovery process can take a lengthy period of time.
Federal leasing requires funders to exercise caution about the entity that contracts with the federal government. That entity, which also acts as the lessor, alone has privity with the government. Stated differently, the funder has no contractual relationship with the government and must therefore rely on and trust its government's prime contractor/lessor. The government, as lessee, is not required to, and generally will not, communicate with any entity in the transaction, including a funder, other than its prime contractor. If a prime contractor fails to perform, the government can terminate for default or not renew the lease (which must usually be renewed annually). The return of the asset due to a non-renewal or other termination can adversely impact the funder.
The variation in this approach may occur when prime contractors, including IT vendors and construction companies, enter into contractor team arrangements to meet the diverse needs of a project. FAR Subpart 9.6 provides for team arrangements relationships to satisfy the requirements of federal contracts. In teaming, the federal government will recognize more than one entity that brings required skills and/or resources to a single project. (see "Hurricane Relief Expands Opportunities for Federal Contractor Team Arrangements," by David G. Mayer, Business Leasing News, Nov. 2005).
Scoring Operating and Capital Leases
In structuring a federal lease transaction, contractors and funders must understand the distinction between an operating lease and a capital lease for several reasons, including budget scoring for capital and operating leases. "Budget scoring" or "budget scorekeeping" is a term that refers to the act of measuring federal spending obligations against amounts appropriated. It calculates the effect of government legislative and administrative actions on the deficit. Under the AntiDeficiency Act, no agency can obligate the federal government to pay more than the amount appropriated to it by Congress. The OMB, House and Senate Budget Committees, and CBO collaborate on the rules that govern this scoring process. OMB guidelines require that obligations be made for the "full economic cost" of an action at the time an obligation is made.
The distinction between a capital lease and an operating lease under federal law is every bit as it is under Financial Accounting Standards No. 13 (FAS 13) issued by the Financial Accounting Standards Board. In fact, the criteria used by the federal government in large part derive from FAS 13.
A federal capital lease is often structured as a lease intended primarily as a lease-purchase transaction (with and without significant ownership risks on the government), but an operating lease is treated as an expense for the use of an asset. Federal agencies view some leases as purchases of assets. General budget principles and authority require federal agencies to keep score at lease inception of an amount equal to the present value of lease payments over the life of such a lease. When an agency enters into a capital lease or lease-purchase under general authorities available to the agency, it must do so within the limits of the budgetary resources available to it and the constraints of the scorekeeping requirements.
The distinction between types of leases and related obligations can determine whether or not an agency can enter into a transaction. For a "capital lease," the federal agency must score the full costs of the commitment up front, at the time that budget authority is first provided and correspondingly record the obligation when the capital lease is signed. For those assets, the agency scores and records the obligations under its budget on an annual and, for some transactions, a two-year, basis rather than capitalizing the obligation at lease inception. Capital budgeting typically involves a demanding and lengthy process of calculating and submitting requests for budget authority each fiscal year (except where multi-year authority exists by statute).
In contrast, for "operating leases" the agency reflects that it is merely purchasing the services of an asset for a part of the asset's life without implying the risks of ownership. For an operating lease, the agency generally will use funds in its "bucket" for operations and maintenance as an "operating expenditure." Although these funds may be scarce, as noted earlier, an agency today may have an even more difficult task of obtaining funds from its capital budgets.
Annex B - Scoring Lease-Purchase and Leases of Capital Assets to OMB Circular A-Il contains six criteria that must be met for a lease to qualify as an operating lease (plus detailed explanations and methods for making the correct determination):
1. The asset must be a general-purpose asset, not for a special purpose of, or built to unique specifications for, the government;
2. There must be a private-sector market for the asset;
3. The present value of the lease payments cannot exceed 90 percent of the asset's fair market value at the start of the lease (90 percent test);
4. The lease cannot contain a bargain-price purchase option;
5. Ownership of the asset must remain with the lessor during the term of the lease and is not transferred to the government at or shortly after the end of the lease term; and
6. The lease term cannot exceed 75 percent of the asset's estimated economic life.
In addition, SFFAS No. 5, Accounting for Liabilities of the Federal Government (Paragraphs 43-36 and Appendix B - Glossary) and SFFAS No. 6, Accounting for Property, Plant and Equipment (Paragraphs 44 and Appendix E Glossary) define the criteria for a "capital leases" and "operating lease." Federal lessors must adhere to these standards.
OMB and GAO Restrictions
The GAO, by strictly construing or enforcing lease accounting guidelines in a manner that has restricted leasing, has at times constrained or questioned the funds flow to the federal government for leasing. On one hand, GAO's efforts maintain a firm grip on deficits by not allowing federal agencies, such as the General Services Administration (GSA), to treat capital transactions as operating leases. On the other hand, GAO's efforts may misinterpret existing federal guidelines in such a way as to cut off or limit a vital source of private funding to the federal government in a time of budgetary crisis.
OMB can skew the analysis against leasing by its choice of how to value the asset. Rather than using the cost the government would pay for an asset, as OMB has previously done, Section 13c of OMB Circular A-94 requires that the "price of the asset for purposes of the lease-purchase analysis is its fair market value, defined as the price a willing buyer could reasonably expect to pay a willing seller in a competitive market to acquire the asset." The price contemplated in section 13c will almost always be higher than the purchase price the government will pay because the federal government's buying power allows it to obtain big price discounts off of "fair market value" prices.
Leasing encounters a further disadvantage when the government uses its discounted purchase price instead of fair market value. Under the 90 percent test, the present value of the lease payments cannot exceed 90 percent of the asset's fair market value at the start of the lease. The higher the original value used for the calculation, therefore, the greater the likelihood that the discounted lease payments will not equal or exceed 90 percent of the fair market value. Correspondingly, if lessors must use the government's highly discounted price rather than fair market value, the less likely that the government can achieve operating lease treatment. OMB has insisted in transactions that the discounted price (instead of fair market value) is appropriate, as a way to block operating lease treatment.
To make operating lease treatment even more difficult for lessors to achieve, the government uses like-term (to the lease term) Treasury Rate to discount the rents under the 90 percent test. That Treasury Rate will always be lower than a lessor's required yield rate (rate of return). The lower the discount rate (that is, the Treasury Rate), the higher the present value of the rent. Under the operating lease calculations, the higher the present value of the rent, the more likely a lessor is to exceed 90 percent test limit (creating a capital lease under federal accounting guidelines).
The Right Pros
Federal leasing and finance is not for the faint of heart or the uninformed. Lessors should use knowledgeable counsel, accounting, government business and pricing professionals to assist in identifying, evaluating, structuring and closing of federal lease transactions. See Sidebar. As part of the legal and business due diligence, lessors should validate the authority of the federal agency to lease the subject assets and confirm the essential nature of the assets to the agency's functions. In this age of budget cuts, lessors may also wish to consider using advisors who, when conducting due diligence, can determine the status of legislation, leasing authority and agency intentions during the anticipated lease term. Lessors can argue for use of appropriate fair market values, discount rates and interpretations of the law and accounting rules. However, a change in laws and regulations may be required to significantly affect the federal government's thinking and process.
Still, amid war and crisis of nature, the federal government faces record deficits and budget cuts. If the government enhances it knowledge of leasing and lowers certain technical hurdles to lease transactions, it can greatly increase leasing as a significant financing tool. By leasing more assets, the federal government can stay within its budget restrictions, satisfy some of its immediate needs for assets, including software, and provide contractors and funders the opportunity to tap into the huge potential for federal leasing. However, regardless of the tact the government takes, federal leasing has been, and should remain, a valuable means for funders and contractors to invest private capital for the benefit of the federal government.
[Sidebar]
Recently federal agencies have inhibited leasing by strictly enforcing accounting policies and applying other technical reasoning to bar operating leasing in favor of purchasing.
The distinction between a capital lease and an operating lease under federal law is every bit as important as it is under FAS 13349975v13
[Sidebar]
Two Approaches to Federal Leasing
Most federal agencies have the authority to enter into leases for capital assets including real, personal and even intangible property (including certain IT assets). Two types of transactions merit special attention.
General Services Administration Schedule TransactionsThe GSA plays a major role in federal leasing today. The GSA established a program for leasing under long-term government contracts with commercial firms to provide access to more than four million commercial services and products. It lists these vendors as its GSA Schedule contractors, and GSA also refers to its lists as "Multiple Award Schedules" and "Federal Supply Schedules."
A federal agency or other eligible organization acts as a customer of the GSA and selects equipment or other items only from the GSA Schedule. Then the agency decides whether it gains advantageous pricing and budgeting by leasing or purchasing the equipment or other item. The Contracting Officer generally compares the leasing terms offered by leasing companies qualified to participate in the GSA Schedule as well as the pricing terms offered by other GSA Schedule sellers. If a lease is selected, the government then enters into lease documentation under the GSA schedule structure.
Enhanced Use Leasing Structure Transactions-Numerous federal agencies, including the Department of Defense (DoD), Department of Veterans Affairs (VA) and the Department of Energy (DoE), use the "enhanced use lease" (EUL) structure. Authorization for EUL reflects a federal policy that opportunities exist for public/private partnerships in financing, constructing and operating federal facilities. The premise of an "enhanced use" transaction is that there is embedded value in under-utilized federal assets that can be brought to bear for the benefit of the federal government by teaming with the private sector. These transactions are often structured using an "out-lease" of an existing asset to a special purpose entity. The entity participates in a securities or other project financing to access capital for improvements to the underutilized asset. The asset is then leased to the federal agency under an operating lease. If properly structured, an enhanced use leasing transaction can provide access to long-term capital at highly competitive rates.
For example, DoD uses the structure to fund capital projects designed to address the challenges of base reductions and closures, force redeployment and the Gulf Coast reconstruction. The VA has constructed hospitals, cogeneration facilities, clinics and senior living centers. One of the most active and progressive participants, the DoE, has engaged in building several laboratories and other facilities in its National Laboratory Programs. Enhanced use leasing maximizes underused assets, provides capital for new acquisitions and increases the commitment of the federal government to engage in public-private partnerships. Enhanced use leasing also has been recognized by the DoE as an important tool in its efforts to address deferred capital expenditures for mission-critical facilities.
Although further discussion of the structure and terms of UELs is beyond the scope of this article, lessors should understand that projects that use the EUL structure can provide significant opportunities to finance a single transaction with hundreds of millions of dollars of real, personal and intangible property.
[Sidebar]
GAO'S efforts may misinterpret existing federal guidelines in such a way as to cut off or limit a vital source of private funding to the federal government in a time of budgetary crisis.
[Sidebar]
If the government enhances it knowledge of leasing and lowers certain technical hurdles to lease transactions, it can greatly increase leasing as a significant financing tool.
[Sidebar]
ELT thanks David G. Mayer, a business transactions partner in the Dallas office of Ration Boggs LLP. The author would like to thank Michael Guiffre and Greg Johnson of the Patton Boggs LLP Federal Leasing Team, and Jack Helmly, President of GTSI Financial Services, for their comments on this article.
