Understanding Legal Agreements

The nature of agreements can often be difficult to identify. To determine the essence of the agreement, what it really is, it is important to look at the substance of the agreement, not its title. For example, it can be difficult to discern between a lease on equipment and a finance agreement. A lease is a contract in which the temporary right to use an asset is conveyed for a specified consideration. The key is that ownership is not conveyed; rather, only the right to use the asset for a specified period. At the end of the period, all rights return to the lessor.

A finance agreement is an installment payment agreement where title reverts to the lender if there is a default in the promise to pay. Title in the property is vested in the borrower, not in the lender. A security agreement gives the lender a lien on the equipment until the debit is paid. Accounting and tax rules require that in a lease, the asset must be implicitly identifiable and the consideration must be reasonably certain. In other words, it cannot be so contingent or variable that its value cannot be determined at any point in time.

To identify if an agreement is a lease, the substance of the agreement must be analyzed to determine:

  • whether the contract is only fulfilled if the specified asset is used by the lessee (or at least if the lessor agrees not to exercise use or control over it); or
  • whether the lessee controls the right to use the asset for the specified period of time; that is, to decide how it will be used and receiving the benefit of such use.

Another example is a trademark or patent license or an assignment. Similar to a lease, a license is the right to use the intellectual property rights for a specified period for a specified compensation rate. In an assignment, the key is that less than full, unconditional ownership is transferred. If the owner retains some right in the asset, however remote (for example, if the contract gives the owner-seller a right of reversion or cancellation), under any condition, full, unconditional rights are being conveyed. It may be a limited use of the asset in certain territories or industries. While the owner-licensor retains the right to use the asset in certain business fields or geographic areas, you must carefully look at a contingent “sale” where the transfer only occurs under certain conditions to determine whether it is truly an assignment or a license. This will be important to understanding what rights you have to convey, encumber and enforce the asset again potential infringers. An experience attorney is a valuable resource for explaining your rights in any agreement.

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