One of the biggest problems our banks are encountering during these tough economic times is rental business owners selling equipment out of trust (SOT).
By definition, SOT means the rental business owner has borrowed to purchase a piece of equipment and the collateral for the loan is the piece of rental equipment. The rental business owner sells the equipment, deposits the check, and fails to pay the lender for the principle balance on the note. SOT has been committed.
When the banks come by to audit their collateral, they usually catch the discrepancy and will mandate immediate payment in full for the sale of the rental asset.
The banks we do restructure work with are encountering more and more of these situations, and they are quite alarmed at this trend. I will tell you from experience that the fastest way to get disqualified from a debt restructure is for a lender to discover that its client is practicing SOT with them. It is the kiss of death. The banks are taking a very tough stance on this issue as it is both a civil and, potentially, a criminal issue. The legal issues are very obvious.
Most of the financial institutions are broadening their audit processes to not only review the list of their assets and outstanding contracts, but they are also evaluating the revenue stream of each of their collateral assets. This is actually a good thing if you are in compliance and not SOT, as this reduces the number of customer visits by bank auditors.
So, in conclusion, I will offer you one piece of advice: "Do not think that this is a way to fund your business... Do not go SOT."
Questions or comments? Contact Mike Farley at firstname.lastname@example.org.