When customers loan your equipment to someone else

QUESTION: I’m amazed at how many large contractors think it’s OK to regularly lend rental equipment and tools to other contractors. They don’t seem to understand the potential consequences of that action. How big of an issue is this from your perspective and what do you recommend doing about it?

Answer: It’s a common occurrence and it yields far more litigation than it should. Goodwill and efficiency considerations, which admittedly can be meaningful, also can be an extraordinarily bad idea from a legal perspective, particularly when a specific sublease agreement isn’t executed and for the owner/lender, one almost never is.

What duties are owed and to whom? In legal parlance, a loan of equipment is a bailment — the process of placing an item in the control of another. The borrower (bailee) owes a legal duty to the lender of the equipment (the bailor) to care for the loaned item while in the borrower’s possession and ultimately, to return it to the lender. Importantly, however, this concept doesn’t include a specific obligation to the actual owner of the property, such as a rental company.

The level of duty may not be clear. The level of care required of the borrower varies based on whether the bailment is for the mutual benefit of the bailor and bailee, which would be ordinary care, or for the sole benefit of the bailee, which would be extraordinary care. It can, therefore, be difficult to tell what the bailee’s obligations really are with respect to loaned equipment.

Hope for the best and assume the worst. The owner of the loaned equipment would prefer to characterize the loan as having been made for the sole benefit of the bailee. The owner almost never controls, or even knows about, loans of its equipment from its customers to third parties. Thus, we generally have to assume that some benefit will accrue to both bailor and bailee. That might be in the form of an exchange of one loaned item for another, an expedited step in the construction process or perhaps some promise of a future return-favor. In any event, both owner and customer/lender always should assume the borrower will voluntarily shoulder as little liability as legally possible. Consequently, if no sublease or re-rental contract is executed by the borrower, the borrower may feel little motivation to protect and care for the borrowed item as the borrower didn’t sign the rental contract. This can place the owner/lessor of the equipment in a dangerous position with respect to equipment damage, particularly if the owner’s rental contract fails to address potential loans of that equipment.

Liability. More worrisome, however, is that if an accident occurs, most borrowers can be expected to disclaim liability for claims made by injured parties — again, because the borrower never signed, or perhaps even saw, the original rental contract. Critically, none of the original rental contract’s warranty waivers, assumptions of risk or indemnity provisions will have been acknowledged by the borrower, making it unlikely that a court would fully enforce them against that borrower, even if the original rental contract included a “successors and assigns” provision. Worse, many of the other contractual protections from products liability lawsuits — potentially enormous lawsuits that can be filed by borrowers against the rental company and others — also would have been rendered largely moot as a result of not having been reviewed or signed by the borrower. This includes acknowledgements of receipt of proper instructions and warnings, selection and examination of the equipment, and its freedom from defects upon delivery. Such acknowledgments can be critical to defending against negligence and strict products liability lawsuits.

Remember also, that if the original customer/lessee (lender) is included in such a lawsuit, he or she also may point the finger at the rental company — after all, a claim that the equipment was defective upon delivery puts the original lessee on offense; whereas, his claim that he did nothing wrong by loaning it to a third party is effectively a defensive claim. The rental company likely will have some recourse against the original lessee for equipment damage no matter how sparse the original rental contract was, unless the equipment was actually defective upon delivery, but few if any rights against the borrower — and crucially, no contractual indemnity from the borrower for personal injury lawsuits filed by the borrower’s employees or third parties.

The result. Loans of rented equipment create far more potential liability for equipment owners, including rental companies, than meets the eye.

The rental contract could help, but it usually doesn’t. Despite the danger, most rental contracts fail to address lending equipment at all — and to the extent they almost do, they tend to say things like, “This contract cannot be assigned without the lessor’s consent”; “subleasing the rented equipment is prohibited”; and/or “this contract will be binding on the parties’ successors and assigns.”

However, these fail to sufficiently address loans of that equipment. Thus, customers may feel largely unconstrained when loaning or trading rentals. Yet, they also tend to feel completely justified in refusing to pay for damage done by their borrower. For equipment owners, equipment loans do not constitute assignments of rental contracts, but are instead, effectively only authorizations to use the rented equipment. Such authorizations, as well as assignments and subleases, are generally presumed authorized unless specifically prohibited in most cases. Therefore, unless a specific prohibition appears in your rental contract, a loan of your equipment likely will not constitute a breach. To make matters worse, the language “this contract will be binding on the parties’ successors and assigns” actually contemplates succession and assignment, thereby implicitly authorizing it if a specific prohibition isn’t included.

The result. Most rental contracts unwittingly authorize loaning out your equipment. Depending on what the rest of your rental contract says or doesn’t say, you could be left with no ability to recover for equipment damage done by borrowers.

What about insurance? Despite their apparent simplicity, equipment loans also can give rise to complex insurance coverage issues and may even leave the equipment wholly or partially without coverage.

The borrower almost certainly won’t have provided a Certificate of Insurance or Endorsement, and won’t be obligated to do so because, again, the borrower didn’t sign the rental contract. Even though the borrower’s insurance might theoretically be capable of covering borrowed equipment, the coverage may only be available if the borrower purchased a special endorsement, which covers borrowed equipment; the insurer may deny coverage, alleging that its insured, the equipment borrower, didn’t have an “insurable interest” in the equipment because it was borrowed; the coverage almost certainly won’t be primary and non-contributory; and it won’t benefit from a waiver of subrogation, such as the borrower’s insurer will still be able to subrogate and demand compensation from others, including the original owner/lessor.

Worse, the customer’s insurer may deny coverage. Some expressly exclude coverage for leased equipment loaned out to others.

Worst of all, the owner/lessor’s own insurer also may deny coverage if the insurer finds that the implicit authorization contained in the owner’s rental contract with respect to loans of the owner’s equipment breached the owner’s own insurance policy.

Damage waiver. Now consider a damage claim on loaned rental equipment on which your lessee purchased damage waiver:

Question: Does your damage waiver provision exclude damage done to your equipment as a result of your customer’s loan of that equipment to a third, perhaps untrained or incompetent, party?

Answer: Probably not. Most damage waiver provisions correctly exclude damage resulting from breaches of the rental contract, but that exclusion would apply only if loaning your equipment itself constitutes a breach — and again, it probably doesn’t if your rental contract is like most.

To sum it up, allowing your customers to loan your equipment out to other parties can be an expensive mistake.

Taxes. Sales and use taxes are due on all leases and loans of equipment, based on the implied rental value if no rent is charged. I know of no instance in which a borrower has paid sales or use taxes on the implied rental value of loaned equipment. Thus, at least theoretically, the owner of the loaned equipment and the loaned equipment itself may be exposed to liability for nonpayment of taxes on loaned equipment. As aggressive as taxing authorities have become in recent years, this is not as far-fetched as it might sound. This also underscores the need for including an agreement to pay all sales and use taxes in the original rental contract, as well as in any sublease or bailment agreement.

To sum it up, allowing your customers to loan your equipment out to other parties can be an expensive mistake. Most rental contracts not only fail to prohibit loans of rented equipment, they actually authorize them. Incorporating some simple protections can largely eliminate the problem.

First, prohibit loaning, subleasing, assigning or surrendering possession of your equipment. Then, if and only if you authorize your customer in writing to loan your equipment to someone else during the rental term, require that customer to obtain from the borrower in advance a signed agreement to be bound by the terms and conditions of your rental contract — which can be done in a loan or bailment agreement, sublease or other similar written instrument acceptable to you, the equipment owner; and an insurance certificate or endorsement evidencing the fact that the borrowed item(s) is/are specifically scheduled on the borrower’s policy. Be sure to require both liability and property damage/inland marine insurance.

In all other events, loaning out your equipment should constitute a material breach of your rental contract. Doing so could save you tens of thousands of dollars as well as years of litigation.