The Bear Minimum

In: Business and Management

Submitted By kstatecane
Words 1019
Pages 5
Background

Big Bear Power is a public utility with a strong financial position for the past several years. As a result of having a positive cash flow, Big Bear is in compliance with all of its debt covenants. Big Bear has entered a 10 year non-cancelable lease with Goliath Company for a combustion turbine. The lease is signed on December 15, 2010 and the right to use the turbine begins on January 1, 2011.

Relevant Issues and Case Facts

The case focuses on whether certain costs and provisions associated with the lease would be included in “minimum lease payments” under ASC 840 under leases. There are three specific provisions under question: legal fees paid in negotiating the lease contract, a possible penalty paid by Big Bear to Goliath in the event that Big Bear a “material adverse change” that leads to a default on its debt covenants, and increasing level rents equal to the increase in consumer price index.

Provision 1:

In negotiating the lease, Big Bear has paid $500,000 to it outside legal counsel. Big Bear is also required to pay $1 million in legal fees incurred by Goliath.

Provision 2:

A provision in the lease states that Big Bear must pay a penalty to Goliath if Big Bear’s bank declares a default under its primary credit arrangement. The provision is dependent upon whether or not there is a “material adverse change” in Big Bear’s financial condition. Big Bear believes that the likelihood of default is remote. Goliath and Big Bear’s bank have no relationship.

Provision 3:

The lease arrangement stipulates that Big Bear make lease payments of $1 million per year, increased (but not decreased) by the same rate as the consumer price index. These increasing level rents are payable ratably over 12 months, at the beginning of each month. At the inception of the lease, the CPI was four percent.

Issues to Resolve

The issue to resolve…...

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