Theoretical and Regulatory

Framework of Leasing

Chapter 2
Management of Financial Services - MY Khan
Lease - definition
 A lease is an agreement whereby the lessor conveys
to the lessee , in return for rent, the right to use an
asset for an agreed period of time.

 A financing arrangement that provides a firm with an

advantage of using an asset, without owning it, may
be termed as ‘leasing’.
Characteristics of lease
 The Parties
 The Asset
 The Term
 The Lease Rentals
Types of Lease
 Financial Lease :  Ballon Lease
 Operating Lease  Close end leasing
 Conveyance Type  Swap Leasing
lease  Wrap Leasing
 Leveraged Lease  Import Leasing
 Sale and Leaseback  Cross Border
 Partial Pay-Out leasing
Lease  International
 Consumer Leasing Leasing
Types of Lease...
 Financial Lease
 Also called ‘Capital Lease’
 A contract involving payment over an obligatory period,
of specified sums sufficient in total to amortize the
capital outlay , besides giving some profit to the lessor.
 ICAI defines it as : financial lease is a lease under
which the present value of the minimum lease
payments at the inception of the lease exceeds or is
equal to substantially the whole of the fair value of the
leased asset.”
Financial lease...
 It is non-cancelable in nature.
 The lessee is responsible for the
maintenance of the asset leased.
 The lease generally provides for the
renewal of the lease on expiry of the
lease contract.
 Variants : full payout lease , True Lease
Operating Lease
 An operating lease is a type of lease
whereby the asset is not fully amortized
during the non-cancelable period of the
lease , and where the lessor does not rely on
the lease rentals for profits.
 Short term lease on a period to period basis.
 Period of the lease is less than useful life of
the asset.
Operating Lease...
 The lease is cancelable at short notice by
the lessee.
 The lessee has the option of renewing
the lease after the expiry of the lease
period
 Asset maintenance and insurance etc. is
the responsibility of the lessor and he
charges for the same.
 It is a high risk lease to the lessor, as any
time it may be cancelled by the lessee.
Types of Lease
Net Lease :
 A variant of operating lease, where the lessor is not
concerned with the repairs and maintenance of the
leased asset.

 Lessor does not provide:

- repairs, maintenance, servicing of lease property
- purchasing parts and accessories.
- loan of a replacement/substitute
- purchase of insurance for the lessee.
Types of Lease…

Conveyance Type Lease :

 Very long type of lease applicable to immovable
property.
 Objective to convey the title in property.
 Lease periods as long as 99 to 999 years.
Leveraged Lease
 Where a financier is involved for the whole or a part
of the financial requirement.
 Used for high value asset.
 The financier will have charge over the leased asset,
over and above the lease rentals.
Types of Lease….
 Sale and Leaseback:
 Owner of the asset sells it to the lessor, and
gets the asset back under the lease
agreement.
 Ownership transfer from the original owner to
the lessor, who again leases out the asset.
 Immediate financing to the seller company,
whose funds are tied up in the asset.
Types of lease…..
 Partial pay out lease: Full payment of the lease in
several leases.
 Consumer Leasing :Leasing of consumer durables
like Refrigerator, televisions, etc.
 Balloon Lease : a lease which has zero residual value
at the end of the lease period. i.e. low lease rentals at
the inception, high in the mid years, and low again at
the end of the lease.
 Close end leasing : the asset is reverted to the lessor
at the end of the lease.
 Open end leasing : the lessee guarantees a minimum
value to the lessor , from the sale of the asset at the
end of the lease term. If on sale of the asset, the
residual value is less , then lessee pays to the lessor
the difference amount.
Types of Lease…..
 Import Leasing :
- leasing of imported capital goods.
- beneficial to the lessee, because arranging
other sources of funds takes long. Lenders do
not usually finance the import duty which forms
sizable portion of the cost.
- during which the prices of imported goods may
rise + fluctuation in exchange rates may
happen.
Types of Lease…..
 Cross Border Leasing :
 A lease where the lessor is in one country and lessee
in another.
 The Jurisdiction of lessors and lessees are in two
different countries.
 Eg. Leasing of airplanes.
 International Leasing
 A case where the leasing company is operating in
various countries through its branches.
 International leasing is active in countries like U.S.,
Japan, HongKong etc.
Regulatory framework of leasing
 Provisions under Contract Act relating to
Bailment:
 two parties - lessor - bailor, lessee-
bailee.
 Transfer of possession of goods from
bailor(lessor) to bailee(lessee), for a
specific purpose.
 As under bailment, on accomplishment
of purpose the goods transferred from
lessee to lessor.
Regulatory framework of
leasing..
 Liabilities of Lessee(Bailee)..
 Reasonable Care :
 The lessee to take reasonable care of the asset. If he
fails he is liable to for loss or damage to the goods
that he has caused.
 If goods damaged despite of reasonable care,
(floods, riots etc), then the lessee is not responsible.
 Generally lease agreements make the lessee
responsible , irrespective of lessee’s negligence.
Regulatory framework of
leasing..
 Unauthorized Use not Permitted to the Lessee:
 The lessee is not allowed to use the leased asset , for
any purpose other than one specified in the lease
agreement.
 If he does so , then the lease agreement is terminated,
and lessor recovers the possession of the goods.
 Return of Goods :
 The lessee has to return the goods :
 on completion of the lease term; or
 the lease agreement has been terminated by the
lessee or lessor/or automatic termination of the
agreement because of breach of conditions.
Regulatory framework of
leasing….
 Not to set up an Adverse Title: must
inform the lessor of any adverse claim.
 Payment of Lease Rental:
 Insure and Repair the Goods:
 Liabilities of the Lessor(Bailor):
 Theoretical Framework of Leasing
 Liabilities of Lessor (Bailor):
 Delivery of Goods:

- Ensure delivery of goods to the lessee, along with

documents for lawful use of asset. Lease commences on
delivery.
 Peaceful Possession:

- Lessor must ensure quite possession of the goods during

the lease term
 Fitness of Goods
 To Disclose All Defects: all known defects to be
disclosed. If not then the lessor has to compensate the
losses incurred by the lessee due to such defects.
Theoretical Framework of Leasing…
 Remedies for Breach;
 Remedies to the Lessor:
- Forfeiture : forfeiture of all lease rentals paid up to the date of
termination, even if it exceeds the amt. of benefit received by
the lessee.
- Repossession : repossession of goods on breach of lease
through serving of a notice on lessee. For repossession of
goods physical force can be used by the lessor.
 Remedies to the lessee: may claim damages for loss resulting
from the termination. This includes increased lease rentals he
has to pay on new lease asset obtained + damages for not
allowing him to use the asset from termination date to the the
date of expiry of the lease term.
Theoretical Framework of Leasing…
 Insurance of the leased Asset ;
 Both lessor or lesse can obtain the insurance.
 Generally obtained by the lessee, covering loss due damage by
fire, riot, faulty handling, Act of God etc.
 Claims Proceeds : in case of asset being fully destroyed, the
claims received , adjusted against the lessor’s dues. In case of
partial damage, the claim proceeds to be adjusted against
amount financed, and then for balance lease rentals is
computed.
 Sub Lease by lessee : not allowed unless provided in the lease
agreement. Except for assets where sub lease is apparent. Sub
lease becomes the lease of the original lessor as well. If Main
lease is terminated then the sub lease gets automatically
terminated.
 Lease Documentation and
Agreement
 Lease Approval Process:
 Appraisal of the Lease proposal. Sanctioning of the
credit amount.
 Letter of Offer, with stipulated time for acceptance.
 Acceptance of Offer by lessee within stipulated time,
with Board Resolution for acceptance of the offer.
 Documents required:
 Purchase Order, Invoice, Bill of Sale from supplier,
delivery note, insurance policies, import license, copy of
shops and establishments registration certificate, copies
of Audited balance Sheet and P&L A/c. for 3yrs, M of A
and Articles of Assocation, Provisional results for the
first 6 mths, IT returns/Salary certificate,
Lease Documentation and
Agreement…..
 All these documents to be obtained by the
lessor from the lessee.
 They are called “Attendant Documents” as
they help in taking a decision for the lease
proposal.
 Insurance Policy compulsory for the leased
asset, in the name of the lessor account
lessee. Policy should be in the custody of the
lessor.
Lease Agreements
 It specifies the legal rights and obligations of
the lessor and lessee.
 Usually a Master lease is signed containing
the qualitative terms in the main part, and the
equipment details, rentals, credit limits and
payment duration etc in attached schedules.
 Additional lease facilities are finalized under
supplemental lease agreements, with
reference to the Main Master Lease
Agreement.
Lease Agreements...
 Clauses in Lease Agreement:
 Nature of the lease : financial lease, operating lease etc.
 Description : of the equipment, its actual condition, size,
estimated useful life, components etc.
 Delivery and Re-delivery : when and how the equipment
would be delivered to the lessee and redelivered by him.
 Lease Rentals ; procedure for payments of lease rentals
with the rates. Besides, the late payment charges.
 Repairs & Maintenance : responsibility of repairs, insurance
etc.
 Title : identification and ownership of equipment.
 Events of default and Remedies : consequences of default
and recourse available to the lessor.
Tripartite Lease Agreement
 Three parties - Manufacturer,
lessor(financier) and lessee.
 Guarantee Agreement : in addition to master
lease agreement. Guarantor liable for the due amt. of
lessee. He signs the guarantee agreement. If
Guarantor is a company then Board Resoultion for
the same is a must.
 Income and Address proof of Guarantor taken.
 Agreement on a stamp paper.
Tripartite Lease Agreement...
 Promissory Note:
 Lessee to execute an unconditional promissory note in
favour of lessor for the full amount of lease rentals payable,
counter guaranteed by the guarantor.
 Beyond three years, a fresh promissory note to be executed.

 Receipt of Goods:
 In case of tripartite lease , the manufacturer/supplier/lessor,
delivers the goods directly to the lessee, so he has the
execute the receipt for the goods.
Tripartite lease agreements...
 Collateral Security/Hypothecation
Agreement:
 Sometimes required if financial position of the
lessee is weak.
 Collateral security may be a Promissory Note
by lessee , insurance policies, shares etc.
 No Pledge Deed is required.
 A deed of Hypothecation may be executed on
stamp paper of appropriate value.