Leasing

Evolution of Leasing

• Leasing activity was initiated in India in 1973. • The first leasing company of India, named First

Leasing Company of India Ltd. was set up in that year by Farouk Irani, with industrialist A C Muthia.

• For several years, this company remained the only company in the country until 20th Century Finance Corporation was set up - this was around 1980.

• By 1981, the trickle started and Shetty Investment and Finance, Jaybharat Credit and Investment, Motor and General Finance, and Sundaram Finance etc. joined the leasing game.

• The last three names, already involved with hire-purchase of commercial vehicles, were looking for a tax break and leasing seemed to be the ideal choice.

• The industry entered the third stage in the growth phase in late 1982, when numerous financial institutions and commercial banks either started leasing or announced plans to do so.

• ICICI, prominent among financial institutions, entered the industry in 1983 giving a boost to the concept of leasing.

• Thereafter, the trickle soon developed into flood, and leasing became the new gold mine.

• This was also the time when the profit-performance of the two doyen companies, First Leasing and 20th Century had been made public, which contained all the fascination for many more companies to join the industry.

• In the meantime, International Finance Corporation announced its decision to open four leasing joint ventures in India.

• To add to the leasing boom, the Finance Ministry announced strict measures for enlistment of investment companies on stock-exchanges, which made many investment companies to turn overnight into leasing companies.

• As per RBI's records by 31st March, 1986, there were 339 equipment leasing companies in India whose assets leased totaled Rs. 2395.5 million.

• One can notice the surge in number - from merely 2 in 1980 to 339 in 6 years.

• Subsequent swings in the leasing cycle have always been associated with the capital market - whenever the capital markets were more permissive, leasing companies have flocked the market.

• There has been appreciable entry of first generation entrepreneurs into leasing, and in retrospect it is possible to say that specialised leasing firms have done better than diversified industrial groups opening a leasing division.

• Another significant phase in the development of Indian leasing was the Dahotre Committee's recommendations based on which the RBI formed guidelines on commercial bank funding to leasing companies.

• The growth of leasing in India has distinctively been assisted by funding from banks and financial institutions.

• Banks themselves were allowed to offer leasing facilities much later - in 1994.

• However, even to date, commercial banking machinery has not been able to gear up to make any remarkable difference to the leasing scenario.

• The post-liberalisation era witnessed the slow but sure increase in foreign investment into Indian leasing.

• Starting with GE Capital's entry, an increasing number of foreign-owned financial firms and banks are currently engaged or interested in leasing in India.

Evolution of Hire-purchase

• The British concept of hire-purchase has, however, been there in India for more than 6 decates.

• The first hire-purchase company is believed to be Commercial Credit Corporation, successor to Auto Supply Company.

• While this company was based in Madras, Motor and General Finance and Instalment Supply Company were set up in North India.

• These companies were set up in the 1920s and 1930s.

• Development of Hire-purchase took two forms:

– consumer durables – and automobiles

• Consumer durables hire-purchase was promoted by the dealers in the respective equipment.

• Thus, Singer Sewing Machine company, or Murphy radio dealers would provide instalment facilities on hire-purchase basis to the customers of their products.

• The other side developed very fast - hire-purchase of commercial vehicles.

• The dealers in commercial vehicles as well as pure financing companies sprang up.

• The value of the asset being good and repossession being easy, this branch of financing activity flourished fast, although until recently, most of automobile financing business was in hands of family-owned businesses.

Leasing and Hire-purchase: A vanishing distinction

• Essentially, asset-based financing in India particularly by non-banking financial companies is split in two documentation modes - lease and hire-purchase.

• These two are technically different instruments, but in essence, there is not much that differs between the two, except for the caption.

• In spite of the substantive similarity, historically, there has been a diametric separation between these two forms.

• The assets usually subject matter of hire-purchase have been different from those generally leased out.

• Leasing has been used mostly for plant and machinery, while hire-purchase has commonly been used for vehicles.

• Even the players have been different.

• The reasons for this diametric distinction are more historical than logical.

• Hire-purchase, essentially a British form, entered India during the Colonial era, and thrived as almost the only form of external finance available for commercial vehicles.

• For the financiers, as witnessed World-over, commercial vehicles was the natural choice for several asset-features he loves: lasting value, ready secondary market, self-paying feature, etc.

• Hence, the industry of hire-purchase became synonymous with truck-financing.

• Besides, the motor vehicles laws gave the surest legal protection any law could give to a financier: the financier would not have to carry any of the operational risks of a motor vehicle, and yet, any transfer of the vehicle would not be possible without the financier's assent.

• Leasing, essentially a US-innovation, entered the country significantly in the early 80s, and was propagated as an alternative to traditional modes of industrial finance.

• Besides, the early motivation (which continues with a number of players even now) of leasing was capital allowances, more significantly the investment allowance, which was not available for transport vehicles.

• Hence, the leasing form historically clung to industrial plant and machinery.

• For several years, there was no lease of vehicles, because the Motor Vehicles law protection was not applicable to a lease, and there was no investment allowance on vehicles, and for reciprocal reasons, there was no hire-purchase of industrial machinery.

• These reasons have vanished over time.– The Motor Vehicles law now treats leases and hire-

purchase at par from the viewpoint of financier-protection.

– Investment allowance has been abolished, and hence, there are no predominant tax-preferences to a lease.

– The RBI treats lease and hire-purchase at par and has stopped giving a distinctive classification to leasing and hire-purchase companies.

– The accounting norms lead to the same effect on pre-tax income, as also balance sheet values, be it a lease or hire-purchase transactions.

Lessors

• Specialized leasing companies• Banks and bank-subsidiaries• Specialized Financial institutions• One-off lessors • Manufacturer-lessors

Specialized leasing companies

• These large companies which have an organizational focus on leasing, and hence, are known as leasing companies.

• Till recently, most of them were diversified financial houses, offering several fund-based and non-fund based financial services.

• However, recent SEBI rules on bifurcation of fund-based and non-fund based activities has resulted into hiving-off of merchant banking divisions of these entities.

• Most of these companies also offer hire-purchase activities, and some of them might have a consumer finance division as well.

• These companies are known, in regulator's jargon, as non-banking financial companies, or NBFCs for short.

• The terms NBFCs includes several other financial concerns too, and all such companies are regulated by the Reserve Bank of India.

• There were no entry barriers to leasing business till recently, but the January 1997 amendments to the RBI law now require any non-banking finance company to have a prior registration with the RBI, and the conditions of registration virtually amount to authorization by the RBI.

Banks and bank-subsidiaries• Till 1991, there were some ten bank subsidiaries active

in leasing, and over-active in stock-investing. • The latter variety was ravaged in the aftermath of the

1992 securities scam.• In Feb., 1994, the RBI allowed banks to directly enter

leasing. • So long, only bank subsidiaries were allowed to engage

in leasing operations, which was regarded by the RBI as a non-banking activity.

• However, the 1994 Notification saw an essential thread of similarity between financial leasing and traditional lending.

• Though State Bank of India, Canara Bank etc have set up leasing activity, it is not currently at a scale to make any difference on the leasing scenario.

• This is different from the rest of the World, where banks are front-runners in leasing markets.

Specialized Financial institutions• There is a wide variety of financial institutions at

the Central as well as the State level in India. • Apart from the apex financial institutions, viz.,

the Industrial Development Bank of India, the Industrial Finance Corporation of India, and the ICICI, there are several financing agencies devoted to specific causes, such as sick-industries, tourism, agriculture, small industries, housing, shipping, railways, roads, power, etc.

• In most States too, there are multiple financing agencies for generic or focussed cause

• Most of these institutions are using the lease instrument along with traditional financing instruments.

• Significantly, the ICICI was one of the pioneers in Indian leasing.

• At State level also, financial institutions are active in leasing business

One-off lessors

• Some of the companies engaged in some other business which gives them huge taxable profits, have resorted to one-off leasing on a casual basis to defer their taxes.

• These people are interested only in leasing of high-depreciation items, preferably those entitled to 100% depreciation.

• The major items eligible for 100% depreciation are gas cylinders, certain energy-saving devices, pollution control devices etc.

• Severe scrutiny by revenue officials into lease transactions at the time of assessment has dampened the enthusiasm in this line of leasing activity, however it carries on.

• Mostly such lease transactions are syndicated, at times even funded, by active players in leasing markets.

Manufacturer-lessors • This part of the lessor-industry is in highly under-grown form in

India, for simple reasons. • Vendor leasing is a product of competition in the product market. • As competition forces the manufacturer to add value to his sales,

he finds the best way to sell the product is to sell it without the buyer having to pay for it instantly.

• Product markets so far for most durables were oligopolistic, and good products used to sell even otherwise at a premium.

• With the economy decisively moving towards market orientation, competition has become inevitable, and competition brings in its wake sales-aid tools.

• Hence, the potential for vendor leasing is truly great.

• Presently, vendors of automobiles, consumer durables, etc. have alliances or joint ventures with leasing companies to offer lease finance against their products.

• However, there is no devoted vendor leasing of the type popular in most of the advanced markets, where a specific leasing company or leasing program takes exclusive charge of a vendor's products.

The lessees

• Corporate customers with very high credit ratings: These essentially look at leasing to leverage against assets which are otherwise not bankable, or for pure junk financing.

• Public sector undertakings: This market has witnessed a very rate of growth in the past.

• With budgetary grants to the PSUs coming to a virtual halt, there is an increasing number of both centrally as well as State-owned entities which have resorted to lease financing.

• Their requirements are usually massive.

• Mid-market companies: The mid-market companies, that is, companies with reasonably good creditworthiness but with lower public profile

• have resorted to lease financing • basically as an alternative to bank/institutional financing,

which to them is time-consuming and tedious.• Consumers: Retail funding for consumer durables was

frowned-upon at one point of time, but recent bad experience with corporate financing has focussed attention towards consumer durables which incidentally, is all the all-time favorite of financiers World-over.

• Most of the larger companies have expressed interest in consumer funding, with ticket size going as low as Rs. 5000.

• Car customers: Car leasing World-over is a very big market, and the same is true for India.

• So long, most car leases were plain-vanilla financial leases but one now finds few instances of value-added car lease services also being offered.

• Commercial vehicles: Commercial vehicles customers have always relied upon funding by hire-purchase companies.

• The customer profile ranges from large fleet owners to individual truckers.

• Earth-moving machinery customers: These customers have also traditionally relied upon lease financing.

• Their requirements are generally large - each excavators costs more than Rs. 25 lacs.

• The income-stream is based on contracts they have - at times, the income generation may be sporadic, or the need might itself be temporary.

• In fact, operating leases would have been ideal in this market, but they are yet to be launched to any serious degree.

• Govt. deptts. and authorities: One of the latest entrants in leasing markets is the Govt. itself.

• The Deptt. of Telecommunications of the Central Govt. took the lead by floating tenders for lease finance worth about Rs. 1000 crores.

• In its reforms programme, India has limits to the extent to which it can resort to deficit financing, and leasing is easily going to appeal to the Govt. , if not for cost reasons, at least for the fact that it will not feature in national accounts as a commercial financing.

• As a spin-off, it might even help reducing the reported deficit, as the Govt. resorts to what is loved World-over as a tool of off-balance-sheet financing.

Sources of Law on leasing and hire-purchase

• Leasing and hire-purchase are essentially hiring transactions - transactions in which possession of goods is handed over along with right to use, for a stated period and for consideration.

• Hiring transactions are species of bailments in contract law - therefore, the transactions of lease and hire-purchase are governed by the common law of contracts dealing with bailment transactions.

• Contracts law, being common law, is codified in the Indian Contracts Act 1872 but is enriched by history of precedents from both English and Indian Courts.

• Notably, the common law of contracts in India is based largely on the British legal principles, which have by and large been accepted as applicable to India.

• Therefore, the principal sources of applicable law on lease and hire-purchase transactions are sections 148 to 171 of the Indian Contracts Act dealing with bailments, and a long series of Court rulings, principally on hire-purchase transactions, but of late, on lease transactions as well.

Leasing and Hire-purchase

• From legal rights and obligations viewpoint, there is no difference between lease and hire-purchase transactions. Both are viewed as bailment transactions.

• Accordingly, most of the common law applicable to hire-purchase transactions is also applicable to leases, and vice versa.

• The difference between the two is principally the non-existence of option to buy in case of lease transactions.

• In other words, lease transactions carrying an option to buy, explicitly or implicitly, will be treated as hire-purchase transactions.

• This may lead to differences in taxation treatment, but there is no appreciable difference in legal rights of parties

Requirements of a valid lease or hire-purchase

• Both lease and hire-purchase, to be valid, must be valid bailment transactions.

• Therefore, all the preconditions of a valid bailment will be applicable to lease and hire-purchase transactions too.

• As the lease contract envisages a delivery of goods to the lessee, to be terminated by redelivery of goods at the end of the lease period, the goods must have the following features:

Durability

• The goods must last for at least as long as the lease period.

• Unless the lessor, or the lessee being under obligation to do so, replaces them and the goods so replaced become the subject matter of the lease, the contract of lease comes to an end as soon as the subject matter of the lease, viz., the leased goods, cease to exist.

• The goods constitute the very string of relation between the lessor and the lessee, and the relation is snapped the moment the string is broken.

• There may be doubts as to the existence of an intended lease where the goods leased are known not to have an estimated life at least equal to the lease period.

• For example, a lease of an umbrella could be intended, but not the lease of an ice cream.

• That is to say, goods which are consumed in the process of using them are incapable of lease.

Movability and severability• The goods leased are to be returned at the end of

the lease period, since the possessory interest is only for a specific period.

• At the end of the period, the goods must redeliverable.

• This requires two attributes: – that the goods must not have been permanently

attached or affixed to an immovable property and hence rendered immovable,

– nor must they have been attached unseverably to any other property

Identifiability• To ensure that the bailee holds the goods owned by the

bailor, the goods possessed by the lessee must be held distinct and ascertainable;

• in other words, the leased goods must not be mixed to render them unascertainable.

• The law of contracts distinguishes between mixture with or without the bailor's consent.

• Where the mixture is with the bailor's consent, the bailor and bailee will have proportionate interest in the lot. [Sec. 155].

• Where the mixture is without the bailor's consent and the goods are unseverable, the bailor becomes entitled to be compensated by the bailee for the loss of goods.

Supreme ownership rights of the lessor

• Indian Courts have generally recognized the ownership rights of a lessor over the leased asset.

• Even if the lease is avowedly a financial lease, such as in case of a hire-purchase transaction, the Courts respect the way the parties have sought to create and protect their rights.

Obligations relating to the goods• While enjoying all the rights of ownership, • the lessor may virtually escape all obligations

relating to the goods - conditions of fitness, quality, usefulness for purpose, or any damages on account of defects in goods,

• can be effectively avoided by a disclaimer clause in the agreement

• backed by evidence that the lessor was not involved in selection of the goods

• nor did he influence the lessee's decision as to the goods or the supplier.

Obligations regarding operation and use of the goods

• While being the owner of the goods, the lessor may completely distance himself from obligations relating to the operation and use of the goods.

• This issue is very comfortably settled in India though there is a raging controversy on this point in number of other markets.

• The lessor is not in effective possession and is not the user of the goods.

• The lessee cannot be taken to be the agent of the lessor.

[Sundaram Finance Ltd. v. D G Nanajappa and Others]

• A bus given on hire-purchase collided with a tree and killed several people. Hire-purchase financier as owner was not responsible. The driver of the bus was not to be taken as agent and the financier a "master".

[Great Finance (P) Ltd. v.The State]

• A truck given on hire-purchase was found carrying opium. The financier cannot be held responsible as the misuse of the vehicle could not have been with his consent and there was no possibility of the financier having control over the actual use by the hirer.

[Pradeep and Co. v. Collector of Customs AIR 1973 Cal 131.]

• While the owner of the asset has been held not to be responsible for misuse, he still claims right to be notified before confiscation of his asset.

Repossession of the goods

• On the lessee committing a breach of contract, the lessor being the owner of the goods is entitled to terminate the agreement of lease or hiring and repossess the goods.

• No judicial intervention is required in case of repossession of goods - however, the practice depends upon the physical ease in repossession and the need to enter private premises or enclosures.

• Repossession being an extra-ordinary remedy should be resorted to with great caution and with full force to the rules of fair play.

• In case of UP State Financial Corporation, • the Supreme Court set a number of preconditions

for possession and sale of confiscated properties • - though those conditions were imposed due to

the benevolent position of the Corporation, to a large extent, these conditions apply to every repossession.

• Hence, it is considered appropriate that before sale of the confiscated goods, the lessee should be given a right of buying the goods at the best available price.

Motor vehicles law on lease and hire-purchase

• Motor vehicles law in India contains specific provisions relating to lease and hire-purchase transactions.

• In respect of all motor vehicles, registration with motor vehicles authorities is compulsory.

• The motor vehicle is given a registration certificate, which contains the name of the "owner".

• Owner, for the purposes of the motor vehicles law, is defined as the person effectively using the asset- obviously therefore, the name of the lessee/hirer is reflected as owner there.

• The name of the legal owner, viz., the lessor or hire-vendor, is reflected merely by way of an endorsement.

• However, it is clear understanding of the law that the neither the name on the registration certificate, nor the endorsement therein, have any reflection on the legal ownership of the vehicle.

• It is also provided that no transfer of a motor vehicle bearing the endorsement of a lease or hire-purchase (or hypothecation) shall be permitted

• without the non-objection letter of the lessor/hire-vendor.

Lease and Hire-purchase documentation

• The documentation recommended for an ordinary lease/hire-purchase transaction is a simple lease or hire-purchase agreement.

• Evidence of having received delivery of goods should be obtained from the lessee/hirer.

• In general, it is advisable that the lessor limits himself to giving delivery of the leased asset, and commences the lease/hire instantly on delivery of the goods.

Basic tax treatment of lease and hire-purchase transactions

• The tax treatment of lease transactions in India is based on whether the lease qualifies as a lease or will be treated as a hire-purchase transactions.

• If the transaction is treated as a lease, the lessor shall be eligible for depreciation on the asset.

• The entire lease rentals will be taxed as income of the lessor.

• The lessee, correspondingly, will not claim any depreciation and will be entitled to expense off the rentals.

• If the transaction is a hire-purchase or conditional sale transaction, the hirer will be allowed to claim depreciation.

• This is based on an old Circular of the Deptt issued in year 1943.

• The financing charges inherent in hire instalments will be taxed as the hire-vendor's income and allowed as the hirer's expense.

What distinguishes between lease and hire-purchase

• Being the sole determinant of the tax treatment of leases, the distinction between lease and hire-purchase transactions becomes extremely important.

• Essentially, the distinction is based on the beneficial ownership of the asset.

• In order to qualify for depreciation, the lessor has to establish himself to be both the legal and beneficial owner of the asset.

• As in a hire-purchase transaction, the lessor allows to the lessee the right to buy the asset at a nominal price, it can be seen that the lessor has parted with the whole of his beneficial interest in the asset.

• The lessor will not be able to benefit from the asset during the lease period (as there is a committed right to use to the hirer), and beyond the lease period (as there is a right to buy the asset with the hirer).

• Having thus permanently divested himself of his beneficial rights, the lessor becomes ineligible to claim depreciation.

• As it is the beneficial ownership rights of the lessor that is crucial, the distinction between lease and hire-purchase goes beyond the mere existence of option to buy in the lease.

• If, explicitly or implicitly, it is apparent that the lessor has agreed to a permanent beneficial enjoyment of the asset by the lessee, the lease may be treated as a hire-purchase or a plain financing transaction.

Sale and leaseback transactions• Sale and leaseback transactions came under a lot of flak

during 1995-96, when transactions in junk funding were being labeled as sale and leasebacks at phenomenal values.

• The Income-tax law was amended to insert a specific provision about sale and leasebacks, which now restricts the amount with reference to which depreciation can be claimed in a sale and leaseback transaction, to the written down value in the hands of the seller-lessee.

• That is, the actual cost of the asset to the lessor will be ignored, and instead, depreciation will be allowed on the seller's depreciated value.

• This provision is applicable only where the seller is the lessee; in other words, not applicable for every lease of second-hand assets.

• However, in such cases, the fair valuation rule that existed earlier, in Explanation (3) to sec. 43 (1) shall continue to apply.

Tax treatment in case of hire-purchase transactions

• In case of hire-purchase transactions, the hire-vendor pays tax on the income inherent in hire instalments, not on the whole of the hire rentals.

• Thus, the tax is charged only on the income, and not the inflow.

• There are no well-defined rules on determination of income in case of hire-purchase transactions - therefore, accounting method adopted by the tax payer will generally be followed.

• Thus, either of the straight-line, sum-of-digits, or actuarial or IRR basis can be adopted for income allocation.

Deduction of rentals by the Lessee

• In general, in a lease, the lessee will be allowed to claim the rentals as an expense

What Is the Concept of Leveraged Leasing?

• It is simply a lease transaction in which the lessor puts in only a portion, usually 20% to 40%, of the funds necessary to buy the equipment and a third-party lender supplies the remainder.

• Because the benefits available to the lessor are generally based on the entire equipment cost, the lessor's investment is said to be "leveraged" with third-party debt.

• Generally, the third-party loan is on a nonrecourse-to-the-lessor basis and ranges from 60% to 80% of the equipment's cost.

• The nonrecourse nature means the lender can only look to the lessee, the stream of rental payments that have been assigned to it, and the equipment for repayment.

• The lessor has no repayment responsibility even if the lessee defaults and the loan becomes uncollectible.

• Although the concept of leveraging a lease investment is simple, the mechanics of putting one together is often complex.

• Leveraged lease transactions, particularly ones involving major dollar commitments, frequently involve many parties brought together through intricate arrangements.

• The "lessor" is typically a group of investors joined together by a partnership or trust structure. The partnership or trust is the legal owner, or "titleholder," of the equipment.

• The "lender" is often a group of lenders usually acting through a trust arrangement.

• This is further complicated by the fact that each participant will be represented by counsel with varying views.

• As a result, the job of organizing, drafting, and negotiating the necessary documents is generally very difficult.

• Because the expenses involved in documenting a leveraged lease can be substantial, transactions involving less than $2 million worth of equipment can be economically difficult to structure as a leveraged lease.

• If, however, documentation fees (such as counsel fees) can be kept within reason, smaller equipment amounts can be financed in this manner.

• In many cases a prospective lessor or underwriter has an in-house legal staff with the ability to originate and negotiate the required documents.

• If so, this will help keep costs down.

• Generally, leveraged lease financings are arranged for prospective lessees by companies or individuals who specialize in structuring and negotiating these types of leases.

• These individuals and firms are referred to as lease underwriters. • Essentially, their function is to structure the lease economics, find the

lessor-investors, and provide the necessary expertise to ensure that the transaction will get done.

• In a limited number of situations, they also find the debt participants. They do not generally participate as an investor in the equipment.

Underwriting

• Because the vast majority of leveraged leases are brought about with the assistance of lease underwriters, lease underwriting has become synonymous with leveraged leasing.

• The premise on which lease underwriting services are provided by an underwriter (that is, on a "best efforts" or "firm" basis) varies significantly.

• It is, therefore, worthwhile at this stage to explore the two types of underwriter offers: "best efforts" and "firm commitment" underwriting arrangements.

A 'Best Efforts' Underwriting Arrangement Can Be Risky

• Lease underwriting transactions are frequently bid on a "best efforts" basis.

• This type of bid is an offer by the underwriter to do the best it can to put a transaction together under the terms set out in its proposal letter.

• There are no guarantees of performance. • As a result, a prospective lessee accepting the offer

may not know for some time whether it has the financing.

• In practice, a best efforts underwriting is not as risky as it appears.

• Most reputable underwriters have a good feel for the market when bidding on this basis and usually can deliver what they propose.

• Thus, there is a good chance they will be able to get "firm commitments" from one or more prospective lessor-investors to participate on the basis offered.

A 'Firm Commitment' Underwriting Arrangement Is Often the Best

• From a prospective lessee's viewpoint, a "firm commitment" underwriting proposal is generally the preferred type of offer.

• When an underwriter has "come in firm" it is guaranteeing to put the proposed lease financing together.

• Typically, before an underwriter submits this type of proposal, it has solid commitments from lessor-investors to enter into the transaction on the terms presented.

• This, however, is not always the case. The underwriter's firm bid may only represent its willingness to be the lessor if it cannot find a third-party lessor.

A PRACTICAL LOOK AT LEASE DOCUMENTATION

Your equipment lease documents are designed to:

• * Protect lease revenues• * Protect residual value • * Protect the lessor from liability • * Protect enforceability

• Overview

Term/Rent

• Generally, the term of an equipment lease will begin on acceptance of the equipment, which sounds much more simple than we all know it actually is.

• This is one of many areas where the reliance on standard form documentation, without periodic review and a bit of thought in individual circumstances, can lead to disaster.

Coordination of the lease

• the schedule (if a master lease is used), the delivery and acceptance certificate and the purchase order are key

• The date on which the term begins should be clear.

• Most leases clearly state whether the rent is intended to be paid in advance or in arrears.

• Be mindful of this in structuring casualty or termination value tables

Interest/Late Charges

• Far more common than problems about the term and rent provisions are problems regarding the lessee's late payment of rent.

• Generally, this is not a usury problem in most states — penalty rent is not considered to be "interest" for usury purposes under most state laws.

• However, several types of problems can arise if the late charges are not consistently applied. If the lessee is going to be given grace for any reason, a written letter to the lessee should explain that the lessor reserves the right to reinstitute the penalty later on.

• Late charges fall into several categories. • Some leases require a single lump sum

payment, which should be invoiced to the lessee as soon as it is due.

• Other leases require a calculation of interest, usually from the date due until the date of payment.

Net Lease/Hell or High Water Clause/Warranty Disclaimer

• The net lease provision states that the lessee is responsible for paying operating costs, taxes and insurance.

• This effectively means that the rent payment is "net" to the lessor (except for the lessor's income taxes and overhead).

hell or high water clause

• The hell or high water clause is important to establish that the lessee must pay the full amount of rent whether or not the equipment functions and has no right of offset. If this clause is explained to the lessee, it should be pointed out that the lessee does not, in this clause alone, give up its right to sue the lessor if it feels that the lessor has breached any terms of the lease, including representations regarding the equipment.

Warranty Disclaimer

• Under Article 2A, a warranty is implied by the lessor whether the equipment is leased under a true lease or a disguised security arrangement.

• In other words, you are all deemed to be making an implied warranty that the equipment is "merchantable" and "fit" for the lessee's intended use

• UNLESS THE WARRANTY DISCLAIMER LANGUAGE IS PRESENT IN YOUR LEASE.

Delivery & Acceptance/Purchase Orders

• As a general rule, virtually all of the lessee's obligations to the lessor, including the obligation to pay rent and to indemnify the lessor, arise only when the equipment has been accepted.

• Likewise, the lessor's obligation to make payment to the vendor of the equipment arises on the lessee's acceptance.

Return Provisions

• One of the provisions which addresses directly the lessor's anticipated residual value realization is the return provision of the lease.

• These provisions include provisions addressing the condition in which the equipment must be on the date of return, the allocation of the costs of redelivery and what additional charges the lessee may be required to pay.

Purchase/Renewal Options

• On their face, few things are as simple as the concept of a renewal or purchase option. In fact, few provisions cause more problems.

• It is essential that the Lessor be fully familiar with the terms of the renewal or purchase option provision as it relates to the particular lessee and equipment.

• "Fair market value" may be a difficult concept

• If the lessee desires to exercise a renewal or purchase option, check to ensure that no default exists, that no liabilities are outstanding and that the lessee has complied with all notice and other requirements.

• In addition, a provision describing how fair market value should be in your lease form.

• Be sure you are comfortable with its workings and the potential cost in dollars and time.

• Contact potential appraisers in advance and be sure that they are familiar not only with the type of equipment but the concept of a fair market value determination for equipment lease purposes.

• Some Terms

Gross Lease

• In this form of lease the lessor is responsible for all expenses associated with ownership of the equipment such as maintenance, taxes and insurance.

Net Lease

• A net lease is the opposite of a gross lease. • Here, the lessee is responsible for expenses

related to the operation of the equipment such as maintenance, taxes and insurance.

Residual Value

• This is the value of the equipment at the end of the term.

Vehicle

• Buying vs. leasing basics

OwnershipBuying Leasing

You own the vehicle and get to keep it as long as you want it.

You don't own the vehicle. You get to use it but must return it at the end of the lease unless you decide to buy it.

Up-front costsBuying Leasing

They include the cash price or a down payment, taxes, registration and other fees.

They typically include the first month's payment, a refundable security deposit, a down payment, taxes, registration and other fees.

Monthly paymentsBuying Leasing

Loan payments are usually higher than lease payments because you're paying off the entire purchase price of the vehicle, plus interest and other finance charges, taxes, and fees.

Lease payments are almost always lower than loan payments because you're paying only for the vehicle's depreciation during the lease term, plus interest charges (called rent charges), taxes, and fees.

Early terminationBuying Leasing

You can sell or trade in your vehicle at any time. If necessary, money from the sale can be used to pay off any loan balance.

If you end the lease early, early-termination charges can be almost as costly as sticking with the contract.

Vehicle returnBuying Leasing

You'll have to deal with selling or trading in your car when you decide you want a different one.

You can return the vehicle at lease-end, pay any end-of-lease costs, and walk away.

Future valueBuying Leasing

The vehicle will depreciate but its cash value is yours to use as you like.

On the plus side, its future value doesn't affect you financially. On the negative side, you don't have any equity in the vehicle.

MileageBuying Leasing

You're free to drive as many miles as you want. (But higher mileage lowers the vehicle's trade-in or resale value.)

Most leases limit the number of miles you may drive, often 12,000 to 15,000 per year. (You can negotiate a higher mileage limit.) You'll have to pay charges for exceeding your limits.

Excessive wear and tearBuying Leasing

You don't have to worry about wear and tear, but it could lower the vehicle's trade-in or resale value.

Most leases hold you responsible. You'll have to pay extra charges for exceeding what is considered normal wear and tear.

End of termBuying Leasing

At the end of the loan term (typically four to five years), you have no further payments and you have built equity to help pay for your next vehicle.

At the end of the lease (typically two to four years), you'll have to finance the purchase of the car or lease or buy another.

CustomizingBuying Leasing

The vehicle is yours to modify or customize as you like.

Because the lessor wants the vehicle returned in sellable condition, any modifications or custom parts you add will need to be removed before you return the car. If there is any residual damage, you'll have to pay to have it fixed.

• LEASE OR BUY

• Companies have usually several options when acquiring capital equipment.

• There are at least three possibilities: – lease– buy and finance through a loan– buy with cash on hand

• Cash flows of these three options are driven by several components including

• interest and discount rates, • effective tax rate, • number of depreciable years for tax purposes, • how long the equipment will be used, • and the salvage value at the end of its use.

• Simply comparing different cash flows in different time periods may not be practical in order to arrive at a capital investment decision.

• Hence there is a need for a metric that can accurately summarize these cash flows for each investment option.

• Net present value (NPV) is such a metric. NPV is calculated as the sum of present values of current and future cash flows.

• The focus on NPV forces companies to identify all cash flows from these three lease-or-buy options, which ensures that not only the month-to-month payments are considered.

• Hence, from a purely financial point of view, companies should acquire capital equipment based on the option with the lowest NPV.

• By leasing, the company can use its cash for investment in its core business rather than in the infrastructure required to run it.

• Equipment that is often leased includes computers and peripherals, office furniture, manufacturing and construction equipment, and commercial vehicles.

• Between leasing and financing, leasing usually offers the lowest month-to-month payments.

• But there are also other costs associated with a lease, especially the residual value of the equipment and the buyout price agreed with the leasing company upfront.

• Some lessees make the mistake of focusing on the low monthly payments and don't consider also the choices that they will need to make at the end of the lease.

• Lessees should keep in mind for example that they may need to continue using the equipment, which may require extending the lease or buying out the equipment.

• Both choices may generate additional costs

• Financing the purchase through a loan may make more sense if the company needs to use the equipment longer than just few years.

• Cash purchase could be the preferred option, on the other hand, if the equipment is needed for longer period of time and the interest rate of the lease or loan significantly exceeds company's cost of capital.

• The decision to buy or lease can be made only after a systematic evaluation of the relevant factors.

• The evaluation must be carried out in two stages: – First, the advantages and disadvantages of purchase

or lease must be considered, and – second, the cash flows under both alternatives must

be compared.

•

• Calculating Lease Payments

Lease Amount

• This is the presumed value of the asset being leased, at the time that the lease is signed. It is the present value of the future payments on the lease, including the residual value.

Residual Value• This is the assumed value of the asset at the end of the life of the lease. • Often, as is the case for auto loans, the lessee has the option of

purchasing the asset for this price when the lease is up. • For example, an auto lease may specify a residual value of $15,000 when

the lease is up in 3 years. • At that time, the lessee has the right, but usually not the obligation, to

purchase the vehicle for $15,000. • If the lessee chooses not to exercise that option, then the vehicle will be

turned over to the lessor. • In this example, the lease has a built-in call option with a strike price equal

to the residual value.

Advance Payments

• Sometimes the lease terms call for a number of payments to be paid in advance, when the lease is signed.

• The number of advance payments could be 0, 1, 2, or more.

• For example, suppose that a lease calls for a $300 monthly payment with 2 advance payments.

• Then, when the lease is signed, you would pay $600 (2 payments) and the first regular payment of $300 would be due in one month.

Calculating the Monthly Lease Payment

• If we assume that the lease does not call for any advance payments, then calculating the regular monthly payment is straightforward.

• The lease cash flows are an annuity (the monthly payment) and a lump sum (the residual value) at the end of the lease.

• Our example lease has a present value of $3,500, a residual value of $1,000, and a monthly payment of $121.71

The cash flows of the lease resemble those on a bond, as can be seen in the picture below:

• The principle of value additivity states that the present value (lease amount) is equal to the present value of the monthly payments (an annuity) plus the present value of the residual value (a lump sum).

Therefore, we have the following formula as our starting point:

• We already know the PV (that is, the lease amount) and the FV (the residual value), and we want to solve the above equation for the monthly payment amount.

• This requires a minor amount of algebra to rearrange the equation, and the result is:

Cross Border Leasing and Marketing Strategy

Vikram Singh Sankhala

• Cross-border leasing is a leasing arrangement where lessor and lessee are situated in different countries.

• This presents significant additional issues related to tax avoidance and tax shelters

Double-dip lease

• Cross-border leasing has been widely used in some European countries, to arbitrage the difference in the tax laws of different jurisdictions, usually between a European country and the United States.

• Typically, this rests on the fact that, for tax purposes, some jurisdictions assign ownership and the attendant depreciation allowances to the entity that has legal title to an asset, while others (like the U.S.) assign it to the entity that has the most indicia of tax ownership (legal title being only one of several factors taken into account).

• In these cases, with sufficiently long leases (often 99 years), an asset can end up with two effective owners, one in each jurisdiction; this is often referred to as a double-dip lease.

History• Leasing techniques have been used for financing

purposes for several decades in the United States. • The practice developed as a method of financing

aircraft. • Several airlines in the early 1970s were notoriously

unprofitable and very capital intensive. • These airlines had no need for the depreciation

deductions generated by their aircraft and were significantly more interested in reducing their operating expenses.

• A very prominent bank would purchase aircraft and lease them to the airlines.

• Because the bank was able to claim depreciation deductions for the aircraft,

• the bank was able to offer lease rates significantly lower than the interest payments that airlines would otherwise pay on an aircraft purchase loan (and most commercial aircraft flying today are operated under a lease).

• In the United States, this spread into leasing the assets of U.S. cities and governmental entities and eventually evolved into cross-border leasing.

• In a globalizing environment, cross-border leasing has not picked up the way it might have been expected.

• Cross-border lease transactions are generally restricted to aircraft leasing, where this is the most popular means of financing, marine equipment and railroad rolling stock to some extent.

• Marketing of Leasing Services

• Equipment Leasing is big business that can bring in good profits for your company,

• but to accomplish that, you need to market your Equipment Leasing business properly.

• Equipment Leasing marketing will work, first of all, if you have the right business plan in place.

• This is the most crucial part of the Equipment Leasing business.

• You will then need to examine the history of your Equipment Leasing company the right way

• by starting at its beginnings and • analyzing how it was able to survive up to its

present state and age without going under. •

• You have to tag the events and trends that influenced the Equipment Leasing industry at various periods in time,

• then look at the present condition of your Equipment Leasing business to see

• what factors exist now • and what events seem to impact on the

company. • This will help as you refine your Equipment

Leasing business plan and Equipment Leasing marketing plan.

• Now you have to analyze how much of a budget you have for marketing your Equipment Leasing company the right way and to the right customers.

•

• Analyze the return on investment properly, • You may have to factor in various aspects of

an Equipment Leasing company's overhead • (such as personnel compensation, lights,

water, and maintenance of the heavy equipment you are leasing out.)

• Steps for Creating the Marketing Plan

Prepare a mission statement

• The mission statement clearly and succinctly describes the nature of the business, services offered, and markets served

• —usually in a few sentences. • Sometimes for larger companies it’s combined

with a vision statement that can be two to three paragraphs in length.

List and describe target or niche markets

• In this section, list and describe potential groups of users or clients.

• After you create the list, identify various segments of a market.

• Segments can include specific types of people in a company by role—for example, chief executive officer, chief financial officer, or marketing director.

• Department heads are another type of market segment. For segmenting the consumer market, consider age groups.

• In addition, niche markets are an integral part of marketing.

• Within a target market of attorneys, for instance, there may be niche groups such as trial or malpractice attorneys.

• In some instances, targeting by firm size is an important consideration

Describe your services

• As mentioned above, it’s necessary to conduct market research to understand your market and to identify the services they require.

• At the same time, inventory the services you currently offer and identify new services you wish to provide.

• Determine what it will take to provide these services in terms of staff, expertise, and costs.

Spell out marketing and promotional strategies

• Various strategies work better for different target markets and, therefore, several may be required to triumph.

• The key for successful marketing is understanding what makes someone want to use or buy services and what type of marketing strategy they respond to.

• This requires you to learn needs, problems, industry trends, and buzzwords.

• Find out what works best for the markets you serve.

Identify and understand the competition.

• As part of the market planning process, you must learn about your competitors and how to position yourself in relation to them.

• Describe your strengths and what you want to emphasize.

• Once you identify both direct and indirect competition (for example, the Internet as indirect competition), you can determine how and why your services are special and benefit users in a particular way.

• You can compete based on value, price, product, or service, or some combination of these.

• Your unique position in the marketplace must be touted in your marketing programs and marketing literature.

Establish marketing goals that are quantifiable

• Marketing goals can include setting the number of new clients you would like to acquire, the number of people you would like to reach, or the amount of income you would like to generate.

• Be realistic and practical in establishing your goals.

• Take a good look at the available skills and resources that you can commit to implement and integrate your goals into your marketing plan effectively.

• Study the budget requirements for the strategies you select and plan accordingly

Monitor your results carefully

• By monitoring results, you determine which of your marketing strategies are working and which are not.

• Identify strategies that generate leads and sales. • This involves tracking and evaluating customers’

responses to each marketing strategy. • Survey or interview regular users for comments

about why they find a service important.

The Steps

• Step One: Situation Analysis• Step Two: Problems and Opportunities

(SWOT-strengths, weaknesses, opportunities, threats analysis);

• Step Three: Goals and Objectives• Step Four: Strategies• Fifth Step: Tactics; analyzing plan results.

• The End