Framework of Leasing Dr Saif Siddiqui Assistant Professor Centre for Management Studies Jamia Millia Islamia (A Central University) New Delhi - 110025

Lease -Defined A lease is a contractual arrangement in which a party owning an asset (lessor) provide the asset for use to another party (lessee) for a agreed period of time in consideration of a periodic payment (rentals). At the end of the contract (lease period ), the asset reverts back to the lessor, unless there is a provision for the renewal of the contract

A lease is a contractual arrangement

in which a party owning an asset (lessor)

provide the asset for use to another party (lessee)

for a agreed period of time

in consideration of a periodic payment (rentals).

At the end of the contract (lease period ), the asset reverts back to the lessor,

unless there is a provision for the renewal of the contract

Essential elements: Parties to the contract Essentially two parties : lessor and lessee Both can be individuals, partnerships, joint stock companies Joint lessor and lessee , where amount is enormous Contract may involve lease financiers , who refinance lessor

Parties to the contract

Essentially two parties : lessor and lessee

Both can be individuals, partnerships, joint stock companies

Joint lessor and lessee , where amount is enormous

Contract may involve lease financiers , who refinance lessor

Essential elements: cont… Asset The asset is the subject matter of the contract Asset must be of lessee’s choice , suitable for his business needs. Separation of ownership from user Term of lease The time period for which lease remain operational A definite time period is required otherwise , it will be legally inoperative The period may stretch over the entire economic life of the asset

Asset

The asset is the subject matter of the contract

Asset must be of lessee’s choice , suitable for his business needs.

Separation of ownership from user

Term of lease

The time period for which lease remain operational

A definite time period is required otherwise , it will be legally inoperative

The period may stretch over the entire economic life of the asset

Essential elements: cont… Lease rentals So structured as to compensate the lessor for the investment made in the asset

Lease rentals

So structured as to compensate the lessor for the

investment made in the asset

Classification basis : The lease transaction can differ on the basis of : The extent to which risk and reward of ownership are transferred Risk refers to possibility of loss for under utilization or technological obsolescence of the equipment Reward mean cash flow generated from the usage of equipment and residual value No. of parties to the transaction Domicile of lessor and lessee

The lease transaction can differ on the basis of :

The extent to which risk and reward of ownership are transferred

Risk refers to possibility of loss for under utilization or technological obsolescence of the equipment

Reward mean cash flow generated from the usage of equipment and residual value

No. of parties to the transaction

Domicile of lessor and lessee

Types of leasing: Finance lease and operating lease Sales and lease back and direct lease Single investor lease and leveraged lease Domestic lease and international lease

Finance lease and operating lease

Sales and lease back and direct lease

Single investor lease and leveraged lease

Domestic lease and international lease

Finance lease and operating lease Finance lease: The lessee select the equipment and negotiate with manufacturer Lessor purchase the equipment and lease Lessor retain the title , lessee uses it lessor transfer all the risk and reward of the asset Involves payment of rental over an obligatory non- cancelable lease period Lessor is a financer , not interested in assets Lessor recover its investment and earn profit Example : ships, aircraft etc.

Finance lease:

The lessee select the equipment and negotiate with manufacturer

Lessor purchase the equipment and lease

Lessor retain the title , lessee uses it

lessor transfer all the risk and reward of the asset

Involves payment of rental over an obligatory non- cancelable lease period

Lessor is a financer , not interested in assets

Lessor recover its investment and earn profit

Example : ships, aircraft etc.

Finance lease and operating lease Operating lease: It is one which is not a finance lease It is also known as service lease Lessor provides for the services attached as maintenance Lessor bears the risk of obsolescence , lessee can cancel the lease any time The lease rental is cost of service provided Lessor does not depend on single lease to cover its entire cost examples: car , computers , charter planes

Operating lease:

It is one which is not a finance lease

It is also known as service lease

Lessor provides for the services attached as maintenance

Lessor bears the risk of obsolescence , lessee can cancel the lease any time

The lease rental is cost of service provided

Lessor does not depend on single lease to cover its entire cost

examples: car , computers , charter planes

Sale and lease back and Direct lease Sale and lease back : Indirect form of leasing Owner sell it to leasing company and take the same on lease Direct lease Bipartite lease : equipment supplier cum lessor and lessee Tripartite lease : equipment supplier , lessor and lessee

Sale and lease back :

Indirect form of leasing

Owner sell it to leasing company and take the same on lease

Direct lease

Bipartite lease :

equipment supplier cum lessor and lessee

Tripartite lease :

equipment supplier , lessor and lessee

Single investor lease and leveraged lease Single investor lease Two parties involved :lessor and lessee Leasing company fund the entire investment leveraged lease Three parties involved : lessor, lender and lessee Leasing company buy assets by borrowing Transaction is routed through a trustee , who look after interest of lessor and lender

Single investor lease

Two parties involved :lessor and lessee

Leasing company fund the entire investment

leveraged lease

Three parties involved : lessor, lender and lessee

Leasing company buy assets by borrowing

Transaction is routed through a trustee , who look after interest of lessor and lender

Domestic lease and international lease Domestic lease If all the parties (lessor, lessee and equipment supplier) are domiciled in the same country International lease Import lease If equipment supplier is domiciled in different country Cross border lease If lessor and lessee are domiciled in different countries

Domestic lease

If all the parties (lessor, lessee and equipment supplier) are domiciled in the same country

International lease

Import lease

If equipment supplier is domiciled in different country

Cross border lease

If lessor and lessee are domiciled in different countries

Advantage of leasing to the lessee Financing of capital goods Less costly Ownership preserved Equity may dilute ownership Avoid conditionality Institutional finance come with restrictions like dividend representation on board, etc Flexibility in structuring of rentals

Financing of capital goods

Less costly

Ownership preserved

Equity may dilute ownership

Avoid conditionality

Institutional finance come with restrictions like dividend representation on board, etc

Flexibility in structuring of rentals

Advantage of leasing to the lessee cont… Simplicity Simple to negotiate Lesser documentation Obsolescence risk is averted

Simplicity

Simple to negotiate

Lesser documentation

Obsolescence risk is averted

Advantage of leasing to the lessor Full security Lessor remain the owner Higher profitability Rate of return is more than the rate of borrowing Trading on equity Lessor can use substantial amount of borrowed funds High growth potentials Leasing is done even in recessionary periods

Full security

Lessor remain the owner

Higher profitability

Rate of return is more than the rate of borrowing

Trading on equity

Lessor can use substantial amount of borrowed funds

High growth potentials

Leasing is done even in recessionary periods

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