Hire purchase agreement - Unitedworld School of Business
Hire purchase is a mode of financing the price of the goods tobe sold on a future date. In a hire purchase transaction, thegoods are let on hire, the purchase price is to be paid ininstallments and hirer is allowed an option to purchase thegoods by paying all the installments. Hire purchase is a methodof selling goods. In a hire purchase transaction the goods arelet-out on hire by a finance company (creditor) to the hirepurchase customer (hirer). The buyer is required to pay anagreed amount in periodical installments during a given period.The ownership of the property remains with creditor and passeson to hirer on the payment of the last installment.Concept of Hire purchase
Hire Purchase AgreementA hire purchase agreement is defined in the Hire Purchase Act,1972 as peculiar kind of transaction in which the goods are leton hire with an option to the hirer to purchase them, with thefollowing stipulations:a. Payments to be made in installments over a specifiedperiod.b. The possession is delivered to the hirer at the time ofentering into the contract.c. The property in goods passes to the hirer on payment ofthe last installment.d. Each installment is treated as hire charges so that if defaultis made in payment of any installment, the seller becomesentitled to take away the goods, ande. The hirer/ purchase is free to return the goods withoutbeing required to pay any further installments falling dueafter the return.
Supreme court has laid down that the sum and substance of hirepurchase is two fold. One, the owner under the agreemententers into a transaction of hiring out the goods on the termsand conditions mentioned in the agreement. second, theoption to purchase exercisable by the hirer on payment of allthe installments of hire, arises when the installments are paidand not until then. There is no agreement to buy goods, thehirer being under no obligation to buy but has an option toreturn the goods or to become its owner by payment in full ofthe hire agreed installments and the price for exercising theoption.
Illustration:A sells a refrigerator to B with a stipulation that B shall pay A fixed sum everymonth by way of installments till the full price of the refrigerator is paid.Now till B pays the full amount to A by way of installments, he does notbecome the owner of the refrigerator . He can discontinue payment offurther installments. In such case, A takes back the refrigerator has noright to recover installments already paid by him to A because the amountpaid by him is adjusted towards the hire charges of refrigerator. This iscalled a hire purchase agreement.
Difference Between Sale and Hire PurchaseAlthough hire purchase system could ultimately result in sale of goods, the sale in normal senseand sale under hire purchase system are not the same. The following are the differences betweensale and hire purchase.Sale• A ‘sale’ is governed by the sale of GoodsAct, 1930.• In case of sale, the ownership of the goods istransferred to the buyer immediately.• In case of sale, the buyer makes payment inlump sum.• The buyer pays only for the price of goods.• On non-payment of the consideration theseller cannot take back the goods, but canonly take legal action on buyer.• Once a sale has taken place, neither theseller, nor the buyer can terminate thecontract (unless it is for genuine reason likedamage of goods etc.)• When the buyer becomes insolvent, the sellerhas to undertake the risk of loss.• A sale is subject to levy of sales tax at thetime of contract of sale.Hire Purchase• Hire purchase is governed by the HirePurchase Act, 1972.• In case of Hire purchase, the ownership ofgoods is transferred to buyer on payment ofall installments.• In case of hire purchase, the payment is madein installments.• The hire purchaser pays for the price of goodsand also some amount of interest.• On non-payment of any installment, the sellercan re-possess the goods.• Either the buyer or the seller can terminatethe contract at any point of time, until thepayments of last installment.• When the hire purchaser becomesinsolvent, the seller can reposes thegoods, and hence need not undertake the riskof loss.• In this case, the sales tax will be leviable atthe time of ownership (i.e. on payment of lastinstallment).
Illustration:A purchases a machine for down payment of Rs. 20000 and3 annual instalments of 20000each. Cash price is 74500. showtheaccounting ? Rate of interest 5%74500 – 20000 = 54500interest = 2725amount due : 572252nd instalement 20000amount due : 37225interest = 1861 due =390863rd instalment : 20000, balance : 19086 interest (balancing amt) :914last instalment 20000 balance = nil
Legal FrameworkThere is no exclusive legislation dealing with hire purchasetransaction in India. The Hire purchase Act was passed in 1972.An Amendment bill was introduced in 1989 to amend some ofthe provisions of the act. However, the act has been enforced sofar. The provisions of are not inconsistent with the general lawand can be followed as a guideline particularly where noprovisions exist in the general laws which, in the absence of anyspecific law, govern the hire purchase transactions. The actcontains provisions for regulating:1. the format / contents of the hire-purchase agreement2. warrants and the conditions underlying the hire-purchaseagreement,3. ceiling on hire-purchase charges,4. rights and obligations of the hirer and the owner.In absence of any specific law, the hire purchase transactions aregoverned by the provisions of the Indian Contract Act and theSale of Goods Act
Terms used in Hire PurchaseAgreements• Hire purchaser: A hire purchaser is a person who possesses thegoods under hire purchase agreement for use within an option toeither purchase it or return after use.• Hire vendor: a hire vendor is a person who sells the goods underhire purchase agreement.• Cash price: it is the price of goods which is sold under ‘contract ofsale’• Hire purchase price: it is the price at which the goods are soldunder ‘hire purchase system’ it includes cash price of the goods andinterest.• Installment money: it is the part of the hire purchase price paid byhire purchaser, in periodic intervals.Down payment: it is the initial payment made by the hire puchaserto the hire vendor at the time of entering into hire purchaseagreement.
• Hire charges: it is an amount refers to the difference betweenhire purchase price and cash price (H P- C P= H C) it alsoreferred to as interest.• Statutory hire charges: it is a hire charges according to thehire purchase act of, 1972.• Hire purchase agreement: it is an agreement between hirepurchaser and hire vendor according to section 2(c) of thehire purchase act 1972, for purchasing of goods according toagreement.• Termination of hire purchase agreement: The hirer canterminate the agreement at any time by giving the 14 daysnotice to the owner. However what ever the amount isalready paid by the hirer is considered as a hire charges.
Procedure of Hire Purchase• The Dealer, contracts with finance co. for financing his hire purchase deals.• The customer selects the goods for HP, and dealer arranges for the complete setof documents.• Dealer sends documents to finance co. with request to purchase the goods, andaccept the HP transaction.• The finance co. signs the agreement and sends copy along with EMI details todealer.• Down payment by customer on completion of proposal form.• Dealer delivers the goods to the customer, property passes on to the finance co..• Hirer pays EMIs, and on last payment , the ownership passes on to him, with loancompletion certificate by the finance co
CASEIn Auto supply company vs Raghunatha chettya company had agreed to offer a bus on a hire purchase agreementon condition that rs 1140/ were to be paid by the hirer on deliveryand 11 monthly installments were to be paid thereafter, each of rs.226 and the owners were to be entitled to terminate the contracton default occurring if hirer for any month was in arrears. A suitwas brought by the owners for possession of the bus on thehappening of the said condition. Lord coutts-trotter,c.j. held thatthough there was no such explicit condition, yet it was thenecessary implication that when the agreement terminated eitherby choice or default of the hirer ,all sums paid by him are to beretained by the owners, the amount Rs.1140/- being construedeither as the installment of the hire money or as the premiumtaken by the owner for granting lease and in either case moneyreceived was not to be refunded. The money was not to beregarded as advance of rent.
Hire purchase vs leasingHire purchase• The hirer has the optionto purchase the goods• Is a method of financing businessassets & consumer articles• Depreciation & investmentallowance can be claimed• Only the interest is tax componentdeductible• Hirer enjoys the salvage valueof the assetLeasing• In leasing the lessee has no optionto buy the goods• Is a method of financing businessassets only• Depreciation & investmentallowance cannot be claimed• Entire lease rental is tax deductible• Lessee does not enjoy the salvagevalue of the asset
Concept Of Lease FinancingLease financing denotes procurement of assets through lease. The subject ofleasing falls in the category of finance. Leasing has grown as a big industry in theUSA and UK and spread to other countries during the present century. In India,the concept was pioneered in 1973 when the First Leasing Company was set up inMadras and the eighties have seen a rapid growth of this business. Lease as aconcept involves a contract whereby the ownership, financing and risk taking ofany equipment or asset are separated and shared by two or more parties. Thus, thelessor may finance and lessee may accept the risk through the use of it while athird party may own it. Alternatively the lessor may finance and own it while thelessee enjoys the use of it and bears the risk. There are various combinations inwhich the above characteristics are shared by the lessor and lessee.
Meaning Of leasingA lease transaction is a commercial arrangement whereby an equipment owner orManufacturer conveys to the equipment user the right to use the equipment in returnfor a rental. In other words, lease is a contract between the owner of an asset (theLessor) and its user (the lessee) for the right to use the asset during a specified periodin return for a mutually agreed periodic payment (the lease rentals). The importantfeature of a lease contract is separation of the ownership of the asset from its usage.Lease financing is based on the observation made by Donald B. Grant:“Why own a cow when the milk is so cheap? All you really need is milk and not thecow.”
Leasing In IndiaLeasing has grown by leaps and bounds in the eighties but it is estimated that hardly1% of the industrial investment in India is covered by the lease finance, as against40% in USA and 30% in UK and 10% in Japan. The prospects of leasing in India aregood due to growing investment needs and scarcity of funds with public financialinstitutions. This type of lease finances is particularly suitable in India where a largenumber of small companies have emerged more recently. Leasing in the sphere ofland and building has been in existence in India for a long time, while equipmentleasing has become very common in the recent times.
Types of lease agreementLease agreements are basically of two types. They are(a) Financial lease and (b) Operating lease.The other variations in lease agreements are (c) Saleand lease back (d) Leveraged leasing and (e) Directleasing.
Financial leaseLong-term, non-cancellable lease contracts are known as financial leases. Theessential point of financial lease agreement is that it contains a condition wherebythe lessor agrees to transfer the title for the asset at the end of the lease period ata nominal cost. At lease it must give an option to the lessee to purchase the assethe has used at the expiry of the lease.Operating leaseAn operating lease stands in contrast to the financial lease in almost all aspects. Thislease agreement gives to the lessee only a limited right to use the asset. The lessor isresponsible for the upkeep and maintenance of the asset. The lessee is not given anyuplift to purchase the asset at the end of the lease period. Normally the lease is for ashort period and even otherwise is revocable at a short notice. Mines, Computershardware, trucks and automobiles are found suitable for operating lease because therate of obsolescence is very high in this kind of assets.
Sale and lease backIt is a sub-part of finance lease. Under this, the owner of an asset sells theasset to a party (the buyer), who in turn leases back the same asset to theowner in consideration of lease rentals. However, under this arrangement,the assets are not physically exchanged but it all happens in records only.Leveraged leasingUnder leveraged leasing arrangement, a third party is involved besidelessor and lessee. The lessor borrows a part of the purchase cost (say 80%)of the asset from the third party i.e., lender and the asset so purchased isheld as security against the loan.
Direct leasingUnder direct leasing, a firm acquires the right to use an asset fromthe manufacturer directly. The ownership of the asset leased outremains with the manufacturer itself. The major types of direct lessorinclude manufacturers, finance companies, independent leasecompanies, special purpose leasing companies etc