1. Theoretical and Regulatory
Framework of Leasing
- MY Khan
Pg 2.0 to 2.13
Important Points

2. Leasing
• Regulatory Framework
• Concept
• Classification

3. Regulation
• There is no exclusive law
/legislation/Act/Regulation/direction to
govern equipment Leasing.
• Framework provided by:
– Allied legislations
– Lease Agreement

4. Allied Legislations
• Contract Act
• Vehicles Act
• Stamp Act
• RBI NBFCs directions under the RBI Act

5. Lease Agreements
• Provide for a number of Obligations on the
part of the Lessee
• Which do not form part of his implied
obligations under the legislative framework.

6. Meaning
• Contractual arrangement/transaction
• Party owning an equipment – Lessor
• Provides the asset
• For an agreed period of time – Tenure
• For consideration – periodic payments

7. At end of lease period
• Asset /equipment reverts back to the lessor
• Unless there is a provision for the renewal of
the contract

8. For the Lessee
• It is a device of financing the cost of an asset
• Has possession and use of the asset on
payment of specified rentals over a
predetermined period of Time

9. For the Lessor
• It is a Form of Investment
• A contract of lending Money

10. Essential Elements
• Parties to the Contract
• Asset
• Ownership separated from User
• Term of Lease
• Lease Rentals
• Modes of Terminating Lease

11. Parties to the Contract
• Lessor
• Lessee
• Lease Broker acts as an intermediary in
arranging the Lease deal
• Lease Financier refinances the lessor

12. Asset
• Is the subject matter of the Contract
• May be an automobile, plant and machinery,
equipment, Land and Building, factory, a
running business, aircraft and so on.

13. Ownership separated from the User
• During Lease Tenure
– Ownership with Lessor
– Use to the Lessee
• On expiry of Lease tenure, asset reverts to the
lessor

14. Term of Lease
• Period for which agreement for lease remains
in operation.

15. Lease Rentals
• Consideration which the lessee pays to the
Lessor for the Lease Transaction.
• Repairs and service charges borne by the
Lessor.
• Compensate the lessor for investment
(depreciation), interest, repairs, servicing
charges etc.

16. Modes of Terminating the Lease
• Possibilities are:
• Lease is renewed on a perpetual basis or for a
definite period.
• Asset reverts to the Lessor
• Asset reverts to the Lessor and the Lessor sells
it to a third party.
• The lessor sells the asset to the Lessee

17. Perpetual Lease
• A lease in perpetuity is one that is renewable
forever at the lessee's option

18. Classification
• Finance and Operating Lease
• Sales and Leaseback and Direct Lease
• Single Investor Lease and Leveraged Lease
• Domestic Lease and International Lease

19. Finance Lease and Operating Lease

20. Finance Lease
• Lessor transfers to the Lessee, substantially all
the risks and rewards incidental to the
ownership of the asset whether or not the
title is eventually transferred.
• Such Leases are also called full payout leases.
• Types of assets included in such lease are
ships, aircrafts, railway wagons, lands,
buildings, heavy machinery etc.

21. Lease Agreement
Is there transfer
of ownership?
Yes
Is there a bargain
purchase option?
Yes
No
Is lease term equal
to or greater than
75% of economic
life ?
Yes
No
Capital
Lease
Operating
Lease
Is present value
of payments
equal to or more
than 90% FMV?
Yes
No
As per IAS - 17As per IAS - 17

22. A bargain purchase option
• allows the lessee to buy the leased asset
• at a price significantly lower than the asset’s
fair value when the option is exercisable
The difference between the option price, and
the fair value (when the option is exercisable)
as determined at the inception of the lease
must render the option reasonably assured.
The Bargain Purchase OptionThe Bargain Purchase Option

23. IAS – 17 Operating Lease
• According to IAS – 17, an operating lease is
one that is not a Finance Lease.
• The Lessor does not transfer all the risks and
rewards incidental to the ownership of the
asset.
• Cost of the asset is not fully amortized during
the primary lease period.

24. IAS – 17 Operating Lease
• The Lessor provides repairs and Technical
advice
• For this reason, operating lease is also called
service lease.
• The lease rentals include a cost for the
services provided.
• Generally for Computers, office equipments,
automobiles, , trucks and some other
equipment like phones etc.

25. IAS – 17 Operating Lease
• Generally for a period significantly shorter
than the expected life of the asset.
• Lease rentals are not sufficient to totally
amortize the cost of the asset.
• The lessor does not depend upon a single
lessee for recovery of investment.
• He has an interest in the residual value and
can lease it to a different lessee upon expiry of
the term.

26. IAS – 17 Operating Lease
• Operating lease normally include maintenance
clause requiring the lessor to maintain the
leased asset and provide services such as
insurance, support staff, fuel and so on.

27. AS -19
• Classified as Finance Lease if it transfers
substantially all the risks and rewards
incidental to ownership.
• Classified as Operating lease if it does not
substantially transfer all the risks and rewards
incidental to ownership.

28. Sale and Leaseback and Direct Lease

29. Sale and Leaseback
• An indirect form of Leasing.
• The owner of the equipment sells it to the
leasing company ( lessor) which eases it back
to the owner (lessee).

30. Example
• Sale and Leaseback of safe deposits vaults by
Banks.
• Banks sell them to a leasing company at a
price substantially higher than book value.
• The leasing company in turn offers these
lockers to the bank on lease.
• The bank in turn sub leases the locker to its
customers.

31. Direct Lease
• The lessee and the owner of the equipment
are two different entities.
• A Direct lease can be of two types –
– Bipartite and
– Tripartite

32. Bipartite Lease
• There are two parties in the lease transaction,
namely,
– Equipment supplier cum lessor and
– Lessee
• Typically structured as an operating lease with
built in facilities like upgradation of the
equipment (Upgrade Lease).
• The Lessor maintains the equipment and if
necessary, replaces it with similar
equipment(Swap Lease).

33. Tripartite Lease
• Three Different parties to the Lease
agreement:
– Equipment supplier
– Lessor
– Lessee

34. Sales aid lease
• Equipment supplier arranges for lease finance
• Like car dealer, leasing (financing) company
and buyer.
• Usually with recourse to the supplier in the
event of default by the lessee either in the
form of an offer to buy back the equipment
from the lessor or guarantee on behalf of
lessor.

35. Single Investor Lease and Leveraged Lease

36. Single Investor Lease
• Only two parties to the transaction i.e.
• Lessor and Lessee

37. Leveraged Lease
• Three parties to the transaction
– Lender
– Lessor
– Lessee
• Lender obtains an assignment of the lease and
the rentals to be paid by the lessee and a first
mortgaged asset on the leased asset.

38. Leveraged Lease
• The transaction is routed through a trustee
who looks after the interest of the lender and
the lessor.
• On receipt of the rentals from the lessee, the
trustee remits the debt service component of
the rental to the loan participant and the
balance to the lessor.
• The lessor can claim tax benefit in the form of
depreciation and debt service charges.

39. Domestic Lease and International Lease

40. Domestic Lease
• If all parties to the agreement i.e equipment
supplier, lessor and lessee are domiciled in the
same country.

41. International Lease
• If the parties to the lease transaction are
domiciled in different countries.
• Two types
– Import Lease
– Cross Border Lease

42. Import Lease
• The Lessor and Lessee are domiciled in the
same country but the equipment supplier is
located in a different country.
• The lessor imports the asset and leases it to
the lessee.

43. Cross Border Lease
• Where the lessor and Lessee are domiciled in
different countries.
• The domicile of the supplier is immaterial.

44. Profile/Structure of Leasing in India
• Independent Leasing Companies
• Other Finance Companies
• Manufacturer Lessors
• Financial Institutions
• In house Lessors
• Commercial Banks

45. Independent Leasing Companies
• A major part of their income is derived from
Leasing.
• Some of them have collaboration with
overseas partners.
• They offer their services through direct
advertisement, personal contacts, lease
Brokers including Foreign Banks and Merchant
Banks.

46. Other Finance Companies
• Leasing is not their regular Business.
• They normally opt for 100 per cent
depreciation items once in a while to defer
taxes.

47. Manufacturer Lessors
• A number of Manufacturing companies have
set up independent leasing outfits
• Or separate Divisions
• That carry on leasing Business to promote the
sale of their own products.

48. Financial Institutions
• The Development Finance Institutions both All
India and State level provide leasing facility.

49. In House Lessors
• Some big businesses have formed captive
leasing companies for providing lease finance
to group companies.

50. Commercial Banks
• With effect from1994-95, banks have been
permitted to directly carry on leasing and Hire
Purchase Business.

51. Salient features
• By and large the structured lease falls in the
category of Finance Lease.
• Operating Lease is not very popular primarily
because of the non existence of resale market
for most of the used equipments.
• The lease transactions do not provide for
transfer of ownership to the lessee as such
transactions are classified as hire purchase
from the tax angle.

52. Salient features
• The Lease rentals are structured so as to
recover the entire investment cost during the
primary period.
• They are quite nominal during the secondary
period.
• The lease rentals are payable generally in
equated monthly instalments at the beginning
of every month.

53. Salient features
• Sale and Leaseback transactions are Rare.
• Most of the transactions are Direct Lease.
• Most assesses view leasing as a form of
standby Finance for meeting unplanned
expenditure.
• Therefore by and large equipment leases are
for capital investment not exceeding Rs 1
Crore.

54. Salient features
• Equipment leasing is popular.
• Project leasing for Infrastructure is done on a
very limited scale exclusively by ILFS.
• Cross Border Lease transactions are also not
very popular.

55. Advantages of Leasing

56. To the Lessee
• No immediate down payment
• Can commence Business with Low initial
Investment.
• No conditions attached like representation on
the Board etc.
• The lease rentals can be structured to
accommodate the cash flow position of the
Lessee.

57. To the Lessee
• The lease period is so chosen as to suit the
lessee’s capacity to pay rentals.
• Simple to negotiate
• Free from cumbersome procedures
• Faster and Simple Documentation.
• Institutional Finance and Term loans require
compliance of covenants, formalities and bulk
documentation causing procedural delays.

58. To the Lessee
• By structuring the rentals, tax advantage can
be derived from it.
• Rentals may be increased or decreased to
decrease or increase tax liability.
• The Lessor does not have the risk of
obsolescence.

59. To the Lessor
• Full Security – Ownership vests with lessor.
• Can take possession if the lessee defaults
• Tax Benefit
– Depreciation – Assets with High depreciation
rates.
– Suitable structure rentals
• High Rate of return as compared to
borrowing.

60. To the Lessor
• For Leveraged Lease – High rate of return on
Equity.

61. Limitations of Leasing
• A lease arrangement may impose certain
restrictions on use of the equipment or
require compulsory insurance and so on.
• If the lessee opts for premature termination in
a financial lease, it may entail higher payout
obligations.
• Lessee is deprived of the residual value of the
asset.

62. Limitations of Leasing
• In case of default, lessor may terminate the
lease and take over possession of the leased
asset.
• Lessee may be required to pay damages.
• Since the leased assets in case of an operating
lease do not appear as assets of the lessee,
there may be an understatement of the
lessee’s assets.

63. Limitations of Leasing
• A lease financing transaction may be charged
to sales tax twice – once when the lessor
purchases the equipment and again when it is
leased to the lessee.

64. Lease Documentation and Agreement
• Lease Transactions involve a number of formalities
and various documents.
• The documentation is significant because:
• It provides proof of indebtedness
• Brings to sharp focus, the terms and conditions
agreed between the borrower and Lender.
• Enables the leasing company to take appropriate
legal action in case of default.

65. Essential Reqirements
• The person executing the document should
have the Legal capacity to do so.
• The documents should be in prescribed
format.
• Should be stamped and witnessed.
• Where necessary, the stamped documents
should be registered with appropriate
authorities.

66. Lease Approval Process
• Letter of offer
• From the Lessor to the Lessee, which is in the
nature of commitment spelling out the main
terms of the Lease facility.
• The lease offer is normally kept open for a
specified period of time.

67. • The Lessee is asked to sign , date and return a
copy of the offer letter within the stipulated
time
• And also to pass a resolution at a Board
Meeting accepting the offer and approving
the financial arrangement.
• Board Resolution is not a legal requirement,
but commercial prudence neccesitates it.

68. Commercial Documents Required
• Purchase Order
• Invoice
• Delivery Note
• Insurance Policies
• Import License
• Etc
• All these documents should be obtained by the
Lessor from the Lessee.
• They are called ‘Attendant Lease Documents’.

69. Insurance
• The equipment/asset leased out should be
properly insured irrespective of the fact who
pays the premium.
• The insurance Policy should be in the name of
Lessor account Lessee.
• All Insurance Policies should be in the custody
of the Lessor.

70. Master and Supplemental Lease
Agreement
• Usually a master lease agreement is signed
which stipulates all the conditions that govern
the lease.
• The qualitative terms are in the main part of
the document while the equipment details,
credit limits rental profile and all other details
are provided in the attached schedules.

71. Supplemental Lease Agreement
• Additional Lease facilities, as and when
finalized, are documented under
supplemental lease agreements.

72. Clauses in Lease Agreement
• There is no standardized lease agreement. The
contents differ from case to case.
• A typical lease agreement has the following
clauses.

73. Nature of the Lease
Operating/Financial/Leveraged

74. Description
Description of Equipment, its actual condition,
size, components, estimated useful life and so
on

75. Delivery and Redelivery
• When and How the equipment would be
delivered to the Lessee and redelivered to the
Lessor on expiry of the lease contract.

76. Period
• Term
• Renewal

77. Lease Rentals
• Rates
• Late Payment charges

78. Use
• Enjoins upon the Lessee the responsibility for
proper and lawful usage.

79. Title
• Identification of ownership of the equipment.

80. Repairs and Maintenance
• This clause specifies the responsibility for
repairs and maintenance, insurance and so
on.

81. Alteration
• It specifies that no alteration to the leased
equipment may be made without the written
consent of the Lessor.

82. Peaceful Possession
• This clause guarantees the lessee peaceful
possession of the leased equipment clear of
any charges, liens or any other encumbrances.

83. Charges
• Which party would bear the delivery,
redelivery , customs, transport, income tax,
sales tax etc.

84. Indemnity Clause
• Indemnifies the Lessor from any
consequential losses arising on account of non
performance of the leased equipment.

85. Inspection
• It gives the Lessor or his representative a right
to enter the Lessee’s premisesfor the purpose
of confirming the existence, condition and
proper maintenance of the equipment.

86. Prohibition of Sub Leasing
• This clause prohibits the lessee from the
subleasing or selling the equipment to third
parties.

87. Events of Defaults and Remedies
• This clause specifies the consequences of
defaults by the Lessee and recourse available
to the Lessor. This clause may also specify
other remedies if any.

88. Applicable Law
• This clause specifies the country whose laws
will prevail in case of a dispute. It may also
provide for arbitration.

89. Tripartite Lease Agreement
• A tripartite lease involves three parties
namely the manufacturer, the
lessor(financier) and the Lessee.
• A common agreement may be made between
the parties, specifying their respective
obligations and so on.

90. Guarantee Agreement
• The Guarantor guarantees the obligations of
the lessee in the event of default by the
Lessee, in which event the guarantor assumes
responsibility as a principal debtor.

91. Promissory Note
• As a matter of abundant precaution, the
lessee is also required to execute an
unconditional Promissory Note in favof the
Lessor or his order, for the full amount of
Lease Rentals payable under the agreement.
• The Promissory Note is counter guaranteed by
the guarantor.

92. Receipt of Goods
• The equipment is delivered by the Lessor or
the Manufacturer / supplier in a tripartite
Lease, to the Lessee. The lessee thus executes
a receipt for the goods.

93. Power of Attorney
• The lessee executes an irrevocable power of
attorney constituting the lessor
• to be the lawful attorney for and on behalf of the
lessee
• to do certain acts such as,
• to take delivery, to transfer, to sell or dispose off the
equipment, to engage broker for effecting such sale
and to receive any consideration.

94. Collateral Security / Hypothecation Agreement
• Sometimes the Lessor may require the Lessee
to provide a collateral security by way of
pledge or Hypothecation of other assets.
• A collateral is normally required when the
financial position of the lessee is considered to
be weak and the risk associated with the
leased asset is high.

95. Hypothecation
• Generally, a hypothecation is a contract which
pledges or creates a lien on collateral to
secure a debt, where possession of the
collateral is not given to the creditor.
• In law, a lien is a form of security interest
granted over an item of property to secure
the payment of a debt or performance of
some other obligation.

96. Questions for Revision
• What is a lease ? What are the essential
elements of a lease ?
• Describe the regulatory framework of
leasing ?
• What is a Finance Lease ? How is it different
from an operating lease ?

97. Questions for Revision
• What are the advantages of leasing to the lessee and
to the lessor ?
• What is a contract ? What are the essential elements
of a contract ?
• Write a short note on Lease Documentation and
agreement ?
• Critically analyze the statement ‘ Lease is a form of
asset funding’. Describe how you would evaluate a
lease option vis a vis a buy option?

98. The End