INDEX

SR NO.

TOPIC

PAGE NO.

Introduction & Definition

Finance Lease

Importance Of Lease Financing

10

Essential Elements Of Leasing

11

Types Of Lease Agreement

13

a) Finance Lease

14

b) Operating Lease

15

c) Sale & Lease Back

18

d)Leveraged Lease

20

e) Direct Lease

21

Features Of Financials Service

24

Advantages & Dis-advantages Of Leasing

25

Factors affecting Leasing Decisions

26

Difficulties Faced by Leasing Companies in India

27

10

LEASING IN INDIA

28

11

Difference Between Lease Financing & Hire Purchase

29

12

Evolution of Leasing

30

13

Evolution of Hire-purchase

33

14

Leasing and Hire-purchase: A vanishing distinction

34

15

Lessors

36
1

16

Specialized leasing companies

37

17

Banks and bank-subsidiaries

38

18

Specialized Financial institutions

39

19

One-off lessors

40

20

Manufacturer-lessors

41

21

The lessees

42

22

Sources of Law on leasing and hire-purchase

44

23

Leasing and Hire-purchase

45

24

Requirements of a valid lease or hire-purchase

46

25

Durability & Movability and severability

47

26

Identifiability

48

27

Obligations relating to the goods

49

28

What Is the Concept of Leveraged Leasing?

50

29

Underwriting

52

30

A Practical Look At Lease Document

54

31

Some Terms

60

32

History

63

33

Summary

64

34

Glossary

65

35

Reference

66

Introduction

In order to start and sustain a business one needs finance. In the unit one on feasibility study, you
have already seen the process of estimating financial requirements. The process involved (a)
making a list of all the assets iNTRODUCTION(b) identifying the sources of supply (c)
estimating the cost of acquisition when the assets are to be acquired on outright basis. Then
investment requirements as well as entrepreneurs fear will increase. To scare away the
entrepreneurs fear, the emphasis should be given to resources and not to the ownership. In this
unit we intend to familiarize you with some important financial innovations i.e., leasing, hire
purchase and factoring.

Definition:
Leasing is a contractual arrangement , where
The owner (Lessor) of the Asset(Equipment)
Transfers the possession / right to use the Asset(Equipment) to another(Lessee)
For an agreed period of time in return for rental.
\

Finance Lease
A lease transaction is a commercial arrangement whereby an equipment owner or Manufacturer
conveys to the equipment user the right to use the equipment in return for a rental. In other
words, lease is a contract between the owner of an asset (the lessor) and its user (the lessee) for
the right to use the asset during a specified period in return for a mutually agreed periodic
payment (the lease rentals). The important feature 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 the cow.
Long-term, non-cancellable lease contracts are known as financial leases.
To record a lease as a capital lease, the lease must be noncancelable.
One or more of four criteria must be met:
1. Transfers ownership to the lessee.
2. Contains a bargain-purchase option.
3. Lease term is equal to or greater than 75 percent of the estimated economic life of
the leased property.
4. The present value of the minimum lease payments (excluding executor costs)
equals or exceeds 90 percent of the fair value of the leased property.

Importance Of Lease Financing

Leasing industry plays an important role in the economic development of a country by providing
money incentives to lessee. The lessee does not have to pay the cost of asset at the time of
signing the contract of leases. Leasing contracts are more flexible so lessees can structure the
leasing contracts according to their needs for finance. The lessee can also pass on the risk of
obsolescence to the lessor by acquiring those appliances, which have high technological
obsolescence. To day, most of us are familiar with leases of houses, apartments, offices, etc.

Essential Elements of Leasing

Parties to a Lease Contract: Essentially two parties
Lessor is the owner of the asset that is being Leased.
Lessee is the receiver of the services of the asset under a Lease contract.
Lessor and Lessee can be Individual or legally recognised party.
The lessor is either the assets manufacturer or an independent leasing company
Lease broker big ticket Leases use him.
Major Players in Lease Market:
oBanks- Indian & Foreign /FIs
subsidiaries of Banks/FIs,
NBFCs
Asset Subject matter of Leasing contract; Automobiles, Plant & Machinery,
Equipments, Land & building, Factory, a running business, aircraft, Ships, etc.
Ownership remains with the Lessor
Use - of the asset is allowed to the Lessee.
Lease Term Primary /secondary Lease Term.
7

 Lease Rentals is the consideration for the lease transaction. So structured to recover the
investment cost, during agreed period.

Types Of Lease Agreements

Lease agreements are basically of two types. They are (a) Financial lease and (b) Operatinglease.
The other variations in lease agreements are (c) Sale and lease back (d) Leveraged leasing and
(e) Direct leasing.

1. FINANCIAL LEASE
Long-term, non-cancellable lease contracts are known as financial leases. The essential point of
financial lease agreement is that it contains a condition whereby the lessor agrees to transfer the
title for the asset at the end of the lease period at a nominal cost. At lease it must give an option
to the lessee to purchase the asset he has used at the expiry of the lease. Under this lease the
lessor recovers 90% of the fair value of the asset as lease rentals and the lease period is 75% of
the economic life of the asset. The lease agreement is irrevocable. Practically all the risks
incidental to the asset ownership and all the benefits arising there from are transferred to the
lessee who bears the cost of maintenance, insurance and repairs. Only title deeds remain with the
lessor. Financial lease is also known as capital lease. In India, financial leases are very popular
with high-cost and high technology equipment.

10

2. OPERATING LEASE
An operating lease stands in contrast to the financial lease in almost all aspects. This lease
agreement gives to the lessee only a limited right to use the asset. The lessor is responsible for
the upkeep and maintenance of the asset. The lessee is not given any uplift to purchase the asset
at the end of the lease period. Normally the lease is for a short period and even otherwise is
revocable at a short notice. Mines, Computers hardware, trucks and automobiles are found
suitable for operating lease because the rate of obsolescence is very high in this kind of assets.
Key Words
Explain the meaning of long term, nominal cost, and economic life

11

Differentiation Between Operating lease and Financial Lease

BASIS

Financial Lease

Meaning

Long-term,

non-cancellable

Operating leas
lease

A Lease which is a short term one

contracts are known as financial

and one which does not cover the

leases.

useful life on an asset is called an

operating lease.

Form

In this type of lease, money is provide

The lessor is carrying on business of

by lessor and the asset is purchase

leasing and he holds such assets or is

form outside

a manufacturer of such asset leases

its asset

Maintenance

The lessee undertakes the maintenance

In this type of lease, repairs and

of the asset, paying insurance premium

maintenance is done by the lessor.

ect.
Risk
Obsolescence

of

In this types of lease, the lessee bears

In this types of lease, the lessor bears

the risk

the risk

obsolescence, so far as he

uses the asset.

obsolescence during the

period of the lease.

12

BASIS

Financial Lease

Operating leas

Period of Lease

Period of lease whole useful life of

Period of lease for shot time.

asset.
Option to Buy

Option to buy for lessee.

Period of lease for shot time.

Accounting

According

international

No entry is made in the balance sheet of

Entries

accounting standard-17, an entery iis

the lassee under this type of lease,

made in the balance sheet of the

because lease is in the form of a hired

lessee on both the side

asset

to

the

13

3. Sale and Lease back:

It is a sub-part of finance lease. Under this, the owner of an asset sells the asset to a party (the
buyer), who in turn leases back the same asset to the owner in consideration of lease rentals.
However, under this arrangement, the assets are not physically exchanged but it all happens in
records only. This is nothing but a paper transaction. Sale and lease back transaction is suitable
for those assets, which are not subjected depreciation but appreciation, say land. The advantage
of this method is that the lessee can satisfy himself completely regarding the quality of the asset
and after possession of the asset convert the sale into a lease arrangement. The sale and lease
back transaction can be expressed with the help of the following figure.
The owner(Lessee) of the equipment sells it to a Leasing company (Lessor).
The Lessor, leases the equipment back to the Lessee.
Under this arrangement, the assets are not physically exchanged but it all happens in
records only.
The seller assumes the role of a lessee and the buyer assumes the role of a lessor.
The seller gets the agreed selling price and the buyer gets the lease rentals.
Two sets of cash flows occur:
The lessee receives cash today from the sale.

14

 The lessee agrees to make periodic lease payments, thereby retaining the use of
the asset.

15

4. Leveraged Lease:
Under leveraged leasing arrangement, a third party is involved beside lessor 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 is held as security against the loan. The lender is paid off from the
lease rentals directly by the lessee and the surplus after meeting the claims of the lender goes to
the lessor. The lessor, the owner of the asset is entitled to depreciation allowance associated with
the asset.
3 parties to the transaction.
Lessor ( Equity investor)
Lender
Lessee.
The Leasing company (Equity investor)
buys the equipment, through substantial borrowing, and
with full recourse to the Lessee and without recourse to it.
The Lender obtains an assignment of the Lease and a first mortgage of the equipment.

16

5. Direct Lease

Under direct leasing, a firm acquires the right to use an asset from the manufacturer
directly.
The ownership of the asset leased out remains with the manufacturer itself.
Bipartite Lease Equipment supplier-cum-Lessor and Lessee.
Tripartite Lease (Sales-aid-Lease) Equipment supplier, Lessor and Lessee.

17

Single Investor Lease

Only two parties Lessor and Lessee.

Leasing company (Lessor) funds the entire investment, having appropriate mix of
Equity-cum-Debt.

Finance raised by the Lessor, is without recourse to the Lessee

Domestic Lease and International Lease

When a lease agreement is made between citizen of same countries, it is called Domestic
lease

18

 When a lease agreement is made between citizen of different countries, it is called

International lease

19

20

Features of Financial Service

A Financial Lease is structured to include:
The Lessee selects the equipment meeting his requirement
The Lessee negotiates the price, delivery schedule, installation, warranties, maintenance,
etc.
The Lessee informs the above details and Lessor makes the payment directly to the
Seller(manufacturer /distributor).
The equipment is directly delivered to the Lessee by seller.
The Lessee enjoys exclusive and peaceful possession and use of the equipment.
Enters in to the Lease agreement with Lessor.
The Lessor pays the amount directly to Seller(Manufacturer/supplier).

21

Advantages of Leasing
Provides full Finance
Flexible
Saves from Recurring cost of finance
Absence of restrictions
Tax Benefits
Increases the capacity to borrow
Useful in case of fast changing technology
Faster and Cheaper credit

Limitations of Leasing
No Benefit of Residual Value
High cost of leaseing
No benefit of ownership
Not Flexible
22

 Disputes

Factors affecting Leasing Decisions

Availability of cash
Effect on Borrowing Capacity
Shifting the Risk of Obsolescence
Convenient Arrangement
Less Restrictions on Firm
Salvage Value
Tax Benefits
Leas Expenses

Institutions In the field of Leaseing.

All India Financial Institutions
Leasing Companies
Banks
Financial Companies
23

 Industrial Groups having Leasing Companies

Difficulties Faced by Leasing Companies in India

Competition
Lack of Trained Employees
Proportion of Debt-Equity not maintained
Lack of Provision for Depreciation
Low Investment of Promoters
Shortage of Funds
Inefficiency of Management
Government Attitude

24

LEASING IN INDIA
Leasing has grown by leaps and bounds in the eighties but it is estimated that hardly 1%
of the industrial investment in India is covered by the lease finance, as against 40% 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 equipment
leasing has become very common in the recent times.

25

DIFFERENCE BETWEEN LEASE FINANCING AND HIRE PURCHASE

BASIS

LEASE FINANCING

HIRE PURCHASE

Meaning

A lease transaction is a commercial

Hire purchase is a type of instalment

arrangement, whereby an equipment

credit under which the hire purchaser

owner or manufacturer conveys to the

agrees to take the goods on hire at a

equipment user the right to use the

stated rental, which is inclusive of the

equipment in return for a rental.

repayment of principal as well as

interest, with an option to purchase.

Option to user

No option is provided to the lessee

Option is provided to the hirer (user).

(user) to purchase the goods.

Nature
expenditure

Components

of

Lease rentals paid by the lessee are

Only interest element included in the

entirely revenue expenditure of the

HP instalments is revenue expenditure

lessee.

by nature.

Lease rentals comprise of 2 elements

HP instalments comprise of 3 elements

(1) finance charge and (2) capital

(1) normal trading profit (2) finance

recovery.

charge and (3) recovery of cost of

goods/assets.

26

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 20 th
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.
27

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.

28

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.

29

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.

30

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.

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.

31

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

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.

32

Lessors

Specialized leasing companies

Banks and bank-subsidiaries

Specialized Financial institutions

One-off lessors

Manufacturer-lessors

33

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.

34

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.

35

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

36

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.

37

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.

38

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

basically as an alternative to bank/institutional financing, which to them is timeconsuming 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 Worldover.

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.

39

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..

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.
40

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.

41

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

42

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 hirepurchase 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:

43

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

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
44

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.

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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.

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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.

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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.

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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.
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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.

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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

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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

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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.

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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.

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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.

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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.

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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.

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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-orbuy 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.
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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.

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

These airlines had no need for the depreciation deductions generated by their aircraft and
were significantly more interested in reducing their operating expenses.

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.

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SUMMARY
A lease is an agreement for the use of the asset for a specified rental. The owner of the asset is
called the lessor and the user the lessee. Two important categories of leases are: operating leases
and financial leases. Operating leases are short team, cancellable leases where the risk of
obsolescence is borne by the lessor. Financial leases are longterm, non-cancellable leases where
any risk in the use of the asset is borne by the lessee and he enjoys the returns too. The other subparts of finance lease are: sale and lease back and leveraged financing. Under sale and lease back
lease the owner of an asset sells the asset to a party, who in turn leases back the same asset to the
owner in consideration of lease rentals. Under leveraged leasing a third party (i.e. financier or
lender) is involved beside lessor and lessee. Direct lease another type of leases, which is
popularly used. Under this, a firm acquires the right to use an asset from the manufacturer
directly. Leasing plays an important role in the economic development of a country by providing
money incentives to lessee. Lease financing has several advantages. In India, the First Leasing
Company Ltd. was set up in Madras in 1973. As per the industrial investment, lease finance in
India just like a newborn baby. Hire purchase and factoring are the other forms of financial
services. Hire purchase is a type of instalment credit under which the hire purchaser agrees to
take the goods onhire at a stated rental. The system of the hire purchase is regulated by the Hire
Purchase Act 1972. Small scale firms suffer from the problem of dearth of funds. In this case hire
purchase system plays an important role by providing equipment; vehicles etc. on hire purchase
without making full payments. NSIC also provides machinery and equipment to Small Scale
units on hire purchase basis and on lease basis. Factoring the other financial service under which
a financial institution undertakes the task of collecting the book debts of it client

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GLOSSARY
Capital lease: It is a lease obligation that has to be capitalized on the balance sheet. It is
characterized by: it is non-cancelable; the life of lease is less than the life of the asset(s) being
leased; and, the lessor does not pay for the upkeep, maintenance, or servicing costs of the asset(s)
during the lease period. Sub-lease: A transaction in which leased property is released by the
original lessee to a third party, and the lease agreement between the two original parties remains
in effect. Wet lease: A wet lease is any leasing arrangement whereby a company agrees to
provide an aircraft and at least one pilot to another company. Dry lease on the other hand, refers
to leasing only the aircraft.

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REFRENCE
1. Lease Financing in India by M. Sree Lakshmi
2. Evaluation of Lease Financing by E. Chandraiah
3. Lease Financing & Hire Purchase (Concept, Law & Procedures) With Consumer Credit
by S. Venugopalan

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