M.F.S.
CHAPTER – 2
M. Y. KHAN
THEORETICAL AND REGULATORY
FRAMEWORK OF LEASING
Leasing In India: Evolution Phases
Pre 1970
1970 - 1995
- Only HP companies
- Entry into equipment
finance through:
- Automobile financing * Leasing
mainly for
* Hire Purchase
commercial vehicles
- Commencement of car
finance
- Access to Capital Markets
Post 1995
- Exit of large no. of
companies:
* Small & Large
* Indian & Foreign
- Regulation by RBI
- Few companies
diversified into
related financial
services
Leasing Industry: Major Players
 SREI International Finance
 Shriram Finance
 Sundaram Finance
Tata Finance
 Cholamandalam Finance
 Mahindra & Mahindra
 GE Capital
Countrywide Finance
Citicorp
Lease Finance: The Concept
• “Conceptually, a lease may be defined as a contractual
agreement between two parties namely Lessor (owner of the
asset) and Lessee (User of the asset) in which the lessor provides
an asset/equipment to the lessee for use over a period of time
and in return the lessee provides periodical lease rentals to the
lessor and at the end of lease period, the asset reverts to the
lessor”
• A lease is a contractual arrangement where the lessor grants the
lessee the right to use an asset in return for periodical
payments.
• Leasing essentially involves the divorce of ownership from the
economic use of an asset/equipment.
Essential Elements of Lease:
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Parties to the contract
Asset
Ownership separated from user
Term of lease
Lease Rentals
Modes of terminating lease:
A. The lease is renewed on a perpetual basis or for a definite period.
B. The asset reverts to the lessor.
C. The assets reverts to the lessor and the lessor sells it to a third
party.
D. The lessor sells the asset to the lessee.
STEPS IN LEASING:
Classification of Lease:
1. Finance Lease and Operating Lease
2. Sales and Lease Back and Direct lease
– Bipartite Lease
– Tripartite Lease
3. Single Investor Lease and Leveraged Lease
4. Domestic Lease and International Lease
– Import Lease
– Cross Border Lease
1. Finance Lease and Operating Lease:
• Finance Lease:
• “According to the International Accounting Standard (IAS - 17), the
finance lease is the one in which the 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”.
 Key Features:
– FL is suitable for ships, aircrafts, railway wagons, lands, buildings
and heavy machines.
– FL is long term, non cancellable lease agreements.
– In FL the cost of an assets is fully amortized during primary lease
period.
– In FL, the lessee has an option to purchase the asset at the end
of lease period.
– FL is also called as “Full Pay Out Lease”.
– Maintenance of asset is done by lessee.
Operating Lease:
• “According to the IAS - 17, an operating lease is one which is
not a finance lease. In an operating lease, the lessor does not
transfer all the risks and rewards incidental to the ownership
of the asset and the cost of the assets is not fully amortized
during the primary lease period”.
 Key Features:
– OL is useful in case of computers, office equipments,
automobiles etc.
– OL refers to short term lease agreement or the term of
lease is always lesser than the economic life of an asset.
– The primary lease period does not cover the cost of an
asset.
– Maintenance of asset is done by lessor.
– OL is also called as “service lease”
2. Sale and lease back and Direct lease
• Sale and lease back:
• “In this, the owner of an asset sales it to the a leasing
company (lessor) which leases it back to the owner (lessee)”.
• For exp. Safe Deposite Vaults by Banks.
• Direct Lease:
A. Bipartite Lease:
“In such lease, there are two parties in the lease transaction
namely equipment supplier cum lessor and lessee”.
B. Tripartite Lease:
“In such lease, there are three parties in the lease agreement
namely equipment supplier, lessor and lessee.
3. Single Investor Lease and Leveraged Lease:
 Single investor lease:
• In such lease, two parties namely lessor and lessee are
included in lease transaction.
• The leasing co’ (lessor) funds/finance the entire investment by
an appropriate mix of debt and equity funds.
 Leveraged Lease:
• Three parties are involved in lease transaction namely Lessor
(equity investor), Lender and Lessee.
4. Domestic Lease and International Lease:
 Domestic Lease:
• “A lease transaction is classified as domestic if all the parties
to the agreement, namely equipment supplier, lessor and
lessee are domiciled in the same country”.
 International Lease:
• “If the parties to the lease transaction are domiciled in
different countries, its known as Int. Lease”.
A. Import Lease: “In an import lease, the lessor and lessee are
domiciled in the same country but the equipment supplier is
located in a different country.
B. Cross Border Lease: “it means the lessor and lessee are
domiciled in different countries. The domicile of the supplier
is immaterial in this case.
Profile of leasing in India
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Independent leasing companies
Other Finance Companies
Manufacturer – lessors
In house lessors
Commercial banks
Advantages of Leasing – To the Lessee
• Financing of capital goods
 100% financing of capital goods w/o capital investments.
 Lessee is able to commence business w/o making any investment.
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Additional source of financing
Less costly (compared to Bank Finance)
Ownership preserved
Avoids conditionalities
 viz. conditionalities associated with EQ/DEBT Issue and Bank Loan
• Flexibility in structuring of lease rentals
• Obsolescence Risk is averted
• Simplicity
Advantages to Lessor:
• Full security
 Only becoz of “Ownership Preserved”
• Tax benefit
 Mainly Depreciation
• High profitability
 Since return from business is more than CoC
• Trading on equity
• High growth potential
Limitations of Leasing:
• Restrictions on use of Equipment
 Addition/alteration of asset is not permissible
• Loss of residual value
 Since Ownership remains with Lessor
• Limitations of financial lease
 Higher payout obligation in case of premature termination
of lease.
• Consequences of default
 Violation of clauses of Lease Contract may result in to
termination of Lease.
• Understatement of Lessee assets
• Sales tax : Double Taxation
Contract Act
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GENERAL PROVISION:
CONTRACT
LEGAL OBLIGATION
LAWFUL CONSIDERATION
COMPETENT PARTIES
FREE CONSENT
DISCHARGE OF CONTRACTS
REMEDIES FOR BREACH OF CONTRACT
INDEMNITY AND GUARANTEE
Special Provision
• Leasing as bailment Agreement
• Liabilities of lessee
 Pay the lease rentals periodically
 Take reasonable care of the asset
 Return the leased asset
• Liabilities of lessor
 Deliver the asset to the lessee
 Authorize the lessee to use the asset
 Leave the asset in peaceful possession
Acts/Laws
• RBI NBFC Directions
• Other Laws
– Motor Vehicles Act
– Indian Stamp Act
Lease Documentation and Agreement
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Lease Approval Process
Guarantee Agreement
Collateral Security/Hypothecation Agreement
Master Lease and Supplemental Lease
Agreements
Clauses in Lease Agreements
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Nature of the lease
Description
Delivery and redelivery
Period
Lease rentals
Use (Purpose)
Repairs and maintenance (Lessor or Lessee)
Alteration