Leasing in its simplest form is a means of delivering finance, broadly defined as ‘a contract between two parties where one party (the lessor) provides an asset, mostly equipment, for usage to another party (the lessee) for a specified period of time, in return for specified payments’.
Leasing is a medium-term form of finance for machinery, vehicles and equipment, with the legal right to use the goods for a defined period of time but without owning or having title to them.
The lease is normally divided into two separate categories:
The operating lease – where the lessee is using the equipment but where the risk of ownership with all its corresponding rights and responsibilities is borne by the lessor, who also buys insurance and undertakes responsibility for maintenance. Furthermore, the duration of an operating lease is usually much shorter than the useful life of the equipment and the present value of all lease payments therefore significantly less than the full equipment value. In most respects, the operating lease is equivalent to rental and, under most jurisdictions, the equipment consequently remains on the books of the lessor.
The financial lease – where all practical risks of ownership are borne by the lessee, who uses the equipment for most of its economic life with or without the ultimate goal of acquiring it at the expiry of the lease at an agreed and often nominal cost. From the outset, the lessor therefore expects to recover from the lessee the capital cost of the investment along with interest and profit during the period of the lease (therefore often called a full payout lease), and where in most cases under the tax laws of most countries, the equipment has to stay on the books of the lessee.
The distinction between these types of lease is not always very clear in reality and many leases are frequently structured in one way while being defined in another, usually owing to potential cost or tax advantages. However, in most countries where leasing is particularly frequently used, such as the United States, tax authorities or the domestic Accounting Standards Board has laid down specified conditions for a lease to be classified as an operational lease.
When the sales contract between the supplier and the lessor, and the leasing contract between the lessor and the lessee have been signed, the equipment is usually delivered directly from the supplier to the lessee, who is the end-user of the equipment. Following approval of the delivery by the lessee, the lessor remits the payment to the supplier. The equipment, together with the leasing contract, constitutes security for the lessor, sometimes together with a limited or full supplementary repurchase agreement with the supplier. But most of the risks, rights and obligations in connection with the use of the equipment rest with the lessee.
The lessee leases the equipment for a period that corresponds to either the economic lifetime of the equipment or a shorter period thereof, with monthly or quarterly lease payments, based on annuities, which could be adapted to the lessee’s own fluctuating liquidity situation during the year. At the end of the lease period, either the equipment is returned to the lessor or the lease is extended for a new agreed period; however, the lease contract could also include an option for the lessee to buy the equipment at the prevailing market value at that time or at a fixed percentage of the original lease value.
This is a general description of a lease. The principles are basically the same irrespective of whether it is a domestic transaction or an export or international lease, the main difference being that in the latter case the parties are located in different countries. However, that difference could have a major impact on the transaction and how it is executed.
The most common form of lease in connection with day-to-day export is when a leasing company in the ‘buyer’s’ country is buying the equipment from a foreign supplier and leasing it to a lessee (the buyer) in their country. Such a lease should be regarded more as a domestic lease, mostly arranged in local currency and with other parts of the contract also adapted to local conditions. It may be arranged or initiated by the seller as part of the offer and normally leads to cash payment for the seller upon acceptance of the delivery by the buyer (the lessee), but with continued responsibility for any contractual repurchase, partial guarantee or other undertaking the seller may have to enter into with the foreign lease company.