Some variants of leases

1. Direct Lease

A direct lease can be defined as any lease transaction which is not a “sale and leaseback” transaction. In other words, in a direct lease, the lessee and the owner are two different entities. A direct lease can be of two types: Bipartite Lease and Tripartite Lease.

Bipartite Lease

In a bipartite lease, there are two parties to the transaction – the equipment supplier cum-lessor and the lessee. The bipartite lease is typically structured as an operating lease with in-built facilities like up gradation of the equipment (upgrade lease) or additions to the original equipment configuration. The lessor undertakes to maintain the equipment and even replaces the equipment that is in need of major repair with similar equipment in working condition (swap lease). Of course, all these add-ons to the basic lease arrangement are possible only if the lessor happens to be a manufacturer or a dealer in the class of equipments covered by the lease.

Tripartite Lease

A tripartite lease on the other hand is a transaction involving three different parties -the equipment supplier, the lessor, and the lessee. Most of the equipment lease transactions fall under this category. An innovative variant of the tripartite lease is the sales-aid lease where the equipment supplier catalyzes the lease transaction. In other words, he arranges for lease finance for a prospective customer who is short on liquidity. Sales-aid leasing can take one of the following forms:

a. The equipment supplier can provide a reference about the customer to the leasing company.

b. The equipment supplier can negotiate the terms of the lease with the customer and complete the necessary paper work on behalf of the leasing company.

c. The supplier can write the lease on his own account and discount the lease receivables with the designated leasing company.

The effect of the transaction is that the leasing company owns the equipment and obtains an assignment of the lease rental. By and large, sales-aid lease is supported by recourse to the supplier in the event of default by the lessee. The recourse can be in the form of the supplier offering to buyback the equipment from the lessor in the event of default by the lessee or in the form of providing a guarantee on behalf of the lessee.

2. Leveraged Lease

In a leveraged lease transaction, the leasing company (called equity investor) invests in the equipments by borrowing a large chunk of the investment with full recourse to the lessee and without any recourse to it. The lender (also called the loan participant)

Obtains the assignment of the lease and the rentals to be paid by the lessee, and a first mortgage on thee leased asset. The transaction is routed through a trustee who looks after the interests of the lender and the lessor. On receiving 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.

3. Domestic Lease & International Lease

A lease transaction is classified as a domestic lease if all parties to the transaction to the equipment supplier, the lessor and the lessee are domiciled in the same country. On the other hand, if the parties are domiciled in different countries, the transaction is classified as an International Lease Transaction.

The distinction between a domestic lease transaction and an international lease transaction is important for two reasons. First, packaging an international lease transaction calls for,

  1. An understanding of the political and economic climate; and
  2. Knowledge of the tax and the regularity framework governing these transactions in the countries concerned.

Second, as the payments to the supplier and the lease are denominated in different currencies, the economies of the transactions from the points of view of both the lessor and the lessee tend to be affected by the variations in the relevant exchange rates. In short, international lease transactions unlike domestic lease transactions are affected by two additional sources of risk – country risk and currency risk.

Notes:

Sale and leaseback: In a sale and leaseback transaction, the owner of equipment sells it to a leasing company which in turn leases it back to the erstwhile owner (the lessee). The ‘leaseback’ arrangement in this transaction can be in the form of a ‘finance lease’ or an ‘operating lease’. A classic example of this type of transaction is the sale and leaseback of safe deposit vaults resorted to by commercial banks. Under this arrangement the bank sells the safe sells the safe deposit vaults in its custody to a leasing company at a market price which is substantially higher than the book value.

In general, the ‘sale and leaseback’ arrangement is a readily available source of funds for financing the expansion and diversification programs of a firm. In case where capital investments in the past have been funded by high cost short-term debt, the sale and lease back transaction provides an opportunity to substitute the short-term debt by medium-term finance (assuming that the leaseback arrangement is a finance lease). From the leasing company’s angle a sale and leaseback transaction poses certain problems. First, it is difficult to establish a fair market value of the asset being acquired because the secondary market for the asset may not exist; even if it exists, it may lack breadth. Second, the Income Tax Authorities can disallow the claim for depreciation on the fair market value if they perceive the fair market value as not being ‘fair’.

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