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Lease Finance


Conceptually, a lease may be defined as a contractual arrangement in which a party owning an asset / equipment offers the asset for use to another for a certain period in exchange for periodic payments with or without premium. At the end of the period of contract, the asset regresses to the lessor, if there is no provision for the renewal of the contract. Leasing essentially involves the divorce of ownership from the economic use of an asset / equipment.

Leasing is a device of money lending. The position of a lessee is akin to that of a person who owns the same asset with borrowed money. The real function of a lessor is not renting of asset but lending of funds and lease financing is, in effect, a contract of lending money. The lessor is an ostensible owner of the asset because the possession and economic use of the equipment vests with the lessee. The lessee is free to choose the asset according to his requirements. The lessor does not resort to the equipment as long as the rentals are regularly paid to him.


The essential elements of lease financing are:

Parties to the Contract

There are essentially two parties to a contract of lease financing, viz. the owner and the user. They are known as the lessor and the lessee respectively. Lessor as well as lessee may be individuals, partnerships, joint stock companies, corporations or financial institutions. Sometimes, there may be joint lessor or joint lessee, particularly where the properties or the amount of finance involved is enormous. Besides, there may be a lease-broker, who acts as an intermediary in arranging lease deals. Merchant banking divisions of foreign banks in India, subsidiaries of some Indian banks, and a few private merchant bankers are acting as lease-brokers. Besides, a lease contract may involve a lease financier, who refinances the lessor, either by providing term loans or by subscribing to equity or under a specific refinance scheme.


The asset or equipment to be leased is the main theme of a contract of lease financing. The asset may be an automobile, plant and machinery, equipment, land and building, factory, a running business, aircraft, and so on. The asset, must, however, be of the lessee's choice suitable for his business needs.

Ownership separated from User

The essence of a lease-financing contract is that during the lease-tenure, ownership of the asset vests with the lesser and its use is allowed to the lessee. On the termination of the period of the lease, the asset reverts to the lessor.

Term of Lease

The term of lease is the period for which the agreement remains in force. Every lease should have a definite period; otherwise, it will be legally inoperative. The lease period may continue the entire economic life of an asset. The lease may be perpetual in nature.

Lease Rentals

The payment that the lessee reimburses to the lessor for the lease transaction is known as

the lease rental. The lease rentals are so structured as to compensate the lessor for the investment made in the asset (in the form of depreciation), the interest on the investment, repairs / insurance if any borne by the lessor, and servicing charges over the lease period.

Modes of Termination Lease

On the termination of the contract, various modes are available:

.The lease is renewed either on a perpetual basis or for a specific period.

.The asset reverts to the lessor.

.The asset reverts to the lessor and the lessor sells it to a third party.

.The lessor vends the asset to the lessee.

The parties may mutually agree to and choose any of the previously mentioned alternatives at the beginning of the lease contract.


A lease transaction differs on the basis of the following parameters:

.Transfer of risks and rewards or ownership

.Number of parties to the transactions

.Domiciles of the equipment manufacturer, the lessor and the lessee

On the basis of these variations, leasing can be classified into the following types:

.Finance lease

.Operating lease

.Sale & lease back

.Direct lease

.Single investor lease

.Leveraged lease

.Domestic lease

.International lease


In a finance lease, the lessor transfers to the lessee substantially all risks and rewards incidental to the ownership of the asset whether or not the title is eventually transferred. It involves payment of rentals over an obligatory non-cancelable lease period, sufficient in total to amortize the capital outlay of the lessor and leave some profit. That's why, such leases are also known as 'full payout leases'. Finance lease is generally used for ships, aircrafts, lands, buildings, heavy machinery, etc.


In an operating lease, the lessor does not transfer all risks and rewards incidental to the ownership of the asset and the cost of the asset is not fully amortized during the primary lease period. The lessor provides services attached to the leased asset, such as maintenance, repair and technical advice. Hence, operating lease is also known as 'service lease'. Operating lease is generally used for computers, office equipments, automobiles, trucks, telephones, etc.


It is an indirect form of leasing. The owner sells his equipment to a leasing company that leases it back to the owner.


In 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 Lease.


There are two parties to the lease transaction, namely the lessor and the lessee. The leasing company funds the entire investment by an appropriate mix of debt and equity funds. The debts raised by the leasing company to finance the asset are without recourse to the lessee.


There are three parties to the transaction: (1) lessor, (2) lender and (3) lessee. In such a lease, the leasing company buys the asset through substantial borrowing with full recourse to the lessee and without any recourse to itself. The lender obtains an assignment of the lease and the rentals to be paid by the lessee are a first mortgaged asset on the leased asset.


A lease transaction is classified as domestic if all parties to the agreement are domiciled in the same country.


If the parties to the lease transaction are domiciled in different countries, it is known as international lease. This type of lease is further subdivided into import lease and cross-border lease. In an import lease, the lessor and the lessee are domiciled in the same country but the equipment supplier is located in a different country. When the lessor and the lessee reside in different countries, the lease is known as cross-border lease. The domicile of the supplier is immaterial.


To the Lessee:

Lease financing offers the following benefits to the lessee:

.Financing of Capital Goods

.Additional Source of Finance

.Less Costly

.Ownership Preserved

.Avoids Conditionality

.Flexibility in Structuring of Rentals

.Tax Benefits

To the Lessor:

A lessor has the following advantages:

.Full Security

.Tax Benefit

.High Profitability

.Trading on Equity

.High Growth Potential


Lease Financing has following drawbacks:

.Restrictions on Use of Equipment

.Limitations of Finance Lease

.Loss of Residual Value

.Consequences of Default

.Understatement of Lessee's Asset

.Double Sales Ta

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