LEASE FINANCING

AND HIRE PURCHASE

Presented by
Ashish .K A
Maria.Joseph
Megha .M
Sneha .M
INTRODUCTION
 The main objective of a business is to maximize the
owner’s economic welfare.
 The firm makes investments to maximize
stockholder’s wealth.
 After identifying attractive projects, the firm considers
various methods of financing them.
 Leasing is quickest and easiest method of financing of
capital
 In India, leasing is a recent development and
equipment introduced by First Leasing Company Of
India Limited in 1973.
PARTIES INVOLVED IN LEASING
 There are mainly two parties involved in lease
financing:

 lessor (owner of the asset)

 lessee (user of the asset)
LEASE FINANCING
 Leasing is a form of renting assets.

 It is a contract between Lessor (the owner of the

asset) and lessee (user of the asset) whereby the
lessor gives the right to use the asset to the lessee
over an agreed period of time for consideration
called lease rental.

 In long term lease contracts, the lessee is generally

given an option to buy or renew the lease
DEFINITION

 The International Accounting Standards

Committee has defined a lease as,
‘an agreement, whereby the lessor conveys to
the lessee in return for rent, the right to use an
asset for an agreed period of time’
FEATURES OF LEASE
FINANCING
 The lessee agrees to insure and maintain the asset
during the tenure of the lease.
 As lease is not a sale, the asset should be re-
deliverable at the expiry of the lease.
 The asset is movable. The law of bailment is only
applicable to movable property.
 The title of the asset remains with the lessor itself.
 At the end of the lease period, the agreement
provides either(1) for the renewal of the
contract(2)return of the asset to the lessor(3)sale of
the asset to lessee by lessor.
ELEMENTS

 No. of parties to the contract

 Ownership
 Lease period
 Consideration
 Asset
ADVANTAGES

 It offers fixed rate financing

 Leasing is inflation friendly
 Leasing is quickest and easiest method of
financing of capital
 potential tax benefits
 Huge capital investment on asset can be
eliminated
 Full Security
DISADVANTAGES
 Costly premature termination

 No equity until lessee decide to purchase the

equipment at the end of the lease term,

 Although lessee is not the owner of the asset, still he is

responsible for maintaining the equipment as specified
by the terms of the lease. Failure to do so can prove
costly.
LEASING PROCESS

 Lease selection
 Lessor’s appraisal
 Lessor’s approval
 Acceptance of the offer
 Agreement
TYPES OF LEASE
Lease transaction is categorized on the basis of:
 Transferability of risks and rewards of ownership.
 Number of parties involved in the transaction.
 Domicile of equipment manufacturer, lessor, and lessee.

Based on these factors lease is broadly classified into:

 Finance Lease
 Operating Lease
A. FINANCE LEASE

 A finance lease is a method of equipment financing.

 It’s a non-cancellable lease contract for a long term or
medium term.
 A lessor extends credit to a lessee and transfers all
responsibilities of ownership such as maintenance, insurance
and taxes to a lessee for a period of time equal to the
economic life of the asset.
 A lessee may either purchase the asset or return it to a lessor
at the termination of the lease contract.
 The lease rentals are fixed in such a way as to recover the
marginal cost of debt financing.
 Characteristics of financial lease

 A lessee selects the equipment and a lessor. A lessor may

recommend alternate equipment but the final decision is with a
lessee.

 A lessee uses the equipment for the purpose of business. Equipment

leasing generally excludes consumer finance and hire purchase
activities.

 The equipment is purchased by a lessor.

 A lessor keeps the title to the equipment throughout the tenure.

 A lessee has the exclusive right to use the equipment. The
third party does not have any right to it.

 lessee and lessor both should agree for a sub leasing

arrangement.

 Finance lease is non cancellable. This means that if a lessee

terminates the lease either voluntarily or by default he has
to pay a sum of penalty as compensation.

 Loss of account of obsolesce of the equipment is to be

borne by a lessee and he is responsible for the repair,
maintenance and insurance of the equipment.
 Working of the finance lease

A lessee takes the decision regarding the asset required and
the manufacture or the supplier. He also decides about his
other requirements like the design, specifications, the price,
warranties, and term of delivery, installation and servicing.

 A lessee gives the quote regarding the equipment to a lessor.

 If the quote is acceptable, a lessee is required to submit an

application in the prescribed format. A soft copy of lease
application is also enclosed along with it.

A lessor processes the application and a letter of offer is

issued immediately after sanction.
 A lessee and lessor sign a lease agreement.

 The purchase order is placed on the supplier at the request of

the lessee. It can either be a fresh one incorporating the terms
suggested by a lessee or he place a novation of an earlier
purchase order.

 After the purchase order is accepted by the supplier,

disbursement is made at the request of a lessee.

 The advance already paid by a lessee to a supplier is

reimbursement on production of necessary supporting
documents. Further payments are released directly to the
supplier at the request of the lessee.

 On installation of the asset capitalization of the asset is done

and rental commence.
B.OPERATING LEASE

 Any lease other than a financial lease is an operating lease.

 It’s a simple agreement between the owner of the equipment (lessor) and the
end user (lessee) which provides for the exclusive use of the equipment by a
lessee for a monthly fee.

 It’s an agreement to rent the equipment to be used for a fixed period.

 In an operating lease a user (lessee) will have to return the equipment to the
lessor at the end of the lease term without an obligation for a residual value.

 Operating lease generally remains in effect for a short to medium period.

 Operating lease agreements are usually for a certain number of months or

year with an option to extend the number of months or period upon mutual
agreement.
 FEATURES OF OPERATING LEASE
 Short term lease.(lease period <useful life of the asset)
 Lease cancelled at a short notice by the lessee.
 Lessee has the option of renewing the lease after the
expiry of lease period.
 Lessor is responsible for maintenance, insurance and
taxes of the asset.
 Higher risk to the lessor.
 Higher lease rent to the lessee.

Operating lease is common to the equipments which

require expert technical staff for maintenance and are
exposed to technological developments.
EG: Computers, Vehicles, Communication Systems
 Working of the operating lease

 An agreement is executed between lessee and lessor for

deployment of equipment for a definite period and agreed
monthly rentals and other associated terms and conditions.

 A lessor has to deploy equipment as per a lessee’s

requirement.

 Equipment deployment can be for a short or medium term.

 Pre-determined monthly rentals are payable by lessee
for use of the equipment.

 A lessor is responsible for the repair and maintenance,

operational crew, insurance etc.

 On expiry of the agreement lessee has to return the

equipment in good condition and lessor has to take
back the equipment.
 Advantages of operating lease

 It improves the profitability of the business.( profits are generated

by the use of the equipment without acquiring ownership).

 It enable lessee to diversify his business by utilizing the available

financial resources which would otherwise have been utilized for
acquisition of the particular equipment.

 It enables one to hedge against equipment obsolescence. Leasing

makes the lessee more comfortable as there is no need to worry
about resale of equipment.

 A lessor is generally responsible for the insurance, operation and

maintenance, repair, operating crew etc.
 Equipment deployed is based as per the users need
either short or long term.

 It allows for replacement of the equipment as and

when needed. (There is scope for selecting multiple
equipments.)

 Helps lessee to accurately forecast the income against

expenses. (Lease equipment cost is predictable and can
be more easily measured against the income that the
new equipment is expected to generate.)

 It provides the lessee a shield against inflation.

DIFFERENCE BETWEEN FINANCE LEASE AND OPERATING LEASE

  FACTOR FINANCE LEASE OPERATING LEASE

Number Of Single Lessee Several Lessees
Lessee
Amortization Of Full Cost Is Full Cost Is Recovered
Cost Of Leased Recovered From One From Many Lessees
Assets Lessee
Maintenance With The Lessor With The Lessee
Responsibility

Revocation Of Non-Cancellable In Cancelled By Short

Lease The Primary Period Notice By The Lessee

Period Of Lease Long Term .Lease Short Term. Lease

Period =Fair Value Period<Useful Life Of
Of Asset The Asset
TYPES OF FINANCE LEASE

ED LEASE
LEVERAG
SALES AND
LEASE BACK AND
DIRECT LEASE

FINANCE
LEASE
TYPES

CLOSE ENDED
ENDED LEASE
AND OPEN
L LEASE
INTERNATIONA
DOMESTIC AND
LEVERAGED LEASE

 Mainly used to provide finance for equipment assets which

require a huge capital outlay.

 Assets leased here are large ticket items which include aero
planes, satellites, ships, power generation plant etc.

 Here the assets are of high cost therefore finance

requirement is also high.
SALE AND LEASE BACK

 In this agreement a company sells an asset to another

party who in turn leases it back to the company.

 The company sells an asset at the present market value.

 By this type of transaction the company is able to use its

financial resources for other purposes in the place of low
yielding fixed assets. However the company has the
obligation to pay periodic rentals.
 This type of lease is beneficial to the lessee and lessor.

 Lessor gets the benefits due to depreciation.

 Lessee gets immediate cash inflow and his liquidity

position improves.

 Company having short term liquidity crisis adopt this

type of leasing.
DIRECT LEASE

 It can be defined as any lease transaction which is not a sale

and leaseback transaction.

 A direct lease may be arranged either by supplier or

manufacturer directly or through leasing company.

 Direct lease are of 2 types. Bipartite lease and Tripartite lease.

 A Bipartite lease consists of two parties, the equipment

supplier-cum-lessor and the lessee.

 A Tripartite lease involves 3 different parties. An equipment

supplier, a lessor and a lessee. Most of the equipment lease
transaction fall under this category.
DOMESTIC LEASE

 Here all the parties to the transaction, namely the

equipment supplier, the lessor and lessee are domiciled
in the same country.

INTERNATIONAL LEASE

 Here all the parties to the transaction, namely the

equipment supplier, the lessor and lessee are domiciled
in different countries.
CLOSE ENDED LEASE

 A closed lease is arranged on a net basis and the equipment is

released to the lessor in the end.
 Loss of residual value is with the lessor.
 
OPEN ENDED LEASE

 Open end lease are generally net lease where the title of the
equipment passes to the lessee upon exercising the purchase
option or upon payment of guaranteed residuals.

 A part of the risk of the loss of residual value is passed to the

lessee.

 The possibility of ownership is also open to the lessee.

OTHER TYPES OF LEASE
 Straight lease
it require the lessee firm to pay lease rentals over
the expected service life of the asset and does not
provide for any modifications to the terms and
conditions of the basic lease.
 Modified lease

it provides several options to the lessee during a

lease period.
e.g. : the option of terminating the lease may be
provided by either purchasing the asset or
returning the same.
 Floating rental rate lease contracts
 frequent changes in the interest rates in the last few years has
led to this type of lease contract.
 here lease rentals are reduced or increased according to the
borrowing rates of the lessor.

 Import lease
 here both the lessee and the lessor are residing in the same
country but the equipment supplier belongs to different country.
 the lessor first imports the equipment and lease it to the lessee

 Cross boarder leave

 when a lessor–leases an equipment to a lessee who is not
falling in the jurisdiction of the lessors country then the lease is
called cross boarder lease.
REASONS FOR THE GROWTH OF
INDIAN LEASING
 Rapid industrial growth

 Availability of funds

 Less legal requirements

 Tax laws
 LEASE
DOCUMENTATION
LEASE DOCUMENTATION
 Lease – a contractual agreement in which a party
owning an asset provides the asset for use/to
transfer the right to use the equipment to the user
over a certain period of time for consideration in
form of periodic payment.
 Lease transactions involve a number of formalities
and various documents.
CLAUSES IN LEASE AGREEMENT
 Nature of the lease : Whether operating lease, financial
lease or a leveraged lease.

 Description : Detailed description of equipment, its actual

condition, size etc..

 Delivery & Re-delivery : When and how

 Period : Lessee has to take the equipment for his use on

lease on terms.

 Lease rentals : Procedure for paying lease rentals.

 Use : Responsibility for proper & lawful usage.
 Title : Identification & ownership
 Repairs : Responsibility for maintenance
 Alteration : No alteration
 Peaceful possession : Guarantees to the lessee
peaceful possession of the leased equipment clear of
any charges.
 Charges : Who bear delivery, re-delivery, customs
charges etc..
 Indemnity clause : Indemnifies the lessor from any
consequential losses arising on account of non-
performance of leased equipment.

 Inspection : It gives the lessor or his representative a

right to enter the lessee’s premises for the purpose of
confirming the existence, condition & proper
maintenance.

 Prohibition of sub leasing : This prohibits the lessee

from the sub-leasing or selling the equipment to third
parties
 Events of default & remedies : Consequences of
defaults by the lessee and recourse available to the
lessor.
 Applicable law : Specifies the country whose laws
would prevail in case of a dispute.
 Purpose of documentation
 Proof of indebtedness
 Enforceability of security
 Focuses the terms & conditions between borrower &
lender
 Enables leasing company to take appropriate legal
action in case of default.
 Essential requirements
 Persons should have legal capacity
 Documents should be in prescribed format
 Should be properly stamped & witnessed
 Should be registered with appropriate authority
LEASE APPROVAL PROCESS
 Letter of offer – Decision of approval to lessee
 Lessee is asked to sign, date and return a copy
 Also should pass a resolution at Board meeting
accepting the offer
 Lease transaction requires [attendant] :
 Purchase order, invoice, bill of sale, delivery note,
insurance policies, memorandum of association,
articles of association, import license, etc..
MASTER LEASE AGREEMENT
 Lease agreement – legal rights & obligations of
lessor & lessee.
 Master lease agreement – conditions that
govern the lease
 Main part – Qualitative terms
 Attached schedules – Equipment details, Credit
limits, Rental profile, Other details
SUPPLEMENTAL LEASE
AGREEMENT

 Additional lease facilities

 Details of specific leased equipment
TRIPARTITE LEASE AGREEMENT
 A common agreement may be made between the
parties, specifying their respective obligations etc..
 3 parties :
 The manufacturer
 The lessor { financier }
 The lessee
GUARANTEE AGREEMENT
 The guarantor guarantees the obligations of the
lessee in the event of default by the lessee.
 While obtaining guarantee, necessary conditions
should be checked
 Guarantor – proof of his income & proof of
address
PROMISSORY NOTE
 Lessee should execute an unconditional promissory
note in favor of lessor for the full amount of lease
rentals payable

 Where the lease term extends beyond 3 years, a fresh

promissory note should be obtained within the
limitation period.
POWER OF ATTORNEY
 Lessee executes this
 To take delivery / transfer
 To sell / dispose the equipment
 To engage broker for such sale and to receive
any consideration
COLLATERAL SECURITY
 Otherwise hypothecation agreement

 A collateral is required when the financial position of

lessee is considered to be weak and risk associated
with the leased asset is high.

 A collateral security is in the form of a promissory note

signed by the lessee in favour of the lessor
 A deed of hypothecation - stamp paper.

 If made by company, must be registered under Section

125 of Companies Act.

 The lessor may also accept pledge of shares or

insurance policies.
HIRE PURCHASE
 HIRE PURCHASE
 A hire purchase agreement is defined as peculiar kind of
transaction in which the goods are let on hire with an option to
the hirer to purchase them,with the following stipulations:

 Payment to be made in instalments over a specified period.

 The possession is delivered to the hirer at the time of entering

into the contract.

 The property in the goods passes to the hirer on payment of the

last instalment.
 Each instalment is treated as hire charges so that if default is
made in payment of any instalment,the seller becomes
entitled to take away the goods.

 The hirer/purchaser is free to return the goods without being

required to pay any further instalments falling due after the
return.

 The finance(hire purchase) company purchases the equipment

from the equipment supplier and lets it on hire to the hirer to
use it who is required to make a down payment of,say 20-25
% of the cost and pay balance with the interest in Equated
Monthly Instalment(EMI) spread over 36-48 months.
 HIRE PURCHASE V/S
INSTALMENT PAYMENT

 The right of the hirer to terminate the agreement at any time

before the payment of the last instalment in the former while
in the latter the buyer is committed to pay the full price.

 In instalment sale the ownership in the goods passes on the

purchaser simultaneously with the payment of the initial/first
instalment,whereas in hire purchase the ownership is
transferred to the hirer only when he exercises the option to
purchase/or on payment of the last instalment.
 LEASE FINANCE V/S HIRE
PURCHASE FINANCE
 The lessor(finance company) is the owner and the
lessee(user/manuf) is entitled to the economic use of the
leased asset/equip only in case of the LF.The ownership is
never transferred to the user(lessee) whereas the ownership
of the asset passes on to the user(hirer) in case of hire
purchase finance on payment of the last instalment.

 The depriciation on the asset is charged in the books of the

lessor in case of leasing whereas the hirer is entitled to the
depriciation shield on assets hired by him.
 Cost of maintenance of hired asset is to be borne
typically by the hirer himself whereas the lessor(seller)
who has to bear the maintenance cost.

 LF is invariably 100% financing where it requires no

margin money or immediate cash down payment by the
lessee whereas in HP transaction typically a margin equal
to 20-25% of the cost of the equipment is required to be
paid by the hirer.
 PARTIES TO HIRE PURCHASE
CONTRACT
 Hire purchase contracts generally involve 3 parties,namely the
seller,the financier and the hirer.

 Dealer normally arranges a hire purchase agreement through a

finance company with the customer.

 A tripartite hire purchase contract is arranged with following

modalities:
 The dealer contacts the finance company to finance hire
purchase deals submitted by him.For this purpose,they enter
into a contract drawing out the terms,warranties that the dealer
gives with each transaction,and so on.
 The customer selects the goods and expresses his desire
to acquire them on hire purchase.The dealer arranges for
him the full set of documents to be completed to make a
hire purchase agreement.The documents are generally
printed by the finance company.

 The customer then makes cash downpayment on

completing the proposal form.
 The dealer then send the documents to the finance
company requesting them to purchase the goods
and accept the hire purchase transactions.

 The finance company signs the agreement and

sends a copy to the hirer along with the
instructions as to the payment of the
instalments.The finance company also notifies the
same to the dealer and asks him to deliver the
goods,if not already done so.
 The dealer delivers the goods to the hirer against the
acknowledgments and the property in the goods passes
on to the finance company.

 The hirer makes payment of the hire instalment

periodically.

 On completion of the hire term, the hirer pays the last

instalment and the property in the goods passes to him
on issue of a completion certificate by the finance
company
 TAXATION ASPECTS
 Income tax: Hire purchase,as a financing alternative,offers
tax benefits both to the hire vendor,(hire purchase finance
company) and the hire purchaser(user of the asset).

 Sales tax: A hire purchase deal is regarded as a sale

immediately the goods are delivered and not on the transfer of
the title of the goods. That is,the taxable event is the delivery
of the goods and not transfer of the title to the goods.For the
purpose of levying sales tax,a sale is deemed to take place
only when the hirer exercises the option to purchase.

 Interest tax: The hire purchase finance companies,like other

credit/finance companies,have to pay interest tax under the
Interest tax Act ,1974.
 PROVISIONS OF HIRE
PURCHASE ACT 1972
 Form and content of the hire purchase agreement:

 There is no prescribed form for a hire purchase

agreement,but it has to be in writing and signed by both the
parties to it.
 It must contain:

 The hire purchase price of the goods.

 The cash price of the goods i.e the price at which the
goods may be purchased by the hirer for cash.
 The date of commencement of the agreement.
 The number of instalments in which the hire purchase
price is to be paid,the amount,due date,the person to
whom and the place where each of the intalments is to
be paid.
 The description of the goods,in a manner sufficient to
identify them.

 Besides,where any part of the hire purchase price is,or is to

be paid otherwise then in cash or by cheque,a description of
that part of the price,must be given in the agreement.
Hire purchase charges:
The net hire purchase charges must not exceed the
‘statutory charges’.Net hire purchase charges
represents the difference between the net hire purchase
price and the net cash price.

Passing of property:
Only on the completion of the purchase,in the manner
laid down in the agreement.
IMPLIED WARRANTIES

 The owner undertakes a warranty that the hirer shall have

and enjoy quiet possession of the goods.

 The goods are warranted as free from any charges in

favour of any third party,at the time the property in the
goods is to pass.Thus where the goods are already pledged
and the owner enters into a hire purchase agreement,it
amounts to breach of warranty.
IMPLIED CONDITIONS
 The goods are of merchantable quality,i.e,reasonably
fit for the purpose for which they have been produced
and marketed.

 The goods are fit for the hirer’s purpose,where the

hirer expressely or implicitly informs the owner,or
any other person through which the negotiations were
conducted, the purpose for which he requires the
goods.
 The goods correspond with the sample and the hirer has
the reasonable opportunity to compare the bulk with the
sample

 The goods correspond with the description,where the

goods are delivered under description.