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Theoretical and Regulatory Framework of Leasing

This document provides an overview of the theoretical framework, classification, players, product profile, significance, and regulatory framework of leasing in India. It discusses how leases are classified as either finance or operating based on the degree to which risks and rewards of ownership are transferred from the lessor to the lessee. The major players in leasing in India are independent leasing companies, banks, and manufacturer-lessors. Lease transactions are governed by various acts like the Indian Contract Act and RBI directions for non-banking financial companies.

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Adison Growar Satye
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497 views16 pages

Theoretical and Regulatory Framework of Leasing

This document provides an overview of the theoretical framework, classification, players, product profile, significance, and regulatory framework of leasing in India. It discusses how leases are classified as either finance or operating based on the degree to which risks and rewards of ownership are transferred from the lessor to the lessee. The major players in leasing in India are independent leasing companies, banks, and manufacturer-lessors. Lease transactions are governed by various acts like the Indian Contract Act and RBI directions for non-banking financial companies.

Uploaded by

Adison Growar Satye
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Chapter 2

Theoretical and Regulatory Framework of Leasing


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Theoretical/Conceptual Framework
Conceptually, a lease is a contractual arrangement/transaction in which the owner of an asset/ equipment (lessor) provides the asset for use to another/transfers the right to use the asset to the user (lessee) for an agreed period of time in return for periodic payment (rental). At the end of the lease period the asset reverts back to the owner. Leasing essentially involves the divorce of ownership from the economic use of an equipment/asset.
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Classification/Types
Leasing can be classified into four categories: (i) Finance and operating lease, (ii) Direct lease and sale and lease back lease, (iii) Single investor and leveraged lease and (iv) Domestic lease and international lease which can be further subclassified as cross-border and import lease. Of these, the classification of lease into finance and operating is of fundamental importance. The distinction between the two types of leases is
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based on the extent to which the risks and rewards of ownership are transferred from the lessor to the lessee. Risk means the possibility of loss arising out of under- utilisation or technological obsolescence of the leased asset, while reward refers to the incremental net cash flows generated by the usage of the equipment over its economic life and the realisation of the anticipated residual value on the expiry of the economic life. If a lease transfers a substantial part of the risks and rewards, it is called finance lease; otherwise it is operating lease. The cut-off
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criterion in India is that if the lease term exceeds 75 per cent of the useful life of the asset or if the present value of the minimum lease rentals exceeds 90 per cent of the fair market value of the equipment at the inception of the lease, the lease is classified as finance lease.

Players
The major players in leasing in India are independent leasing companies, other finance and investment companies, manufacturerlessors, development finance institutions, inhouse lessors and banks.

Product Profile
As far as the product profile of leasing in India is concerned, by and large leases, are of finance type and operating leases are not very popular. The lease rentals are payable generally in equated monthly instalments at the beginning of every month. The rental structures are related to the requirements of the lessee and projected cash flow pattern. They are structured so as to recover the entire investment during the primary period.
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Further, most of the transactions are direct lease; sale and lease back type are rare. Equipment leasing covers a wide range of assets and equipment but project leasing and cross-border leasing are not popular.

Significance/Limitations
The significance of lease financing is based on several advantages both to the lessors and the lessees such as flexibility, user-orientation, taxbased benefits, convenience, expeditious disbursements of funds, hundred per cent financing and better utilisation of own funds and so on. However, the advantages of off-balance sheet financing in the sense that it does not affect the debt capacity of the firm is not real.
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Regulatory Framework
There is no law/legislation/act/direction which exclusively applies to equipment leasing. Such transactions are governed by the relevant provisions of number of acts/laws/directions and so on. Some of these are quite intricate involving fine points of law. The main elements of the framework are: Indian Contract Act, RBI NBFCs Directions and Lease Documentation and Agreement.
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Contract Act
Since the features of an equipment lease transaction closely resemble the features of bailment, the provision of Contract Act in general and those relating to contracts of bailment in particular apply to equipment lease transactions. The implied obligations of the bailor (lessor) and bailee (lessee) are defined by this enactment. However, one implied obligation of lessor,

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namely, fitness of the bailed goods is inapplicable. As in a typical equipment lease transaction, the lessor plays the role of a financier, the implied obligation of the lessor (bailor) relating to fitness of the goods/assets is expressly negatived by the lease agreement.

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Motor Vehicles Act


Some provisions of Motor Vehicle Act and Stamp Act also apply to equipment leasing.

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RBI Directions
With a view to coordinate, regulate and control the functioning of all the NBFCs, RBI has issued directions under the RBI Act. These also apply to leasing companies.

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Lease Documentation
The lease documentation process is fairly simple. It starts with the submission of a proposal by the lessee. On approval, the lessor issues a letter of offer detailing the terms and conditions of the lease. The letter of offer is accepted by the lessee by passing a Board resolution. This is followed by the lessor and lessee entering into a formal lease agreement.

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Lease Agreement
The lease agreements provide for a number of obligations on the part of the lessee which do not form part of his implied obligations under the Contract Act. While the exact contents of the lease contract differ from case to case, a typical lease contract provides for nature of lease, description of the equipment, delivery and re-delivery, period, lease rentals, repairs and maintenance, alteration, peaceful possession, charges, indemnity clause, inspection, prohibition of sub-leasing, defaults and remedies and so on.
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