Leasing: The Legal Framework A leasing contract is formed the moment the request for lease is accepted and a signed copy returned to the lessee by the lessor. There are three important factors in negotiation: the elements of the contract, the contracting process, and the contract entities. We will now deal with each in turn. Contract elements and terms A leasing contract is made in written form, typically on already prepared forms, which elaborate the rights and obligations of the parties. Typical contract provisions include: The contracting parties The subject of the contract The terms of delivery The rental sum and payment modality The consequences of missing payments The risk of damage or destruction of the asset Ownership of the asset Assurance against possible defects of the asset Terms of cessation of the contract Grounds and conditions for terminating the contract A purchase option (during or after the lease period) The transport cost of delivery and dispatch of the leased asset Insurance and insurance costs during transport and use of the leased asset Technical assistance to enable the lessee to use the leased asset Grounds for extension of the leasing contract beyond the initial period Dispute resolution and applicable law Other common elements of the contract Of all these elements, the most interesting one for both lessor and lessee is the rental amount and modality. There are a number of forms of rental, the most common being: Fixed or linear rental - used when the lessor wants to avoid the risk of poorer than expected performance by the lessee Rental, using a revision clause to protect both partners' interests, should business conditions change due to the use of leased asset, allowing them to change the rental sum, similar to the sliding scale method High initial rental sums, followed by fairly low sums in subsequent months - this form of rental is used, where the possibility of purchase exists Low initial rental sums, followed by significantly higher rental later on - suitable for a lessee that achieves full utilization of the leased asset, e.g. an industrial facility, in the beginning Rental sums that are adjusted according to the intensity and duration of equipment use In practice, these common forms tend to be tailored to actual cases. In Bosnia, most leasing companies apply monthly rental calculations based on the quarterly or semi-annual EURIBOR, a foreign currency clause, and the Euro exchange rate. Contracting process and subjects The basic course of a leasing contract is as follows: On deciding to finance acquisition of an asset by leasing, the prospective lessee first fills in a Lease Request. Based on the documentation submitted, the leasing company assesses the lessee's credit rating, from two perspectives: the ‘asset' approach and the ‘business' approach. On comparing the value of the collateral and the leased good and reviewing the lessee's financial performance, the leasing company decides on financing [1] Once the lessee's credit rating has been determined, a leasing contract is signed. This can include a third party, a guarantor or co-debtor, if the leasing company considers the lessee's credit rating unsatisfactory. The repayment schedule, which defines the lessee's monthly obligation, is an integral part of the leasing contract. On signing the contract, the lessee is invited to pay a deposit, due before activation of the leasing contract. The invitation to pay specifies the amount of the client's down-payment, the costs of processing the leasing transaction, and the total VAT (VAT for both the financed asset and the interest due to leasing). Once this payment has been made, the leasing company pays the supplier of the financed asset, whereupon the supplier issues an invoice to the leasing company (the license plates for vehicles are issued based on this invoice), which then issues an invoice to the lessee. On entering into possession of the asset, the lessor, lessee, and supplier all sign a ‘Takeover Log.' The contract is then considered active and the lessee's obligations start. Partners in leasing A leasing activity typically takes place between three business partners: The lessee, i.e. user of the leased asset The supplier, i.e. manufacturer of or dealer in the required asset The leasing company (the finance provider) Lessees can be either individuals or companies. If the latter, they are typically smaller in size, focused on productivity, and technology oriented. A company which decides for leasing is usually a good entrepreneur with a good competitive position. The lessee has an irrevocable right to use the equipment, while the leasing company is entitled to rent, paid in instalments. The lessee is a potential buyer who has delayed the purchase of the equipment, while making use of it at the same time. The second participant in this transaction is the supplier or manufacturer. They have not sold the equipment, but have obtained the financial resources necessary for continuity of production. Equipment manufacturers are generally unable to finance the purchase of their product, particularly if large sums are involved. In such cases, leasing can be very useful. The leasing company (financing provider) is a mediator with capital between the manufacturer and the lessee. The leasing company buys the equipment from the manufacturer and makes it available to the lessee, while charging compensation. [1] One should keep in mind that the ‘asset' approach can always be improved by increasing the down-payment. In practice, this means: If a leasing company is addressed by a client with satisfactory cash flow who can service the leasing debt without difficulty, the leasing company will accept the minimum down-payment. This is because the leasing company owns both the financed asset and the lessee's drafts, and the latter's performance allows this debt. If, however, a leasing company is addressed by a client whose current performance barely covers current obligations, they will insist on as high a down-payment as possible so that the financed amount is as close as possible to the market value of the financed asset. In reality, the financed asset is the only collateral and must be sellable in the secondary market.
