Hire of Movables
The hire of movables covers many different types of transactions and arrangements. They may range from the long-term leasing of major items of capital equipment to a short term hiring of consumer goods and equipment. The hire or leasing may range from a whole of life transaction equivalent to a purchase in economic terms to a short-term hire for temporary use.
A finance lease is similar to a purchase and mortgage back. The financing / leasing charges effectively pay for / amortise the capital cost of the leased item over the term of the agreement.
Under a contract of hire, the hirer obtains the right to use particular goods or chattels in return for a payment or more commonly a series of payments. The owner of the goods gives possession to the hiree, in most cases. The common law principles of bailment apply, subject to the terms of the contract which provide to the contrary. See generally the sections on bailment. The common law implies similar terms into contracts of hire, as contracts of sale.
A significant advantage of hire and lease arrangements is that the bill of sales legislation applicable to individuals does not apply because there is no mortgage. Equally, there is no requirement to register the arrangement in the Companies Registration Office The lessee never owns the goods, so there is no security by the lessee / hiree.
Contract of Hire and Implied Terms
It is implied in a contract of hire that the hiree will have quiet possession of the goods / item concerned. If he is disturbed in possession by reason of the lack of title on the part of the hirer, he may sue the hirer for the breach of the implied warranty on title. Similarly, if the owner directly interferes with the hire party in the use of the goods then the warranty of quiet possession is breached. However, if a third party wrongfully interferes with quiet possession (other than by reason of claiming under an inconsistent title), the owner has not breached the implied term.
At common law, it is an implied term of a contract for hire, that the goods are reasonably fit for the purpose. The common law duty does not appear to be as absolute as the Sale of Goods Act duty. It is a duty to take reasonable care and skill to guard against such defects. It is arguable whether, and to what extent, the obligations differ from the obligations in negligence. It is argued that the owner’s liability is greater than that applicable under general principles of negligence in the case of defective goods as it implies that the goods must be reasonably fit for purpose.
Leasing / Hiring Movables
A lease of goods is a contract of hire and a bailment, irrespective of how it is characterised. In essence, the goods are bailed by the lessor to the lessee / by the owner to the hirer. Many leasing arrangements are in the nature of financing / credit facilities for so-called “big ticket” items such as aircraft and oil tankers.
A distinction is commonly made between an operating lease and a finance lease. An operating lease is effectively a rental of goods. The rent paid equates in approximate terms, to the useful periodic value of the goods to the lessee. The payments are current and not capita in nature
A finance lease is equivalent to the acquisition of the asset (typically equipment) with finance, such as by purchase and mortgage. The lease’s minimum period is effectively the expected useful life of the equipment. There is not expected to be a series of leases of the same piece of equipment. The rent is not based only on the use value for each period, but on the basis, that it produces a total payment over time which is effectively equivalent to the purchase price
The transaction may be initiated by the lessee, who may have specific requirements for specialised and expensive equipment. The finance house, which acts as lessor may have no knowledge of the equipment and no technical knowledge of what is required. In substance the finance house acts as financier. In this scenario, the lessee having found the equipment, arranges for the finance house to purchase it and lease it back to it.
Nature of Finance Lease
The payments are structured so that at the end of the primary period, the equipment will have minimal residual value at most. The lessor commonly transfers this residual balance to the lessee by credit for a new finance lease (typically for replacement equipment) or the proceeds arising from sale, if any.
The sale may be a sale by the lessee as agent or the lessor at the end of the lease. The lessee is not given the option to acquire the equipment as this would make the transaction a hire purchase arrangement, which is subject to restriction in some cases.
In effect, the rental payments in a finance lease write off / amortise the capital cost of the goods/ equipment over the period, commonly described as the primary period. The arrangement is very similar in substance to a conditional sale agreement with a grant of security to the financing entity.
From an accounting perspective, a finance lease is one that transfers substantially all the risks and rewards of ownership to the lessee. Finance leasing may be attractive, as it may allow the acquisition of business equipment without payment of an upfront down payment or deposit. It may sometimes give the benefit of tax allowances, which the lessee cannot use, to the lessor, albeit that the rules have been restricted.
Tax and Financial Advantages
Formerly, leasing was a form of off-balance-sheet acquisition. Neither the equipment nor the liability to show it are shown on the balance sheet. Accounting requirements, however have changed the treatment so that finance leases are required to be capitalised and depreciated in the balance sheet.
Tax legislation has provided, historically for capital allowances on leased equipment to be claimed by either lessor or lessee. This was useful in providing cheaper financing, where the lessee did not have profits available for offset, while the lessor had such profit (formerly at a higher corporate rate than now applies).
If the finance house has insufficient profits to absorb to use the relevant capital allowances (to the extent available), it may involve another finance house or entity which has the ability to use them. This is subject to the restrictions that now exist in respect of capital allowances. The taxation rules have restricted allowances to lessors over time so that taxation benefit now available to lessors, has been reduced or eliminated.
A significant advantage of hire and leases arrangement is that the Bill of Sales and Companies legislation which require registration of security over goods does not apply. There is no mortgage or charge. The lessee / hiree has never owned the goods, notwithstanding that the arrangement is similar in substance to a secured finance facility.
If the lessee is dealing with a finance house on a regular or ongoing basis, there may be a master lease agreement with standard terms and conditions which are incorporated in the subsequent specific leasing transaction for successive goods equipment.
The lessor may permit the lessee to purchase the equipment in its own name as agent for the lessor / finance house. This will enable the lessor to appear to be legal owner.
In other instances, the lessor itself may enter an agreement with a bank or another financier to purchase the equipment. In this case, the interest and capital repayments are financed by the payments under the leasing arrangement. The finance house’s profit reflects in the difference. This arrangement gives the finance house/lessor increased leverage as it can undertake a greater number of transactions with the lesser capital outlay, subject to the risk involved.
The rights and relationship between the lessor and lessee are governed by the terms of the agreement. Outside of consumer cases, parties are y free to agree whatever terms they wish, subject to general principles of contract law and public policy considerations.
If the lessor terminates the agreement due to default on the part of lessee, the lessor is usually entitled to damages. The lessor may seek to define a minimum payment so that where the lessee defaults, he obtains the capitalised value of its expected return and outlay. The lessee’s future financial obligations may be accelerated. Allowance should be made for any alternative use so that it is not rendered void as a penalty. There may be a formula to calculate the sum payable.
In a finance lease, the finance and the interest charges are merged in the rental. The formula reflects the lessor’s periodic return as well as the amortisation of the value of the equipment and lessor’s profit. They may be a discount for the acceleration of the lessee’s liability. Complex issues may arise in formulating the lump sum applicable. This incorporate the loss of tax benefits and claw back.
Structures and Arrangements I
There is usually no contractual relationship (and therefore warranties) between the supplier and the lessee. Therefore, in the purchasing and leasing transactions, there may be a mismatch between the party entitled to the warranties and the party who requires them.
A range of structures are possible. The lessor may authorise the lessee to purchase the equipment as undisclosed agent of the lessor. Another possibility is that the lessee enters the agreement to purchase with the supplier and by novation, a new sale contract is put in place between the supplier and the lessor.
A purchase as undisclosed agent may assist in ensuring a direct contractual relationship between the supplier and the lessee. Where the supplier later becomes aware of the undisclosed status it is usually bound by its pre-contact election to treat the lessee as principal.
Sale and lease back is commonly employed to raise finance from assets that are already owned. In this case, the asset, which has been acquired (either recently or held some time) is sold back. If the transaction is in substance a mortgage, it may be re-characterised as such, with implications in terms of registration of security. However, if the transaction is properly documented reflects true nature as a lease and sale back, it is unlikely to be re-categorised.
Structures and Arrangements II
A separate financier may be involved. The lessor may bring in a financier or funder which purchases the equipment. The funder then leases or hires to the leasing company, which has power to grant a sub-lease to the lessee / end user. There may be a master hire purchase or master leasing agreement.
The funder takes charge over the subleases and their rentals. This is a charge over book debts and is registrable security. The head lessor may terminate the head lease in the event of enforcement, in which event, it becomes lessor under the sub-leases of equipment. It collects the charges as owner rather than as chargee of the rental payments.
Alternatively, the lender may lend the lessor monies to purchase the equipment for the purpose of the onwards lease. It will then take a charge over equipment, leases and the lease rental. This is a registrable security.
The hiree lessee must pay the hiring charges when they fall due. The failure to do so is a breach of contract for which the owner may exercise remedies. He must take reasonable care of the goods. He must take care to return the goods in the state in which they were hired, with due allowance for wear and tear at the end of the period. The failure to return the goods would leave the hiree liable in detinue or conversion.
A finance lease generally excludes the liability of the lessor for defects in the equipment. The lessee may enter a collateral agreement with the supplier of the equipment. Where the lessor seeks to assign the benefit of its rights, difficult issues regarding interest and loss may arise. The assignee will not necessarily be able to recover its own loss in such circumstances, as opposed to that of lessee.
Where the termination arises by reason of defects in the equipment, in a case where the lessee has chosen the equipment, it may be appropriate that the lessor has no responsibility. Collateral agreements and assignments of rights allowing for direct recourse to the supplier are desirable in these circumstances.
The hire of goods to consumers is regulated by the Consumer Credit Act. It covers consumer leasing, hiring and hire purchase agreements. The Hire Purchase Act and later the Consumer Credit Act has largely restated in modern the key statutory Sale of Goods Acts rights in the context of consumer hire. They treat the consumer hiree (to whom the hire is made) as the equivalent of a purchaser.
In the case of International Equipment Leases, the UNIDROIT Convention on International Financial Leasing makes the lessor immune from liability for non-conforming equipment, which is accepted by the lessee. The duty of the suppliers is owed to the lessee.