1. Economic purpose of leasing
Initially, leasing was resorted to by large manufacturers as an instrument to increase transaction volume. It allowed them to rent out their products to clients who would otherwise hardly have been in a position to use those products due to the lack of capital resources. From this, one can easily gather that, originally, leasing was structured around two parties and was characterized mainly by the aforementioned function of increasing revenues. Nowadays, that function has to compete with a financing function. This does not mean, however, that the original function of leasing cannot constitute the main function of leasing even today. This remains true, for instance, with regard to operating leasing which, given that it runs for less than the full economic life of the leased assets, is from the outset aimed at the same assets being used by more than one lessee. This type of leasing is, however, characterized not only by the short terms of the contracts and the multiple use of the leased assets that necessarily come with it, but also by generally being cancellable, due to the lack of a minimum running time of the contract and by the lessor, who is responsible for maintenance and insurance of the assets, bearing the risk of the assets’ depreciation.
Still, what characterizes today’s leasing is not only the different function it mainly serves, but also the fact that it involves three different parties as opposed to only two, namely the client/lessee who is interested in the assets, the producer/ seller of the assets who is interested in selling them and the lessor who makes it possible for the lessee to use the assets without having to buy them. This does not mean that leasing contracts cannot involve only two parties. This is true, for instance, where the manufacturer or producer of the goods acts also as lessor. Since, however, in these instances some of the advantages of leasing are lost, it is no surprise that this type of leasing is resorted to very rarely.
Regarding the advantages of leasing, the main benefit lies in the possibility for the lessee to obtain the use of—generally—rather expensive assets without having to pay a—generally—rather high purchase price, thus allowing the lessee to obtain the use of assets irrespective of the availability of capital and without a high impact on cash flow. In effect, leasing allows the lessee to make periodically recurring payments of smaller amounts that have been agreed upon in advance (thus making budgeting easier) over the duration of the leasing contract in lieu of a one-time payment of a high purchase price. As for these payments, which can often be deducted as expenses against taxable income, they can be made out of the revenue the leased assets deliver to the lessee, in line with the rule ‘pay as you earn’. Thus, leasing not only preserves the capital and, consequently, the liquidity of the lessee (which may well lead to a higher rating of the lessee’s business), but it also makes advance payments unnecessary, as it is self-financing.
Furthermore, since leasing only binds the lessee to the assets for a given period, it limits the lessee’s exposure to the risk of the assets becoming obsolete. Moreover, leasing allows the lessee to focus on its core business, since the lessor often assumes tasks that go beyond that of financing.
Still, leasing may also have some disadvantages for the lessee. By way of example, it is worth mentioning that the lessee has to make payments to the lessor even when the assets are not used. Thus, the periodically recurring payments constitute fixed costs that the lessee cannot avoid. Moreover, not being the owner of the assets, since property title is retained by the lessor, the lessee cannot sell them in case of sudden need of capital or in case of the assets not being used or having become prematurely obsolete. Also, leasing is not necessarily cost effective since the lessee will not only have to pay the actual cost of the assets, but also the lessor’s charges.
2. Definition and types of leasing
A statutory definition of leasing contracts can now be found in various legal systems. In Poland, for instance, it is Art 709 of the Polish Civil Code in its version in force as of 9 December 2000 that defines a leasing contract as an agreement pursuant to which a lessor undertakes to purchase an asset from a certain seller and release it to the lessee for use for a certain period of time and the lessee undertakes to pay the lessor a financial consideration in agreed instalments, at least amounting to the price or consideration borne by the lessor for the purchase of the asset.
Other legal systems also provide a statutory definition of leasing. This is true in Estonia, for instance, where § 361 of the Estonian law of obligations of 26 September 2001 defines a leasing contract as a contract by which ‘the lessor undertakes to acquire a certain object (the object of leasing) from a seller determined by the lessee and to grant use of the object to the lessee, and the lessee is required to pay a fee for use of the object of leasing’. Similar definitions can now also be found in Macedonia (See Art 2 of the law on leasing of 31 December 2002), Romania (see Art 1 of the decree on leasing of 28 August 1997), Russia (see Art 665 of the Russian Civil Code) and Serbia (see Art 2 of the law on leasing of 27 May 2003).
The existence of various statutory definitions does not mean, however, that there is an obvious trend towards the leasing contract achieving a standardized definition. In many European legal systems, such as the Austrian, German, Italian, Spanish and Swiss ones, the leasing contract remains, despite its wide use, an innominate contract (a contract that lacks a statutory definition), at least from a civil law point of view, although not necessarily from the perspective of tax law (for the purpose of which some standardized definitions can be found). This is advantageous insofar as it allows the elaboration of a flexible definition capable of covering all types of leasing contracts that exist in practice. On the other hand, this flexibility leads to the lack of a widely recognized and uniform definition. This, in turn, means that there is no uniform legal qualification of the leasing contract. In effect, the leasing contract has been qualified at times as a simple rental agreement, at times as a sale contract, as a sale by instalments, etc. One must wonder, however, whether the existing classical—and rather rigid—categories can be used to qualify the leasing contract. In light of the different functions served by leasing contracts and their interrelationship—which may differ very much in relation to the various types of leasing—this is to be doubted. This is also why it has been suggested that the leasing contract is a contract sui generis. This is perhaps the best view, as it allows one not only to take into account all the different functions served by leasing and the way those functions may interact with each other, but also to emphasize the independence of leasing contracts from other types of agreements (such as rental agreements, sales agreements, etc) which the other qualifications seem not to take into consideration.
In light of what has just been said, the leasing contract may be defined as a contract sui generis, the core contents of which consist in the lessor granting the lessee the use of an asset for a minimum period of time agreed upon in advance and the lessee making periodically recurring payments to the lessor.
This very wide definition of leasing—which also covers operating leasing—is to be distinguished from that of leasing stricto sensu that corresponds to the definition of finance leasing. Finance leasing is that transaction that obliges the lessor to conclude a contract with a third party regarding assets generally to be identified by the lessee which the lessor then delivers to the lessee, granting the lessee the use of those assets for a period of time agreed upon in advance, which, as a rule, coincides with at least the economic life of the assets, during which the lessor cannot cancel the leasing and the lessee is bound to make periodically recurring payments to the lessor for financing and granting the use of the assets, which generally cover all of the lessor’s costs of the assets as well as interest on the costs incurred. Where the lessee’s payments from the outset do not cover the lessor’s full costs, finance leasing normally provides for the lessee making a final payment in the amount of the lessor’s outstanding costs and profit expectations.
The foregoing definition of (finance) leasing covers most types of leasing and does not resort to criteria (such as the degree of amortization of the assets, the assets leased, whether the lessor is also the manufacturer of the assets, etc) that are used to distinguish one type of leasing from another and that are based more on practical experience rather than on distinct legal grounds. In effect, quite often, the terms used to label a given type of leasing are nothing ‘but labels given by practitioners to types of leasing encountered in practice’ (Michael Martinek) that lack any justification based on structural or legal divergences.
3. Specific issues
Regarding the rules governing leasing, it must be pointed out that leasing contracts normally do not require a given form. This does not mean that there are no legal systems requiring a given form. In Poland, for instance, leasing contracts must be in writing. Also, one has to always keep in mind that even in those legal systems that, as a rule, do not require a given form, the principle of freedom of form may be limited by rules protecting consumers. Many of these rules can, in EU Member States, be traced back to secondary EU law, such as Dir 2008/48 on credit agreements for consumers. But even where the lessee is not a consumer, the leasing contract may be required to observe a given form. This is the case where the leasing contract concerns immovable property. In this case, the contract may have to take a written form to be valid or, in some legal systems, may even require the involvement of a notary. In some legal systems, leasing contracts concerning immovable goods even require entry in the land registry.
Regarding the principal obligations of the parties to a (finance) leasing contract, the legal systems are characterized more by commonalities than differences. The lessor is obliged to obtain the assets chosen by the lessee, thus performing the financing part of its obligations, and grant the lessee the free use of the assets for a certain period of time (which in some legal systems is fixed by statute). The lessor remains the proprietor of the assets, but after delivering them, the lessor does not bear the risks associated with ownership since the lessor generally imposes clauses excluding liability for the delivery of non-conforming goods. Where this exclusion from liability is to be found in standard contract terms, it must first be established whether the standard contract term is valid, which may also depend on whether the lessee is a consumer. Where the lessee is not a consumer, an exemption from liability is generally valid, at least in those cases where the lessor unconditionally assigns to the lessee all the rights that the lessor would be entitled to exercise against the supplier in case of the supplier’s non-performance.
The lessee, on the other hand, is obliged to make periodically recurring payments, to keep the assets in good condition and to use them in conformity with their intended use. The obligation to make the aforementioned payments does not cease even where the assets lose their value, where they cannot be used or even where they are destroyed. In other words, the lessee bears the risk of having to make payments, even though the lessee is not able to profit from the assets as intended. The lessee is not bound to make payments in those instances, however, where the assets have not at all been delivered by the lessor.
In case the lessee does not perform its main obligation (payment of the monthly rent), the various legal systems provide for different solutions, ranging from the possibility to terminate the contract after expiration of a grace period (Nachfrist) to the possibility to terminate the contract in case of non-payment for two consecutive months.
Regarding the contract itself (lease), it comes to an end with its expiration, ie the termination or cancellation of the contract, but not with the complete amortization. Where the contract has come to its end, the lessee is, absent an option to buy, obliged to hand back the assets. In case the lessee does not comply with this obligation, the lessee is obliged to continue to make monthly payments even where full amortization has already occurred.
4. Unification of law
Although the (finance) leasing contract is defined in most legal systems in similar ways, there are differences regarding certain aspects. Where the leasing contract is international, these differences lead to uncertainty as to the applicable rules and, thus, constitute an obstacle to international leasing. It is with the goal of overcoming this obstacle that UNIDROIT elaborated the UNIDROIT Convention on International Financial Leasing, adopted in Ottawa on 28 May 1988, which has to date entered into force in ten countries.
Article 1 of this Convention—which is as non-exhaustive as any other uniform commercial law Convention and merely governs a limited number of issues, albeit important ones—defines the leasing contract as a contract in which one party (the lessor), (a) on the specifications of another party (the lessee), enters into an agreement with a third party (the supplier) under which the lessor acquires plant, capital goods or other equipment on terms approved by the lessee so far as they concern its interests, and (b) enters into an agreement with the lessee, granting to the lessee the right to use the equipment in return for the payment of rentals that are calculated so as to take into account in particular the amortization of the whole or a substantial part of the cost of the equipment. This latter requirement excludes that operating leasing can be governed by the Convention, operating leasing being from the outset not aimed at full or substantial amortization of the assets.
For the Convention on International Financial Leasing to apply, it is, however, insufficient that the aforementioned substantive application requirement be met. The contract also has to be international in the sense that the parties to the contract have to have their place of business in different countries. Moreover, it is also required either that the countries in which the parties have their place of business are contracting states to the Convention or that both the supply agreement and the leasing agreement are governed by the law of a contracting state.
Regarding the rights and obligations of the parties, it must be pointed out that the Convention states that the lessor shall not, in its capacity of lessor, be liable to third parties for death, personal injury or damage to property caused by the equipment (Art 8(1)(b)). Also, the Convention grants the lessee the same rights as the lessor vis-à-vis the supplier as it states that the duties of the supplier under the supply agreement shall also be owed to the lessee as if it were a party to that agreement and as if the equipment was to be supplied directly to the lessee. This is necessary as leasing contracts often include, as mentioned earlier, provisions exempting the lessor from liability towards the lessee for defective assets. Still, the lessee is not entitled to terminate or rescind the supply agreement without the consent of the lessor (Art 10).
It is worth pointing out that the Convention also provides rules on the consequences of both the lessor’s (Art 12) and the lessee’s default (Art 13). The Convention also deals with the lessor’s right to transfer or otherwise deal with all or parts of its rights in the equipment as well as with the lessee’s rights to transfer the right to use the equipment (Art 14).
Finally, it must be pointed out that the Convention is a default rule in nature. In effect, the application of the Convention may be excluded as a whole, but only if each of the parties to the supply agreement and each of the parties to the leasing agreement agree to exclude it (Art 5(1)). The parties may also, in their relations with each other, derogate from or vary the effect of most, although not all, of the Convention’s provisions.
Herbert Kronke, ‘Finanzierungsleasing in rechtsvergleichender Sicht’ (1990) 190 AcP 383; Michael Martinek, Moderne Vertragstypen, vol 1, Leasing und Factoring (1991); Daniel Girsberger, Grenzüberschreitendes Finanzierungsleasing. Internationales Vertrags-, Sachen- und Insolvenzrecht. Eine rechtsvergleichende Untersuchung (1997); Simon Gao, International Leasing: Strategy and Decision (1999); Eric Garrido, Le cadre économique et réglementaire du crédit-bail (2002); Eckhard Wolf and Hans-Georg Eckert, Handbuch des gewerblichen Miet-, Pacht und Leasingrechts (9th edn, 2004); Mauro Bussani, I contratti moderni. Factoring, franchising, leasing (2005); Marco Torsello, ‘La disciplina uniforme del leasing finanziario internazionale’ in Aldo Berlinguer (ed), Finanziamento e internazionalizzazione di impresa (2007) 187 ff; Friedrich Graf von Westphalen (ed), Der Leasingvertrag. (6th edn, 2007); Thomas Ackermann and Michael Martinek (eds), Handbuch des Leasingrechts (2nd edn, 2008); Kåre Lilleholt and others (eds), Principles of European Law: Lease of Goods (2008).