The Features Of A Leasing Agreement And Accompanying Documentation
A Paper Presented At A Workshop For The Ghana Judiciary On Leasing On March 3rd, 2007 At Fiesta Royale Hotel, Accra, Ghana By Hon Mr Justice Nicholas R.O Ombija, Judge Of The High Court Of Kenya.
The World has become a global village. In this regard the special need to harmonize legal rules governing the financing of equipment of every level of value in developing countries and countries engaged in the transition to market economy, in order to develop the economic infrastructure to the level of developed countries or somewhere near there cannot be gainsaid.1
With few exceptions like Ghana, Kenya and Tanzania, there is currently no specific leasing law in place in most African countries.2
These considerations led the UNIDROIT council to draw up the model law of leasing on the basis of the UNIDROIT convention on International Finance leasing. The model law is considered as a particularly helpful tool for those countries engaged in the drafting of leasing considerations.3
Whilst it is my brief to give a general overview of the substantive provisions of the Act, it would not be possible to do so without introducing its basic structure. First, it is intended to cover both what is commonly referred to as financial leases and operating leases, the idea being that it should be broad as possible in its substantive sphere of application so as not only to encompass the present-day needs of developing countries and transition economies but also to envisage likely trends in the development of such markets.4
Secondly, it provides uniform rules governing the effects of the leasing agreements [ enforceability, the running of the supplier’s duties to the lessee, priority in relation to liens and liability for death, personal injury or property damage to third parties, the performance of the leasing agreement, the irrevocability of the lessee’s duties as from the time when the leasing agreement is entered into the risk loss under a lease, the lessee’s rights in the event of damage to the leased asset, the conditions for and consequences of the lessee’s acceptance and rejection of the leased asset, the extent of rights of parties to the leasing agreement to transfer their rights and duties thereunder, the extent of the warranties of the parties to the leasing agreement, the extent to the lessee’s duty to maintain and return the leased asset] 5
Thirdly, default remedies [ the definition of default, the need for giving notice, the measure of damages, liquidated damages termination of the leasing agreement and the lessor’s right to recover possession and dispose of the leased asset where the leasing agreement comes to an end or is terminated].
Fourthly, it has been structured as a model law expressly with a view to enabling national legislators to adopt it. This aspect calls for appreciation of the relationship between international law rules vis-à-vis the municipal or domestic law rules as explained by two theories: 6
Doctrine of transformation.
Doctrine of incorporation.
With regard to transformation7; before any rule or principle of international law can have effect within the domestic jurisdiction, it must be expressly and specifically transformed into a municipal law by the use of the appropriate constitutional machinery, such as an Act of Parliament. This idea has developed from the doctrine that any rule of international law must be transformed, or specifically adopted, to be valid within the internal legal order.
With regard to incorporation8; international law is deemed as part of the municipal law. Accordingly there is no necessity for the interposition of constitutional ratification procedure.
In the context of international law, once a Government becomes a signatory of the UNIDROIT CONVENTION the unidroit model law will automatically become the law. This is based on the general principle of international law that every treaty in force is binding upon the signatories to it.9
Accordingly, the first step will be for the general assembly of Unidroit to lay the draft model law before Governments and organizations for ratification; thereafter it will be the responsibility of each Government to transform or specifically adopt the model law of leasing to be valid within the internal legal order of each country.
1. Documentation Accompanying A Leasing Contract: Major Provisions And Significance
The term lease has two contextual meaning. The first meaning is in the realm of real property. The second meaning is in the realm of finance. What is germane to our discussion is the second meaning.
In the realm of finance, a lease is an agreement allowing one party to use another’s property, plant, or equipment for a stated period of time in exchange for consideration. Leases have become more prevalent as business and consumers look for alternatives to finance the acquisition of fixed assets. A lease agreement involves at least two parties; a lessor (such as a bank), who owns the property and a lessee, who uses the property. The lessor, essentially a creditor in the transaction, is repaid from the combination of lease, or rentals payments, benefits, and proceeds from the sale or re-lease of the property at the end of the lease term10.
In simple terms, it is delivering finance over an asset where one party (the lessor) provides an asset purchased from a supplier for use by another party (lessee) for a specified period of time in return for specified payments. Unless the context indicates otherwise, the term includes a sub-lease11.Lease financing focuses on the ability of the lessee to generate cash from the use of the leased asset to service the lease payment.
The Unidroit model law of leasing defines a financial lease as a lease with or without an option to purchases, that includes the following characteristics.12
a) The lessee specifies asset and selects the supplier;
b) The lessee acquires the asset or the right to possession and use of the asset in connection with a lease and the supplier has knowledge of that fact; and
c) The rentals or other funds payable under the leasing agreement take into account the amortisation of the whole or a substantial part of the lessors’ investment.
The United States Experience
Leasing is the most widely used method of personal property financing in the United States today. For bank lessors, leasing is another competitive product that can satisfy the needs of bank customers; leases may be safer than other bank products because the transactions are secured, and leases are generally more profitable than commercial loans because of the advantages inherent in their structure, such as the tax benefits.13
Leasing is a way of lessees’ (customers) to conserve capital because, in effect, they obtain 100% financing. Depending on the structure of the lease, the risk of ownership such as possibility that the product will become obsolete can be transferred to the lessor.
Tax benefits could also be transferred to a lessor, resulting in lower lease payments to the lessee.Operating leases are off-balance-sheet, which may improve certain of the lessee’s key financial ratios.
A special type of transaction, the sale-leaseback, allows the owner of a piece of property (usually real estate) to raise funds while retaining use of the property. In such a transaction (actually two separate transaction), the owner of the property sells the property and immediately leases it back. There is no physical transfer of the property.
From a safety and soundness perspective, leases that result from sale-lessee back transactions should be received in essentially the same manner as other leases15, National banks may engage in leases for agricultural, business, commercial or consumer purpose. As a general rule, they may acquire property to be leased only after the bank enters into a legally binding commitment to lease or legally binding written agreement indemnifying the bank against loss in connection with the acquisition of the leased property. 16
National banks may act as lessors’ and finance “net leases” for personal property. In a net lease, the bank is not directly or indirectly obligated to assume the expenses of maintaining the property. This does not prohibit the bank from arranging for an independent third party to provide servicing, repair, or maintenance of the leased property during the lease term.17
A National bank is prohibited from being a general partner in a commercial endevour. Therefore, when a National bank sells participation in a lease, it must avoid becoming a general partner, generally by entering into co-trust arrangement or forming a limited partnership.18
In developed countries, like United Kingdom and United States, lease financing is now in the vogue. The last 25 years have witnessed a great expansion of the use of the lease in aircraft and other asset financing. With this development various different types and forms of lease have emerged, whose legal effect can vary from jurisdiction to jurisdiction. 19
The first kind of lease is one in which the lessee wishes to take on lease an aircraft and to treat it as its own for the period of the lease. The lessee becomes the operator of the aircraft, appointing its own flight crew, who will be its servants, and operates the aircraft in accordance with the regulatory requirements and procedures governing its operations. This is usually known as “dry lease” or, to use the maritime analogy, a bare hull charter by demise.20
It is the dry lease which forms the basis of most of the leasing structures used in aircraft transactions, and which can produce contractual forms of great flexibility. However, to complicate matters, the dry lease concept can be subdivided into a number of further categories, the main divisions being the finance lease and the operating lease.21
The second type of agreement is one in which the lessee wishes to have available to it the use of an aircraft but, either by choice or necessity, wants the lessor to remain the operator of the aircraft. Such a lease or charter can either be for one flight, a series of flights, or even for a given period of time.
Strictly speaking, this is not a lease, since possession of the aircraft and flight crew to perform flights that, but for the lack of sufficient aircraft and flight crew of its own, the lessee would perform under its operating approvals, such lease is known as a ‘wet lease’.22
Akin to a wet lease is the ‘aircraft charter agreement’ In this arrangement, the lessor is, again, the operator, but the lessee has no involvement in the operation of the aircraft. The lessee is merely contracting for the passenger and/ or cargo capacity of the aircraft to be made available for its use on the agreed flight or service of flight.
This is a straightforward finance lease, the lessor remains the “owner” in a capacity which is almost minimal; he provides the capital and makes a profit on it, but under the terms of the lease, he does not expose himself to the liabilities of commercial risks of being the operator of the aircraft.23
“The Kenya Experience”
Kenya’s experience with asset leasing, on the one hand, is largely confined to agriculture, manufacturing, building and construction, property, buses, trucks and lorries, tankers, long haulage, tourism to name but a few.
On the other hand kenya’s experience with hire purchase is with domestic goods and personal as well as small commercial vehicles which we have nicknamed “matatus”.
Kenya’s Hire Purchase Act 24 is drawn from the English Statute of 1964.25 That The English Act repealed and re-enacted the Hire Purchase Act 1938, 1954 and 1964. It applies to all such agreements where the hire-purchase price does not exceed £2000, except where the hirer or buyer is a body corporate. The Act came into force in 1965.
For the English lawyer, therefore, the most important initial question which confronts him in any installment transaction is whether or not the agreement falls within the statutory control. Although the Act came into force in 1965, it applies to all agreements made after January 1965 [ the date in which the Hire Purchase Act 1964, came into effect ] if any problem arises concerning an agreement made before October, , 1965, it will be necessary to consider the transitional provision contained in Section 59 (3) and Part I of the schedule to the 1965 Act. 26
Though the provisions of the 1965 Act have supplanted much of the law on Hire Purchase, there are still considerable areas in which the common law is left untouched, even when a transaction falls within the statutory control it will be necessary to consider the common law in conjunction with the Acts’ provision. Where the hirer is a body corporate, the common law will, of course apply without any consideration of the statute.27
In Kenya, the Hire Purchase Act came into force on 2nd November 1970. The preamble28 to the Act states:
“ An Act of parliament to make provisions for the regulation of certain hire-purchase agreements, and for the licensing of hire-purchase concerns, and for purposes connected herewith.”
The Act was meant to protect, as it should, the small man or woman who enteres into transaction relating to household goods, that is the “ raison d’etre” for Section 3 which provides,29
“ 1. This Act applies to and in respect of all hire-purchase agreements entered into after the commencement of this Act under which the hire-purchase price does not exceed the sum of three hundred thousand other than a hire purchase agreement in which the hirer is a body corporate, wherever incorporated.
3(2) Notwithstanding subsection(1), nothing in this Act shall apply to any scheme controlled, managed or guaranteed by the Government for the purpose of providing loans to any person.”
The English Act provides, inter-alia that it does not apply to agreements where the hirer is a body corporate. Kenya’s Act30 replicates the same. It appears to me that the reason for this is that a body corporate is deemed to have a substantial bargaining power in comparison to an individual. The Act is tailored to provide statutory protection to hirers who are individual traders from exploitation by hire-purchase companies.
See DIAMOND TRUST BANK KENYA LTD V
JASWINDER SINGH ENTERPRISES 31
See CFC BANK LTD V KEINAN INVESTMENT COMPANY LTD & 4 OTHERS 32
See JOSEPH GICHERE KIMANI V REGAL HIRE PURCHASE LTD.33
Though the provisions of the Kenya Hire Purchase Act 1970 have supplanted much of the law on Hire Purchase, there are still considerable areas in which the common law is left untouched, and even when a transaction falls within the statutory control, it will be necessary to consider the common law in conjunction with the Acts’ provision. Where the hirer is a body corporate, the common law will, of course apply without any consideration of the statute.
Section 434 of the Act makes it mandatory for every agreement of hire purchase to be registered.
Section 535 of the Act provides that unless the hire-purchase agreement has been registered, no person shall be entitled to enforce the agreement against the hire, or to enforce a contract of the hirer, or to enforce a contract of guaranteed relating to the agreements, and the owner shall not be entitled to enforce any right to recover the goods from the hirer. No security given by the hirer in respect of money payable under the agreement, or given by a guarantor in respect of money payable under the agreement, or given by a guarantor in respect of money payable under the guarantee relating to the agreement shall be enforceable against the hirer or the guarantor.
Section 6 of the Act gives provision which must be in every hire purchase agreement e.g.
i) It shall be in writing in a prescribed form
ii) Price of the goods
iii)Amount of installments
iv) Description of the goods
v) Notice in prescribed form relating to the rights of the hirer
vi)Within 21 days a copy of the agreement be delivered to the hirer.
Section 736 of the Act provides for an evidence of certain provisions on the agreement. Any provisions in the hire purchase agreement enumerated (a) – (c) make the contract void.
Section 837 of the Act embodies conditions and warranties implied in agreement of hire purchase .
Section 938 of the Act deals with instances of change of address and removal of goods.
Section 1039 of the Act deals with situations in which removal of goods under hire-purchase from Kenya is prohibited. It provides penal consequences; a fine of Sh. 10,000/= or to imprisonment for a term of not exceeding one year.
Section 1140 of the Act gives the Court jurisdiction to adjudicate over instances where hire-purchase agreement restricts possession of hired goods at a particular place. The Court can approve by an order, the removal.
Section 1241 of the Act provides conditions under which the hirer may terminate the agreement.
Section 1342 of the Act provides conditions under which the hirer may complete the agreement.
Section 14-1743 of the Act deals with recovery of hirer-purchase goods by suit.
Section 18-2344 of the Act provide for licensing of hire purchase business.
Section 24-3545 of the Act encompasses miscellaneous provisions.
Similarities Between Hire Purchase And Lease Financing
There are very few differences between a hire-purchase agreement and lease financing.
a) Both are based on contract and are premised on the concept of freedom of contract.
b) Security-the lessor already owns the assets and may require little or no additional collateral.
c) Coverage-leasing can provide up to 100% of your financing need. Hire purchase requires a down payment by the lessee ranging from 30% to 50%.
d) Leasing or Hire Purchase is often cheaper than bank credit.
e) Leasing as a concept has been tailored for small and medium size enterprises. On the other hand, hire purchase is more tailored for domestic furniture and equipment. It is not suitable for small and medium sized business enterprises.
f) Leasing has an added advantage over hire purchase in that it has in-built flexibility whereby the pattern and size of the lease payments can be tailored to business needs.
Similarities Between Hire Purchase And Lease Financing
i) Hire purchase agreements are purchase agreements with a default clause.
ii) National law governs hire purchase and certain terms and conditions are implied by statute. On the other hand, either national or international law can govern lease hire. Further, lease hire agreements have a higher monetary maximum ceiling compared to hire purchase agreements.
iii) Hire purchase does not take into account amortization or depreciation of the whole or substantial part of the lessor’s investment. Lease hire rentals or payments take amortizations into account.
iv) Hire purchase agreement is only enforceable between the parties and the asset is the security. On the other hand, lease hire agreements are enforceable against the party to the agreement and purchasers of the assets and against creditors of the parties including an insolvency administrator.
Advantages Of Leasing To Developing Countries And Countries In Transition.
i) It provides developing countries with an external source of capital for purchase of heavy equipment and technology and development of infrastructure.
ii) Enables developing countries to access international legal arena on lease agreement dispute settlement system.
Major Provisions In Lease Agreement And Their Significance
A lease finance agreement has various features that are incorporated in the agreements as follows:-
i)The agreement is based on the concept of freedom of contract and hence the lessor and lessee may derogate from or vary the effect of law and are free to determine the contents of the agreement.
ii)In a financial lease, the lessor is not liable to the lessee or third party for death, personal injury or damage to property caused by use of the asset.
iii)The lessor has a lien over the asset and any third party deals with the asset subject to the lien.
iv) The lessor duty to the lessee in a financial leases is irrevocable and independent whereas in other type of leases, the parties may make the duties revocable.
v) In a financial lease, the risk of loss of the asset is borne by the lessee who retains the risk of loss unless expressly stated.
vi) In a financial lease, when there is a partial loss of the asset, the agreement is terminated, whereas when there is a total loss, the lessee may demand inspection and at the lessee’s option, the agreement may be terminated or he shall accept the asset with due allowance for the loss.
vii) The lessor’s right under the lease may be transferred without the consent of the lessee but the lessee’s rights can only be transferred with the consent of the lessor, which may not be unreasonably withheld.
viii) The lessor grants the lessee a warranty of quiet possession, acceptability and fitness for purpose.
ix) The lessor is under an obligation to maintain and return the asset.
x) Normally in default of any obligation, the aggrieved party is entitled to damages in combination with other legal remedies.
Documenting A Lease
The bank, finance house or any institution involved in a finance leasing should have a legally binding agreement to lease and a lease contract that incorporate all the points in the commitment letter. The contract also should outline the rights of all parties in the event of default. The lease contract is usually signed a the same time as the order to purchase and the agreement to lease. Each lease, is an individual contract written to fulfill the lessee’s needs, consequently, there are many variations in lease terms. Every lease should convey a clear understanding of the lessee’s positive right to use the property for a specific period of time, and every lease should make the payment plant irrevocable.46
When drafting a lease agreement, the following clauses should be provided for:-
a) Preamble and parties
c) Applicable law
e) Priority of lien
f) Liability of death, personal injury or damage caused to third party by use of the asset.
g) Risk of loss
h) Damage to the assets
i) Transfer of rights and obligation
j) Lessor’s obligations
k) Lessee’s obligations
m) Default clause
n) Termination clause
p) Possession and dispossession of the asset.
On the one hand, the Kenyan experience with asset leasing is largely confined to agriculture, manufacturing, building and construction, property, buses, tracks and lorries, tankers, long haulage, tourism ejus-dem-generis.
On the other hand, the Kenyan experience with hire purchase is with domestic goods and personal as well as small commercial vehicles which we have named matatus.
Though the Kenya Hire purchase Act 1965, have supplanted much of the law on the Hire purchase, there are considerable areas in which the common law is left untouched. Even when a transaction falls within the statutory controls, it will be necessary to consider the common law in conjunction with the Acts’ provisions. When the hirer is a body corporate, the common law will of course apply without any consideration for the state.
HON. JUSTICE NICHOLAS R.O OMBIJA
HIGH COURT OF KENYA
1. Unidroit note for the attention of Governments and organizations ( Prepared by the secretariat, Rome, 19th July 2006)
2. Leasing in West Africa, Afrolease, Volume: Issue 1,P.10
3. Preliminary draft model law on leasing, Unidroit 2006, Study LIRA-DOC.11; Original: English/ French July 2006
4. Ibid, n 1
5. Ibid, Note 1
6. Nalcolm N. Shaw: International Law, 4th Edition pp 102-110
7. Ibid, P105-110
8. Ibid, P105
9. Ibid, p105
10. Comptroller of the Currency, Administration of National Banks;
Lease Financing Comptroller’s Hand Book January 1998. Pp1 - 2)
11. Unidroit model law, Article 2
13. Ibid n10 Supra
19. For a more detailed discussion on this topic generally see TM Clarke Leasing Finance ( 2nd Edn 1990) chs,6,7, and also Littlejohn and MCGairi Aircraft Financing ( 3rd Edn.1998)
20. Much of the terminology used is derived from the maritime law and practice
21. Ibid n10 supra
23. Ibid n 22 supra. A useful definition of a finance lease in the Standard Accounting Practice No p21 ( SSAP21), dealing with accounting for leases and hire purchase contracts published by the Accounting Standards Committee of the various accountancy bodies in the United Kingdom and Ireland 1984. According to this definition a finance lease is “a lease with transfers substantially all the risks and rewards of ownership of an asset to the lessee”. It should be presumed that such a transfer of risks and rewards occurs if at the inception of a lease the present value of the minimum lease payments, including any initial payments amounts to substantially all [ normally 90% or more] of the fair value of the leased asset. The present value should be calculated by using the interest rate implicit in the lease SSAP21(1984) paragraph 15. See also Volume 25(2) 2003; Re issue LEASING.
24. The Hire Purchase Act ( Cap 507) Laws of Kenya
25. See S. 59 and Part I of the Schedule to the English Statute 1965
26. See the Law of Hire Purchase, by A.G Guest, p5
28. Ibid n 19 Supra
31. Civil Appeal No. 285/99 ( C.A)
32. Milimani Commercial Court Nairobi, Civil Case No. 51/99
33. Milimani Commercial Court Nairobi, Civil Case No. 921/02
34. Ibid, n 30 Supra
35. Ibid, n 34 Supra
36. Ibid, n 35 supra
37. Ibid, n 36 supra
38. Ibid, n 37 supra
39. Ibid, n 38 supra
40. Ibid, n 39 supra
41. Ibid, n 40 supra
42. Ibid, n 41supra
43. Ibid, n 42 supra
44. Ibid, n 43 supra
45. Ibid, n 44 supra
46. Ibid, n 24 supra