How a Finance Lease Works
The Nature of a Finance Lease
A finance lease is a method of acquiring equipment without paying for it outright. The lease will last for the useful life of the equipment and you take over the entire risk for the equipment during that time including insurance and maintenance even if the equipment malfunctions or is destroyed.
The key characteristic of finance lease is that, unlike lease purchase, you cannot legally own the equipment.
Before entering into a finance lease, you should take professional advice about, firstly, whether that form of financing is appropriate for you, and secondly the accounting, tax, capital allowance, and balance sheet consequences of the particular commercial and legal terms of the finance lease contract you are considering.
The Structure of Finance Lease Documentation
Where you are entering into a series of transactions with the same lessor, there will commonly be a Master Agreement governing all future transactions between you and the lessor, supplemented by a short-form schedule or equipment lease contract for each item of equipment. Generally, a breach of one of the equipment lease contracts would trigger a default in the master agreement and would give the lessor the right to terminate all the transactions.
Rentals under a Finance Lease
The key terms of a finance lease will be financial. The minimum term of the lease (the primary period) and the rent payable during that primary period, representing the equipment's useful life, will be stated and is calculated to cover the lessor's outlay on the equipment and his return on capital. After the primary period you may still wish to use the equipment (especially as it has been paid for). Hence there is a secondary period during which very much lower rents will be payable (secondary rent). At the end of the lease the equipment will generally be sold. As the lessor has already made his money he may allow you to keep between 95% and 99% of the price obtained.
Other Key Terms under a Finance Lease
As well as rental levels, a finance lease will commonly include the following provisions:
- the inter-relationship between the master agreement and individual equipment lease contracts;
- as the commencement of the lease and the payment of rentals is triggered by installation and acceptance, you must deliver a formal certificate of acceptance when you are happy with the equipment;
- the timing and mode of payment of rentals;
- as the level of rent is based on assumptions about capital allowance and other tax issues current at the beginning of the contract, the lessor will reserve the right to change the rent if there is a change in relation to those issues - rental levels are otherwise normally constant throughout the agreement;
- confirmation of your obligation to maintain and insure the equipment;
- the lessor will generally exclude all warranties for the equipment (normally) except for those given to him by the manufacturer of the equipment;
- events which allow the lessor to terminate the lease (e.g. non-payment of rent and your insolvency); and
- the lessor's rights to recover the equipment and money owing.
Negotiating the Lease
You cannot generally expect the lessor which is generally a finance house to enter into much negotiation over the terms.