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Guide to Understanding Leasing

A lease or tenancy is the right to use or occupy personal property or real property given by a lessor to another person (usually called the lessee or tenant) for a fixed or indefinite period of time, whereby the lessee obtains exclusive possession of the property in return for paying the lessor a fixed or determinable consideration (payment).

In law, there are two types of property:

  • Real property is land or any permanent feature or structure above or below the surface. Ownership of land is an aspect of the system of real property or realty in common law systems (immovables in civil law systems and Conflict of Laws).

  • All other property is considered personal property or personalty in common law systems (movables in civil law and Conflict of Laws), and this property is either tangible or intangible, i.e. it is either physical property that can be touched like a computer, or it is an enforceable right like a patent or other form of intellectual property.

There are three separate levels of rights or interests affecting both forms of property.
In descending order of importance they are:

  • ownership,

  • possession or

  • control and use.

The legal documents that transfer these rights are respectively: conveyance/transfer, lease/tenancy, and bailment/pledge for tangible personalty, assignments and licenses
for intangibles.

Conceptual Background

Under normal circumstances, owners are free to do what they want with their property. In the case of personalty, the normal rule is that owners in possession cannot steal their own property, nor can they be prosecuted if they destroy it. Owners can, however, steal their property from another if they have already surrendered possession to that person. This reflects the power of the state to regulate the rights and duties of an owner and to impose liabilities should others suffer loss or be endangered by any use to which the property is put. But, in general terms, owners have considerable freedom of action under all legal systems, both national and international. By definition, owners also have the rights of both possession and control over their property, and they can transfer those subordinate rights to others.

Leasing of Real Property

There are different types of ownership for land but, in common law states, the most common form is the fee simple absolute, where the legal term fee has the old meaning of real property, i.e. real estate. An owner of the fee simple holds all the rights and privileges to that property and, subject to the laws, codes, rules and regulations of the local law, can sell or by contract or grant, permit another to have possession and control of the property through a lease or tenancy agreement. For this purpose, the owner is called the lessor or landlord, and the other person is called the lessee or tenant, and the rights to possess and control the land are exchanged for some payment (called consideration in legal English), usually a monthly rent.

The acceptance of rent by the landowner from a tenant creates (or extends) most of the rights of tenancy even without a written lease (or beyond the time limit of an expiring lease). Although leases can be oral agreements that are periodic, i.e. extended indefinitely and automatically, written leases should always define the period of time covered by the lease. In the 1930s, the British government introduced infinite leases, only to remove the power to create these in the early 1990s. A lease may be:

  • a fixed-term agreement, in other words one of these two:

      1. for a specified period of time (the "term"), and end when the term expires;
      2. conditional, i.e. last until some specified event occurs, such as the death of a specified individual; or
  • a periodic agreement, in other words renewed automatically

      1. usually on a monthly or weekly basis
      2. at will, i.e. last only as long as the parties wish it to, and be terminated without penalty by either party.

Because ownership is retained by the lessor, he or she always has the better right to enforce all the contractual terms and conditions affecting the use of the land. Normally, the contract will be express (i.e. set out in full and, hopefully, plain language), but where a contract is silent or ambiguous, terms can be implied by a court where this would make commercial sense of the transaction between the parties. One important right that may or may not be allowed the lessee, is the ability to create a sublease or to assign the lease, i.e. to transfer control to a third party. Hence, the builder of an office block may create a lease of the whole in favour of a management company that then finds tenants for the individual units and gives them control.

Under English Law, a lease should have three essential characteristics:

  • A definite Term (whether fixed or periodic)

  • At a Rent

  • Exclusive Possession

However, according to Ashburn Anstalt v Arnold [1989], a rent is not essential but will help to contribute towards finding a lease. In addition Prudential Assurance Co Ltd v London Residuary Body[1992] seems to allow for an implied Periodic Tenancy where a lack of a 'Fixed term' would otherwise have made the lease void.

Leasing of Tangible Personal Property

An owner can allow another the use of a vehicle (such as vehicle leasing of a car, a truck or an airliner) or a computer either for a fixed period of time or at will. This can be a simple leasing transaction, or it can be a transaction intended to allow the user the right to buy the item at some future time.

  • In a simple lease (rental) of a car, P pays O a rental for the use of the car during the agreed period which may be a few days (e.g. for a holiday trip) or longer where it is more economic to pay for use rather than pay for the ownership of an asset of depreciating value. Normally, only P will be allowed to use the vehicle and, in such a case, P has possession and control. But, P could be an employer who allows C the use of the car to visit clients, and thereby gives C control.

  • In a lease with the possibility of purchase, O could allow P to lease the car for a specified period of time. If all the rental payments are made in full, P will then be allowed to buy the car at the contractual purchase option price. In a consumer lease subject to the federal Consumer Leasing Act and the Truth in Lending Act, the purchase option price can not be a "bargain" purchase, that is, it cannot less than the originally estimated fair market value. A "bargain" purchase creates an installment sale, to which the Truth in Lending Act (TILA) applies including the standardized disclosures, most importantly the Annual Percentage Rate (APR). Typically, the vehicle dealer or other personal property seller offers the leasing terms and contract of a third party finance company. Hence, O leases the vehicle to P, and upon execution of the contract simultaneously sells ownership of the car to F and assigns the lease contract to F. It is standard for the contractual terms to prohibit P from parting with possession or control of the car to another (if P does part with possession, this can be a theft of the car from F).

There are two principal types of leasing, depending upon the party taking the risk of the value of the vehicle (or other leased property) at lease end. In the U.S. this is called Closed-end leasing. In other jurisdictions, it is called hire purchase, lease purchase or finance leasing. These transactions are complicated. The most common problem arises when O makes specific representations as to the quality and reliability of the car to P during the initial negotiations. If what is said induces P to buy the car from O, those representations would usually be enforceable against O. But, in this transaction, O first sells the car to F who makes no representations to P. The laws vary from state to state on the extent to which P might be allowed a remedy if the car proves to be of poor quality.

To clarify the concept, the owner of tangible movables has the power to keep possession and only to transfer control. This may be for:

  • short- or long-term storage (e.g. leaving a passport with hotel staff or depositing valuable property in a bank vault — a hotel or bank holding property is a bailee); or

  • for delivery purposes (e.g. using a carrier to transport goods to a specific destination);

  • or it may be a form of mortgage — a pawnshop holds a pledge over the goods deposited until the money lent is repaid.

Leasing is a common method by which airlines acquire their aircraft, usually from companies specialised in the field of Commercial Aircraft Sales and Leasing. Aircraft leasing transactions are typically divided into finance leasing and operating leasing.

Businesses often choose to lease rather than buy office equipment, including computers. Since office equipment depreciates rapidly, leasing can be more cost-efficient than ownership.

Real Leases

Whether it is better to lease or buy land will be determined by each state's legal and economic systems. In those countries where acquiring title is complicated, the state imposes high taxes on owners, transaction costs are high, and finance is difficult to obtain, leasing will be the norm. But, freely available credit at low interest rates with minimal tax disadvantages and low transaction costs will encourage land ownership. Whatever the system, most adult consumers have, at some point in their lives, been party to a real estate lease which can be as short as a week, as long as 999 years, or perpetual (only a few states permit ownership to be alienated indefinitely). For commercial property, whether there is a depreciation allowance depends on the local state taxation system. If a lease is created for a term of, say, ten years, the monthly or quarterly rent is a fixed cost during the term. The term of years may have an asset value for balance sheet purposes and, as the term expires, that value depreciates. However, the apportionment of relief as between business expense and depreciating asset is for each state to make (all that is certain is that the lessee cannot have a double allowance).

Private Property Rental

Rental, tenancy, and lease agreements are formal and informal contracts between an identified landlord and tenant giving rights to both parties, e.g. the tenant's right to occupy the accommodation for an agreed term and the landlord’s right to receive an agreed rent. If one of these elements is missing, only a tenancy at will or bare licence comes into being. In some legal systems, this has unfortunate consequences. When a formal tenancy is created, the law usually implies obligations for the lessor, e.g. that the property meets certain minimum standards of habitability. With a bare licence, some states do not imply any significant lessee protections

A tenancy agreement can be made up of:

  • express terms. These include what is in the written agreement (if there is one), in the rent book, and/or what was agreed orally (if there is clear evidence of what was said).

  • implied terms. These are the standard terms established by custom and practice or the minimum rights and duties formally implied by law.

Commercial Leasehold

For businesses, leasing property may have significant financial benefits:

  • Leasing is less capital-intensive than purchasing, so if a business has constraints on its capital, it can grow more rapidly by leasing property than it could by purchasing the property outright.

  • Capital assets may fluctuate in value. Leasing shifts risks to the lessor, but if the property market has shown steady growth over time, a business that depends on leased property is sacrificing capital gains.

  • Leasing may provide more flexibility to a business which expects to grow or move in the relatively short term, because a lessee is not usually obliged to renew a lease at the end of its term.

  • Depreciation of capital assets has different tax and financial reporting treatment from ordinary business expenses. Lease payments are considered expenses, which can be set off against revenue when calculating taxable profit at the end of the relevant tax accounting period.

Disadvantages

There are some significant drawbacks:

  • If circumstances dictate that a business must change its operations significantly, it may be expensive or otherwise difficult to terminate a lease before the end of the term. In some cases, a business may be able to sublet property no longer required, but this may not recoup the costs of the original lease, and, in any event, usually requires the consent of the original lessor. Tactical legal considerations usually make it expedient for lessees to default on their leases. The loss of book value is small and any litigation can usually be settled on advantageous terms. This is an improvement on the position for those companies owning their own property. Although it can be easier for a business to sell property if it has the time, forced sales frequently realise lower prices and can seriously affect book value.

  • If the business is successful, lessors may demand higher rental payments when leases come up for renewal. If the value of the business is tied to the use of that particular property, the lessor has a significant advantage over the lessee in negotiations.


 
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