Main Elements of Financial Leasing Contract

1. Gross purchase value of the lease object – this differs from supplier to supplier, but it can also differ depending on the conditions that the lessor is offered by the supplier. It is in the lessee’s interest that this value be as favourable as possible for the lessor, as the lessee’s obligations to the lessor will depend on that amount (see also: Terms of the Delivery Contract).;
2. Residual value of the lease object – including residual value of the lease object in the contract decreases the level of individual installments; however, this at the same time implies that the lessee will be obligated to pay a higher amount after the expiration of the lease term if he/she wants to acquire ownership of the lease object. This means that, during the period of paying lower installments, the lessee should save up a certain amount of money in order to have sufficient funds for the substantial payment lessee will in that case have to make in the future.
3. Insurance costs – although insurance of the lease object is lessee’s legal obligation, the lessor can assume that obligation subject to a contract. Damage indemnity will be paid to the lessor. Insurance costs are not included in the effective lease fee rate (ELR).
   If the lessor specifies the insurance company with which the object must be insured, the lessee will lose the possibility to choose the company with the most favourable terms of insurance.
   Also, attention should be paid to the way in which the lessor/lessee relation in the event of damage is regulated, i.e. if and under which conditions the lessee is entitled to a part of the indemnity paid by the insurance company. It is desirable that all such relations be regulated in the contract.
4. Other costs of concluding a financial lease contract – these are very important in terms of comparing different offers for financing. There is a possibility that low interest rates are counterbalanced by the high level of other expenses that the lessor charges. Also, some costs present in one form of financing are not present in other forms of financing. The effect these costs have on the nominal interest rate (only the part of costs credited to the account of the lessor) will be reflected through ELR.
5. Currency clause – if you assume a foreign currency-indexed obligation, you are also assuming a substantial foreign exchange risk, unless you have a steady cash inflow in the same currency. The lessor will contract a foreign currency clause in order to safeguard against foreign exchange risk when its obligations (sources of financing) are denominated in that currency.
   If, however, you are ready to bear the exchange rate risk, pay attention to the exchange rate at which lease fee installment is recalculated – is this the median or selling exchange rate, is the rate valid on due date of the lease fee installment applied, or is it the rate valid on the date of payment.
6. Option right – are you entitled to buy out the lease object at the end of the lease term and under which conditions? Is that in line with your needs (or do you want to purchase an entirely new object at the expiration of the lease term)? The lessor can make this right conditional upon the payment of a particular fee (option price).
7. Terms of early repayment – if you have planned to save up money during the lease term in order to repay the remaining lease fee and buy out the lease object early, bear in mind that early redemption can only be effected after two years have expired. A larger part of interest is also usually repaid in that period – the principal of the remaining debt does not commonly decline with the lapse of time – as you can see from the Repayment Schedule. In addition, pay attention to whether and how the lessor will calculate the cost of early repayment, which, in some cases, can be all but insignificant. Because of all this, consider well the justifiability of early repayment before you decide to take such a step.
8. Effective lease fee rate – as has already been explained, this rate shows the relative cost of financing approved by the lessor (gross purchase value less share), in a way that ensures the comparability of terms of financing among different lessors, and between lessors and banks. The level of this rate is determined by the level of the nominal interest rate, other costs of concluding a financial lease contract, as well as the moment of start of cash flows, i.e. leasing payments.
   For example, if we have two lessors, lessor A and lessor B, with entirely identical terms of financing, except for the fact that, in the case of lessor A, total other costs are paid one year after the day of signing the contract, whereas, in the case of lessor B, they are paid immediately after signing the contract, ELR will be higher with lessor B. This is because, if the lessee now has the amount required for the payment of other costs subject to the terms approved by lessor A, the lessee has the possibility to deposit these funds until the payment obligation is due (or to invest the funds in another way) and thereby earn some profit. The higher the amount of costs and the longer the difference between the periods when financial obligations fall due, the larger the difference between the two lessors.
   Moreover, the level of the share does not influence ELR; it is therefore very important to compare this amount with other forms of financing, and with other lessors, especially in view of the previously explained time value of money, and the fact that the lessor, regardless of the level of your share, is the formal and legal owner of the entire lease object.
9. Level and time of cash outflows – the user should assess the level and time of cash outflows in order to be able to settle them, and of expected cash inflows in the period under review.
10. Possibility of change of the nominal interest rate – special attention should be paid to the contract provision governing lessor’s right to change the level of lease installment during the term of the lease contract. This most frequently happens in the event of increase of the EURIBOR or another reference interest rate (the type of interest rate on the domestic or international financial market with reference to which the interest rate in a particular transaction is set). Thus, EURIBOR, for instance, is the interest rate applied to euro-denominated deposits in the interbank market. Depending on the maturity of deposits, there is one-week, two-week, three-week, monthly, quarterly etc. EURIBOR. Lessors include this provision in the contract, as a way of protection against the exchange rate risk, and this is most often an indicator of the fact that the interest lessors pay to their creditors is set against the same reference interest rate.
    It is important for the lessee to know that an increase in the EURIBOR will result in a corresponding rise in lessee’s future monthly obligation to the lessor, and a rise in total interest the lessee will pay. If the contract includes the right of the lessee to buy out the lease object at the end of the lease term, the change in the lease fee installment will also lead to the obligation to pay additional VAT, as the basis for VAT calculation has been changed.
    The financial lease contract should specify the manner of adjusting the lease fee installment to changes in the reference interest rate, as well as setting down dates on which it will be assessed whether any such change has occurred.
    Data on EURIBOR levels can be accessed through the following link: http://www.euribor.org/html/content/euribor_data.html.  Data posted on this web page are informative in character, as only the data published by Reuters is deemed official.

11. Terms of the delivery contract – Delivery contract is the contract whereby the lessor purchases the lease object from a supplier. The Financial Leasing Law sets down that the lessee should give its approval of terms of the delivery contract that concern lessee’s interests. In particular this refers to:
    • object of the contract – is the object in the delivery contract unambiguously identified as the object you want to procure,
    • place, deadline and manner of delivery – it is desirable to specify all details related to object delivery, especially the final delivery deadline. It is also desirable to specify these terms in the financial lease contract. In the event that delivery fails to take place in accordance with defined terms, the lessee will have the right to refuse to accept the delivery or terminate the lease contract, as well as being entitled to damage indemnification. The lessee will also be entitled to suspend the payment of the agreed fee to the lessor until the fulfillment of the delivery obligation in conformity with terms set down in the contract. A precise specification of the delivery deadline is particularly important in cases when the lessor charges interim interest from the lessee, accruing in the period between the moment of paying for the object to the supplier and the moment of delivery of the object, or due date of the first lease fee installment. This additional cost for the lessee can only be limited by specifying the deadline until which the supplier is required to deliver the object,
    •  lease object price– is the price broadly the same as the price you would pay if you procured the lease object for cash? Does the lessor pass on to you any discounts approved by the supplier?
12. Tax treatment for different ways of procuring the lease object – When selecting the form of financing the procurement of the object, legal entities should pay particular attention to the impact such selection will have on their tax obligations.

Before signing a financial lease contract – make sure that all reasons that prompted you to choose this type of financing and a particular lessor are precisely and unambiguously stipulated in the contract.
BEFORE SIGNING A FINANCIAL LEASE CONTRACT – STUDY ITS CONTENTS THOROUGLY AND REQUEST ADDITIONAL EXPLANATIONS FROM THE LESSOR REGARDING ALL CONTRACT PROVISIONS THAT YOU DO NOT FULLY UNDERSTAND.