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CLFP Chapter 1: History & Overview
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Code of Hammurabi ๐ธ๐ธ : Around 1750 B.C. - The Code of Hammurabi
- King Hammurabi acknowledged leasing of personal property in his Code of Laws
- First record of leasing law Beginning of Leasing ๐ธ๐ธ : - Oldest record 2010 B.C. in the Sumerian City of Ur
- Used clay tablets for documenting leases for agricultural tools, land leases for agricultural tools, land and water rights, oxen and other animals Ship Charters ๐ธ๐ธ : - Early example of a true lease.
- Phoenicians were shipping and trading experts used ship charters to obtain a ship and crew.
- Other charters covered the economic life of the ship and required the lessee to assume the benefits and obligations of ownership
Statute of Wales ๐ธ๐ธ : English Common Law
- Used in England to deal directly with the leasing of personal property
- Further clarified in 1571 to define who actually owned the leased property Railroad Industry - Industrial Revolution ๐ธ๐ธ : - In the UK and the United States, the railroad companies could only afford the tracks
- Sought financing from private, the investors for the railroad locomotives and companies railcars could only afford
- Accomplished through the track equipment trusts
- Most well-known finance plan was the Philadelphia Plan Post WWII, there was an economic slump ๐ธ๐ธ : - The government tried to stimulate the economy and in 1953, Section 167 of the Internal Revenue Code was issued
- Gave the owner/lessor the ability to take ordinary payments into income associated with a lease and accelerate depreciation
- Designed to encourage capital spending ITC ๐ธ๐ธ : Investment Tax Credit
- Eliminated the Investment Tax Credit (ITC) 1990s ๐ธ๐ธ : โข Credit Scoring Innovation
- Independents led the charge, followed by some captives and finally banks
- Third Party Originators (TPO)
- TPOS were now accepted by banks
- Creative Financing Structures & Large-Ticket Leasing FMV, PUT, 1st Amendment Leases and other creative leasing structures grew
- Independent and captive leasing companies sought to distinguish themselves from the banks Synthetic Lease ๐ธ๐ธ : โข Designed to be a loan for tax purposes, but an operating lease for accounting purposes โข Still in existence today The NorVergence Program ๐ธ๐ธ : - Massive case of telecom equipment fraud withwidespread industry impact
- There was a crowd mentality of credit, "If known better company X approves it, we should be able to as well"
- The Hell or High-Water clause did not hold up in many jurisdictions because courts thought the equipment specialists should have known better
- The equipment was worth 10% or less than the amount financed
- Changed the concept of financing for services included in leases 2010 Consumer Financial Protection Bureau (CFPB) ๐ธ๐ธ : - created by the Dodd-Frank Wall Street Reform and Consumer Protection Act
- Although designed to protect consumers, many laws are written to apply to smaller equipment financing transactions Equipment Lease Definition ๐ธ๐ธ : A transaction in which use and possession, but not title to tangible property, is transferred for consideration Government Leasing ๐ธ๐ธ : Three categories
- Municipal leasing (1. taxing power; 2. police power; 3. power of "eminent domain")
- Leases to the federal government government for
- Lease to Native American tribes and nations
- Does not involve financing, but accelerates the cash flow of the business in exchange funds to for a slight discount on the face value of the invoice
- It's an off-balance sheet receivables method of financing
- is not a loan and does not create debt to a company The Three Lenses for Examining Leases ๐ธ๐ธ : ะขax
- IRS determines the eligibility for tax benefits (IRS Rev. Ruling 55-540)
- "Tax Lease" or "Conditional Sales Contract"? Accounting
- FASB determines eligibility (ASC 842, fka FASB 13)
- Lessee: "Operating Lease" or "Finance Lease"
- Lessor: "Operating Lease," "Sales-type Lease," or "Direct Financing Lease" Legal
- UCC Articles 2, 2A and 9 - determine whether a transaction is a true lease and who owns the equipment
- Proper handling of these filings perfects an interest in the asset and makes ownership known
Accounting Lens ๐ธ๐ธ : FINANCE LEASE
- has the characteristics of a purchase agreement and meets any of the five criteria as set forth in ASC 842
- requires LESSEE to record lease liability on the balance sheet at commencement; interest and amortization is expensed
- LESSOR must capitalize the stream of pmts (show as lease receivable on the balance sheet); only take into come the portion of the payment applicable to interest. OPERATING LEASE
- characteristics of a usage/rental agreement and meets NONE of the criteria set forth in ASC 842
- requires LESSEE to record Right of Use Asset and Lease Liability on the bal sheet at commencement; lease expense to portion applicable to interest
- LESSOR must record property as a fixed asset and record depreciation. All payments are taken into income Legal Lens ๐ธ๐ธ : UCC ARTICLE 9 :
- governs any transaction that is not a lease but a secured transaction
- UCC ARTICLE 2A
Often during a specified period during the contract Equipment Finance Agreement ๐ธ๐ธ : Agreement that resembles the structure of a finance lease, but provides for the lender to lend the borrower an amount for the purchase of the equipment typically, lender pays the vendor invoice and files a lien against the collateral Finance Lease ๐ธ๐ธ : * used in many forms
- Frequently as a Net Lease - purpose of which is to financing the use of the property for the majority of its useful life.
- typically used in reference to leases written by TPOs
- often confusingly used to refer to a conditional sale in the form of a lease transation
- is a specified lease classification type under ASC 842
- Defined by UCC Article 2A
- Lessor is not the mfg or supplier
- Lessor does not select the equipment or lease from inventory of like items
- Lessor makes sure the lessee is apprised of their rights against the seller with respect to warranties FMV Lease Option ๐ธ๐ธ : Provides that at the end of the lease contract, a determination is made for the assets then fair market value and the Lessee has the option to purchase it at for that amount. Note: normally a pure FMV is indicative of a true lease but the presence of the option does not ensure a finding that it is a true lease. Leveraged Lease ๐ธ๐ธ : Involves at a minimum, a lessee, lessor, and funding source from which the lessor borrows a significant portion of the cost of the equipment (20% or more throughout) Fair Market Value Lease (FMV) ๐ธ๐ธ : A lease which contains an option for the lessee to purchase the leased property at the end of the contract term for its then Fair Market Value (the price that a willing seller and buyer negotiate in an open marketplace) Managed Services (Contract Services)
๐ธ๐ธ : A non-tax lease or conditional sales contract in the guise of a lease, in which the title is intended to pass to the lessee at the end of the lease term Nominal Purchase Option ๐ธ๐ธ : Payment as a residual to the lease that is so minimal that the Lessee is extremely likely to exercise the option
- Lessor is unlikely to have a "meaningful residual interest"
- The Lessor's no residual interest in the asset at the end of the term is enough to recharacterize it as a secured sale or financing transaction rather than a true lease Other names for this type of lease
- Nominal Purchase Option
- $1.00 Buyout
- Bargain Purchase Option
- Buck Out
- $1 Out
- $101 Purchase Option Operating Lease ๐ธ๐ธ : Accounting term of a lease that fails to meet any of the ASC 842 criteria
Characteristics of a usage agreement. Non-Tax Lease ๐ธ๐ธ : Any lease in which the lessee is, or will become, the owner during or at the end of the lease term and is entitled to all the tax benefits of ownership Examples of leases which in substance is in fact one of the following
- conditional sales contract
- money-over-money transaction
- purchase money security agreement
- OR other lease intended as security agreement Purchase Upon Termination (PUT) ๐ธ๐ธ : Lessee agrees to buy and the lessor agrees to sell the equipment for a predetermined amount upon termination of the lease. Rental Agreement ๐ธ๐ธ : A short service lease; typically less than 12 months Sale-Leaseback
Therefore entitling the lessor to qualify for the tax benefits of ownership And the lessee to claim the entire amount of the lease rental as a tax deduction. IRS Revenue Ruling 55- 540 ๐ธ๐ธ : Defines what is NOT a lease for tax purposes: P (Payments > Rental): Rental payments are not substantially higher than rental value a fair the asset does not automatically A (Automatic Title): Ownership of pass to the lessee at the end of the term I (Interest): No portion of the lease payment is characterized as interest N (Nominal P.O.): The transaction does not include a nominal purchase option E (Equity) No portion of the lease payments can be applied to an equity position in the asset E (Excessive Payments): The amount paid under a short term lease is not a significant portion of the purchase price (excessive lease payments)
ASC 842
๐ธ๐ธ : From an accounting perspective, if any one of the FIVE following are true, then it is NOT a true lease / conditional sales contract
- Title to the property automatically transfers to the lessee by or at the end of the lease term
- The lease contains a bargain purchase option
- The lease term is equal to or greater than 75% of the estimated economic life of the leased property
- The present value of the minimum lease payments at the beginning of the lease term is equal to or greater than 90% of the fair market value of the property
- The underlying asset is of a specialized nature Drivers of Equipment Financing & Leasing Industry ๐ธ๐ธ : FIVE:
- Economy
- cost, availability and variety of funding
- turnover of plant and machinery
*Ex: fleet vehicles, large medical (CT, MRI) construction, CNC, mfg, ag equipment Large-Ticket ๐ธ๐ธ : * transactions over $5,000,
- sometimes referred to as "big ticket"
- Ex: rail cars, aircraft, mfg, marine, energy equipment Lease ๐ธ๐ธ : generally defined as a transaction where a lender/lessor loans funds to a customer/lessee for a particular asset. The lessor retains ownership/title of the asset and transfers "possession in use" to the lessee for a specified term, after which the asset is returned to the lessor.
