In a landmark decision, the Sindh High Court has drawn a clear distinction between operating and finance leases, laying down the distinguishing features between the two, which is expected to have a huge impact on the whole leasing industry.
Earlier, the leasing companies and banks, on default by their customers, faced a dilemma as to whether or not they should take possession of the leased asset for selling it. The problem was that despite the commitments that may have been given by the lessee in the agreement to the contrary, immediately upon taking of possession, the lessee would refuse to make any further payments.
Listing the most important distinguishing features between the two types of leases, the honourable court stated that the "financial lease is a lease that transfers substantially all the risks and rewards incident to owner of an asset. Lessor is only a financier and is not interested in the asset."
On the other hand, according to the court, "in an operating lease, the lessor will have the continuing interest in the leased equipment and thereby undertakes to bear the maintenance etc. Lessor retains the usual risks and rewards that come from the ownership of the assets."
Another feature that has been specified by the honourable court for an operating lease is that the lessor remains responsible for maintenance and insurance of the assets. "Thus the equipment/machinery, like the buses, which are the subject matter of this suit, cannot be included in the category of operating lease."
Justice Zia Pervaiz, in his judgement, stated that in case of default of a financial lease, "lessor indulges only to the extent of financing, which is his main vocation; the ordinary course to be followed to minimise the losses would be to dispose off the chattel or machinery. The amount of sale proceeds be adjusted towards the unpaid instalments due for the entire tenure of the lease under contract."
The crucial part of the judgement is with regard to the outstanding balance obligations of the lessee even after taking possession and sale of leased assets.
After hearing arguments from both sides, the honourable court finally decided that the lease, being a financial lease, even after taking possession of the leased assets, and even after the application of the sale proceeds towards adjustment of the liability of the lessee, "the balance outstanding, if any, may be recovered from the lessee to secure the agreed amount of return and the finance availed."
According to the honourable court, if the lease is a financial lease, and if the lessee is not disputing that he entered into the agreement without his free consent, then, if the agreement itself contains a continuing payment schedule to which the customer has committed to meet, then there is room for adjudication by any court.
The customer must comply with that schedule and he is not entitled to take the plea that his liability to continue making payment in accordance with the agreed schedule will stand somehow extinguished upon the leasing company or bank having taken possession of the leased asset.
While the financial and accountancy distinction between financial and operating leases has always been there, the judgement is being seen as quite an important legal breakthrough for all the leasing industry in that the superior courts have, for the first time, laid down a legal distinction between the two kinds of leases and have also accepted the leasing companies and banks' right to continue claiming agreed payments of money from their customers even after they have taken possession of the leased assets.