Obligation Under Finance Lease

A finance lease, also known as a capital lease, effectively transfers the risks and rewards of ownership of an asset from the lessor (the owner) to the lessee (the user). This is distinct from an operating lease, where the lessor retains significant ownership benefits. Consequently, the lessee assumes significant obligations under a finance lease agreement.

Key Obligations of the Lessee

Lease Payments:

The primary obligation is to make regular lease payments as stipulated in the agreement. These payments are typically calculated to cover the lessor's cost of the asset, plus a return on their investment (essentially, interest). The payment schedule and amount are usually fixed for the lease term. Failure to make timely payments can lead to penalties, default, and even repossession of the asset.

Maintenance and Repairs:

Unlike operating leases where the lessor often handles maintenance, the lessee in a finance lease is usually responsible for maintaining the leased asset in good working order. This includes routine maintenance, repairs, and any necessary upgrades. The lease agreement usually specifies standards for maintenance, and the lessee must adhere to these to avoid breaching the contract.

Insurance:

The lessee is generally required to insure the asset against loss or damage. This insurance policy protects both the lessee and the lessor's financial interests. The lease agreement typically specifies the required coverage amounts and types of insurance. The lessor might also be named as a loss payee on the policy.

Taxes and Other Expenses:

The lessee may be responsible for paying property taxes and other expenses associated with the asset's use, such as registration fees or license fees. The specifics of these responsibilities will be clearly outlined in the lease agreement.

Use and Location Restrictions:

The lease agreement may place restrictions on how the asset can be used and where it can be located. These restrictions protect the lessor's investment and prevent misuse or relocation that could diminish the asset's value. The lessee must comply with these restrictions throughout the lease term.

Obligation at Lease End:

At the end of the lease term, the lessee may have several options depending on the lease agreement. These could include:

• Purchasing the asset for a predetermined price, often a bargain purchase option.
• Renewing the lease for an additional term.
• Returning the asset to the lessor.

The lessee must fulfill the chosen option according to the terms of the agreement. If the option is to return the asset, it must be returned in the condition specified in the lease, typically "fair wear and tear" accepted.

Indemnification:

The lessee often agrees to indemnify the lessor against any losses, damages, or liabilities arising from the use of the asset during the lease term. This protects the lessor from claims related to accidents, injuries, or property damage caused by the asset's operation.

It is crucial for lessees to carefully review and understand all the obligations outlined in a finance lease agreement before signing. Legal counsel should be sought if the terms are unclear or potentially disadvantageous. Understanding these obligations allows lessees to manage their responsibilities effectively and avoid potential financial penalties or legal disputes.