Under an operating lease agreement, the lessor grants a particular asset to the lessee for temporary use, while the lessee undertakes to pay consideration in the form of lease instalments. The operating lease – also known as an operational, ordinary or true lease – has much in common with the tenancy agreement, yet it also has significant features that make it a preferred instrument in business.

In practice, the operating lease agreement is usually concluded in writing with notarial certification of the signatures. Under the law this is not a mandatory condition for its validity, but lessors require it as a matter of course. Notarial certification enables them more easily to obtain an order for enforcement from the court in the event of default by the lessee and upon termination of the agreement and, in the case of a lease of real estate, to register the agreement in the Property Register. In addition, where the parties to the agreement are commercial companies, the lessor usually has an interest in registering the agreement in the Central Register of Special Pledges as well.

SUBJECT MATTER OF THE AGREEMENT

Most often, an operating lease agreement is used to provide for use passenger cars and lorries, lifting and agricultural machinery, machines and production equipment, office equipment, as well as software. In recent years this type of agreement has increasingly been used for real estate as well – for example production halls, administrative and office premises, storage areas and the like.

Unlike a finance lease, in an operating lease the lessor is the owner of the asset at the time the agreement is concluded.

After the agreement has been signed, there is nothing to prevent the parties from amending their relationship by mutual consent so that the operating lease is converted into a finance lease.

TERM OF THE AGREEMENT

The term of an operating lease agreement is usually shorter than the expected period of economic use of the leased property.

In practice, the most common agreements are those with a term of between 3 and 5 years. In the case of real-estate leases, significantly longer terms are often agreed – of up to around 10 years.

Both the lessor and the lessee are able to terminate the agreement unilaterally at any time. In order to limit this freedom, the parties usually include a clause fixing a period during which neither of them may unilaterally rescind the agreement without cause. This stipulation does not, however, deprive the party that is not in default of the right to terminate the agreement in the event of culpable non-performance of the obligations by the other party.

LEASE INSTALMENTS

For the use of the asset, the lessee owes monthly lease instalments, which by their nature are close to rental payments.

As a rule, the amount of the instalments is fixed for the entire term of the agreement. It is possible, however, to agree periodic indexation as well – for example an annual updating of the instalments in a manner similar to that used in tenancy agreements.

RIGHTS AND OBLIGATIONS OF THE PARTIES

The lessor assumes functions similar to those of a landlord – it is obliged to hand over the asset for use in the agreed condition and to ensure quiet and undisturbed use for the entire term of the agreement.

The lessee has the obligations of a tenant. It must pay the lease instalments regularly, bear all costs of using and maintaining the asset, including the costs of routine repairs, and, upon expiry of the agreement, return the asset.

The parties may also expressly agree additional costs to be borne by the lessee. It is common practice to include clauses in the agreement under which the lessee also bears the costs of insuring the asset, as well as the costs of creating security in favour of the lessor. It may also be agreed that major repairs are to be at the lessee's expense.

The lessee may also be granted a right to provide the asset for use to third parties – so-called subleasing or subletting. Such a sublease is permissible only with the express consent of the lessor; otherwise the sublease agreement is null and void. It is accepted in case law that if the lessor gives its consent at a later stage, this initial nullity is overcome and the sublease agreement becomes valid.

A key point in the agreement is also the stipulation as to who bears the risk of accidental loss of or damage to the asset, including in the case of theft. As a general rule, the risk lies with the lessor. The courts, however, accept that the parties may agree that the risk is to be borne by the lessee. Such a stipulation brings the operating lease closer to a finance lease and may affect the treatment of the transaction for VAT purposes. A classic operating lease is in principle regarded as a supply of a service. It may be treated as a supply of goods, that is, equated with the acquisition of a tangible fixed asset, if clauses are agreed which in practice transfer all the risks and rewards of ownership of the asset, if the sum of the lease instalments is practically equal to the market value of the asset, and if – even though the agreement contains no express purchase option – the parties subsequently agree to transfer ownership.

CLAUSE FOR ACQUIRING THE LEASED ASSET

In the classic operating-lease model, the lessee is granted only a right to use the asset, with no provision for a transfer of ownership. The lease instalments paid over the term of the agreement do not fully cover the value of the asset, and the lessor relies on its residual value, since it may afterwards sell the asset or lease it again to another lessee.

Nevertheless, the parties may include a clause under which the lessee has the right to acquire the leased asset – whether during the term of the agreement or after its expiry. In these cases, the sale price is usually set at the amount of the residual value of the asset.

The transfer of ownership itself cannot occur automatically by virtue of the lease agreement. A separate contract of sale must be concluded between the parties. Practice shows that the costs of this transaction are usually borne by the lessee.

If you need legal advice and assistance in connection with operating or finance lease agreements, contact us on 0887550706 or by e-mail: [email protected]