Secured Debt for Finance Lease
Hi guys got a question.
In a finance lease, who has title over the asset?
For example if we have an aircraft on finance lease from a lessor to a lessee and the funding of the aircraft asset is via a lender, what happens during a default situation?
Does the lender seek enforcement from the lessor or the lessee?
Thanks!
Would be interested in the answer to this.
It is important to differentiate between accounting ("economic") and legal ownership since the classification of a lease as finance or operating is independent of legal title. If a lessor has title to an asset but the substantial risks and rewards of the asset reside with the lessee, the asset sits on the balance sheet of the lessee regardless of ownership. Unfortunately your question is a little vague on detail, but my initial read is that in this situation the ultimate lessee has what is called a right to quiet enjoyment meaning the lender cannot enforce on the assets unless the lessee has defaulted on its obligation to the lessor/owner or otherwise explicitly agreed to grant a security interest in the asset to the lender (unlikely). In most jurisdictions the lender will retain a security interest in the ongoing lease payments anyway so the lease should continue on foot and payments made out directly to the lender. The correct answer will dependent on the contractual circumstances and the jurisdiction you are operating under as in many cases legal ownership has no impact on security arrangements for enforcement purposes.
Not disagreeing here, but here is what I would imagine would happen. The lessor has bought the asset from the bank, and so the bank has privity of contract with the lessor. Now, in real-estate there is a thing such as privity of estate, but we didn't discuss whether this applies to items outside real-estate. If part of the agreement called for the lessee to pay the bank, then the bank would be in privity of estate with the lessee because he has contractually obligated himself to make payments on the asset (the plane). (This normally occurs where you sublet your right to an apartment to a sublessee). Bankruptcy law would probably guarantee that the bank gained the lessor's rights to the contract, if they had decent lawyers when they set it up. So, considering that, I imagine that the bank has the right to go against the lessor for the full value of the contract. As part of that process, the bank could gain the lessor's rights to the contract that the lessee agreed to. This would happen either through privity of estate or through bankruptcy law. However, he would only be entitled to that contractual value.
Btw, this answer could be changed if the lessor, lessee, and bank were in on an original agreement that adjusted the legal responsibilities. Also, the explanation isn't for you diverse_kanga it is for the poster.
Also, I made an assumption here that it was the lessor that defaulted, and that he was the one that took the loan. All the rules above stay the same but the explanation would differ if that isn't true.
This is more or less what I was getting at. Obviously if there is a direct agreement between the lessee and the bank the answer will be straightforward, however I have assumed the lease contract is separate to the loan the lessor has entered into with the bank. The point is that if there is nothing to bind the lessee to the obligations under the loan contract, he should be able to keep possession/use of the plane under the lease agreement. Again, everything depends on the jurisdiction and specific contractual wording.
To be clear, (if I did actually imply this) I didn't intend to imply that you were wrong. I just wanted to give the OP some basis for a decision so that he would feel more comfortable with it.
As a side note, I don't actually think I said that the lessee would be able to keep its plane; so excellent catch there.
I don't think it is good for the right point of view. Some way it is right and other way wrong.
So, I am actually in secured transactions this fall, so I can explain a bit better than before. First off, the bank would have to secure its loan to the lessor. This would give it priority, basically means your debts get covered in full before there is any other distribution, over any other creditors to get the plane back to pay off the loan in the event of default. After that, the lessor is going to want to go through the same process with the lessee. He will want to secure the plane so that he has priority in the event of default. So, visually priority is Bank-1, Lessor-2... Lessee has no security interest in the plane.
Now, in the event of default(and I am assuming that it is the lessor that is defaulting) we go to bankruptcy court, and a bankruptcy trustee will be assigned, and one of his goals is to do everything he can to say that the interests weren't secured so that the unsecured creditors get a pro-rata share of the proceeds of the debtors assets. Assuming that doesn't happen, lessee is SOL actually. The bank has full priority and can take the plane back, and lessee is left to pursue the lessor for breach of contract, which is worthless as he is in bankruptcy court. Now, obviously this situation could have been changed in contract to change the result. Also, the bank could choose to opt to create an entirely new creditor debtor relationship with the lessee. The bank might also choose to enforce the lessor's contract, but this is less likely for several reasons. If the lessee needed a finance lease to begin with, it isn't likely that it's financials have improved enough to warrant a bank wanting to trust lending to it. Also, the bank simply wants its money returned as soon as possible which is most easily done by selling the plane.
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