The lease agreement is an agreement documented between the lessor (owner of the asset) and the lessee (user of the asset), stating the terms and conditions of the lease. It is a written document that guides all the future actions of the lessee and lessor relevant to the asset under the lease. The lease agreement is very carefully drafted to include all future situations.
The lease agreement is a legal document that both the lessor and the lessee sign, thereby agreeing to the terms and conditions mentioned in the agreement. The contract covers the basic details like the asset, lease rental, etc., but it extensively covers all the important points that may form part of a conflict between the parties during the lease period. A good lease agreement will be crystal clear on all the terms.
- Content of a Lease Agreement
- Particulars of the Parties
- Description of the Asset
- Primary Period, Effective Date, and Renewal
- Initial/Security Deposit, Lease Rental & Payment Terms
- Manufacturer’s Warranty
- Equipment Delivery and Installation
- Repair and Alteration
- Government Dues
- Termination of Lease Agreement
- Restricted Activity
- Option to Purchase (Equipment Lease)
Content of a Lease Agreement
The contents of a lease agreement would be different for different types of leases. There can be various leases based on different dimensions like a finance lease and operating lease, direct lease and sale and leaseback lease, single investor and leveraged lease and domestic and international lease. The contents of a lease would also depend on the industry and the asset under review. A residential property lease, plant and machinery lease, car lease, or music system lease will be different because the asset involved is entirely different from each other in terms of their importance and costs.
Although the following points will cover all the typical clauses of a lease agreement, it is not an exhaustive list.
Particulars of the Parties
The lessor and lessee need to clearly state their names and addresses. In the case of a leveraged lease, tripartite agreement, etc., it should also include third-party information.
Also Read: Types of Lease
Description of the Asset
Name and identification of the asset with its economic or domestic usage information. Name of the manufacturer, capacity, etc., in the case of a giant plant or machinery. And, in the case of a residential property, the complete address and covered area.
Primary Period, Effective Date, and Renewal
There should be a clause mentioning the lease period along with its clause on renewal after the primary period. It should also define the effective date and time of the beginning and end of the lease agreement.
Initial/Security Deposit, Lease Rental & Payment Terms
It should cite the amount of the initial deposit with clarification on whether the security deposit is interest-bearing or interest-free. The amount of lease rental with the mode of payment (NEFT/RTGS, Cheque, Wire Transfer, etc.), the currency of payment, frequency of payments, etc. Penalty information in case the lease rental is not paid on time. Advance rent, if payable, and the adjustment procedure in further payments. Rent escalation clause and the conditions to exercise it. The lessor may include a hell or high water clause in the agreement. This clause reduces the risk of the seller as it lowers the possibility of the buyer defaulting on payments.
It should contain the warranty information with its scope and validity.
In most long-term leases, the ownership of the asset changes from the lessor to the lessee. But, it is not necessary as it depends on this clause agreed between the lessor and lessee.
Also Read: Lease Payment
Equipment Delivery and Installation
Delivery and installation of equipment at the start of the lease and the end of the lease have to be revealed in advance. It is because delivering a big plant or machinery is a costly affair.
Repair and Alteration
The agreement should clarify the terms concerning services like repair and alteration of the asset because it may pose problems between the parties if such a requirement arises.
It must have clarity on the point “who will bear the cost of insuring the asset, the owner (lessor) or the user (lessee)”.
It answers questions like “is the lessee allowed to sub-lease the asset if he cannot use the asset for any reason”.
Can the asset be surrendered during the period of the lease? If yes, what penalties will be charged?
In the case of default in the payment of lease rentals, what are the circumstances, and what steps can the lessor take?
Details of arbitration should be mentioned in case such a situation arises even after the careful drafting of the agreement.
The agreement should be precise on who will pay the municipal dues, property taxes, etc.
Termination of Lease Agreement
Grounds under which either of the parties can terminate the agreement and the notice period to be given to each other.
It is ideal for listing down the activities restricted by the owner to avoid any future issues.
It is a long list but not comprehensive. In essence, a lease agreement should be as exhaustively written as it is possible to avoid any future conflict between the parties. An ideal lease agreement will not find any issue out of its scope in the life of the lease agreement.
Option to Purchase (Equipment Lease)
This is a contract between the lessor and the lessee, where the latter is given an option to purchase the equipment after the tenure of the lease is over. For example, the tenure of the lease agreement between John (owner) and Smith (lessee) is for 10 years. On the expiry of the period, if Smith has the option to purchase the equipment, then such an agreement is termed as an equipment lease agreement with an option to purchase.
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Explain the disadvantages of lease agreement
Refer Advantages and Disadvantages of Capital Lease