This alert analyses key changes in the regulation of buyout financial leasing, as adopted by the Plenum of the Supreme Commercial Court of the Russian Federation (the “SSC”) in its Resolution No. 17, dated 14 March 2014, “On Certain Issues Relating to a Buyout Financial Leasing Contract” (the “Resolution”)1. The Resolution will contribute to developing financial leasing relations in the Russian market. The most important achievements of the Resolution include: ■■ defining “financial leasing” through the notion of a facility secured by the transfer of title to the lessor (title financing), in contrast to the former approach where financial leasing was treated as a lease; ■■ establishing the balance-based method for calculating settlements between the parties to a financial leasing contract if the contract is terminated; ■■ confirming a principle according to which the parties to a financial leasing contract must cooperate in order to mitigate the risks of the leased object not being supplied; ■■ providing the lessee with a right to claim reimbursement of losses from the relevant third parties (e.g. the supplier, the insurer) if it is the lessee that bears the risks of incidental loss; ■■ setting measures to protect a diligent sub-lessee in financial sub-leasing transactions; and ■■ protecting the lessee’s rights if the lessor fails to perform the obligations secured by the pledge of the leased object. Scope of application The provisions of the Resolution cover buyout financial leasing contracts2. Such contracts provide for the transfer of title to the leased object to the lessee if the lessee has paid all the buyout payments, including the buyout price, even if it is merely a nominal payment. The Resolution does not cover situations where, for instance, the lessee may decide not to buy out the leased object and the lessor, therefore, bears the risk of not being reimbursed for the remaining book value of the leased object.
Nevertheless, some provisions of the Resolution can have a wider application and cover, by way of analogy, any financial leasing contracts. Such general provisions include the rules for allocating risk in a situation where the leased object has not been delivered3, the provisions stipulating the procedures for recovering (i) the penalties from the supplier if it breaches delivery terms4, and (ii) the insurance compensation if the leased object has been lost or damaged5. Credit-based financial leasing model The Resolution defines “buyout financial leasing” based on the facility that the lessor provides to the lessee. Repayment of the facility is secured by the lessor acquiring the title to the leased object until the lessee buys it out. The lessee’s interest lies in acquiring the title to the leased object while the lessor’s interest is in receiving its principal amount back with a profit6. Hence, the SCC Plenum has overruled the previous case law that treated financial leasing as a lease. Now the Resolution considers financial leasing as financial relations relatively similar to lending against pledged security. A secured transfer of title to the leased object is specific since this type of security terminates when the lessee has made all the contractual payments, unless the parties have expressly agreed on different terms and conditions for the transfer of title7. According to the Resolution, the title to the leased object may still pass to the lessee in the above circumstances if the lessor is undergoing bankruptcy. Therefore, if the lessee has made all the contractual payments, the lessee’s claims are not to be included in the creditors’ register and the lessee may withdraw the leased object from the bankruptcy estate. At the same time, the SCC Plenum has not clarified the relationship between the parties in a situation where the lessee has not made all the contractual payments in full, leaving open the question as to whether or not the lessee’s claims would be included into the register in this case and whether or not the lessee would enjoy any priority in respect of the leased object it possesses8. Nevertheless, it seems that, when a financial leasing contract concluded with a lessor that later becomes bankrupt is terminated and the balance of reciprocal obligations (which will be discussed later) is in favour of the lessee, the latter may retain the leased object according to the rules of lien and it acquires the status of a secured creditor9. Unless the parties have agreed otherwise, the title may also be transferred if the lessee has made all the contractual payments but the lessor avoids formalising a transfer and acceptance certificate, a sale and purchase agreement or other documents. Previously, the lessor could avoid signing the above documents in order to create a cross-default – a situation where the breach by the lessee of its payment obligations for a given leased object caused the lessor to refuse to transfer the title to another leased object. From now on the lessor must agree in advance on the terms and conditions of the transfer of title or use various contractual structures to create a similar situation. For instance, a financial leasing contract may provide that, as of the time when the title to the leased object is transferred to the lessee, the leased object will be regarded as pledged to the lessor to secure the lessee’s obligations under another financial leasing contract. Balance-based calculation method The Resolution10 stipulates a balance-based method to calculate reciprocal claims between the parties to a financial leasing contract when the contract is terminated and the leased object is returned to the lessor11.
This method is in line with the nature of financial leasing. Financial leasing involves a facility, for which, after the funds have been utilised, the final obligation of one party to the other party, as of the contract termination date, is determined as the difference in the consideration of the lessee (the subtrahend in the calculation formula) and the consideration of the lessor (the minuend in the calculation formula). If this difference is in favour of the lessor, the lessor may recover it from the lessee and vice versa. The consideration on the part of the lessee is a sum of leasing payments (apart from the advance payment paid by the lessee) and the value of the leased object returned to the lessor12. Importantly, the value of the leased object should be determined as at the time when the leased object is returned to the lessor. This value is to be determined on the basis of the amount of proceeds that the lessor has received upon the sale of the leased object or on the basis of a professional valuation. The lessee may contest the purchase price of the leased object. In this case the court should consider, in particular, the valuation13 and should also take into account the defects specified in the acceptance certificate formalised when the lessee returned the leased object to the lessor14. The obligations and expenses of the lessor include the facility that the lessor has provided to the lessee, annual interest accrued on such facility until it was actually repaid, as well as the losses that the lessor has suffered and other sanctions stipulated by law or the contract15. The financing provided by the lessor consists of the purchase price of the leased object (decreased by the advance payment the lessee made) and the expenses on delivery, repair and transfer of the leased object to the lessee, etc.16 Payment for the financing that the lessor provided to the lessee is calculated as an annual interest accrued on the facility. The parties may agree on the interest rate in the contract. If no such rate has been agreed, the court will calculate the interest rate by applying the formula provided in the Resolution17. Actual damage of the lessor may include expenses for dismantling, repossession, transporting, storing, repairing and selling the leased object; payment for early repayment of the loan the lessor obtained in order to acquire the leased object18. Cooperation by the parties to a financial leasing contract to mitigate the risk of non-delivery The Resolution19 endorses the rule already developed by the case law20 that imposes on the parties to a financial leasing contract a duty to cooperate in mitigating the losses for non-delivery of the leased object. In particular, when the risk of a failure on the part of the supplier is borne by the party to the financial leasing contract that chose the given supplier21 (which is, as a rule, the lessee), this will not release the lessor from liability for contributing to increased losses or failure to take reasonable measures to mitigate such losses. This liability arises when the lessor is at fault (fails to act as a reasonable and diligent merchant). If the lessor commits such a breach, the lessee may demand that the lessee’s liability be reduced.
Exercising rights under other contracts relating to the leased object The SCC Plenum has stipulated a procedure for claiming reimbursement under other contracts relating to the leased object, in particular: a procedure for recovering a penalty from the supplier that has breached the obligation to supply the leased object22, and an insurance recovery from the insurer if the leased object has been lost or damaged23. Prior to the Resolution these issues were not clearly resolved in practice, due to the contrary interests that were pursued by the “economic” owner of the leased object (the lessee whose interest was to acquire title to the leased object) and the legal owner (the lessor that was entitled to perform certain legal actions as the owner of the leased object). The SCC took the position that the lessee is entitled to claim the reimbursement of incidental losses if it bears the risk of such losses. In particular, when the supplier breaches the obligation to deliver the leased object and it is the lessee that bears this risk (since the lessee has to make leasing payments irrespective of whether or not it possesses the leased object), then the lessee is entitled to claim penalty and other sanctions against the supplier for breaching the supply contract. In situations involving recovery of insurance compensation, the lessee (that bears the risk of accidental loss or damage of the leased object) may demand that the lessor assigns to it the right to claim under the insurance if the lessor refuses to take or avoids taking action to obtain the payment under the policy. In order for the lessee to exercise this right efficiently, the Resolution specifically entitles it to suspend making leasing payments as a remedy if the lessor avoids such assignment. It should be noted that, if the insurance recovery has been paid to the lessee, the lessor may claim from the lessee the amount so paid. The reimbursement which the lessor received in the form of a penalty or other sanctions for the breach of the supply contract or in the form of insurance compensation should be offset against the lessor’s claims against the lessee for leasing payments. If the financial leasing contract has been terminated the above payment should be taken into account while the balance of the reciprocal claims is being calculated. This rule will make it possible to avoid situations where the lessor, having received reimbursement from third parties, additionally claims the leasing payments from the lessee. According to the Resolution, if an uninsured leased object has been lost, the lessee shall not be released from the obligation to compensate the lessor for the cost of acquiring the leased object and the cost of the facility until these costs are actually reimbursed24. Regulating financial sub-leasing relations The Resolution sets forth a rule aimed at protecting the interests of the sub-lessee if the sub-lessor breaches its obligations to transfer to the lessor the leasing payments which the sub-lessee has paid25. Despite the sub-lessor having breached its payment obligations, it will acquire the title to the leased object provided that it has made all the payments under the financial subleasing contract. The functions of a sub-lessor are deemed to be those of an intermediary. The risk of the sub-lessor breaching its obligations to make leasing payments will be borne by the lessor if the lessor knew that the assets were sublet (in particular, if the lessor approved such financial subleasing). This risk may fall on the sub-lessee only if it has been proved that the sub-lessee acted on agreement with the sub-lessor or was legally or economically connected with the sub-lessor from the outset. This provision drastically changes the practice that had existed previously26 and will, in many instances, cause financial leasing companies to adjust contractual forms. It is expected that the changes made to contracts will directly prohibit financial subleasing or demand that the sub-lessor provide additional security for defaulting on payment obligations. In order to comply with the principle of legal certainty and to avoid undermining the reasonable expectations of market participants, this provision of the Resolution will apply to financial subleasing contracts concluded after its publication (3 April 2014)27. Correlation between financial leasing “encumbrances” and a pledge of a leased object The Resolution28 confirms the previous case law29 that treated the pledge of a leased object as terminated after the lessee takes possession of the leased object and fully buys it out30. This position is aimed at protecting the interests of a lessee in a situation where it becomes aware that a pledge was created either before or after the execution of the financial leasing contract. It should be noted that, as a general rule, the transfer of title does not terminate the pledge31. However, the Resolution specifically stipulates that this rule does not apply to the pledge of leased objects. Therefore, if the lessor is declared bankrupt, the lessee that has made all contractual payments, will acquire the title to the leased object free from the pledge and the pledgeholder will lose the status of a secured creditor. Provisions aimed at protecting the interests of a good-faith pledgeholder supplement the above regulation. In particular, if the pledgeholder has not known and should not have known that the object of the pledge is or will be leased out, the pledge shall operate notwithstanding the transfer of title to the object of the pledge to the lessee. The pledgeholder may be aware of the financial leasing if a pledgor is a legal entity carrying out financial leasing operations. In any case, a good-faith pledgeholder should take measures to check if any financial leasing “encumbrances” exist. The provisions aimed at protecting good-faith pledgeholders preclude the creation of artificial financial leasing “encumbrances” over pledged objects by pledgors seeking to subsequently release the object from the pledge. In general, the legal position to protect a good-faith pledgeholder is in line with the latest amendments made to the legislation on pledges32. It is widespread practice to provide lending to purchase leased objects where such objects are concurrently pledged to secure repayment of the loan. Therefore, the Resolution stipulates a welcome provision, according to which a pledge of a leased object simultaneously entails a pledge of the rights to claim leasing payments. It follows from the above that the scope of pledge claims may be determined by the balance of the leasing payments payable before the lessee buys out the title to the leased object33. Conclusion The key achievement of the Resolution is that it has established a uniform approach to financial leasing and recognised it as a financing transaction. This approach is more in line with the nature of the financial leasing relationship than the statutory classification of this type of contract as a lease under § 6, Chapter 34 of the Civil Code. The SCC Plenum has not determined timeframes for applying the legal positions formulated in the Resolution, apart from the provisions relating to financial subleasing. Consequently, taking into account the above limitation, courts may apply these legal positions when considering cases for which the proceedings have not yet been completed. At present, commercial courts actively apply the clarifications of the SCC Plenum, in particular, the clarifications regarding the balance-based method for calculating and determining the final obligations of the parties to a financial leasing contract on the basis of the calculation formula provided in the Resolution. Despite the abolishment of the Russian Supreme Commercial Court, the Resolution will remain effective because, under the law34, clarifications of the SCC Plenum shall remain in force until they are repealed by the Plenum of the newly established Russian Supreme Court.