Under Republic Act No. 8556, also known as the Financing Company Act of 1998 (“FCA”), the term financial leasing refers to a mode of extending credit under which the lessor purchases or acquires, at the instance of the lessee, movable or immovable property in consideration of the periodic payment by the lessee of a fixed amount of money over a period of not less than two (2) years during which the lessee has the right to hold and use the leased property. Through a financial lease, one can use a property (e.g., equipment or machinery) without having to make an upfront payment.
However, as noted by the Supreme Court in PCI Leasing v. Giraffe-X, the FCA does not specify the rights and obligations of the parties to a financial leasing arrangement. This gap in the law has caused issues between parties to such a contract, particularly in determining whether their arrangement is in fact a financial lease. In PCI Leasing, the Supreme Court ruled that in identifying the real contractual relationship between the parties to a contract purported to be a financial lease, the following should be taken into account:
- the imperatives of equity;
- the contractual stipulations in question; and
- the actuations of the parties vis-à-vis their contract.
The Supreme Court has ruled that a contract alleged to be a financial lease may actually be a sale of a movable property on installment or a simple loan with security, among other arrangements. The buyer’s right to buy the leased property at the end of the lease period may also be recognized even if such option is not expressed in the written contract. This is because financing arrangements, which include financial leases, are regulated activities that are not meant to quench only the thirst for profit – they serve a practical and salutary purpose.
The foregoing discussion shows the difficulties that may arise when dealing with contracts of this nature. Contracts involving the lease of property may not be classified as a financial lease even if captioned as such. Similarly, a contract may be deemed as a financial lease even if called by some other name. This is problematic because only duly licensed financing companies are allowed to extend financial leases. Engaging in financial leasing activities without being authorized to do so will expose the violator to the penalties of fine and/or imprisonment, as provided under the FCA.
In a recent opinion (the “Opinion”), the Securities and Exchange Commission (“SEC”) clarified a feature that must be present for a transaction to be considered a financial lease. According to the SEC, there must be a trilateral relationship where the financial lessee is obligated to make periodic payments denominated as lease rentals that enable the financial lessor to recover the purchase price of the equipment that had been paid to the supplier thereof. From this, the following requirements may be inferred:
- there must be three parties (i.e., the lessor, the lessee, and the supplier);
- the financial lease must be preceded by a purchase and sale contract covering the property which becomes the subject matter of the financial lease; and
- the lessee must pay lease rentals to the lessor, which must be a financing company.
Based on the Opinion, a contract that involves two parties only will not be considered a financial lease, regardless of the provisions stipulated. Thus, if the manufacturer/supplier leases a property it owns directly to its customers, such a transaction is not a financial lease and the manufacturer/supplier will not need to have a license as a financing company. That’s because (1) there are only two parties; (2) the financial lease is not preceded by a purchase and sale contract covering the property which is the subject matter of the financial lease; and (3) the lessee pays rentals directly to the manufacturer/supplier, not to a financing company. This clarification is beneficial to manufacturers, suppliers and similar entities who want to offer a lease arrangement to their customers directly, i.e., without the intervention of a financing company.
Although non-binding by nature, the Opinion sets forth a simplified interpretation of Section 3(d) of the FCA and provides guidance on when lease agreements can be entered into without being licensed as a financing company – an interpretation that appears to be consistent with the law and jurisprudence on this matter.
This article is for informational and educational purposes only. It is not offered and does not constitute legal advice or legal opinion.
Ralph Christian P. Rosales is an Associate of the Corporate and Special Projects Department of the Angara Abello Concepcion Regala & Cruz Law Offices (ACCRALAW).
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