LEASING LITIGATION IN UGANDA

CHALLENGES OF LEASING LITIGATION IN UGANDA. The terminology commonly used in the field of leasing that would be important for this discussion are; operational leasing, finance leasing, asset, rentals, hire purchase, bailment, lessee, lessor. What is leasing? The International Accounting Standards 2000, on page 381 defines both a “lease” as “…. An agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time” and “finance Lease” as “… a lease that transfers substantially all the risks and rewards incidental to ownership. Title may or may not eventually be transferred”. In a typical lease, the lessor, usually a bank, leasing company, or other financial Institution, (often a special-purpose entity formed by the parties for the sole purpose of holding title to the asset), purchases the asset from a vendor and leases it to the user, or lessee. The lease agreement requires the lessee to pay the lessor periodic lease payment during the lease term. At the end of the term, the lessee may purchase the asset at a predetermined fixed purchase price. Alternatively, the lessor may sell the asset to a third party, with the lessee providing a first-loss guarantee in the form of a termination payment

Types of Lease transactions and their Structures Finance leasing and operational leasing The concept of finance leasing has been set out in Chitty on contracts (27th Edition, Vol II, 1994 at para 32-56 thus; “… in a finance lease, the lessee selects the equipment to be supplied by the manufacturer or dealer, but the lessor (a finance company) provides funds, acquires title to the equipment and allows the lessee to use it for all (or most) of its expected useful life. During the period of the lease, the usual risks and rewards of ownership are transferred to the lessee, who bears the risk of loss, destruction and depreciation of the eased equipment (fair ware and tear only excepted) and of its obsolescence or malfunctioning….. The regular rental payments during the rental period are calculated to enable the lessor amortise its capital outlay and to make a profit from its finance charges. At the end of the primary lease period, there will frequently be a secondary leasing period during which the lessee may opt to continue the lease at a nominal rental, or the equipment may be sold and a proportion of the sale proceeds returned to the lessee as a rebate of rentals...” That definition of finance leasing was cited with approval in the case of ON DEMAND INFORMATIO p/c (under Receivership) & Anor vs Micheal Gerson (Finance) p/c & Anor (1999) CD 810. Section 19 of the of the Ghanaian finance Lease Statute defines a finance lease follows; “Finance Lease agreement means a written agreement between two parties whereby one of the parties (known as the lessor) undertakes to lease to the lessee for the latter’s use only and against payment of mutually agreed rentals over a specified non-cancellable period- a) either the lessor’s own already acquired assets; or b) an asset that the lessor agrees to acquire from a third party, known as the supplier, chosen and specified by the lessee so that the lessor shall retain full title to the asset during the period of the lease and, under which subject to the agreement by the lessor, a lessee may exercise an option to purchase the asset outright after the period of the lease at a price to be agreed upon by the parties” Where as the provisions of that statute have no legal force in Uganda, the cited section demonstrate the essential ingredients of finance leasing arrangements that suffice to guide in the appreciation of a finance lease structure. A finance lease is where a lender/lessor purchases an asset on the lessee’s behalf before leasing it back to it for a fixed period. Following the repayment period, the term can be renegotiated or the asset lender will arrange the asset’s sale to a third party with the lessee keeping a portion of the takings. In a nutshell, a finance lease or capital lease is a type of commercial arrangement where: — the lessee (customer or borrower) will select an asset (equipment, vehicle, software); — the lessor (finance company) will purchase that asset; — the lessee will have use of that asset during the lease; — the lessee will pay a series of rentals or installments for the use of that asset; — the lessor will recover a large part or all of the cost of the asset plus earn interest from the rentals paid by the lessee; — the lessee has the option to acquire ownership of the asset (e.g. paying the last rental, or bargain option purchase price); Comparison with operating lease A finance lease differs from an operating lease in that: — In a finance lease the lessee has use of the asset over most of its economic life and beyond (generally by making small payments at the end of the lease term). While in an operating lease the lessee only uses the asset for some of the asset's life. — In a finance lease the lessor will recover all or most of the cost of the equipment from the rentals paid by the lessee. While in an operating lease the lessor will have a substantial investment or residual value on completion of the lease. — in a finance lease the lessee has the benefits and risks of economic ownership of the asset (e.g. risk of obsolescence, paying for maintenance, claiming capital allowances/depreciation). While in an operating lease the lessor has the benefits and risks of owning the asset. In Uganda, there is no specific legislation that regulates business and practice of leasing. Therefore, finance leasing is generally governed by certain provisions of the Finance Acts, the Income Tax Act, principles of the law of contract and legal precedents.

What can be leased? Virtually and equipment can be leased ranging from few thousands to many millions of dollars. However, a study shows that leasing equipment in Uganda has been in areas of; a) Communication and administration- computers and related items, office equipment, telecommunication equipment etc b) Industrial and manufacturing equipment- machine tools, contractor’s plant, c) Agriculture equipment- tractors, combine harvestors, medical and hotel equipment d) Transportation- commercial vehicles like buses, taxis etc Most of these items give rise to no special difficulties in the creation of the lease but might have attending problems at the time of recovery, should the lessee default

Distinction between a Lease facility and other transactions akin to Leasing. A distinction ought to be drawn between a finance leasing transaction and a hire purchase agreement. It will be shown that the two agreements are more dissimilar than similar. — Hire purchase is a purchase of an asset in which customer makes down payment and finance rest of the amount through financial institutions or bank. On rest of the unpaid amount he pays interest at a certain pre-described rate of interest. After making complete payment the assets becomes the legal right of customer. Lease on the other hand is an agreement of using asset for certain period and paying rent on it at a pre-described rate of interest. It is a temporary acquiring of an asset just to use it. — Whereas in a hire- purchase agreement the hirer pays owner of the equipment rentals that are a composite of the price, in a finance lease the lessee is paying rentals to enable the lessor recoup its capital outlay and realize profits from finance charges. Thus, while having met the installment obligation of the contract ownership passes under hire- purchases, under finance lease merely meeting rental payments as and when they fall due does not give rise to transfer of ownership, a further contract is required. — The latter agreement non-cancellable while the former may be cancelled. — The remedy of an owner under the hire purchase agreement are to recover the rental arrears with interest for default. While in finance lease the lessor is not only entitled to recover rental arrears but to compensations that would place him in the position he would have been had the lessee performed the agreement. Actually, a finance lease agreement is likened more to a loan agreement than a hire purchase agreement. This similarity is more emphatic in Section 59 of the Income Tax Act Cap 340, Laws of Uganda. The impugned provisions states that; (1) Where a lessor leases property to a lessee under a finance lease, for the purposes of this Act- (a) The lessee is treated as the owner of the property; and (b) The lessor is treated as having made a loan to the lessee, in respect of which payments of interest and principal are made to the lessor equal in amount to the rental payable by the lessee. It is apparent from the above section that the closest transaction akin to finance lease is a loan agreement. Thus Finance Lease is a full payout and lessor has a right to recover any unpaid rentals not only arrears up the date of termination but what was agreed upon.

Formal documentation of the Lease In a typical finance lease transaction the following documents/ steps ought to be present, (the fact that a lease is a contract must be born in mind and basic tenets of a valid contract must be present- offer, acceptance, and consideration) — An application for the facility from the intended lessee — An offer letter from the financing institution ie the leasing company or the bank — A master lease agreement. This ordinarily lays down the general terms of the agreement — A lease schedule agreement. This agreement is an integral part of the master lease agreement by incorporation, it lays down the specific terms of the lease, the nature of the equipment financed, capital cost, rentals payable and any other condition precedent to performing the agreement like providing security for payment of rentals, directors or personal guarantees, spousal consent in case of mortgaging family property. — Proforma invoices and other documents in proof of purchase. — Supply agreement from the supplier — A sale and lease back agreement — The Lease Ledger maintained by Lessor with the guiding lease accounting principles.

Securitization under a lease transaction. Mortgage on immoveable property to secure rental payments ü Search if there are any existing encumbrances ü Valuation of the property ü Spousal consent ü Proper execution, attestation and witnessing ü Registration with the Lands Registry Fixed and floating Charges/debentures on the company’s present and future assets ü Articles and Memorandum of association ü Board resolutions ü Assessing bank statements to determine the cash flow. The lessee must have a predictable stream of cashflows ü Schedule of Inventory of existing assets ü Personal guarantees from directors or shareholders Since in Uganda there is no central registration for the registration of such leases, registration will depend on the nature of the document and the equipment financed. ü Registrar of documents ü Motor Vehicle registry manned by Uganda revenue Authority ü Land Registry for Land ü Companies’ registry for Debentures Common claims in a Lease Litigation v Over charging, excessive or punitive interests; Deluxe Enterprises vs Uganda Leasing co. Limited v Pre mature repossession and recovery/ security realization v Under valuing and selling of the security equipment cheaply/at an under value. v Supplying of defective equipment- Nassolo Faridah vs Dfcu Leasing Co Ltd. v Refund of the monies being the ‘excessive’ rentals paid to the lessor or sums being excess from security realization. This is sometime brought about by overcollateralization as a means of internal credit enhancement. Challenges in Litigation.

v No statute or legislation governing Leasing The concept of leasing is not well understood by many, including a number of experienced professionals. In the case of Deluxe Enterprises vs Uganda Leasing co. Limited HCCS No1253 of 2000, the first leasing case in Uganda, the plaintiff was claiming refund of excessive rentals paid to the defendant, remitted balance from the sale of the mortgaged property, both counsel and court recognized the fact that there was no legislation to govern the issues at hand. There was skepticism from court whether the defendant was licensed to carry on the business of finance lease. However the issue would be whether there was such a requirement since there was no statute regulating such business. Counsel for the defendant had intimated in his submission that since there was no legislation governing leasing, court should lay down a precedent upon which future cases on finance leasing would be decided. However, the court was hesitated to transcend into the untrodden path which was a missed opportunity to guide future cases. Justice C.K Byamugisha, as she was then stated that; “What I have done is not to lay down any ground rules or parameters to govern the business of finance leasing in Uganda. I just put inot effect what the parties agreed on. However, I think it is the duty of the legislature to put in place an appropriate legislation to govern this type of business…” Apparently no legislation has come in place. The bill was formulated a couple of years a go but has been shelved. Leasing suits continue to flock court house without any guiding legislation. Her Lordship was shy to lay down simple parameters notwithstanding the defendant counsel’s vehement submissions with a view of guiding court on the same. Much as some suits have genuine claims, some of them are a manifestation of failure to appreciate the leasing industry and how it works. I would be hesitant not to blame it on the absence of legislation as court stated in the above cited case. Interim remedial way forward- the leasing officer must be prepared to gauge his customer’s understanding of leasing, and be prepared to provide education accordingly.

v General deficiency in the knowledge on finance Leasing In addition to absence of a statute, there is a lack of knowledge on the business of leasing. Parties just look at the product the way they perceive for instance hire purchase. Such deficiency cuts across the judiciary, litigants and law enforcement agencies like police who ought to assist in repossession. Many of the finance leases contain a provision for the lessee to buy the asset at the end of the rental period, and concern or misconception is most of the time expressed that this brings the lease within the hire purchase provision. Such provisions would imply that there has been capital expenditure and that the right of ownership falls on the performance of the contract. Under hire purchase agreement such is the case: having met the installment obligations of the contract, ownership passes. Under a finance lease merely meeting rental payments as and when due does not give rise to transfer of ownership; a further is required. The mere payment of the rentals does not in itself involve acquisition of an asset (which hire purchase payments do). Such has been the misconception that has dragged litigants to court. Coupled with lack of legislation, this would result in erroneous decisions that do not appreciate the international leasing transaction.

v Third party claims or suits – This is normally as a result of insufficient or little knowledge about leasing; especially tortuous claims in respect of the leased equipments like negligence and accident claims where the equipments financed are motor vehicles. Ordinarily the master lease agreement and the schedules make for the provisions to the effect that risk passes to the lessee. However such third party suits come as a result of the fact that; a) There is no independent registry for lease equipments especially automobiles for registration. This would help in providing the central registry where searches can be made before commencing the suit to ascertain the proper party to sue. b) Since the ownership has not passed under leasing the equipment like the vehicle would still be registered in the names of the lessor. c) The vehicle is normally is driven by the servant of the lessee of the lessee himself, a fact not known to the accident victim. d) This brings about increased costs of litigation on the victim and the lessor amending pleadings when such facts come out which might in turn drag the suit for a long time in court. v Repossession. In many leasing transactions, the lessor’s reversionary right constitutes its security interest in the goods. Since the value of the reversion depends upon the goods being properly maintained, close attention needs to be paid to the maintenance requirements. However, due to the specialty of the equipment, the lessor especially the leasing company under finance lease may not have the technical expertise to maintain. This becomes problematic at the recovery time when the valu of the equipment hugely depreciates for lack of proper maintenance. To mitigate such risk, the lessee is subject to onerous provisions in the lease agreement that makes the whole transaction complex making litigation inevitable. The capacity to repossess the leased assets when the lessee is in default is an important risk mitigation tool not only for the lessor but also for the development of the leasing industry itself. Much as the civil and commercial litigation rules are structured in a way that accommodates judicial assistance to repossession of the lease equipment, the reality is that the delays in the judicial process are often so great that the equipment has so declined in value that the recovery is economically meaningless. Additionally, the present value of the sums realized upon such delayed disposition of the asset makes the effective recovery even worse. Although there will always be there infuriating lessee that just refuses to cooperate when he is default not only with the lessor but also with the courts, the lessees in Uganda still have the mind-set that they are buying the equipment and that the leased equipment “is theirs”. This makes litigation a battle field for determining ownership, a situation that would not have happened, had the lessees been oriented on the nature of a lease transaction.

v Feasibility of recovery Normally the legal remedy in case of the event of default is repossession and sale of the leased equipment or realization of the security. Most of the equipments financed are mobile. The lessor may not be able to trace the equipment for self-help. Costs involved eg in repossessing a combine harvestor from rural areas is high. Most times the equipment has been tapered with engines or other vital parts of the equipment. This is coupled with the difficulty in disposing off specialized equipment results in realizations below the estimated market value. This bleeds conflict between the lessee and the lessor when the lessor seeks to recover the balance of the unpaid rentals. Some equipments are unique, imported only for the lessee’s use, hence no market for the equipment. This is further aggravated by old modeled or archaic technology which the lessee wanted but not marketable once the lessor has repossessed.

v Unique accounting Principles The accounting principles employed in finance leasing especially in preparing ledger postings by the lessor are unique and complex to be apprehended by lessee let alone court. This bleeds claims like over changing because of failure to appreciate the concepts of accounting in leasing. This is aggravated by the courts’ unwillingness/slowness in adapting to the new concepts.

Additional challenges

v Lease Administration. The administration of the lease is so complex especially where expertise is required to supervise the lessee in the use of the unique equipment. The lessor may not have the expertise in such equipment which calls for hiring expertise to supervise eg laboratory equipment, combine harvesters, Fixed plant may raise the question of ownership if a chattel becomes fixed to the land it may form part of the freehold and so belong to the landlord. If the Lease is registered (that is if there is a lease registry) the lessor should be entitled to a summary repossession procedure under O. 36 Rule 1& 2 of the Civil Procedure Rules.