Question

CASE 12 A common complaint about leasing contracts is that the consumer lessee rarely understands the terms of the contract - how much is she really paying and what happens if she wishes to terminate the lease? According to one recent report, People sometimes confuse leasing with renting – when they don’t want the car anymore, they think they can just walk away from their monthly payments… in fact, they cannot, without incurring adjustment costs. During the term of the lease, circumstances may change. The lessee may lose her job and be unable to keep up the payments, or may move and find that the leased article is no longer suited to her needs. It is then that she discovers that she cannot just stop payments and return the article. In the majority of cases, the leased terms are quite fair – it is simply that the terms were never properly explained to the lessee. But in some cases, the terms that apply on early termination can be quite harsh. Some provincial consumer protection legislation (including that of Ontario, British Columbia, Alberta, and Manitoba) specifically addresses the harshness of consumer leasing contracts through the following requirements and limitations:  a written disclosure statement showing the itemized costs of the lease, including the financed amount, interest rates and calculations, and implicit financing charges  caps on termination penalties equal to three months of average payments (British Columbia and Alberta cap this amount if the goods have been returned)  disclosure and restrictions on form and content of advertising (not in the B.C. statute) Question (18): Does capping the termination penalties unfairly penalize lessors? Why is leasing less popular with the auto industry since the 2008 economic crisis?

Answer 1

Q. 18) Why is leasing less popular with the auto industry since the 2008 economic crisis?

A lease is a contractual arrangement between lessee who is user to pay the lessor who is the owner of an asset. Land, buildings and vehicles are general assets that are normally leased. Global Economy normally follows a cycles from the great recession to the bulls and then again recession. The problem is as long as there are bulls in the market, investors and companies forget how bad the recession can hurt. Recessions can hurt badly for some companies but particularly for companies that operates on leasing business model it can be very painful.

Automotive Leasing companies but cars using long term debt and lease them our to companies. These are expensive items into which their customers would rather not spend capital or could use their capital to expand operations in other ways. Also leasing is cheaper than buying, a company can get more leased Vehicles (Assets) than outright buying, allowing it better serve end customers. Automotive leasing can be extremely profitable during economic expansions. The problem comes when demand recedes and there is a deep recession. The leasing rates fall are it is also likely that companies will get their vehicles back from customers. This is exactly what happened during 2007 to 2009 and due to which leasing is less popular in Automotive industry.

Question (18): Does capping the termination penalties unfairly penalize lessors?

Early termination formulas often contain inherently unfair provisions despite regulation. Some older automobile leases required the lessee to make all the remaining payments even though the lease was terminated, and the car returned early. This type of provision is almost certainly invalid under the new laws. Analytically, such a provision is the same as one that would require a borrower to pay all of the interest on a loan even though the loan is repaid halfway through the term. Hence the early termination charges may still be unfair.

A closed end lease, the lessee is not responsible at the scheduled termination of the lease for any shortfall between the residual value of the car and the actual value of the car. On early termination, however, the lessee is often required to pay any shortfall between the residual value and the actual price the car brings at a wholesale auto auction ("realized value"). Thus, if the residual value is an overly optimistic estimate or a subsidized number, a very large penalty is built into the lease. Even if it is accurate, the capitalized cost is a retail figure, while an auto auction price is a low wholesale figure. Therefore, the lessee is required to pay the difference between the wholesale and retail values of the car upon early termination.

Lessors credit the lessee with the difference between the "realized value" (i.e., the amount the lessor actually receives for the car when the lessor sells it at the time of early termination) and the "residual value" (i.e., the amount pre-designated in the lease as the value of the car at the end of the lease term). The residual value is what the lessor may claim at the end of the lease-not at the earlier time of termination. The right to the residual value at the time of early termination (before it is due), is worth less than the full amount of the residual value. Therefore, the credit to the lessee should be the difference between the residual value and the present worth of obtaining the residual value.

An additional problem results when some leases both use the realized value of the vehicle upon early termination to determine the lessee's liability and assess excess mileage charges against the lessee. This is unfair because any greater-than-normal usage of the vehicle will be reflected in a lower-than-normal realized value. In effect, the depreciating impact of the extra miles is counted twice.

Hence I believe Capping the Early termination is in the interest of the Consumers on which the leasing industry thrives. Hence it is not unfair for the Lessors