In financial lease default disputes, when the lessee defaults, the lessor has the option to call in all of the rent or terminate the contract and recover the leased thing. However, pursuant to the Interpretations of the Supreme People’s Court on Law Application Issues in the Trial of Financial Lease Contract Disputes, the lessor may opt for only one of the remedies, failing which, its claims will be deemed to be unclear and the court may dismiss its suit on this basis.
If the lessor can only choose one of the options, the remedy may be insufficient to make up all of its losses. However, article 22 of the interpretations affirms that any remaining loss may be claimed: if the lessor requests termination of the contract and simultaneously requests recovery of the leased thing and compensation for its losses, the court is to uphold such requests, and the lessor may still request compensation for any loss that is not fully indemnified. The scope of such compensation is “all of the unpaid rent + other charges – value of the recovered leased thing”.
“All of the unpaid rent” generally refers to the total of the rent in arrears and the anticipated payable rent. The “other charges” may include such charges specified in the contract as late payment interest, liquidated damages, damages, expenses incurred in resolving the dispute, etc. The “value of the recovered leased thing” generally should be subtracted to prevent an unfair situation where the lessor receives double compensation and the lessee pays double compensation. However, if it is specified that “upon expiration of the lease term, the leased thing shall vest in the lessor”, the value of the recovered leased thing need not be subtracted as no issue of double counting is involved. Furthermore, if return of the leased thing is impossible in fact or in law due to such a reason as bona fide acquisition by a third party, subtraction of the value is likewise not required.
Although the interpretations support “other charges” within the scope of compensation, in judicial practice not all amounts specified in the contract are supported.
(1) They do not support rent late payment interest, late payment fines and liquidated damages – the nature of all of them are penalties for default – excluding the situation that they do not lead to double counting because the basis of calculation, and the dates they commence to count, etc., are different. The courts once did not simultaneously support liquidated damages and rent late payment interest (or late payment fines) on the grounds that they were of the same nature;
(2) They do not support any portion exceeding the anticipated benefits or the loss incurred. If the recovered leased thing, or the expenses claimed, are sufficient to make up the losses incurred by the lessor, they do not support other manner of compensation for default;
(3) The court will not support the expenses incurred by the lessor in managing the leased thing, its travel expenses incurred during the legal action or expenses that have yet to actually be incurred; and
(4) Standard terms that exempt one from liability, increase the liability of the other party or exclude major rights of the other party are invalid they may not serve as the basis for determining the scope of compensation.
In light of precedents and the issues in dispute commonly seen in practice, we would argue that a lessor may set out clear provisions from the following perspectives to best protect its rights.
Vesting of the leased thing. In addition to expressly stating that the leased thing vests in the lessor during the lease term, current laws encourage and respect the parties themselves providing for the vesting of the leased thing. If the parties provide that ownership of the leased thing vests in the lessor upon expiration of the lease term then, if the lessee defaults, the lessor is not required to subtract the value of the recovered leased thing when calculating, after termination of the contract, the scope of compensation for its losses.
Calculating the value. Pursuant to article 23 of the interpretations, the contract provisions have priority over the value of the leased thing. If the contract is silent or the provisions are unclear, reference is to be made in sequence to such methods as depreciation, appraisal and auction. However, determining the value of the leased thing by appraisal or auction presents numerous inconveniences, with such issues as the leased thing being overly specialized, resulting in only a small number of qualified appraisal firms, high appraisal costs, high chance of an aborted auction, etc., potentially arising. Starting an appraisal or auction procedure also presents difficulties, as such a procedure can only be started if one of the parties objects to referring to the depreciated value and provides the necessary evidence. The authors recommend that the method of calculating the value of the leased thing be expressly provided for in the contract to minimize dispute costs.
Try to expressly state the nature of each charge and enumerate the “other charges”. The nature of each charge should be defined in the financial lease contract, e.g., specifying whether unpaid rent will be deducted from the deposit, the nature of the downpayment and the method of deducting the same, and whether service charges are deducted from the financing amount, and the nature of late payment interest, liquidated damages and damages should be expressly specified. The expenses actually paid in resolving a dispute should also be expressly enumerated to provide a basis for future claims.
Protection of lessor’s rights in rem. The law likewise recognizes the validity of a bona fide acquisition under a financial leasing relationship. To block a bona fide acquisition, the lessor may take such means as placing a mark in a prominent location on the leased thing to the effect that it is a leased thing, authorizing the lessee to mortgage the leased thing to it, and carrying out mortgage registration with the registrar, carrying out financial lease transaction registration according to laws, administrative regulations or the requirements of the industry or competent local authority, etc., to achieve the effect of protecting its rights in rem.
Considering the special nature of financial leasing transactions, laws and the interpretations accord the financial lease parties a great deal of room for party autonomy, and this wide space presents both an opportunity and a challenge for lessors. In the transaction arrangements it is important to skilfully use the agreement of the parties in the hope of realizing a safe and valid transaction.
Yang Guang is the director and Lian Tianjiao is an associate at Lantai Partners
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