Financial leasing insurance and methods of risk control

By Harry Wu, Wintell & Co
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Afinancial leasing contract refers to the contract under which the lessor, based on the selection of the seller and the leased property by the lessee, purchases the leased property from the seller for the lessee to use, and the lessee pays the rent. Different risk control methods of the projects must be applied to different leased properties involved in financial leasing. Vessels, aircraft and other property financial leasing projects mainly focus on the safety of the leased property itself, so the projects often involve property, all risk, machinery damage, operational interruption, and theft insurance.

HARRY WU Associate  Wintell & Co
HARRY WU
Associate
Wintell & Co

Financial lease projects involving movable property mainly focus on the liability for breach of contract of the transaction subjects, and the risk is generally avoided by property guarantee, enterprise or personal guarantee. Commercial credit insurance and lessee liability insurance may serve as financial instruments to enhance credit for such projects, and substitute traditional means of security to some extent.

BUSINESS MODEL

Framework agreement plus multiple implementation agreement. In practice, the lessor (the financing party), the seller of the product and the insurance company always enter into a tripartite framework agreement before the launch of a financial leasing project, and specify the overall objectives of the project and its implementation methods. Then each party will execute a purchase and sale contract, financial leasing contract and insurance contract etc., respectively. It’s common that the lessor purchases products from the seller, and finances and leases the products to the lessee; sometimes, it’s permissible for the seller to sell products to the lessor and finance the products and lease back, and then the seller will sublet to the actual lessee.

The effect of the lessor as beneficiary. The “insurance liability” insured by the lessee’s liability insurance is the late payment of rent by the insurant, and the actual lessee is entitled to insurance claims as the insurant. To protect the interests of the lessor, it is usual to make the lessor the “beneficiary” or “the owner of insurance claims” under the insurance contract. According to the doctrine of privity of insurance contract, insurance claims rights are the exclusive rights of the insured, and cannot be transferred without authorization.

Even if it is agreed in the tripartite agreement that the lessor can be considered as “beneficiary” or “the owner of insurance claims”, the insurant cannot be exempt from the obligations to prove the occurrence of an insurance accident in accordance with the insurance terms, and submit the appropriate claim documents. If the lessor fails to submit appropriate documents to prove the insurance accident, the claims may be rejected.

Lease contract relationship fraud. In practice, financial leasing companies tend to be more concerned about the “financing” process, while ignoring the audit of the authenticity of purchase, and sale of the products and the lease, and they always believe that as long as they actually make loans, they can claim successfully.

In several disputes over claims of lessors’ liability insurance and commercial credit insurance handled by the lawyers at the author’s law firm on behalf of insurance companies, through field investigation and access to official information and other evidence, it was found in many cases that the seller and the lessee conspired to deceive and defraud the lessor, to gain the funds of the lessor with a non-existent lease relationship but with complete written formalities. False lease contracts belong to exclusions of insurance claims. The insurance company will not be liable for compensation according to law if the contract is proven to be false.

KEY POINTS IN RISK CONTROL

Choosing the right insurance. If the lessor chooses the right insurance at the initial stage of project negotiations, it will offer greater protection and financial security. The author believes that commercial credit insurance offers a more direct guarantee to the lessor, because the insurant of commercial liability insurance is the lessor, and the “insurance liability” guaranteed is the rent loss arising from failure by the lessee to keep the promise. Unless a financial leasing relationship is flawed, such as with a fictitious lease relationship, the insurance company must settle the claim in accordance with the insurance contract. The insurance company must guide the insurant to choose the right insurance, thus avoiding the occurrence of a dispute over the insurance claim.

Improve the terms of the co-operation agreement. The parties of the transaction must respect the characteristics of the insurance product during negotiations of the framework agreement, and make a legitimate co-operation agreement based on the characteristics of the leased property, for the purpose of ensuring the safety of project funds and avoiding moral hazard. For example, the insurance company may request the lessor to obtain a judgment against the lessee as a condition of the claim after the occurrence of insurance accidents. Thus it cannot only reduce the risk of insurance accident, but also urge the lessor be more prudent in choosing projects, and better fulfil its contractual obligations.

It must also avoid terms that require the insurance company to assume guarantee obligations under the framework agreement of the parties. Finally, the parties need to expressly specify that the insurance company shall assume relevant responsibilities subject to the terms of the insurance contract, and no party is entitled to directly request the insurance company to assume responsibilities according to the co-operation framework agreement.

Strengthen the review of credit and supervision of lease contracts. Credit investigation, review of business authenticity and supervision procedures during the performance of a contract should not be ignored by the funding parties, as well as insurance companies. Before performance of a contract, the lessor and the insurance company should co-operate to investigate the credit and performance capabilities of the lessee and the seller, and review relevant certificates, credit records, financial statements, capital verification reports and other materials that reflect their operations and credit status.

In case of any possibility of material breach of contract, the insurance company may refuse the insurance application. During the course of fulfilling the contract, the delivery of the leased property must be strictly supervised to prevent the lessee and the seller colluding with each other to invent a leased property and deliver false information. In the course of using the leased property, the lessor and the insurer must follow up with the usage of the leased property and performance of the contract, and handle any subletting behaviour from the lessee, or deterioration of its operation, in a timely manner.

Harry Wu is an associate at Wintell & Co

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