Leasing agreement (operational vs financial)

Leasing agreement (operating vs finance)

What is a leasing agreement?

A leasing agreement is a contract under which one party – usually the lessor – grants another party – the lessee – the right to use an asset for an agreed period in exchange for periodic payments. In practice, leasing is commonly used for vehicles, machinery, production equipment, IT infrastructure, and other business assets. Depending on the legal and accounting structure, a lease may function primarily as a use arrangement or as a financing tool.

The distinction between an operating lease and a finance lease is important because it affects the parties’ rights and obligations, tax treatment, accounting recognition, allocation of risks, and the economic purpose of the transaction. In broad terms, an operating lease is typically focused on temporary use of an asset, while a finance lease is more closely connected with long-term financing of the asset’s acquisition and transfer of its economic benefits to the lessee.

The terminology used in practice may differ depending on the applicable legal system, tax rules, accounting standards, and contract drafting. For that reason, classification should not be based on the label used in the contract alone. What matters is the substance of the arrangement, including lease term, residual value, maintenance obligations, transfer of title, purchase options, and allocation of risks connected with the asset.

What is the difference between an operating lease and a finance lease?

An operating lease generally means that the lessor retains a larger part of the economic risks and benefits associated with ownership of the asset. The lessee uses the asset for a specified time and returns it at the end of the lease term, unless the parties separately agree on a purchase. In many cases, the lessor remains responsible for some ownership-related matters, and the lease term is shorter than the asset’s full economic life.

A finance lease is usually structured so that the economic burden and benefits connected with the asset are transferred to the lessee to a much greater extent. The lease often covers most of the asset’s useful life, and the payments are designed to recover the value of the asset together with the lessor’s financing cost. In many finance lease arrangements, the lessee is responsible for maintenance, insurance, and risks of loss or obsolescence. The agreement may also provide for transfer of ownership at the end of the term or a purchase option on terms that make acquisition commercially likely.

From an accounting perspective, classification may depend on the applicable framework. Under IFRS 16, lessees generally recognise most leases on the balance sheet through a right-of-use asset and a lease liability, while for lessors the distinction between operating and finance leases remains relevant. Under other accounting regimes, including local statutory frameworks, the classification criteria and practical consequences may differ. Tax treatment can also diverge from accounting treatment, which means that one arrangement may be viewed differently for tax and reporting purposes.

What does a leasing agreement regulate in practice?

A well-drafted leasing agreement should define the leased asset, duration of the lease, payment schedule, rules for delivery and acceptance, maintenance obligations, insurance, liability for defects, early termination, default consequences, and end-of-term arrangements. In commercial practice, these provisions are critical because leasing often concerns assets necessary for day-to-day business operations.

For an operating lease, key practical issues usually include permitted use, servicing responsibilities, mileage or wear limits for vehicles, return conditions, and potential additional charges. For a finance lease, the parties often focus more on payment security, consequences of delayed instalments, risk allocation, purchase mechanisms, and remedies if the asset becomes unusable or damaged.

Leasing agreements may also interact with other legal documents, such as supply contracts, guarantees, general terms and conditions, security agreements, and insurance policies. In cross-border transactions, governing law, jurisdiction, currency clauses, sanctions compliance, and registration requirements may become particularly important.

When is legal review of a leasing agreement advisable?

Legal review is advisable before signing a lease, when negotiating amendments, during disputes over termination or payment defaults, and whenever the economic structure of the arrangement is unclear. Individuals may need advice when leasing a vehicle or high-value equipment. Businesses often require support where leased assets are essential to production, transport, logistics, construction, or IT operations.

For companies, legal assistance is particularly useful when a lease forms part of a broader financing structure, investment plan, asset acquisition, restructuring process, or sale of business. Review may also be necessary when the agreement includes unusual buyout terms, complex indexation clauses, foreign law elements, or broad default provisions allowing accelerated termination.

Early consultation can help identify hidden costs, unclear liability rules, improper tax assumptions, or contractual mechanisms that expose a party to operational disruption, litigation, or financial loss. It may also reduce the risk of entering into an arrangement that does not match the intended accounting or tax treatment.

Support from a law firm in relation to leasing agreements may include in particular:

review and drafting of operating and finance lease agreements;
analysis of risk allocation, termination rights, and default clauses;
assessment of purchase options, transfer of title provisions, and end-of-term obligations;
support in disputes concerning instalments, return of assets, defects, or early termination;
coordination of lease documentation with tax, accounting, and financing structures;
advice on commercial negotiations and cross-border lease arrangements.

Need legal advice on a leasing agreement? Contact us.