Financial Leasing as Compositary Construction

Annotation
The paper presents a further substantiation of S. Shatalov’s theory of compositarity, in accordance therewith the “tripartite” finance lease is a combination of a sales contract between the seller and the EC and a lease contract between the LC and the user, where: EC (emptor compositus) is the buyer made up of the finance lessor and the user who, in a certain way, distribute the rights and duties of the buyer between themselves; and LC (locator compositus) is the lessor made up of the finance lessor and the seller who, in a certain way, distribute the rights and duties of the lessor between themselves.

Entia non sunt multiplicanda praeter necessitatem. [1]

A universal methodological principle known as Okkam's Razor.

You may disagree with me, but I believe that analyzing leasing…
we shouldn't start with some artificial dogmas squeezing real life relations into them,
but we should do quite the opposite…

E.Sukhanov
"Polemics on the future that is formed today"
(Review of S.Shatalov's article [2] by Professor E. Sukhanov).
Khozyaistvo i Pravo. 2001, No.9. Pp.130-131.

A lot of problems connected with the legal regulation of financial leasing both in Russia and abroad, at national and international levels, arise due to the wrong qualification of leasing resulting in its turn fr om such apparently correlated factors as:

• biased understanding of the economic meaning of leasing;
• seeming complexity and unconventionality of leasing relations fr om the perspective of civil law;
• confusion of their public and private law aspects;
• terminology used to define and describe these relations;
• neglect of the qualitatively new phenomenon in economic relations development and of the tasks set for the law by this phenomenon.

I suggested a new interpretation of leasing, free fr om still existing wrong stereotypes: leasing as a combination of a sales contract between the seller and the EC and a lease contract between the LC and the user, where:

EC (emptor compositus) is the buyer made up of the finance lessor and the user who, in a certain way, distribute the rights and duties of the buyer between themselves (in particular the finance lessor receives the property right to the purchased thing and pays for the thing, whereas the user receives the right to submit claims regarding the thing's quality to the seller);

LC (locator compositus) is the lessor made up of the finance lessor and the seller who, in a certain way, distribute the rights and duties of the lessor between themselves (in particular the finance lessor is the owner of the leased property and the recipient of the lease payments, whereas the seller is responsible to the user for the quality of the leased property).

It is exactly the simultaneous formation and existence of the EC and the LC, where each of them represents a united debtor and creditor of their contractor, that allows the finance lessor, the user and the seller to achieve the desired economic result. After all, in spite of the complexity of leasing relations claimed by many researchers, their economic meaning is a "good old" sale and lease that legally have to be arranged as, correspondingly, sale and lease contracts.

The seller has to sell a thing, and it doesn't matter for him how the buyer is going to dispose of it. The important aspect here is only that the buyer (EC) has the rights and duties regarding the seller arising under the sale contract.

The lessee (user) has to receive a lease on the same thing, and it doesn't matter for him how this thing turned out to be leaser’s property. The important aspect here is only that the lessor (LC) has the rights and duties regarding the user arising under the lease contract.

The finance lessor has to become the owner of the thing under the sale contract and the recipient of the lease payments under the lease contract, but he shouldn't and doesn't have to be either the buyer or the lessor.

The user, in order to achieve his own goals, agrees to form the EC together with the finance lessor in the sale contract and to become the lessee in the lease contract with the LC (see above) because, exercising the rights and duties of the buyer (EC), the user simultaneously exercises the rights and duties of the lessee under the lease contract with the LC.

The seller, in order to achieve his own goals, agrees to form the LC together with the finance lessor in the lease contract and to become the seller in the sale contract with the EC (see above) because, exercising the rights and duties of the lessor (LC), the seller simultaneously exercises the rights and duties of the seller under the sale contract with the EC.

I want to stress again that the sales relation (sale and purchase) and the lease (rent) relation have an equal degree of significance, and, in qualifying leasing we can't consider one of them basic (main or primary) or auxilary (subsidiary or secondary). In leasing, the finance lessor, the user and the seller do not have any common goal to achieve. For the seller, the essence of leasing is the sale of the good, whereas for the user, it is the lease of the property. Any particular emphasis on one of these economic, and predetermined by them juridical, relations in qualifying leasing contradicts to the common sense (objective economic reality). [3]

Nevertheless, many researchers contend that the relation between the finance lessor and the user (granting a lease on property), has a higher priority, though any known attempts to provide grounds for this approach are based on a number of biased and artificial assumptions.

Thus, M.Giovanoli suggests that, in spite of a variety of leasing modifications existing in actual practice, the essence of the transaction in all of them is the investment guaranteed by the property right. Consequently, the essence of leasing is in principle the same both in the classical lease operation (l’op'eration classique de cr'edit-bail), and in the lease-back. Thus, it would be natural to start the juridical analysis of a lease transaction with its simplest form, i.e. the lease-back, where both phases – "realization of investment" and "financing" – are still clearly differentiated, which makes it easier to observe and understand the legal relations under study. These two phases are mixed in the classical lease operation because its components are not always clearly defined, especially, due to the involvement of the supplier (seller or constructor) of the financed property. It is noted that "the supplier of the financed property appears in a very inconspicuous way at the initial phase of the contract during the 'tripartite' operation of the cr'edit-bail of the classical type, whereas in the lease-back he doesn't appear at all". Therefore, it is suggested that "the initial analysis should be limited to the bilateral 'inner' relations between the finance lessor (cr'edit-bailleur) and the user (preneur) before studying at a later stage their 'outer' relations with third parties…" [4]

At the same time, the above-mentioned author doesn't regard as cr'edit-bail (leasing) the direct leasing, where the direct involvement of the manufacturer or supplier that wants first of all to expand his market allegedly changes completely the economic nature of the operation. It acquires not so much the financial as the commercial character, whereas the real finance lessor is a pure financier, “bailleur de cr'edit”, who, unlike the seller (supplier or manufacturer) bears no responsibility for the property comprising the object of the transaction. [5]

Such considerations have several shortcomings.

Firstly, only a few characteristics of leasing are taken into account, while the significance of the others is either diminished or ignored. Though for example, in the economic sense, the lease-back differs from the “classical” leasing in at least the absence of sale and lease goals that are present, however, in the direct leasing. As a prototype of "classical” leasing, it is more logical to consider direct leasing, wh ere some part of the leaser's functions is not yet transferred from the manufacturer to the "pure financier". It is no less logical to suggest that "classical” leasing has originated from two absolutely independent contracts concluded and fulfilled in a strict and obvious chronological sequence: 1) a sale contract between the manufacturer and the future lessor and 2) a lease (direct leasing) contract on the thing acquired by the first contract. It is hardly necessary to prove that we can't objectively speak about the primary or secondary nature of either of these contracts, or about a decisive role of any of the three participants, or about the principal nature of someone's initiative to enter into the corresponding contractual relations, etc. However, when these two contracts as if overlap with the partial transfer of the lessor's functions to the seller and the buyer's functions to the lessee in the case of "classical leasing", many authors for some reason start to believe that it is the use of the property that should be prioritized, and it is the user who should sel ect the seller and request the finance lessor to acquire the thing from the seller, and it is the "lease contract" that should be concluded first, etc.

Secondly, we see here the mentioned confusion of public law and private law aspects. The amount of the gratuity is not important for the private law qualification of leasing. The fact that regarding leasing as an economic category, we can find elements of crediting both in "classical" leasing and in the lease-back (and in direct leasing) doesn't give us any grounds to trace similarities between "classical" leasing and the lease-back (and direct leasing) from the civil law perspective, though of course, it can be meaningful, for example, for tax law.

In qualifying leasing, we shouldn't be mislead by such terms (even fixed in the existing legislation) as "cr'edit-bail" or "financial lease".

We also shouldn't be misguided by the fact that the complex of relations between the seller, finance lessor and user is traditionally called "leasing" (Eng. lease) and not, say, "saling" (Eng. sale).

The essence of leasing is also obscured by the names traditionally used for its participants. Thus, the term "seller" shows that the corresponding participant of leasing relations has functions of the seller but this term doesn't reflect his lessor’s functions.

Apparently, the much debated unusualness of relations between the seller and the user is also an artificial problem. Their relations might of course look unusual if we admit the existence of contracts between the finance lessor and user and between the seller and finance lessor. And a great many authors try to discuss the nature of leasing imagining exactly this kind of a situation, though considering it real without any evidence.

However, it is no less logical to think that leasing consists of contracts between the seller and user and between the finance lessor and user. Under such an approach, relations between the seller and finance lessor look unusual. It is also logical to think that leasing consists of contracts between the seller and user and between the finance lessor and seller. Under such an approach, relations between the finance lessor and user look unusual. It should be noted that, in particular, the relations between the seller and user can be equally soundly regarded both as a sale contract and a lease contract, wh ere some rights and duties of the correspondingly buyer and lessor are transferred to the third person, finance lessor.

And it is exactly the equal logicality of recognition of the possibility of the existence of all the three constructions that testifies to the illogicality of recognition of the possibility of the existence of any of them.

It is equally wrong to assume, like in case of the legislator, that first the lease contract [6] between the finance lessor and user is concluded, and then the sale contract between the finance lessor and seller. The prospective finance lessor and user may indeed agree to enter leasing relations provided the seller gives his consent to participate. However, the essence of leasing doesn't depend on the fact which two of its future participants had reached such an agreement before the third participant decided to join.

Whatever the chronological sequence of agreements between the prospective leasing participants, it is important that they all give their consent to accept the distribution of rights and duties between the seller, finance lessor and user described in the first paragraphs.

I think that my construction can successfully compete even with such fundamental remarks by E.A.Sukhanov:

"It appears that the concept suggested in your work too is not irreproachable, especially, from the perspective of the 'pure civil law approach' (article, p.17). It is confined to the proposal to combine some participants of leasing relations, on one hand, in sale (regarding the finance lessor and user as a single buyer) and, on the other hand, in lease (regarding the seller and finance lessor as a single lessor) (pp.19-20). From the "classical" perspective, it means that in constituent leasing contracts there is a plurality of persons, first, on the buyer's side and, then, on the lessor's side." However, solidary plurality in this case is obviously non-existent, and in shared plurality we can't speak about the situation when one participant has only these rights and duties, and the other – completely different. Therefore, the variant of the "split status" of one of the parties to the contract cannot be described from the "classical" approach either.

In the opinion of E.A.Sukhanov, "in analyzing leasing, as well as some other new institutions of Russian contractual law (e.g. the agent contract or contract of entrusted administration of property), we shouldn't start with some artificial dogmas squeezing real life relations into them, but we should do quite the opposite (as it was always excellently done in Roman private law). The leasing 'story' resembles very much the 'story' of the freight-forwarding contract, which is known to have been characterized in Russian pre-Soviet literature, e.g. by G.F.Shershenevich, as a 'set' of elements from five known contracts (labour contract, storage, commissioning, etc.) and was singled out as an independent contract only in Soviet time. Probably, the leasing contract will have a similar fate." [7]

It is quite natural to formalize new, previously unknown types of economic relations with new, previously unknown contracts. But the matter is that leasing doesn't have this novelty: sales relations (emptio-venditio) and lease relations (locatio-conductio rerum) have been well-known in civil law for a long time. And it is exactly my interpretation of leasing, based, unlike others, on the objective analysis of the entire complex of relations between the finance lessor, user and seller, that allows us to see that leasing is made up of such full-fledged standard contracts. As for the lease contract per se, singled out by other authors and the legislator (be it a bilateral or tripartite contract, a variation of lease or different from it civil law institution), relations of the parties in such a contract definitely look unusual and do not conform to the general scientific understanding of contractual relations.

Comparing leasing with the freight-forwarding contract, we can also note the following. Whether the latter is an individual contract or a mixture of contracts, in any case it is a contract between the same pair of contracting parties (similar to the above-mentioned agent and entrusted administration of property contracts), whereas leasing as a combination of two simultaneously concluded contracts between different pairs of contracting parties, has a more complex structure of contractual relations. Using other than mine approaches, we can really have reasons to regard the above-mentioned lease contract per se as a mixed type and discuss when and by what criteria we should treat a contract as an individual contract or as a set of known elements from traditional contracts.

I agree that in analyzing leasing "we shouldn't start with some artificial dogmas squeezing real life relations into them, but we should do quite the opposite", but I can't accept as a general civil law axiom the statement that participation of two or more persons on the same side in the obligation means just the plurality of persons. And in analyzing leasing, I don't start with this dogma, squeezing real life relations of sale and lease into it. I named the phenomenon of the split status of the parties to interrelated contracts (in our case, the sale and the lease contracts) and of the formation of composites (in our case, the EC and the LC) as compositarity (compositaritas). In the case of leasing, there is compositarity of persons on the buyer's side in the sale contract and on the lessor's side in the lease contract.

The following observations can also speak in favor of such an approach.

In economic development, emergence of new relations between subjects of economic activity is an objectively conditioned phenomenon marked by science and seeming quite obvious at present. For millennia, law has been accomplishing the task set by this phenomenon (further, primary phenomenon): to formalize the emerging economic relations trying to reflect their peculiarities and simultaneously to fit them in the general system of legal regulation. In fact, Roman private law was quite successfully accomplishing this task in the economic conditions of that period, and its achievements are successfully used to pursue the same goal under modern economic conditions.

But apparently it is only with the emergence of financial leasing that we confronted a qualitatively new phenomenon in the development of economic relations, a certain complication of the structure in already existing relations (further, secondary phenomenon). And now law has to accomplish a second task: to formalize this complication of the structure in already formalized during the first task economic relations, also trying to reflect the peculiarities of the emerging structure and simultaneously to fit it in the general system of legal regulation.

Science, which has observed for millennia only the primary phenomenon, has always been oriented towards it and has never admitted the possibility of existence of any different, and so far it has not yet noticed the emergence of the secondary phenomenon. Therefore, no matter what new and unconventional nature law ascribes to leasing, it neglects the qualitative novelty of the task itself and tries to explain leasing as if the matter concerned the primary phenomenon [8] , be it attempts of explaining it by means of existing contracts (or their elements), or by recognition of the emergence of a new contract type. [9]

Even the arguments discussed above allow us to contend that results of such attempts unavoidably contradict to the general principles and sense of civil legislation, to say nothing of the general provisions on purchase-sale and lease. Therefore, these attempts don't suit well to the regulation of leasing relations.

Leasing is an example of the higher complication of old, and not the emergence of new contractual relations between participants of civil circulation.

In fact, compositarity, unlike plurality of persons, doesn't comply with the "classical", i.e. developed in servicing the primary phenomenon, assumptions, and the primary phenomenon as a matter of principle doesn't need it. However, the secondary phenomenon, and leasing as its example, requires this concept with all due objective character.

The compositary interpretation of leasing allows us to most entirely apply general rules established for the sale and lease contracts, and, consequently, like no other concept, it helps us solve theoretical and practical problems.

Consider this "real life" case.

"Neither the Civil Code, nor the Law on Leasing stipulates any consequences when the buyer-lessor or the lessee, in case the seller breaks his obligations in the sale contract, has the only option – to annul the sale contract on the leased property. In this case, what are the actions of the leasing contract parties? It's not just a theoretical question because chances of such a situation are rather high, and the lessee together with the lessor has to foresee its consequences beforehand.

In practice, the parties stipulate in the lease contract that in case the seller violates his obligations, the lessor has to annul the sale contract on the leased property. In this case, the lessee can identify a new seller and address the lessor with the request to conclude a new purchase-sale contract on the leasing property, or the lessor and the lessee annul the leasing contract completely. At this, the lessor returns to the lessee the amount paid on the leasing contract with the exception of expenses incurred by the lessor within the contract's period and connected with the effecting of the leasing contract. The practice mentioned is to be stipulated in the normative act." [10]

Regarding leasing as a compositary construction, we avoid such difficulties. Relations between the seller and the user are simultaneously relations:

• of purchase-sale between the seller and the EC represented by the user, and
• of lease between the user and the LC represented by the seller.

If, for example, the seller is obliged to hand over the object of leasing to the user and fails to fulfil this obligation, this means the following:

1. The seller violates his obligation to give the good to the EC and is answerable to him for the violation of this duty. And in case the purchase-sale contract (together with the lease contract) is annulled, the seller is to return to the EC represented by the finance lessor the price of the thing paid by the finance lessor on the purchase-sale contract.

2. The LC doesn't fulfil his obligation to give the property to the user and is answerable, in the person of the seller, to the user for the violation of this duty. And in case the lease contract (together with the purchase-sale contract) is annulled, the LC represented by the finance lessor returns to the leaseholder the amount paid by the latter on the lease contract.

OIn my previous articles I demonstrated advantages of the suggested theory in regard to the international law regulation of leasing [11] and elimination of problems connected with the state registration of the real estate leasing [12] .

On the whole, the suggested rejection of a small part of established assumptions not only allows us to preserve untouched their remaining part, but also opens up wide opportunities for the efficient use of this remaining part.

In order to develop in the reader a more in-depth, systematic and complex vision of the problem, I would like to consider some other examples of compositary constructions.

For example, how should we qualify relations that, for the purpose of this work, I would call "shifted lease", which resemble leasing but wh ere the user pays to the seller [13] part of the purchase price? And what if the user pays to the seller part of the lease payments? As a matter of fact it is a question of relations that represent something intermediate between  direct leasing and “classical” leasing.

What is the structure of contractual relations in this case? Which of the participants conclude contracts, and which of them have an extra-contractual link de facto, or "unusualness of relations"? What relations appear earlier, and what later? Which of them are primary, and which secondary? Which of the contracts should be regarded as the contract of shifted lease itself (in contrast to the entire complex of relations between the seller, finance lessor and user)? What is the juridical nature of the shifted lease contract? Is it a bi- or a trilateral contract, a standard or a sui generis, independent, new contract, or a combination of elements of standard (known) contracts? What elements in this contract are prevailing, proprietary or obligational? How should its public-law classification be effectuated?

In fact, in shifted leasing there is the same combination of the sale and the lease contracts with the same composites as in "classical" leasing (the EC and LC). Only their rights and duties are distributed in a bit different way. Using my approach, we apparently avoid numerous problems connected with its qualification (including the public law qualification) and eliminate obstacles impeding emergence and development of such relations.

Compositarity is also possible in another combination of contracts. For example, if instead of a sale contract a contract for works (locatio-conductio operis) is concluded, the contractor’s contracting party is now the conductor compositus consisting of the finance lessor and user, who distribute in a certain way the rights and duties of the customer. The LC in this case is made up of the finance lessor and contractor. There are many different variants of distributing rights and duties within the composites, the contracts however still being of the works contract and lease contract types.

In principle, analogous combinations of similar contracts are also possible.

No matter how strange such constructions might seem, all of them are, inter alia, characterized by the absence of any economic relations making up their basis, which couldn't exist outside such constructions. The "unusualness" is contained not in the relations between parties but in the parties per se of these "usual" relations (standard contracts).

And it is compositarity that allows us to objectively reveal the economic and juridical nature of such constructions, single out clearly their public law and private law aspects and avoid both conventionality, artificiality or asymmetry (so apparent in leasing analysis), and the need to acknowledge the possibility of existence of practically endless number of sui generis contracts (tri- or multiple-partite contracts, special legal institutions, etc.). [14] , which however do not formalize any specific economic relations.

All this, in its turn, allows us to fit leasing and similar constructions in an optimal way in the system of legal regulation, which probably will become more and more significant as not only new economic relations formalized by new contract types emerge (primary phenomenon), but also the structure of contractual links between participants of civil circulation grows more complex (secondary phenomenon). In this process the suggested theory would remove numerous problems of qualification and would promote a free emergence and development of various compositary relations. It would also allow us not to deviate too far from general rules used in connection with "usual" contracts with all the ensuing consequences.

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[1] Entities are not to be multiplied above the necessary. (Latin)

[2] Shatalov, S.S. New Concept of the Juridical Nature of Leasing Relations. Yurist. 2001, No.1. pp.16-26.

[3] See also: ibid. pp.17-18. (On absence of logic in prioritizing a relation between any two participants of leasing.)

[4] Giovanoli M. Le cr'edit-bail (leasing) en Europe: d'eveloppement et nature juridique. - P., 1980. pp.366-368.

[5] Ibid. pp.56 – 57.

[6] Or any other contract to grant property in temporary use.

[7] Sukhanov, E.A. Ibid. pp.130-131.

[8] Which also embraces relations within the above-mentioned freight-forwarding, agent, entrusted administration of property contracts, as well as the lease-back and direct leasing relations.

[9] I want to remind that the understanding of the essence of leasing is also hampered by several other mutually related factors discussed above. For example, if we from the very beginning assume that leasing is a contract to grant property in temporary use, aggravated by the presence of the seller (what seems to be the common approach of many authors), and then we'll start to simply explain and clarify (even though in different ways) the structure of this very construction for some reason, we are unlikely to find the features of the secondary phenomenon in leasing.  Lack of the objective understanding of leasing can also, to this or that extent, be conditioned by all the other factors. It should be noted that the ability to resist these factors could be less expected exactly from common law with its peculiarities, including its casuistic nature, and it failed to understand clearly the essence of leasing and to formalize it correctly. It is interesting that Roman-Germanic law, which in spite of all its doctrinal and methodical character has borrowed this mistake made by common law, suffers from it even more. However, it is not surprising under the conditions of a codified law system.

[10] Korolev, S. We Need New Approaches to Leasing Legislation. Khozyaistvo i Pravo. 2001, No.9. p.120.

[11] See Shatalov, S.S. Ibid. pp.24-25.

[12] See Shatalov, S.S. Real Estate Leasing and Problems of Registration (New Approach). Khozyaistvo i Pravo. 2001, No.9. pp.125-129.

[13] For the purposes of the present work I use the terms "finance lessor", "user" and "seller" to denote also participants of relations similar to leasing, who have a set of rights and duties similar to, correspondingly, the finance lessor, user and seller participating in leasing.

[14] Interpretations of leasing ("contractual leasing") as a sui generis contract (a tripartite contract, a special legal institution, etc.) are not free fr om the above-mentioned shortcomings either.