Defending interests in financial leasing contracts through litigation

Q: If a lessee does not pay rent pursuant to a financial lease contract, how could a lessor institute proceedings?

A: According to article 248 of China’s Contract Law and the Interpretation by the Supreme People’s Court of the Applicability of Laws to the Hearing of Disputes over Financial Lease Contracts, if a lessee does not pay the rent as agreed, and still fails to pay the rent within a reasonable time after receiving a reminder from a lessor, the lessor may request the payment of the rent in full or the termination of the contract, recovery of the leased property and claim for damages.

Q: Could the above two requests be made together?

A: The above two requests cannot be made simultaneously because the claim to the payment of the rent in full is, in essence, a request to continue performing the contract. It is just a way to make the rent due early. If a lessor requests to terminate the contract or recover the leased property at the same time, this means the lessor chooses two claims that reject each other simultaneously. It is logically infeasible.

Accordingly, article 21 of the interpretation specifies that if a lessor requests a lessee to pay the outstanding rent in full as well as requests to rescind a financial lease contract, the court should tell the lessor to make a choice in accordance with article 248 of the Contract Law. During case filing and review, if the lessor still insists on making the two claims after the court gives an explanation, the court will not accept the claims. If the court finds this situation after accepting the claims, it can dismiss the action.

However, pursuant to article 21 of the interpretation, if the lessor requests the lessee to pay the outstanding rent in full, and the lessee fails to do so after the court delivers a decision, and if the lessor makes a request again to rescind the financial lease contract and recover the leased property, then the court can still accept the claim.

Pursuant to these stipulations, the lessor should, prior to the choice of action plans, first assess the performance capability and creditworthiness of the lessee. If the lessee is assessed to have the ability to perform or have enough property available for execution, then the lessor may choose to request the lessee to pay the rent in full. If this judgment is not enforceable, the lessor should make a separate claim to terminate the contract and recover the leased property. If the lessee is assessed to have poor performance capability or financial standing, the lessor can directly choose to request termination of the contract, return of the leased property and claim for damages.

Q: If the lessor chooses to terminate the contract, recover the leased property and claim for damages, then what is the principle or scope of the claim for damages?

A: As the lessee breaks the contract so that the financial lease contract is discharged, the damages to be paid to the lessor should be limited to making up the loss of available benefits for the lessor. During the normal performance of the financial lease contract, the benefits of the contract available to the lessor should be all the unpaid rent and other charges. Therefore, the criteria for the claim for damages should be determined accordingly. It should be noted that since a leased property will usually contain certain residual value, the recovery of the leased property can make up the loss for the lessor within the range of the residual value. Therefore, the value of the recovered leased property should be used to offset against the lessor’s losses.

In practice, a lessor and a lessee will often agree upon, on their own and under a financial lease contract, the method for the calculation of loss and the principle of indemnity. For example, a financial lease contract may specify that if the lessee commits a serious breach, the lessor may recover the leased property and claim for damages for all the rent, and that the value of the recovered leased property will not be used to cover the losses. Admittedly, the parties may agree upon the principle of indemnity on their own, but the terms of the contract must not be in violation of the principle of indemnity for available benefits under the first paragraph of article 113 of the Contract Law. This means the total amount of damages available to the lessor should not exceed all potential benefits available to the lessor following the normal performance of the contract.

If the lessor is permitted to claim for the damages as agreed above, the lessor will receive double compensation for the value of the use of the leased property during the lease period. The total compensation received is significantly higher than the available benefits. Therefore, the above agreement will not be sustained because it is inconsistent with the principle of indemnity under the Contract Law.

Q: How is the value of a leased property determined?

A: The determination of the leased property’s value plays a very important part in litigation in which the lessor asks to terminate the contract, recover the leased property and claim for damages. Pursuant to article 23 of the interpretation, the value of a leased property is to be determined first by an agreement between both parties. If the agreement contains unclear stipulations, the value will be determined with reference to the depreciation and residual value of the leased property.

In practice, some financial lease contracts clearly provide for the method of determination or depreciation of the value of a leased property during a period from the performance of the contracts to each time point. Once there is a dispute between two parties, the court may make a judgment based on mutual agreement. However, if there is no such agreement in some contracts, or even though there is, the parties will argue that the value determined in the manner described above will substantially deviate from the actual value of the leased property.

In view of this, the interpretation clearly provides that a lessee or a lessor may request a court to appoint a qualified agency to determine the value of a leased property by means of evaluation or auction to ensure that no party can overestimate or underestimate the value of a leased property by taking advantage of its dominant position.

Gao Ping is a partner and Zhang Miao is a lawyer at AnJie Law Firm