The Law of Commercial Leasing in Canada 1999

By: Tamara M. Buckwold, College of Law, University of Saskatchewan

INTRODUCTION

1.1  The Commercial Leasing Market

[1]  Leasing as a device for the acquisition and financing of goods has become an extremely important component of the Canadian and global economies. The Canadian Finance and Leasing Association, relying on World Bank and United Nations sources, recently advanced these statistics:

In 1978, annual plant and equipment leasing volumes worldwide (excluding vehicles and real estate) were about US$40 billion. By 1986, plant and equipment leasing had grown to almost US $175 billion and by 1996, worldwide annual plant and equipment leasing volumes had grown two and a half times to about US $430 billion. Canada ranks ninth in the world in annual plant and equipment leasing.1

[2]  The same organization estimates the leasing industry to have a total of over $60 billion in financing in place with businesses and consumers in Canada. In 1997, 25% of business investment in leasing and equipment was financed through leases, and 46% of new light passenger vehicles were leased, 2 as compared with 34% acquired through loans and 20% purchased with cash.See footnote 3

[3] The explosion of leasing activity since the 1980s has prompted a variety of legislative responses in the United States. The most significant of these was the promulgation in 1987 of Article 2A of the Uniform Commercial Code (the UCC) by the National Conference of Commissioners on Uniform State Laws (NCCUSL) and the American Law Institute (ALI), currently adopted by forty-eight states and undergoing periodic revision.4 In addition, aspects of consumer leasing, particularly in the automotive field, are subject to a variety of state and federal statutes.5 The NCCUSL's most recent efforts to codify and harmonize leasing law are embodied in a proposed Uniform Consumer Leases Act, the current draft of which is expected to receive first reading at a meeting of the Commissioners to be held this summer. 6

[4] Internationally, the Unidroit Convention on International Financial Leasing 7 represents an attempt to harmonize important aspects of lease financing on a global basis.

[5] In contrast, Canadians have undertaken no comprehensive statutory reform of leasing law, though some aspects of leasing activity are regulated by provincial legislation.8 One can only speculate on the reasons for Canadian inaction. It seems likely that the absence of a significant demand for rationalization of this very complex area of the law reflects the minimal amount of litigation of leasing issues and the scarcity of published writings or commentary on the subject.9 It may be that this state of affairs indicates that there are few problems in the law of leasing worthy of statutory redress. However, it is equally possible that the problems that exist are simply not litigated for practical reasons. Issues arising from the consumer leasing market are not likely to be presented for judicial determination since they are most likely to affect the consumer lessor who, for reasons both of cost and lack of legal sophistication, will rarely go to court. In the commercial leasing market, parties create their own private legal structures by contract. The preponderance of the caselaw that does exist in this field addresses third party priority issues, supporting the supposition that inter partes matters are largely resolved extrajudicially.

[6] While it is therefore difficult to draw firm conclusions regarding the need for legislation from a survey of the legal literature and caselaw alone, that exercise is nevertheless an important first step in addressing the question. Identification of the legal issues inherent in the current state of the law assists in the determination of what practical problems might arise in the real world of leasing. In addition, it enables us to draw informed inferences about problems that likely do exist, whether or not they are evidenced by litigation. This is particularly true in the rapidly expanding consumer leasing market.

[7] This study therefore undertakes a survey of existing Canadian law governing commercial leasing transactions, as a basis for consideration of the need for statutory reform.10Possible statutory responses to leasing issues are considered through a comparative examination of Article 2A of the United States Uniform Commercial Code, United States consumer leasing legislation and the Unidroit Convention on International Financial Leasing.

1.2  The Lease Transaction

[8] Because modern lease transactions adopt a variety of legal and functional forms, it is virtually impossible to delineate discrete categories or kinds of lease. Furthermore, the descriptive terminology applied to these forms varies, and no apt labels exist for some leasing structures. One can only describe in general terms the nature and objective of the several leasing devices currently in use.

[9] A lease transaction entails a contractual relationship between the lessor and the lessee, as well as a bailment. It thus invokes the traditional law of bailment along with the general principles of contract law. In its simplest form, there are only two parties to the transaction, the lessor, who owns the goods subject to the lease, and the lessee, who is entitled to their possession and use over a stipulated term in return for monetary payment, ordinarily by way of installments. The lessee may or may not be entitled to acquire title to the goods through the exercise of an option to purchase, usually at the end of the term. The lessor is generally a dealer who inventories goods for lease. Such transactions may range from the hourly rental of ski gear at a resort to the long term lease of business equipment.

[10] The functional objectives of a transaction of this kind may vary. In its "pure" form, such a lease is designed simply to enable the lessee to use the lessor's property on a pay-as- you go basis. Such a lease is sometimes described as an operating lease or in some contexts as a "true" lease, by way of distinction from a "security" lease, which lies at the other end of the spectrum.11

[11] A security lease is designed as a device for the acquisition of the leased goods under a deferred payment schedule, comparable in many respects to a conditional sale contract. As such, it is primarily a financing mechanism, though it may give rise to issues ordinarily arising in the context of a contract of sale or a true lease. In these transactions, the lessor retains title to the leased goods as security for payment of the sums stipulated in the contract through periodic instalments of "rent," usually along with a terminal purchase option sum.

[12] A simple lease may also function as a financing device if it is part of a "sale-leaseback" transaction. In that scenario, the original owner of the goods sells them to a financial institution, which then leases them back to the owner-cum-lessee. The lessor in such a relationship cannot be expected to assume any obligations relating to the quality or performance of the goods, which will have been acquired from another source either contemporaneously with or some time prior to the financing transaction.

[13] In the case of long term leases, a second contractual relationship is very often introduced into the picture through the assignment of the lessor's interest to a third party financer, who may or may not be related to the lessor.12 Functionally, this arrangement enables the lessee to finance the acquisition of goods through indirect resort to the assignee's capital, simultaneously facilitating the business operations of the lessor, who would otherwise not be in a position to inventory or acquire goods for lease to its customers. The assignee in this scenario is a provider of credit, not goods. It is therefore concerned to avoid any responsibility for the quality, performance or maintenance of the goods subject to the lease, while enjoying the benefit of the lessee's payment obligations thereunder.

[14] The most complex variant of current leasing structures is what UCC Article 2A designates the "finance lease," terminology which is adopted in this context hereafter. 13 In this situation, goods are sold by a supplier to a lessor, who then leases them to the lessee. The lessor is a financial institution whose role is to finance the acquisition of the goods in question by the lessee. It is ordinarily not related to the supplier, and is not involved in the selection or evaluation of the goods acquired for purposes of the lease. The lessee will have chosen the goods subject to the lease and dealt directly with the supplier in determining their performance attributes and suitability. However, there is no contractual relationship between the supplier and the lessee. The payment structure in the lease is designed to enable the lessor to recover its capital cost and a return on its investment. The lease is functionally a device for repayment over its term of the funds advanced for acquisition of the leased goods by the lessor. Legally, the transaction entails two related contracts; the contract of sale between supplier and lessor, and the contract of lease between lessor and lessee. The adoption of the finance lease as a device for the acquisition of goods by the lessee reflects the taxation and financing strategies of the lessee and lessor, rather than a decision to "lease" goods in the traditional sense.

[15] While the various kinds of lease transaction described above are legally and conceptually distinct in certain aspects, they share one functional objective. In today's commercial leasing market, a lease (other than one of short duration) is designed to finance the acquisition of goods, regardless of whether it is a "true" lease or a security lease. 14 The assimilation of purchase and financing functions with a legal form historically intended simply to regulate the use of one person's goods by another has broadened and complicated the range of legal issues arising from these transactions, particularly insofar as those functions entail the introduction of a third party financer. Those issues may invoke aspects of the common law of bailment, contract and assignment, choses in action legislation, the statutory and common law of sales, the provincial and territorial Personal Property Security Acts and a variety of consumer protection statutes.

[16] The complexity of modern leasing transactions, matched by the complexity of the potentially relevant law, would make a fully comprehensive analysis of all of the legal aspects of modern leasing a monumental task. However, it is possible to identify and address the primary issues that might merit attention through statutory reform. They are considered hereafter under the headings 2) quality and performance issues affecting the lessee, 3) enforcement and remedies, 4) third party rights and priorities and 5) consumer leases.

[17]  In the general discussion under the first three of these headings, no attempt is made to draw the reader's attention to issues or points of law of particular relevance in the context of consumer leases. Those issues are addressed under the separate head of consumer leases, along with a discussion of currently applicable law.

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