LEGAL AND REGULATORY FRAMEWORK FOR LEASING IN RUSSIA DURING YEAR 2000
[Derek Bloom is a practising lawyer with the Moscow office of Coudert Brothers. Derek can be reached at dab@mos.coudert.com.]
Introduction
The International Monetary Fund is projecting that the gross domestic product of Russia will increase by two percent during the year 2000. Reports in the fall of 1999 indicate that the Russian economy may have grown by two percent during 1999 as compared to 1998. The “correction” in the value of the Russian Ruble, and the cessation of speculative investments in high-yield securities in the fall of 1998, coupled with higher oil prices, and stable government policies have, notwithstanding several changes in the head of the Russian government during 1999, quite possibly, laid the foundation for economic growth in Russia during the year 2000 and beyond.
As of the fall of 1999, there is the likely prospect that elections to the Russian Parliament (the Duma) in December 1999 will remove the controlling influence of the Communist Party and its allies and install a majority of progressive political forces. The election of a new President in June 2000 may mark the end of recurring and paralyzing conflicts between the executive and legislative branches of government in Russia. There appears to be an emerging political consensus to support the macroeconomic and other government policies that are necessary for economic growth in Russia.
There is a large requirement in Russia to introduce modern equipment in many industries. Russia presents a significant market for all types of agricultural equipment, telecommunications equipment, manufacturing equipment, oil field equipment, computers, ATMs, trucks and aircraft. Leading global manufacturers in each of these and other industries have been pursuing sales of their equipment in Russia during 1999 and making plans for expansion in the year 2000 and beyond.
Notwithstanding the realistic prospect that the economic and political foundation for growth of the Russian economy is being put in place, and will be consolidated in pending elections, Russia is grappling with burdensome legacies from the past and significant current problems. A realistic understanding of these problems is essential for a manager of a foreign company that is considering how to conduct business in Russia in order to participate in anticipated economic growth. Before turning to the discussion below of legal aspects of cross-border leasing, domestic leasing, and leasing in the context of large project financings, it is useful to consider a few of the macroeconomic problems that have impeded leasing in Russia to date.
The Absence of Bank Capital and a Functioning Capital Market
Potential customers for new equipment in Russia typically have insufficient cash to pay in advance for the new equipment they need. As a rule, sales of a vendor’s equipment to Russian customers must, therefore, be financed in full, with payments to be made in installments.
The Russian banking system and capital markets can presently extend very little, or no credit to finance the sale of equipment in Russia. It has been observed by Alan Greenspan, Chairman of the U.S. Federal Reserve, in remarks to the World Bank Group and International Monetary Fund in September 1998, that the process of credit creation was able to continue in the U.S. during the global economic crisis of 1997 and 1998 because multiple alternatives exist in the US to transform the US economy’s savings into capital investment. In 1998, in the United States, the banking system replaced the capital markets as the primary source of credit to sustain production, and business and consumer confidence. In contrast, in Russia, as a result of the economic crisis of 1998, both the banking system and the capital markets largely collapsed, and, as of the fall of 1999, are still largely incapacitated.
In this environment, James Harmon, President of the U.S. Export-Import Bank, has praised Russia for its progress in reviving its economy saying that “[m]ore has been accomplished in the economy in Russia than most in the United States realize,” and “[w]ithout any bank capital available, it is pretty impressive [that] the economy has been able to restart itself.”
The Gray Market
The problem of capital flight from Russia, and the gray market, has received much attention during the fall of 1999. Many aspects of these problems are interrelated and bear directly upon the planning for equipment sales in Russia.
Prior to the economic crisis of 1998, instead of playing their expected role as capital intermediaries between investors and enterprises in need of capital investment, many Russian banks focused on speculative gains to be earned on high yield bonds. Also, it has come to light that for years prior to the economic crisis of 1998, and continuing thereafter, many Russian and non-Russian banks were caught up in earning fees from shady transactions to import goods to Russia through illegal gray market transactions.
As discussed below, “unfair competition” from illegal gray market transactions has largely impeded the growth of legitimate leasing transactions in Russia. Legitimate leasing transactions were made to appear more expensive than other solutions available to Russian enterprises to the problem of how to acquire a needed piece of equipment.
Gray market transactions have thus distorted the market for legal equipment sale financing in Russia, and have distracted and misused the meager banking resources that were available in Russia. Published reports indicate that a World Bank report on Russia’s banking system completed in 1999 is scathing about the lack of transparency in transactions at many of Russia’s major banks. The report indicates that “[i]t is difficult to avoid the conclusion that one of the main differences in the Russian environment is that the largest banks [on whom one ought to be able to rely] actually seem to have led the way in developing techniques for concealing imprudent conduct.” The use of “imprudent” gray market transactions ultimately reached scandalous proportions and, no doubt, played a large role in depriving the Russian government of essential funds to meet its obligations leading up to the economic crisis of 1998, and beyond.
A prototypical gray market transaction was designed to avoid or minimize payment of customs duties and import VAT. One such method of avoiding customs duties and import VAT in many Russian industries has been widespread resort, knowingly or unknowingly, to “employing” the “services” of intermediary companies that are in the business of making false customs declarations and paying reduced customs duties. For example, valuable computerized equipment may be imported to Russia as scrap metal, with greatly reduced customs duties. Alternatively, false invoices may be prepared indicating that the equipment has a value that is only a fraction of its actual market value. Then, customs clearance is accomplished, and import duties and VAT are paid, based on a false low stated value for imported equipment, resulting in a “saving” to the customer. The Russian customer’s bank would then make payment for the stated low value of the imported goods, in apparent conformance with the requirements of Russian law that regulate the payment of hard currency from Russia to a foreign supplier of imported goods.
Widespread graft has reportedly been essential to the success of the gray market in motivating tax, customs and banking officials not to examine gray market transactions too closely. The cumulative cost of graft to the Russian state, arising from unpaid taxes and duties, and other losses, is reported to have been $20 billion per year in recent years.
In many instances, the “savings” realized by participants in such transactions in avoiding taxes and duties are offset by fees charged by the intermediaries in such transactions. The administrative fee charged by intermediary companies to arrange a transaction in which customs duties and import VAT are avoided or minimized appears, commonly, to equal approximately the same amount as the taxes and duties not paid to the Russian treasury. This situation indicates that customs clearance service companies which take delivery of goods at a Western location and deliver them to customers in Russia are more or less in the business of misappropriating Russian customs duties for themselves by making false customs declarations. This situation also suggests that a fully tax-paid transparent transaction designed to take advantage of the low cost of capital available to Western equipment vendors ought to be able to compete, economically, with a gray market transaction if approximately the same costs are being incurred, although such expenses are paid to different payees.
A prototypical gray market transaction also required a further payment from the Russian customer to the foreign supplier to make up the difference between the price of the goods declared to Russian customs and tax authorities, and the actual cost of the goods. There have been numerous reports to the effect that the bulk of the billions of dollars that passed through certain Western banks in recent years were payments of the differential between the stated and actual value of goods imported to Russia.
A surprising number of Western equipment manufacturers have allowed themselves to be caught up in gray market transactions in Russia on advice from people they trust that, otherwise, competitors would undercut their potential sales in Russia by using such transactions. However, it appears that the previously prevalent, but illegal, methods to import equipment and goods into the country and avoid customs duties and import VAT are becoming no longer viable on a large scale. Large losses have been incurred when Russian customers defaulted on their payment obligations in gray market transactions, and many foreign equipment vendors have had inadequate legal recourse, as they have frequently not had “clean hands”. Further, the financial scandal in the fall of 1999 that is associated with the transfer of billions of dollars through banks accounts in New York to suppliers of goods shipped to Russia will likely result in a reluctance on behalf of Western vendors to engage in such transactions.
Issues that impede effective legal recourse for a Western manufacturer whose goods were delivered to Russia through a gray market transaction include a lack of contractual privity between the Western shipper and the ultimate Russian customer. The intermediary companies used in gray market transactions typically use an intentionally incomprehensible series of transactions, and numerous other legal entities that are subsequently dissolved, to bring goods to Russia. This gives inadequate legal recourse to the Western shipper against the intermediary company itself. Frequently, the contracts between a Western supplier of goods and an intermediary shipper, and between the intermediary company and the ultimate customer, are wholly inadequate. In the event of a default by the ultimate Russian customer, the customer may make the brazen claim that it owes nothing to the Western company, but only has an obligation to the intermediary company. Further, the ultimate Russian customer may seek to offset the amount owed to the intermediary company against amounts allegedly owed to it by the intermediary company. Then, the customer may claim that it owes no amount to anybody for the goods that it had received. In addition, goods that are found to have been imported improperly are subject to seizure by Russian customs authorities, making legal recourse in the event of a default embarrassing or impossible.
In view of these and other well publicized problems with gray market transactions, foreign businesses selling goods in Russia appear now to be improving their business practices. There is evidence of a new desire for businesses oriented around equipment imports to Russia to be conducted “by the book”. Transparent leasing transactions should compete more successfully in the emerging new environment.
A Culture of Nonpayment
A further problem in extending credit to finance sales of equipment in Russia is that there is, according to a May 1999 report by the International Monetary Fund entitled the “World Economic Outlook,” a “culture of nonpayment” in Russia which presents fundamental risks to extensions of credit and risks that expected installment payments will not be received. The report provides that “[w]idespread graft and a culture of nonpayment—with the government itself, at central and local levels, repeatedly failing to meet its obligations to public sector wage earners, pensioners, and suppliers—have eroded the social fabric. The lack of political consensus and commitment to the reform process caused the situation to deteriorate until the accumulation of debt and erosion of confidence made it untenable [prior to the economic crisis of 1998].”
The IMF Report continues that, “[i]n order to promote growth it will be particularly critical to (1) tackle the economy-wide nonpayment problem through the establishment of hard budget constraints, beginning with the government and the energy sector; (2) reduce the claims of ailing large enterprises on scarce resources by encouraging industrial restructuring, including through the exit of nonviable enterprises; (3) foster the development of small and medium-sized private enterprises and stimulate – among other measures by a revitalized privatization process – foreign participation and investment in the economy; and (4) strengthen the legal system, including property rights… The agenda of structural reforms that Russia still needs to implement is formidable… A very high priority is to address the culture of non-payment.
One symptom of the “culture of nonpayment” is that, in a number of instances we are familiar with, certain Russian businesses have not paid foreign equipment suppliers what was owed, perceiving they could avoid making such payments, and, essentially, get away with it by imposing prohibitive costs on their suppliers and creditors in seeking to repossess equipment. Defaulting on obligations became widespread after the financial crisis in Russia in August 1998, giving the impression that the crisis of August 1998 has been used by unscrupulous organizations in Russia as cover to default on all varieties of legal obligations, and to disavow all manner of debts.
High Taxes
A partial, sympathetic, explanation for the prior widespread resort to gray market transactions in Russia is that Russian taxes and duties have been, and are, too high. It has been economically rational for foreign suppliers and Russian concerns to avoid taxes by engaging in gray market transactions.
Not surprisingly, a leading proposal in the reform program of one progressive Russian political party, Yabloko, is a significant reduction of all Russian tax rates, coupled with an increased effort on collection. In contrast, the Communist majority in the Duma has consistently favored very high taxes on businesses and individuals in Russia, providing a strong incentive for tax avoidance transactions. Again, the pending elections of a new majority in the Duma, and of a new President next year, may result in a significant shift in tax policy that would favor capital investment and payment of taxes, and alleviate the culture of nonpayment discussed above.
The Use of Leasing in Large-Scale Projects
In the prevailing environment in Russia, business must be conducted pursuant to a well thought out plan. All elements in the cycle of a given business must be analyzed, planned and controlled.
Certain Western equipment vendors are employing a new comprehensive scheme for large scale industrial investments in Russia in the telecommunications and agricultural industries. The new model for a corporate structure for a large scale investment by a global vendor in selling equipment in Russia has seven defining characteristics.
First, industrial investors should consider forming joint ventures with their intended customers, and arrange the sale of equipment to the newly formed joint ventures. In other words, the corporate investor must create its own customer in Russia. An industrial investor may increase the probability of successful enforcement of a loan, lease or installment sale contract if the industrial investor controls the borrower, lessee or customer. The vendor that is bearing the financial risk of providing loan, lease, or installment sale financing should wield control over the legal entity that is being financed. Control should not be vested in the hands of third parties whose interests may ultimately diverge from the vendor’s.
Second, the “natural enemies” of the proposed business in Russia must be identified and coopted. The goal is to give competitors, regulators, and customers a legitimate stake in the success of the industrial investor’s business in Russia. Interest groups that could impede a new business in Russia should have as an “upside potential” the possibility to benefit economically, and legally, from the success of the new business by becoming minority partners.
Third, adequate due diligence investigations of prospective business partners, regional governments, and customers must be completed in order to assess the creditworthiness of each of these parties.
Fourth, all new equipment that is sold to a joint venture should be pledged as security for the vendor financing. Alternatively, the new equipment should be leased to the new joint venture company from a captive leasing company.
Fifth, the use of new equipment may be made available to the consumers of such equipment pursuant to service contracts, rather than purchase and sale agreements. This mechanism is suitable for providing the use of new equipment to large collective farms, and to oil fields pursuant to oil field service contracts, while retaining ownership of the equipment with the vendor-controlled joint venture company. This model may also be adopted for use in numerous other industries.
Sixth, the charter documents for new joint venture companies should provide that a large percentage of revenues, for example 80 percent, will be applied to debt service. When the cost of new equipment is paid, control over the new legal entities formed in Russia may either be conveyed to Russian partners, or retained, and perhaps form the core for a successful publicly-held company that may attract new investments into its industry.
Seventh, where possible, such as in the agricultural sector, the vendor providing financing must also seek to acquire physical control over the crops or other goods produced, and obtain an assignment of resulting revenues from sales. It is possible that a key joint venture partner may be a customer of the joint venture that would purchase a portion of the crops or goods produced, and provide a reliable source of cash payments from the sale of such goods on the Russian or world markets.
The Need for Vendor Financing
Regardless of whether a foreign vendor is interested in a large-scale project, such as that described above, or in the delivery of limited amounts of equipment to various customers in Russia, there is an unavoidable need for vendors to provide their own vendor financing to facilitate sales of their equipment sales in Russia. Most potential customers in Russia, and the banks which service such customers, do not have sufficient capital to finance the purchase of needed equipment. See the attached summary of the activities of several leading Russian leasing companies which shows a large percentage of their financing that is provided by global equipment vendors. The financing of captive leasing companies in Russia is generally 100% attributable to commercial financing provided by the sponsoring vendor.
Planning Points for Cross Border Leasing Transactions
The principal planning points for cross border leasing to a Russian lessee include: obtaining a leasing license, obtaining a currency license or permission (or establishing that a particular transaction is exempt from this requirement, as discussed below), clearing equipment through customs, and planning for payment of import VAT.
Leasing license
While the point is sometimes debated, it seems clear that a leasing license is required to be obtained by a foreign leasing company in order to engage in a single cross border “financial lease” of equipment to a Russian lessee. A license may not be required in the case of the “rental” or operational lease of equipment.
The origin of the requirement for a lease license is found in Decision of the Government No.1418 (“Decision 1418”), dated December 24, 1994, as amended, which approved appended licensing procedures, and endorsed a list of activities that require licenses and of bodies authorized to carry on licensing, as set forth in Appendix 1. Appendix 1 provides that the Ministry of Economics is to license the activity of leasing companies.
The procedure to obtain a leasing license was detailed in Regulation No. 167 (“Reg. 167”), dated February 26, 1996, as amended, the “Decision of the Government of the Russian Federation on Endorsement of Regulations on Licensing of Leasing Activities in the Russian Federation.” Reg. 167 provides, in Section II(5) that the licensing of leasing activities shall be vested in the Ministry of the Economy. Reg. 167 sets out the procedure for an applicant to obtain a lease license. Reg. 167 provides in Section I(4) that: “[t]he effect of the present Regulations shall apply to leasing activities carried out on the territory of the Russian Federation by non-resident leasing companies.”
A leasing transaction that is engaged in without a license is potentially illegal and voidable. Letter No. 119 of the Ministry of Finance of the Russian Federation and the State Tax Service, dated November 1, 1993, provides, in Paragraph 3, that “[i]f [licensable] activity is carried on without a license, it shall be regarded as illegal in accordance with …” a decision of the Higher Arbitration Court of the Russian Federation, No. S-13/OP-19vya-21, dated January 19, 1993. Paragraph 6 adds that, “[i]n case it is shown that business activity is conducted by an enterprise… without an appropriate license, … [action may be brought pursuant to] civil legislation… [in a] court of law… to recognize any transactions as invalid, and to recover for the state everything that was received in such deals, and to liquidate an enterprise, and in case of need to file a request about prohibition of business activity.
Article 49 of the Civil Code of the Russian Federation provides, in Paragraph 1, that “[a] legal entity may engage in certain types of activity, a list of which is determined by a statute, only on the basis of a special permission (or a license).” Paragraph 3 adds that “[t]he right of a legal person to conduct activity for which a license is necessary shall arise from the moment of receipt of such a license, or at the time indicated in it, and shall terminate on the expiration of the term of its effectiveness, unless otherwise established by a statute or other legal acts.”
Letter No. 18-1-04/69, of the State Tax Service of the Russian Federation, dated February 6, 1998, repeats the substance of Article 49 of the Civil Code and adds that “[a]ccordingly, if the activity for the pursuance of which a special permission (license) is required has been pursued by an enterprise without such a permission, such activity shall be deemed to be illegal, i.e. given the absence of the license the legal entity initially was not authorized to pursue the said activity and enjoy exemptions from the [any] taxes levied in connection with the pursuance thereof.”
The Russian Federation Federal Law on Leasing, approved by the State Duma on September 11, 1998, and signed by President Yeltsin on October 29, 1998 (the “Leasing Law”), provides, in Article 5, that “… leasing companies (firms) shall be commercial entities, whether residents of the Russian Federation or otherwise, which shall perform, in accordance with their constitutive documents, the functions of lessor and which shall have obtained, pursuant to the procedure established by the legislation of the Russian Federation, permits (licenses) to engage in leasing activities. Article 6 adds that “Non-residents of the Russian Federation shall be licensed to engage in leasing activities after they shall have registered in the territory of the Russian Federation for tax purposes.”
In practice, a leasing license may be obtained in the course of two months. There seems to be little reason to undertake the risk of engaging in a cross border lease transaction where a license may be required, without obtaining that license. In our practice, we have seen examples of lessees challenging their obligation to make lease payments, after equipment has been delivered and put to use, based on the argument that a lessor holds an invalid lease license. Unscrupulous lessees could make a similar argument if no license had been obtained at all. We have also seen the deductibility of lease payments by a lessee challenged until a valid leasing license was produced, particularly if accelerated depreciation of the equipment, a benefit reserved for financial leasing transactions, had been claimed by the lessee.
Currency license
The Leasing Law purports to provide, in Article 34, that a currency license or “permission” is not required for a cross border lease of equipment for a period longer than 180 days. This is one example of where a provision of the Leasing Law is in conflict with other generally applicable Russian laws.
There is a conflict between Article 34 of the Leasing Law and Article 6 of the “Law on Currency Regulation and Monetary Control” (The “Currency Law”). Article 1 of the Currency Law provides that any extension of financial credit for a term in excess of 180 days, and any other cross border financial transaction that is not specifically exempted, is defined as a “currency transaction connected with the movement of capital.” Article 6 provides that “currency transactions connected with the movement of capital” shall be conducted by residents in accordance with the procedure established by the Central Bank of the Russian Federation. The reference is to the existing procedure for obtaining “permission” to engage in the extension of financial credit for a term in excess of 180 days, as in the case of a long-term lease.
During 1999, various banks in different parts of Russia have interpreted the conflict between the Leasing Law and the Currency Law differently. In some cases, banks have allowed payments to be made without a currency license or permission. In others, lessee’s banks have not allowed payments to be made, resulting in situations in which foreign lessors were denied payments they were owed. At the present time, there seems to be little benefit for a foreign lessor to allow a leasing transaction to go forward without requiring that a “permission” be obtained by the lessee to make its scheduled payments of hard currency.
It does appear that a simplified “registration” process for cross border leases is scheduled to be introduced by the Central Bank. See Central Bank Letter No. 175-T, dated June 11, 1999. The Letter describes draft regulations to be considered, including a registration procedure for finance leasing agreements with terms exceeding 180 days. The proposal is to work out a simplified registration process that would be similar to the registration process for cross border loans as set forth in Central Bank Regulation No. 527, dated October 6, 1997.
In practice, Russian banks may likely refuse to make lease payments to a foreign lessor without the lessee first producing a license or “permission” to make a hard currency payment abroad pursuant to the transaction. In one case in which a Russian bank refused to acknowledge the exemption from general currency licensing requirements set forth in Article 34 of the Leasing Law, the Russian bank involved submitted a written inquiry to the Central Bank in late 1998 and, as of the fall of 1999 is still, to our knowledge, waiting for a reply. The lessor located a different bank that agreed to apply the exemption set forth in the Leasing Law. One major Western bank operating in Moscow has indicated that, after close study of all transaction details, it would probably agree to make rental payments in hard currency without a currency license or permission. In another recent instance, a foreign lessor encountered an outright refusal by the lessee’s bank to make lease payments, based apparently on concern that such payments could be viewed as capital flight transactions.
The staff of the Central Bank appears itself to be split on the issue as to whether a license or permission is required for a cross border lease payment. Different staff members in the bank’s currency control department take inconsistent positions. A distinction may be drawn between cases in which a foreign lessor acquires ownership of assets in Russia to be leased domestically, where a license or permission seems more likely to be required, and a case in which assets are imported to the Russian lessee. Bank regulators seem to be particularly troubled if title to assets is acquired within Russia by means of the offset of a monetary claim the lessor had against the prior owner of the equipment, and does not pay for the equipment with new cash.
With regard to the use of bank accounts in Russia to receive deposits of lease payments that are due, under recent amendments to Central Bank Instruction No. 16, a foreign lessor may open a “T” account in Russia, not being physically present, and receive lease payments in rubles. Such rubles may be converted to hard currency and paid out of Russia. Hence, ruble payments may be used as an alternative to hard currency payments in the event that a lessee experiences difficulty in making hard currency payments to foreign a bank due to reluctance by its local bank to abide by Article 34 of the Leasing Law.
Customs Clearance
Customs issues are among the most significant practical issues for leasing foreign made equipment into Russia. As a general matter, Chapter 11 of the Russian Federation Customs Code sets forth the basic rules governing the “temporary importation” of goods into Russia for a period up to two years; an amount equal to 3% of the full customs duties that would normally have been paid upon entry of the goods into Russia must then be paid on a monthly basis during such a period of temporary importation. Interest is charged on the unpaid amount of customs duties, and the applicable rate of interest may exceed 20% per annum. The period of temporary importation may be extended for an additional year under certain circumstances. Upon expiration of the period of “temporary importation,” the goods are normally to be re-exported out of Russia.
In practice, companies which have leased equipment into Russia pursuant to the “temporary importation” regime have almost uniformly found this approach to paying Russian customs duties on a deferred basis to involve more trouble and risk than it is worth. Our advice, for the reasons discussed below, is that all customs duties should be paid in full when equipment is first shipped to Russia; the cost of the customs duties should be included in the cost of the financing.
Some of the problems that may be encountered under the temporary import regime include: (1) The interest rate charged on the deferred customs duties may make it uneconomic to use this regime. (2) The process of shipping leased equipment out of Russia again has been found to involve many unexpected logistical difficulties and unpredictably high expenses. In the case of financial leasing when the goods are not expected to leave Russia, as opposed to an operating lease, the temporary importation regime may not be appropriate because it will normally involve shipping the goods out of Russia, and possibly re-importing them into Russia. (3) If the temporary importation regime is used, then the lessee is normally designated as the lessor’s agent to make customs duties payments each month, or the lessor must have personnel in Russia responsible for making these payments. There have been several examples of trucking companies having their trucks seized in Russia by customs due to non-payment of deferred customs duties by Russian lessees. Notwithstanding the fact that the contract language required the lessees to pay the monthly customs duties as they became due, such payments were not made, and the lessors did not know of the existence of the problem until large penalties were due or the goods forfeited altogether. If property in Russia is seized, even at no fault of the lessor, substantial storage fees and penalties will be imposed. (4) The process of extending the period of temporary importation for an additional year is cumbersome and uncertain. If the extension is not obtained in time, significant penalties are imposed. (5) If goods temporarily imported into Russia are not re-exported out of Russia on time, they may be seized on the basis that, following a deemed or actual violation of the rules for the temporary importation regime, the goods are unlawfully located on the territory of the Russian Federation.
The Leasing Law provides that customs clearance problems are a thing of the past for cross border leasing transactions. Article 34 of the Leasing Law provides that, customs taxes and tariffs shall be paid: (1) as of the moment of the subject matter of leasing is imported/exported, in the amount of the paid portion of the customs value of the property whose value shall be evidenced by bank documents; and (2) subsequently, customs taxes and tariffs shall be paid at the time that leasing payments are made or within 20 days of receipt of the leasing payments. Further, the Leasing Law provides that the procedure/system for payment of customs taxes and tariffs set forth by Article 34 shall be not deemed a deferral of customs payments nor shall it be deemed an investment tax credit. Therefore the provisions of Chapter 11 of the Russian Federation Customs Code setting forth the rules for “temporary importation” of goods into Russia, and payment of interest on deferred payments, are, according to the Leasing Law, no longer applicable.
In Letter No. 01-15/14858 released by the State Customs Committee on May 5, 1999, the Customs Committee announced that Article 34 of the Law On Leasing, insofar as it provides for a deferral of customs payments, contradicts the Tax Code and, therefore may not be applied. Accordingly, it seems highly risky for a cross border lessor to rely upon Article 34, and it would be most prudent, as a general rule, to require that customs duties are to be paid in full when equipment is first imported to Russia.
A joint letter issued by the Central Bank and the Customs Committee on May 28, 1996, No. 285, 01-42/9482, provides the generally applicable requirement that a “passport for an import transaction” must be obtained in order to clear goods though Customs is not applicable in the case of a cross border lease. The generally applicable requirement is set forth in Instruction No. 30 “On Currency Control Over the Payments for Imported Goods”, dated July 26, 1995. The exception is based on recognition by the Central Bank and the Customs Committee that the passport of transaction rules do not work with regard to a finance lease arrangement in which the shipper of the goods and the lessor may be different parties.
Notwithstanding the existence of Letter No. 285, Russian Customs authorities may, nonetheless, require that a “passport for a transaction” be obtained to clear leased assets through customs. The passport may be required to be obtained by a bank in Russia where the lessor may be required to open a bank account. In one instance, we were able to persuade local customs authorities to withdraw their requirement for a passport after presenting letter No. 285. However, customs clearance practices seem to be inconsistent at the present time.
Payment of import VAT
Indirect taxation of leases, i.e., VAT, continues to be very costly, and cross-border leasing continues to be impeded by Russian VAT. The VAT Law presently imposes an additional non-recoverable 20% expense on the import of many types of equipment leased from outside Russia, as opposed to equipment leased or purchased by a Russian entity. Nonrecoverability stems from the requirement that equipment leased pursuant to a finance lease must be recorded on the balance sheet of the lessor pursuant to Ministry of Finance Order No. 105. Further tax instructions allow equipment delivered to Russia pursuant to a cross-border lease to be placed on the balance sheet of the Russian lessee. See Order No. 15 of the Ministry of Finance. If equipment leased in Russia pursuant to a cross-border lease is placed on the balance sheet of the lessee, then the lessee may offset the import VAT paid by it against VAT received with regard to leasing services and from other sources. However, once equipment is placed on the balance sheet of the lessee, the lease payments are no longer deductible. Thus, cross-border leasing continues to be impeded by the non-recoverability of VAT.
It has been clarified that the leasing services related to cross-border leases are subject to VAT. However, pursuant to Letter No. VG-6-06/525, issued by the State Tax Service on July 30, 1996, a Russian lessee may offset “reverse charge” VAT (in reality, VAT withheld) with regard to the leasing service involved in a cross-border lease.
RF Government Regulation No. 1133 provides that interest paid on borrowed funds used by a leasing company for the realization of financial leasing may be included in the leasing company’s cost of production.
Lessees in Russia must withhold income tax at the rate of 20% on lease payments made to a lessor outside of Russia, except where there is a treaty with Russia that allows an exception from normally required tax withholding. An offshore lease company must register to pay property tax in each Russian jurisdiction in which it has property leased to Russian lessees.
Planning Points for Domestic Leasing Transactions
As an alternative to coping with the foregoing regulatory issues in order to engage in cross border leasing, a foreign vendor desiring to lease equipment to a Russian customer may either employ the services of an existing Russian leasing company, or may organize a wholly-owned captive leasing company in Russia. If there is to be a “one-off” transaction, it may be most economical to employ a Russian leasing company. Indeed, most Russian leasing companies are engaged in vendor-financed domestic leasing transactions. See the attached summary of the activity of domestic Russian leasing companies prepared by Victor Gazman of the Russian consulting firm “Garantinvest.”
A captive leasing company in Russia offers a favorable resolution of several of the regulatory issues enumerated above. Instead of engaging in a cross border lease of equipment that may require a currency license in order for the Russian lessee to be able to make scheduled payments, the lessee would make Ruble denominated payments to the captive leasing company in Russia. The amount of rubles to be paid would be indexed to equal the equivalent in dollars of the scheduled lease payment. The captive leasing company in Russia could pay the import VAT and offset this amount against VAT received on lease payments. The import VAT would not remain as a potentially unrecoverable expense. The captive Russian leasing company could verify that import duties have been properly paid.
The Currency Law issues that would be of concern in the case of a captive leasing company in Russia would be limited to the procedure for the leasing company to register the existence of its long-term financing. In principal, a single financing transaction would have to be registered, rather than a myriad of separate cross border leasing transactions. The Currency Law allows several different means of financing a lease company. Large contributions to the charter capital of the company may be made free of import duty and VAT at the time a company is organized, although, most likely, not of the equipment that is to be leased. Additional capital may be provided by means of a cross-border loan to a lease company. Such a loan would require a license or “permission” from the Central Bank if its term would exceed 180 days.
Presently, no debt-to-equity limitations for lease companies exist in Russia. Accordingly, the emerging model has been for foreign leasing companies to form low-capitalized, highly leveraged lease companies, working in close cooperation with a bank in Russia holding a general banking license. Such a bank is authorized to receive rubles, convert them to dollars and repatriate them off-shore. In the future, debt-to-equity limitations may be imposed by the Tax Code, creating a limitation on the deductibility of interest expenses in certain circumstances.
Alternatively, equipment may be delivered to a Russian leasing company pursuant to an installment sale arrangement. At the present time, payments may be made to an off-shore vendor for equipment that has previously been delivered to a Russian company pursuant to an installment sale arrangement.
Tax Planning for Leasing Transactions
The primary tax planning point about leasing transactions in Russia is that leasing payments are deductible in full by a lessee. Lease expenses are fully included in the cost of production of goods, i.e., fully deductible for profits tax purposes. Further, all “movable property acquired pursuant to a leasing agreement” is subject to accelerated depreciation at a rate three times faster than otherwise allowed.
In contrast, interest expenses have been deductible only in part, and the amortization of assets acquired with the proceeds of borrowing has been at “normal” rates rather than the accelerated rates available for leased assets. Interest on loans used to purchase capital assets is not deductible at all.
Generally, interest expense on a loan used for capital expenditure purposes is not deductible in Russia. Interest on a loan used for a purchase of equipment is generally required to be capitalized. Interest expense on intercompany loans (non-banks loan) is generally not deductible in Russia. Interest expense on a loan from a commercial bank that is used for working capital purposes, rather than for capital expenditure, is deductible by a Russian legal entity.
Notwithstanding the foregoing general rules, Section (q) of Decision No. 552 of the Government of the Russian Federation provides an exception for leasing operations. Section (q) allows interest on loans received from banks and other organizations to be “included in the cost of production” (i.e., deducted) if the borrowed amounts were used to finance leasing operations. Thus, interest on a loan from a corporate, or non-bank lender would be deductible by a Russian leasing company, as the holder of a Russian leasing license. Interest on a cross border hard currency loan is not deductible, even by a leasing company, if the amount of interest exceeds 15% per annum.
It should be borne in mind that Letter No.04-05-11/108 of the Ministry of Finance, dated September 15, 1998, provides that rentals received by a lessor under a leasing agreement are subject to the Road User’s Tax. Thus, one drawback to leasing in Russia is a liability of the Lessor to pay the Road User’s Tax (2.5%) and Housing Fund Tax (1.5%). These revenue taxes apply to gross revenues from sales of goods and services, and may apply to the entire amount of lease payments, which would seem inequitable because a major portion of lease payment represents a return of the asset cost.
Again, true to its character, the Leasing Law seeks to greatly expand the deductibility of expenses that are related to leasing transactions. Article 27 of the Leasing Law includes an extensive list of expenses related to a leasing transaction that are considered to be included in the lease financing and, therefore, fully deductible. Since very few, if any, tax returns by Russian lessees have yet been audited since the Leasing Law was enacted, there is, as of the fall of 1999, no guidance as to whether the Russian Tax Inspectorate is going to allow the deductibility of otherwise non-deductible, or amortizable expenses, because the Leasing Law so provides. It appears that a prudent approach in examining the cash flow for a lessee in a proposed leasing transaction would be to assume that the expenses that the Leasing Law says are deductible, in conflict with other generally applicable provisions of Russian tax law, will ultimately be disallowed as deductible expenses.
Part One of a new Tax Code came into effect in Russia as of January 1, 1999. Part One contains only organizational and procedural points, and does not alter the description of the taxation of lease transactions set forth above. It is not clear whether, or when, Part Two of the new Tax Code may be enacted.
When it is enacted, Part Two of the new Tax Code will likely alter existing tax laws in a manner adverse to the interests of leasing companies in Russia. The Tax Code would do away with the existing special depreciation regime for leased assets, discussed above, under which a leasing company may depreciate leased assets at a rate three times faster then normal amortization of a class of assets. The Tax Code would also allow the full deductibility of interest paid on credits, no longer requiring that the credits must be received only from banking institutions. The Tax Code would impose some debt/equity ratio limitations on the financing of leasing companies.
The Tax Code would treat leased assets the same as assets financed in any other manner for the purposes of depreciation. Draft provisions of the Code classify all types of property into one of six groups. The third group includes items classified as “working and power-producing machines and equipment” and “measuring and controlling instruments and devices.” The fourth group includes “computers and office equipment.” The fifth group includes “transportation resources.” These groups are not precisely defined.
The Code sets forth a standard monthly rate of depreciation for each group of assets. The third group depreciates at the rate of 2% per month, the fourth at the rate of 4% per month, and the fifth at the rate of 3.5% per month. No accelerated depreciation for leased assets would exist, unlike in the present law. Slightly faster rates of depreciation for small enterprises and other special circumstances would be available, and rates of depreciation for property entered on to balance sheets prior to enactment of the new Tax Code appear to be preserved. However, rules regarding grandfathering existing rates of depreciation and reference to the special regime for leasing appear to be eliminated.
With regard to the deductibility of interest, the Code provides that the following expense shall be included in allowed expenses for the production and sale of goods, work and services: “interest paid on credits received for purposes directly associated with production, acquisition, and/or realization of goods, work, and services; and interest accrued on securities and other obligations . . .”
These changes allowing the full deductibility of interest expenses and the same depreciation treatment for leased or purchased assets may seem unremarkable to American taxpayers where these rules are the norm. But these two alterations to the existing tax regime will remove two comparative advantages for lease financing, as compared to loan financing.
The Civil Code, and the Leasing Law
Prior to passage of the new Leasing Law in October 1998, the legal environment for leasing had been quite stable since Part Two of the Civil Code of the Russian Federation entered into force on March 1, 1996. Part Two of the Civil Code contained provisions governing rental in general (Articles 606 – 670) and financial leasing in particular (Articles 665 – 670). The provisions added to the Civil Code in 1996 by Part Two were regarded, prior to the passage of the Leasing Law, and are still regarded by many commentators as providing a workable and sufficient legal framework for such transactions.
On October 29, 1998 President Yeltsin signed a new Federal Law on Leasing. Many provisions of the new Federal Law on Leasing conflict with several other provisions of Russian tax, currency, customs, and civil procedural law, and the Civil Code, and will give rise to several new questions. As noted above, Russian Customs authorities have issued a letter indicating that the customs authorities will disregard those provisions of the Leasing Law that conflict with any provisions of the Customs Code until such time as the Customs Code, and related regulatory materials are amended. Russian Central Bank officials have also taken inconsistent positions regarding whether a currency license is required to be obtained by a lessee in order to make hard currency payments to a foreign lessor. As of the fall of 1999, the Russian Federal Tax Inspectorate appears not yet to have issued any written guidance whether it will abide by provisions of the Leasing Law that seek to expand the number and types of expenses that may be included in a lease payment, and thereby made deductible by a lessee while such expenses would not be deductible if incurred directly.
The Leasing Law is generally regarded by commentators as poorly drafted, and the history of the development of this law, and its eventual passage is an interesting one. From the beginning, the draft lease law was the work product of a small group of persons affiliated with leasing company subsidiaries of certain Russian commercial banks. The draft law went through many versions and was vetoed by President Yeltsin in August 1998, only to be resuscitated in the State Duma again in September 1998.
In March 1998, the International Finance Corporation (“IFC”) issued a lengthy analytical report (the “IFC Report”) on the legal and regulatory framework for financial leasing in Russia. The IFC Report contained several criticisms of the draft leasing law as well as a description of the fundamental elements of a successful financial leasing law. The IFC’s comments were based on the input of various international leasing experts, as well as the IFC’s own experience in stimulating the growth of lease financing in various nations. The drafters of the lease law pending in the Duma rejected and did not use any IFC recommendations.
On April 11, 1998, the Government of the Russian Federation issued a lengthy letter (No. 1866-p5) (the “April Letter”) recommending a veto of the draft lease law. The letter included a lengthy list of certain legal issues and drafting problems present in the draft law.
Despite criticism of the draft law by the Government in April, proponents of the law nonetheless advanced the same criticized version of the law through approval by the State Duma and the Council of the Federation on July 15 and July 17, respectively; however, the President then vetoed this draft lease law on August 2, 1998.
A Statement from the President’s Press Service on August 2, 1998 concerning the veto (No. 1998-08-02-003) instructed the Duma not to undertake any more work on preparing a new draft lease law. The Statement indicated that Yeltsin vetoed the draft lease law because: (1) leasing does not constitute an independent subject for legal regulation, meaning that all the points addressed in the draft law should be addressed in other federal laws which bear upon tax, customs, contractual and civil procedural issues, (2) several provisions of the draft law were inconsistent with existing provisions of the Civil Code, (3) existing provisions of the Civil Code provide a sufficient basis for leasing contracts, and (4) the Unidroit Convention on International Financial Leasing applies to certain cross-border lease transactions.
The vetoed draft lease law, nonetheless, came back to life as a consequence of subsequent political events in Russia. The vetoed lease law was originally submitted to the State Duma by several deputies, including Communist Party member Yu. D. Maslyukov. Following the removal of the Kiryenko government in late August 1998, a political compromise led to Mr. Maslyukov being appointed as First Deputy Prime Minister under Prime Minister Yevgeni Primakov. Thereafter, a slightly revised version of the draft lease law was again submitted to, and approved by, the State Duma on September 11, 1998, and as noted, was ultimately signed by the President on October 29. At the time, it appeared that the resurrection and passage of the much criticized draft law on leasing was a political concession to Mr. Maslyukov and the Communist bloc in the Duma, and came about as a result of insider intriguing. The draft law was supported by only a narrow circle of well connected Russian leasing companies and had been widely criticized by independent experts.
A comparison of the current draft lease law with the vetoed version of the law reveals that the changes which were made were cosmetic responses to some of the criticisms made in the April Letter recommending a veto of this law. The adopted version of the Leasing Law did not attempt to reconcile many of its substantive provisions with existing provisions of the Civil Code, Civil Procedural Code, Tax Law, Customs Law, Joint Stock Company Law, and Bankruptcy Law. The draft law contemplates that changes to all of these laws shall be made by regulations approved by the Government, rather than by amendments to these laws to be approved by the Duma.
As of October 1999, none of the amendments to the other Federal Laws that would be required to bring them into compliance with the Leasing Law have been adopted, or formally proposed to the Duma. Accordingly, a number of interpretive problems exist due to conflicts between provisions of the Leasing Law and provisions of other Federal Laws.
Most likely, resolution of the numerous conflicts between provisions of the Leasing Law and other Federal laws will have to await the election of a new majority in the Duma, and perhaps also the election of a new President next June. One potentially desirable outcome would be for the Leasing Law itself to be repealed because it is of little practical use, and gives rise to much confusion, and leasing transactions may proceed on the basis of the applicable provisions of the Civil Code.
As noted in several places in this article, the Leasing Law is in conflict with numerous other provisions of Russian tax, currency, customs, civil and civil procedural laws. It seems that these obvious “imperfections” in the law have come to be regarded with favor by certain lessors and lessees because their “creative interpretation” can result in beneficial consequences for particular transactions. This opportunity for “creative” and particularized benefits appears to have been one of the special purposes in mind by the draftspersons. However, such wholesale disregard by the draftspersons for conflicts between provisions of the Leasing Law and other applicable laws appears to be an example of poor quality legislation that frustrates one of the primary purposes of the rule of law in any country – the creation of predictable outcomes for identical transactions.
While the Leasing Law may largely be disregarded in practice and does not impose any substantial restrictions on a foreign lessor’s operations in Russia, the following is a summary, but not an exhaustive list, of certain provisions of the new Leasing Law that may be problematic from the point of view of a Western lessor.
1. In Article 2, definitions of “currency operations”, “resident and non-residents of the Russian Federation”, and the “customs border” have been removed. This removal of defined terms was done in response to a comment in the April Letter that these phrases are defined in the “Law on Currency Regulation and Currency Control” and the “Customs Code” and are not a subject for regulation by this law. However, despite removing certain defined terms, the Leasing Law continues, in Article 34, to call for a wholesale exemption of financial lease transactions from otherwise applicable currency and customs law, as discussed below. The net effect of removing defined terms while continuing to seek to implement substantive changes in other laws is to create an additional layer of ambiguity in the law about the relation between this law and other existing laws.
2. Articles 2 and 4 contain contradictory statements about whether lessees have a right to ownership of leased property. Article 2 provides that, in a leasing transaction, “the lessee shall have the right to buy out the property so leased.” Article 4, Par. 1 provides that property is be used by the lessee for a certain term “with or without subsequent transfer to the lessee of the right of ownership to the subject matter of leasing.” The two statements are contradictory – and with regard to a fundamental question.
3. Article 3 defines the subject matter of leasing to include buildings, structures and other movable and immovable property. Financial leasing is normally limited to movable property. A lease transaction of buildings and structures in Russia is normally considered to be a “rental transaction” within the meaning of Articles 606 – 625 of the Civil Code. The attempt to provide for “leasing” of real property is probably designed indirectly to accomplish a tax strategy of obtaining accelerated depreciation for real estate, notwithstanding the relatively slow rate of depreciation allowed by otherwise applicable law. In most all other jurisdictions in the world, financial leasing is restricted to leasing of equipment, and no express statement in any Russian Federation government release confirms that it was intended that financial leasing be available for a lease of real estate. This unclear matter is unlikely to be resolved without amendment of the relevant tax laws.
Also, the Leasing Law goes on, in Articles 7 and 8, to define operating leasing and subleasing as forms of leasing. In the case of operating leasing where property that is being leased is intended to be returned to the lessor and re-let several times, the “seller” plays no ongoing role in the transaction. The intended effect is to obtain the benefit of accelerated depreciation for “rental” activity when the benefit of accelerated depreciation was meant for financial leasing involving investment in new equipment effected through a three party transaction. Confusion will result, perhaps intentionally, about whether transactions that are meant to be “rental” transactions within the meaning of the Civil Code end up being treated, nonetheless, as “leasing transactions” defined elsewhere in the Civil Code. The intentional creation of confusion as a basis for seeking to claim tax advantages for rentals of real estate seems a poor way to make tax law.
4. Article 6, Par. 3 would provide that a foreign lessor must register with the Russian tax authorities in order to obtain a license to engage in a cross border lease. This requirement has been waived in practice by the State Registration Chamber and the Ministry of the Economy which requires proof that a foreign lessor is registered with tax authorities in its home jurisdiction. It appears not to be necessary for the Ministry of the Economy’s purposes that a foreign lessor register with Russian tax authorities. This point is being included at the request of Russian leasing companies that are subsidiaries to Russian commercial banks which want to make it a bit more burdensome and risky for foreign lessors to obtain a lease license.
Substantively, registration in Russia with the tax authorities may be necessary for the purpose of registering as a payer of property taxes, and liability for profits taxes would depend upon whether a foreign lessor had a permanent establishment in Russia. Such registration may be avoided if property is electively placed on the balance sheet of the lessee, as is currently allowed. However, Article 12 would remove the freedom to elect which party would record equipment on its balance sheet. Article 12 would require that equipment that is the subject of an “operating lease” which may, as noted above, include financial leases with a term shorter than the period of full amortization of the property, would be required to be recorded on the lessor’s balance sheet.
5. Article 7, Par. 3 creates some fundamental problems because of its definitions of “finance leases” “lease-back” and “operating leases.” Article 8 goes on to provide a separate definition for “sub-leasing.” Article 10 goes on to describe something else called “mixed leasing” which is not defined anywhere. The interaction of these definitions with subsequent provisions concerning the allocation of rights and obligations among parties to financial leasing and operating leasing, and other provisions of the Leasing Law has not been thought through and may give rise to problems.
It is said in the Leasing Law that a “finance lease” must be for a term that is commensurate in duration to, or exceeds, the term of full depreciation of the subject matter of leasing. This is wrong. There does not, in fact, need to be any correlation between the term of a finance lease and the depreciation of the asset, which may be quite slow under standard Russian depreciation schedules. If this aspect of the definition is retained, then many leases that provide for full payment for the subject equipment over a period shorter than its full amortization may be disqualified from being considered finance leases, and would appear to be operating leases, which would entail the loss of tax benefits reserved for finance leases.
6. Article 7, Par. 4 provides a host of “extra services” which may be included in a lease transaction. The extra services each involve expenses that are, under generally applicable rules, not allowed to be fully currently deducted. Thus, Article 7 attempts to re-write Russian tax laws by lumping into fully deductible lease payments a number of expenses that otherwise would be required to be amortized. Some of the extra services that may be lumped into leasing payments are the cost of acquiring intellectual property rights, inventory, the performance of installation and assembly, personnel training, post-warranty servicing, the preparation of production premises (i.e. a building) complete with utility supply lines and conduits, and all other work and services without which the subject matter of leasing may not be used. Again, this seems to be a poor way to write tax law, and one that is not likely to be successful. The tax laws should, instead, be amended directly.
7. Article 8 which defines subleasing as a form of leasing directly conflicts with the definition of financial leasing in the Civil Code. The Civil Code definition which disqualifies subleasing as a finance lease should instead be altered directly.
8. Article 9 contains poorly conceived limitations on the combinations of roles that may be played by parties to a leasing transaction which would exclude certain commercially viable transactions for no apparent reason. For example, a creditor and a lessee may not be the same person. Why should it be prohibited for a company to lend money to a lessor to acquire equipment to lease to that company. Would a downpayment be considered a prohibited loan?
9. Article 10 sets forth a completely unnecessary set of rules concerning the allocation of rights and obligations between parties to a leasing arrangement. These matters should be left to resolution by contract among the parties. In addition to being unnecessary, the rules that are stated do not make sense because the defined terms are so poorly written. For example, Par. 4 and 5 make a distinction between: (i) financial leasing and mixed leasing (not now defined anywhere – it was removed incompletely from the prior draft) and (ii) operating leasing. In the case of financial leasing, the lessee is to address claims to the seller regarding quality, completeness, and other warranties. In the case of an operating lease, the lessor is liable for such claims.
First, these matters should be left to the parties to be resolved by contract. Second, as noted above, the definitions of financial leasing and operating leasing are wrong. What should qualify as a finance lease may be disqualified if its term is shorter than the period of full amortization of a piece of equipment. The result under this law would be that the lessor would, unexpectedly, be liable for breaches of the manufacturers warranties. The lessee is then granted a unilateral right to demand a reduction of lease fees and damages. This re-writing of international norms for financial leases may be perceived as so adverse to a lessor’s interests that the risk of assuming the manufacturer’s obligations under its warranties if equipment is leased to a Russian lessee will be judged to be so large that lessors will be reluctant to lease equipment to Russian lessees. Alternatively, leases may be required to be on a cross-border basis, and governed by a foreign law. A Russian court may conclude that a limitation on the lessor’s liability is contrary to the public policy expressed in this Leasing Law.
After that swing in the lessee’s favor, the Leasing Law then swings in the lessor’s favor. Par. 7 of Article 10 provides that, “in the event that the leasing market situation and the conditions of the lessor’s business change, leading to a material deterioration of the financial status of the lessor, the terms and conditions of the leasing agreement may be revised, subject to the consent of the parties.” This one-sided provision for a change in the contract if business developments have turned out adverse to the lessor’s interests may lead a prospective lessee to believe that it has inadequate certainty about the terms of a proposed transaction with a leasing company. This uncertainty may make leasing compare poorly to a loan of enough funds to buy a piece of equipment.
10. Par. 3 of Article 11 and Article 13 set forth extrajudicial means for a forced recovery of leased property following a lessee default. The strong-arm tactics referred to in the discussion of the “right of unconditional repossession” of leased equipment, and the unconditional seizure of bank account balances, conflict with the provisions of the Civil Code that are in effect. Existing provisions of law require court proceedings to rescind a lease, and eventually to obtain the services of a bailiff from the Ministry of Justice to enforce a writ of execution to repossess equipment. Again, the draftspersons should instead have proposed an amendment of the relevant provisions of the Civil Code and the Civil Procedural Code, rather than seeking to revise them with an overlay of special rules for leasing transactions. Otherwise, it is very likely that the desired repossession techniques may be found to be invalid, and enjoined, by a Russian court.
11. Articles 15 – 22 contain a lengthy and unnecessary list of required contents of leasing contracts. Some of these provisions may be included in lease contracts, but this should only be at the discretion of lessors and lessees.
12. Article 25 provides for more “Wild West” enforcement tactics implying a regulation of a physical conflict between guards working for the lessor and lessee. The Article provides that “If the lessee prevents the lessor from taking the subject matter of leasing, the lessor may exercise in court any remedies available thereto.” Only if a lessee is successful in a physical defense of the leased assets will the lessor have to go to court to try to enforce its rights legally. It is not clear what is contemplated by Article 25, or may arguably be sanctioned by Article 25. Such ambiguity may be construed as giving broad sanction to “uncivilized” repossession tactics.
13. Article 25 was altered prior to passage to remove a clarification of the treatment of leased property in the context of a lessee’s bankruptcy. The vetoed version of the lease law clarified that leased property could not be seized in the event of a lessee’s bankruptcy. Probably, the point of the requested removal of the discussion was only that this is a matter to be resolved in the bankruptcy law itself, and not in a leasing law. The answer appears to be clear in the bankruptcy law that leased property is not “property of the debtor” that should be subject to inclusion in the bankruptcy estate. See Article 103 of the Bankruptcy Law. However, whatever clarification the authors of the leasing law were seeking should be sought by means of a clarifying amendment to the Bankruptcy Law, rather than as an add-on to the leasing law.
14. Article 27 of the Leasing Law contains an extensive list of approximately 20 kinds of expenses that may be incurred by a lessor, and which are to be reimbursed to him by the lessee. All of these provisions belong in a contract between a lessor and a lessee, rather than in a lease law. Article 29 provides that all of these expenses shall be included in leasing payments. To the extent that the purpose of spelling them out is to accomplish a tax objective of making all such expenses currently deductible by the lessee, where a portion of them are not otherwise deductible, such a change in the tax laws should be accomplished in an amendment to the relevant tax laws. For example, insurance premiums would be made deductible if characterized as a lease service while insurance premiums are otherwise not deductible. It is unlikely that this ruse would withstand a tax audit.
15. Article 28 addresses the pricing of goods accepted as payment in kind (barter) as lease payments. This discussion should be left to the lease contract, or related commodities purchase and sale contracts. Article 28 also limits the number of months that lease payments may be deferred, for reasons that are not apparent.
16. Article 34, Par. 1, exempts lease transactions from the currency licensing requirements of the Central Bank. This provision is inconsistent with the Central Bank’s position. The Central Bank’s position should be changed directly by an amendment of the Currency Law rather than by the adoption of a leasing law that is in conflict with published interpretations of the Currency Law.
17. Article 34, Par. 3, provides for a customs clearance regime that conflicts with applicable provisions of the customs law. Customs duties would only be paid with regard to the portion of the cost of the leased equipment that was paid with a downpayment. This regime conflicts with the “temporary import” regime of the Customs Code, and alters the application of value added tax (“VAT”) to imports to Russia. The new law would provide that no interest would be paid with regard to deferred payments of import duties and VAT, creating a further conflict with the requirement that interest apply to deferred customs payments.
In sum, the Leasing Law is both poorly conceived and written, and conflicts with numerous other provisions of Russian law. To the extent that the Leasing Law contains some good ideas, they should have been, and still could be, distilled and drawn up in a package of proposed amendments to all the other laws with which provisions of the Leasing Law conflict.
Repossession of Leased Property
As in other jurisdictions, leasing offers the fundamental advantage, as compared to lending funds to purchase an asset and taking a pledge of the purchased asset, that the lessor retains ownership of the asset involved and may obtain repossession of leased property. In contrast, if the delivery of equipment is financed by a loan and a pledge of the equipment, in the event of a default, the pledged equipment must generally be sold at auction after a court proceeding.
Yet, in practice, difficulties arise in enforcing a lessor’s rights in Russia in the event of default. Russian finance lease companies express frustration with the amount of time required to enforce repossession rights in the Russian legal system following the breach of a lease’s terms. Certain provisions in the Russian Arbitration Code intended to expedite enforcement proceedings still take three months or more in practice. Sometimes, a lease company will forcibly take repossession of leased property. Forcible repossessions leave a lessee able to start a legal proceeding if it claims that its rights as lessee were violated, despite the lessee’s default under the terms of its lease. In a case of leased equipment installed in distant locations, or equipment such as oil field equipment that is installed underground, retention of the right of ownership may be of little real value. Repossession of leased assets, as elsewhere in the world, is the least desirable method of addressing a default, and may be logistically impossible in some cases.
The Leasing Law purports, in Article 13, to have strengthened a lessor’s right to repossess leased property. It would be prudent, however, to have a skeptical view toward the use of the rights set forth in the Leasing Law to the extent that they conflict with other provisions in the Civil Code, Civil Procedural Code, and other applicable laws that provide procedural or substantive protections for a lessee of its right to cure a default and remain in possession of leased equipment.
Thus, in addition to retention of the right of ownership of an asset under Russian law, various other arrangements are always made in lease transactions in Russia to secure the payment of lease charges. Less comfort is taken from the retention of ownership rights than in most other jurisdictions in the world.
Additional forms of security for lease transactions include guarantee agreements from equipment vendors, guarantees from companies affiliated with a lessee, re-sale agreements, price guarantees, pledges of other assets owned by a lessee, off-shore escrow accounts, bills of exchange from off-shore banks, and other mechanisms. A requirement for insurance against loss of the equipment and repossession risks is becoming increasingly common in Russian lease financing. Several Russian insurance companies offer such coverage backed by re-insurance provided by various European insurance companies. The leading global and Russian leasing companies operating in the country are finding realistic solutions to most problems that may be encountered, and are setting their approval criteria high prior to entering into proposed transactions in order to avoid the obvious risks.
As elsewhere in the world, good credit analysis, significant non-refundable downpayments, and use of the best available forms of security interests and insurance are both the most effective means of securing a lessee’s promise to pay and the first resort in the case of default. A lease contract must also be soundly written, from a legal point of view, so that its terms are enforceable and avoid hidden problems presented by Russian legislation. Various grounds for rescission of the contract need to be examined and reflected in the contract.
Russian Leasing Companies
For a survey of general information about Russian leasing companies, please see the attached article prepared in conjunction with Victor Gazman of the Russian consulting firm “Garantinvest.” Also, there are at least three useful web sites regarding leasing activity in Russia. These are: (1) a site maintained by the International Finance Corporation that may be found at www.ifc.org/russianleasing; (2) a site maintained by the Russian Association of Leasing Companies that may be found at www.rosleasing.ru; and (3) a site maintained by Vinod Kothari, a leasing consultant that may be found at www.geocities.com/WallStreet/Exchange/8413/index.html.
Conclusion
Leasing should prove to be a growing, flexible and promising means of financing the acquisition of many types of equipment needed by Russian industry and entrepreneurs. Foreign leasing companies should have certain compelling advantages over their Russian competitors due to their experience with such transactions and access to relatively inexpensive sources of capital. Russian leasing companies would welcome joint lease/sub-lease transactions in which they would assume responsibility for all activities in Russia, and provide guarantees of lease repayments to a foreign partner. Alternatively, a foreign leasing company that desires to capitalize upon the opportunity to develop a larger scale business in Russia of its own in coming years should set up a wholly-owned, or jointly-owned leasing company in Russia.
I. Simple cross border sale of equipment, subject to VAT and customs duties
Vendor ………….. Contract of Purchase and Sale …..Border………… Customer
Equipment —>
<— Payment
II. Gray Market (Illegal) Transaction
Equipment delivery: 2 Scenarios
A. False Customs Declarations
1. Vendor….Equipment –>….Off-Shore Intermediary
2. Off-Shore Intermediary…Equipment –>…Black Box Co. No. 1
3. Black Box Co. No. 1…Equipment –>… Black Box Co. No. 2……Border
4. Black Box Co. No. 2….Border….Equipment –>…..Black Box Co. No. 3
(then, liquidated) (Customs Clearance at 10% of value, or as scrap metal)
5. Black Box Co. No. 3……Black Box Co. No. 4
(then, liquidated) #9; (acting as agent for Black Box Co. No. 3)
6. Black Box Co. No. 4 ……Customer
(reports little or no income attributable to nominal agency fee)
B. False Contribution to Charter Capital
1. Vendor…Lease or Installment Sale of Equipment –>..Off-Shore Intermediary
2. Contribution by Off-Shore Intermediary of Equipment to charter capital
of new Russian legal entity, free of import duties and VAT per exceptions
intended to promote foreign investment in Russia
3. Use of equipment by Russian customer
Note risk that legal entity appears, for Russian legal purposes,
to own equipment free and clear; and therefore may attempt to sell
the equipment and disavow any debt to equipment vendor
Payment: 4 Scenarios
A. Prepayment Scenario
1. Vendor…–>…financial guarantee…–>…independent bank or finance company
2. Bank or finance company…dollar loan…–>…Customer
3. Customer…full prepayment…–>…Vendor
Note risk of loan proceeds, subject to financial guarantee
from Vendor, being misappropriated by Customer,
creating risk of liability to Bank and loss of equipment
B. Installment Payment / Workout Scenario
1. Customer…….Black Box Co. No. 4
(Ruble payment for cost of goods, plus the customs duties not paid,
but excluding import VAT – the “savings”)
2. Black Box Co. No. 4…Rubles–>……. Co in Russia earning
dollars off-shore from exports
3. Unaffiliated Company….Dollars–>…Vendor
C. Use of Off-Shore Bank Scenario
1. Customer…………….Bank in Russia
(Dollar payment for majority of cost of goods,
with perhaps 10% paid in fraudulent customs declaration)
2. Bank in Russia………Off-Shore Money Transmittal Company
3. Off-Shore Money Transmittal Company…..(Seller)
D. Payment of Dividends
In the event that equipment was contributed to the charter capital of a Russian legal entity free and clear, there is no obvious basis for the equipment vendor to receive any payments. Payments to the vendor would require further fraudulent transactions, or payment of dividends to the owner of the Russian legal entity. It appears, most likely, the vendor will encounter a default and a loss.
III. Possible Transparent Arrangement
Intended to be able to compete with gray market
transaction economically, and to be legally enforceable.
Equipment delivery
1. Vendor Finance Company
Banks, Guaranteeing Agency…..loan–>…..Off-Shore Holding Company
2. Off-shore holding company..cross border loan->.On-Shore Leasing Company
3. Seller … Contract of Purchase and Sale…Border…On-Shore Leasing Company
Equipment —> (Or, other customer)
<— Payment
4. Leasing Company…..Lease of Equipment…..Joint Venture in the
region of the ultimate consumer
5. Joint Venture……Provision of Services…… Consumer
6(a). Consumer …..sale of product: crops, oil, services…..Buyer
6(b). Consumer…..delivery of portion of product in kind to Joint Venture
Payment
7(a). Customers….payment–>…Consumer, or Joint Venture, or Leasing Company
7(b)(i). Joint Venture…..delivery of portion of product taken in kind–>..Buyer
(b)(ii). Buyer ……payment–>……Joint Venture or Leasing Company
8. Leasing Company (or Joint Venture)..payment->.Off-Shore Holding Company
9. Off-Shore Holding Company….payment–>….Banks
Activity of Russian Leasing Companies Between August 1998 and August 1999
By: Derek Bloom of Coudert Brothers, Moscow and
Victor Gazman of Garantinvest, Moscow
The Russian financial leasing sector demonstrated sustained growth during several years before the crisis of the fall of 1998. The aggregate annual amount of new financial leases was as high as one billion dollars. The Russian market became an attractive place for doing business for such companies as Sogelease Leasing GmbH, a Societe General company (Austria/France); Capita Corporation CIS, previously affiliated with AT&T Capital company (USA); ABN Amro Lease (the Netherlands); Rank Xerox Leasing (Europe) Limited and Xerox (CIS), Xerox companies (UK/USA); Hewlett Packard A.O., a Hewlett Packard company (Austria/USA); Sudleasing GmbH (Germany); ABB Credit (Sweden); Motorola Credit Corp. (USA); Mietfinanz GmbH and Akf Unilease GmbH (Germany); and Lease Finanz Ag (Austria); etc.
The year 1998 was by no means the best period in the history of financial leasing in Russia although original projections for 1998 were very optimistic. Leading Russian leasing companies, including RTK Leasing, Interrosleasing, RusLeasingsvyaz, Inkom Leasing, Russian-German Leasing Company, and LK Leasing had been projecting growth in the Russian leasing sector during 1998 of as 40% to 50% over the level achieved in 1997. However, it appears that actual growth in 1998 as compared to 1997 was half that rate. The value of equipment delivered pursuant to new leasing contracts executed in 1998 was approximately $1.2 billion. According to the Rosleasing Association its members executed contracts for a total of $510 million of this amount.
In late 1998 and in the first six months of 1999 the Russian financial leasing market witnessed the following developments. A number of new leasing companies were established or proposed in the nearest future. They include John Deere Credit and Case for agricultural equipment, Metrosvyaz Limited of Cyprus, and Svyazinvest of Russia for telecommunications equipment; Scania Credit Ak of Sweden and DaimlerCrysler Service (debis) of Russia for trucks, buses and cars; Investpromhold, a Russian group of companies, and Sokolovskaya Limited of the United Kingdom for equipment used in coal mining, aluminum and copper industries, banking, etc.
Certain existing Russian leasing companies increased their authorized capital or sold shares of their stock to Western investors. Andrew Financial Services Corporation, a US telecommunications company, purchased a 16% equity interest in RusLeasingsvyaz in December 1998. Prodmashleasing increased its capital from $3 million to $4 million.
The number of financial leasing licenses issued to residents and non-residents continued to grow, albeit at a slower pace. The licensing statistics of the Ministry of the Economy indicate that, as of September 1, 1999 the Ministry had issued financial leasing licenses to 936 Russian residents and 89 non-residents. Of the licenses issued to resident companies, 368 licenses, or 39.3 percent of the total number were issued to companies registered in Moscow.
The State Registration Chamber and the Rosleasing Association of Russian leasing companies estimate that 60% to 70% percent of domestic license holders have not started leasing operations. There are very few such instances among the non-residents. Western lessors typically applied for a license to implement specific leasing projects in Russia.
Before the crisis in the fall of 1998, new leases executed by the members of the Rosleasing Association had the following annual breakdown in terms of price: 43.2% below $10 million; 18.1% between $10 million and $100 million; and 2.3% above $100 million.
Our review of the operations of 82 Russian lessors as of the close of 1998 revealed that the breakdown of new financial leases by the price of the goods financed was as follows: 45.1% below $2 million; 28.0% between $2 million and $10 million; 18.3% between $10 million and $50 million; and 8.6% above $50 million.
Many Russian leasing companies that are actively involved in leasing transactions were established prior to the crisis in the fall of 1998 by Russian banks or industrial corporations. Before the crisis, most of the equipment purchased by leasing companies, approximately 70% to 80%, was manufactured in the outside of Russia. In late 1998 and during the first six months of 1999, the ruble depreciated, and the price of imported equipment increased fourfold. Consequently, the cost of products manufactured using such equipment went up by a factor of 2 to 2.5. As a result, a new trend emerged in 1999 for equipment purchases by Russian leasing companies: more financial leases now involve the supply of Russian-made equipment.
However, purchases of many types of Western-made equipment continue to be made on the basis of business contacts that were established prior to the fall of 1998 between Western equipment manufacturers and Russian customers and leasing companies. Also, Western equipment is still required for many applications. The cost effectiveness of imported equipment has become a more significant factor for leasing companies in their selection of equipment purchasing strategies.
Under Russian law annual external audits are mandatory for many lessors which have a volume of business higher than $2.021 million, or if total assets exceeds $809,000, or if the leasing company is organized as an open joint stock company. Accordingly, a number of Russian leasing companies undergo annual audits by international accounting firms. In addition to Russian regulatory requirements, such audits are required by lenders and equipment suppliers.
Our review of audit reports on several Russian leasing companies indicates that vendor financing has become the most important source of financing for the leasing operations of leading Russian leasing companies. For example, commercial credits account for 45% of the total financing of RTK Leasing and up to 61% of the long-term liabilities of Russian-German Leasing Company. A quarter of the 60 Russian lessors we surveyed manage to obtain commercial credits from equipment vendors for terms of six months to three years, covering most of the term, or the entire term, of the leases financed by such vendor credits.
The value of the commercial credits obtained by Russian leasing companies is typically less than the value of bank loans. For example, Promsvyazleasing obtained commercial credits from non-Russian suppliers at a rate of 8 to 10% per annum. A German supplier of equipment for making confectionery and bakery products extended to the Vladkhleb leasing company of Vladivostok a commercial credit for 3 years at 8% per annum. A Sakhalin leasing company (Salco) obtained a commercial credit from a German drilling equipment supplier for 2 years at rate of 10% per annum.
Cross-border leases may become more attractive as a result of a decision taken by the Commission for Protective Measures in Foreign Trade and Customs/Tariff Policies under the Russian Government on July 19, 1999 to lower import duties on many types of imported equipment. Import duties are to be reduced for many types of equipment to 5%, as compared to 10% to 15% of the declared customs value. The reduction in import duties is first to be made available to equipment for the medical, textile, food, lighting, and electronic industries. The reduction in import duties is intended to be extended in the future for other equipment that has no Russian manufactured equivalent.
The development of the leasing industry may also be promoted by the enactment of Law No. 160-FZ on Foreign Investments in the Russian Federation, dated July 9, 1999. The law applies to financial leases of any equipment with a customs value of $40,900 or greater. The law declares that a foreign investor shall be subject to legal regulation no less favorable than the legal regulations applicable to Russian investors. The law provides guarantees of legal protection for foreign investors’ operations in the Russian Federation, and guarantees the ability to transfer a foreign investor’s rights and obligations to another party. The law also provides for indemnification in the event of the nationalization or expropriation of a foreign investor’s property. A grandfathering clause is included to protect foreign investors and business entities with foreign investment against any adverse change in Russian law. In particular, the law grants stabilization to any foreign investor in an investment project (including a financial lease) for the period required to pay back the amount invested, or 7 years, whichever is less.
Published Data on Equipment Leases in Russia
between August 1998 and July 1999
|
Owner |
Lessee |
Leased Property |
|
Interrosleasing |
RAO Norilsky Nickel |
Mining equipment for a total of $37.5 million |
|
AK Alrosa (Yakutia) |
Mining equipment for a total of $6.3 million |
|
|
Baltiyskiy Leasing (Saint Petersburg) |
Admiralteyskiye Verfi (Saint Petersburg) |
Shipbuilding equipment for a total of $38 million |
|
OAO Elektrosvyaz (Orenburg) |
AO Orensot (Orenburg) |
Cellular communications equipment with a value of $1 million |
|
Avtopromleasing (Moscow) |
Construction and road maintenance companies in Moscow |
200 bulldozers manufactured by a tractor plant in Chelyabinsk |
|
Western aircraft suppliers |
Russian airlines |
31 passenger aircraft; about $150 million in annual leasing payments |
|
Rusleasingsvyaz |
Regional telecommunications companies |
Telecommunications equipment with a value of $128 million and projected deliveries in the amount of $200-250 million in 1999 |
|
Moscow Leasing Company |
Small businesses in Moscow |
Processing, transportation and shop equipment for agricultural produce, for a total of $30 million |
|
SBS Leasing (Moscow) |
Vesna (Samara) |
A Balestra detergent production line and a Matsoni toilet soap production line under a 4-year lease |
|
John Deere, Case |
Russian agricultural businesses |
Agricultural equipment leases for a total of $2 billion |
|
Boeing |
Aeroflot |
August 1998: ELFC, a US leasing company, delivered a Boeing-777-200 under a lease expiring in 2003, with a price of $150 million and under a 7-year lease |
|
December 1998: four Boeing 767-300E aircraft leased |
||
|
March 1999: delivery of the last of ten leased Boeing 737-400 aircraft (with a total contract price of $350 million) for flights between Moscow and Rome and between Moscow and Milan |
||
|
Yakovlev |
Polyot |
Plans to lease three Yak-42 aircraft for charter flights to Turkey, Syria, Italy, and UAE |
|
Yakovlev, Tupolev |
Inkom Avia |
Lease and maintenance of Yak-42D aircraft to Krym Company ($6 million) |
|
Lease of a Tu-154M to Belavia ($6 million) |
||
|
Krasnoyarsk Airlines and ARBANT, an Iranian airline |
Acquisition and joint operation of two Tu-154M aircraft under lease arrangements |
|
|
Aerokuznetsk, an airline in Novokuznetsk |
Lease of two Tu-204 aircraft for a total of about $50 million |
|
|
Sirocco Aerospace, an Egyptian leasing company |
Three Tu-204 aircraft manufactured by Aviastar in Ulyanovsk. The price of one aircraft is about $36 million. |
|
|
Oktyabrsky Plant (Novosibirsk) |
Russian-Chinese bottling line for 1.5l plastic bottles |
|
|
Haas (Denmark), Tetra Pack |
OAO Petrokholod (Saint Petersburg) |
Baking and packaging equipment |
|
ANTK Antonov (Kiev) & OAO Aviastar (Ulyanovsk) |
Royal Air Force, UK |
Bidding for the lease of 4 strategic military transport aircraft for 7 years. The contract will be awarded in January 2000. |
|
Road maintenance and construction equipment manufacturers |
Rosdorleasing |
Requirements for new repair and construction equipment are $490 million. The Federal Fund has provided $16.3 million to the company for equipment purchases. |
|
AO Flotinvest together with the Russian Ministry of Transportation and EBRD |
Russian shipping companies |
Leases of ships for a term of 8 years; each ship to be built within one year. |
|
Ford, Ford Credit, Rust Leasing Company (Saint Petersburg) |
Purchasers |
Leases of at least 200 Ford automobiles |
|
Inkas Service Leasing Company together with Inkasbank (Saint Petersburg) |
Gold mining companies |
Gold mining equipment valued at $410,000 |
|
RTK Leasing |
Rostelecom |
Samara/Orenburg microwave link ($5.2 million), switches for trunk exchanges ($12.7 million), equipment for a multimedia communications network ($12 million), etc. for a total of more than $100 million |
|
Russian Government |
Rostselmash (Rostov-on-Don) |
Lease of grain and other combine harvesters for a total of $6.3 million |
The following is a summary of information provided by several leading Russian leasing companies.
Interrosleasing Leasing Company was founded in December 1994. The company is part of the Interros financial and industrial group. Its authorized capital is $100,000. The company leases mining, petrochemical, oil and gas, medical, power generation, transportation, telecommunications, and printing equipment, sophisticated computers, bottling lines for mineral water and soft drinks, medium-size food processing units, packaging and loading lines, equipment for gas stations as well as equipment for the iron, steel, non-ferrous metal, and timber industries. As all procurements are made through a single leasing company that acts as a single contracting agency, suppliers are often required to give extra discounts and to compete for contracts.
In 1998 the company leased equipment with a total value of approximately $51 million. The crisis in the fall of 1998 prevented the completion of several equipment leases of medical and printing equipment valued at $24 million.
The equipment lease requirements for Norilsky Nickel are estimated at $100 million. In 1998 the company delivered Swedish drilling equipment to Norilsky Nickel value at $14 million. The lease was financed by Union Bank of Switzerland and guaranteed by the Swedish Export Agency, EKN. In addition the company entered into other financial leases including the delivery by Alpine of a 50-ton drilling machine to Almazy Rossii – Sakha and the delivery by Wayne-Priscon A/S of Denmark to Sidanko Neft in Saratov of LPG filling stations including storage tanks, a cafeteria, car wash and car servicing and repair posts. Interrosleasing has obtained accreditation with the national export agencies in Sweden (EKN) and Finland (FGB). As a result, the Swedish Government represented by EKN guarantees for 85% of the contract price under a contract for the supply of Volvo diesel tractors.
In mid-1998 before the crisis the company launched pilot projects to obtain syndicated loans directly from consortiums of major Dutch, Swiss or other Western banks at an interest rate of LIBOR plus 0.8-1%. Interrosleasing would invite bids from 3 to 4 banks. The terms and conditions of such tender included a requirement to advance funds for financing VAT and customs charges and also sales tax on the vehicles supplied. Such loans are secured by a pledge of supply contracts, e.g. contracts providing for the supply of nickel for 3.5 years, with the proceeds thereunder to be accumulated in a special debt service account. For the first time, such an account is held in the Russian Federation, i.e. as an onshore account. Settlements are made through a major Russian bank or a Russian banking subsidiary of the relevant Western creditor.
The management of the leasing company believes that any lease should have the following mechanism. Interrosleasing (IRL) would enter into an import contract with the relevant equipment supplier. The manufacturer’s trading agent would enter into an export contract for the export of products with a contract price approximately equal to the credit extended to IRL. The credit would be secured by the following contracts and guarantees: a guarantee/policy issued by the national export agency of the supplier’s home country; a contract of assignment of export revenues under the trading agent’s export contract; a contract of assignment of leasing payments under the lease between IRL and the manufacturer; a pledge of onshore (Russian) accounts with the bank used to make settlements under the transaction; and a guarantee issued by the Manufacturer (Lessee). Such solid security for credits helps Interrosleasing obtain loans from Western banks on quite favorable terms and conditions.
Another arrangement used does not include any guarantee from the relevant national export agency and hence involves a more complex system of guarantees provided by the Russian parties to the transaction, including: a financial guarantee issued by the manufacturer; a contract of assignment of export revenues under the Trading Agent’s export contract; a contract of assignment of leasing payments under the lease; a pledge of IRL’s, the manufacturer’s and the trading agent’s bank accounts; a pledge of equipment between IRL and the Lender; and a buyback agreement among the Lender, the Supplier, and IRL.
Under the second approach, the lender’s risk is generally higher than the risk under the first arrangement. For this reason, the terms and conditions of the loan will be less favorable. The resulting terms should be compared to the cost of a guarantee/policy issued by the national export agency of the Supplier’s home country, and a final selection may be made between the first and the second arrangement to determine the more attractive option for the lessee.
Interrosleasing may require buyback arrangements in which a manufacturer may be required to buyback its equipment for a price equal to 10% to 15% of its acquisition cost at the expiration of a financial lease. This results in a cost savings to lessee’s of 7% to 15% of the dollar value of the leased equipment. Interrosleasing is introducing vendor leasing (or sales-aid leasing in European terminology) on a pilot project basis. Vendor leasing is a vehicle used by manufacturers to sell their products under leasing arrangements through a controlled leasing company. Such services offered by the leasing company are available to Interros companies as an additional channel for the sale of their products.
RTK Leasing was founded in April 1996 by Rostelecom and its subsidiaries. Its authorized capital is $400,000. In 1998, the company delivered the following: Ericsson AXE-10 digital exchanges worth more than $40 million which were supplied to upgrade Rostelecom’s national and international long-distance services; equipment supplied by Fujitsu for a Samara/Orenburg microwave link ($5.2 million); and equipment supplied by Siemens for an intelligent communications platform ($2.8 million). The company completed the delivery of equipment for optical fiber links from Saint Petersburg to the Northern Caucasus. Multimedia communications equipment worth more than $12 million was acquired from Ericsson Corporation AO to deploy a multimedia network covering all regions of Russia. Total investments in various projects amounted to more than $100 million, a 27% increase over the 1997 figures.
The most important source of financing for RTK Leasing is suppliers’ commercial credits. They account for 45% of total financing. Syndicated loans provide 35% and direct bank loans cover the remaining 20%. Banks that have extended credit to RTK Leasing include Credit Suisse of Switzerland, ING Barings of the Netherlands, West LB of Germany, the Bank of America of the United States, and Credit Lyonnais of France as well as Morgan Stanley, Lehman Brothers, and Eurofinance. The equipment leased by RTK Leasing to its lessees is mostly supplied by Alcatel, Siemens, Ericsson, NEC, Fujitsi, ECI, Iskratel, New Bridge, and Soft PRO. The company cooperates with export insurance agencies in Sweden (ENK), Germany (GERMES), the United Kingdom (DGEC), and France (COFACE).
The Russian-German Leasing Company was founded in September 1993. Its shares are held by the Savings Bank of the Russian Federation, the largest Russian bank, by Eurasco Zurich AG, a Swiss financial services company reorganized into a bank, Eurasco Bank AG, and individuals employed by the leasing company. The authorized capital of the company is DM3 million and its annual leasing operations amount to $35 million.
RG Leasing is a diversified leasing company. It invests in industrial expansion and upgrading projects of Russian companies by offering financial leases of equipment for the food industry, including dairy products; various engineering, agricultural, and other industrial equipment; packaging equipment; equipment used to manufacture construction equipment; and printing equipment. In addition, the company leases furniture, motor vehicles, armored vehicles, and banking equipment. In 1998 the company started to offer financial leases of medical equipment. The equipment purchased by RG Leasing for its customers is imported from Germany, Switzerland, France, Norway, Denmark, the Czech Republic, the United States, and Japan. Its suppliers include many well-known companies such as Hewlett Packard, IBM, Siemens, Petro-Pak, etc.
The company’s main market segments include the supply of imported equipment to medium-size and small-size businesses. Such equipment would typically be worth at least DM100,000. The lease term is typically from 3 to 5 years.
The Savings Bank is the most important customer of the leasing company. The amount of their largest leasing transaction to date is US$30 million. The deal has a term of 3 years and provides for the supply of computers by Hewlett Packard. RG Leasing currently owns all the computers, cash registers and terminals of the Savings Bank.
The company relies on three principal sources of financing for its leases: loans extended by Russian banks at a fixed interest rate for 3 to 5 years; commercial credits extended by equipment suppliers such as Hewlett Packard, and advances made by the company’s customers; and the leasing company’s own funds. Commercial credits make leases less expensive. Such credit is based on a foreign equipment supplier’s confidence in RG Leasing generated by a good faith business relationship maintained for several years. The respect won by RG Leasing on the West European market helps obtain more favorable payment terms for imported equipment. For example, RG Leasing manages to acquire leased equipment in Germany without a 15% advance payment which would normally be required.
RusLeasingSvyaz Leasing Company was founded in May 1997 by Svyazinvest, a Russian telecommunications holding company, and regional telecommunications companies. In December 1998 a 16% equity interest in the company was sold to Andrew Financial Services Corporation, a US telecommunications company. Within eighteen months of its operations the company entered into financial leases for a total of about $40 million. RusLeasingSvyaz acquires and then leases equipment for the national public telephone network.
Unlike most other Russian leasing companies RusLeasingSvyaz offers a lease term of 5 to 7 years which is not common in Russia, and also offers a varying schedule of leasing payments. Such special terms and conditions of its financial leases reflect the complexity and high price of the leased equipment and the uneven flow of revenues to the company’s customers. The average price of a financial lease executed by the company is $2 million to $3 million. The credit policies of the leasing company are based on Svayzinvest’s investment program for 1998-1999 which provides for international equipment acquisitions worth $400 million.
Rust Leasing Company was founded in 1994 in Saint Petersburg by the Savings Bank of the Russian Federation. The company offers leases of various types of equipment to customers of the Savings Bank based in Saint Petersburg or the Leningrad Region. In 1998, the company entered into about 20 financial leases including the delivery of a packaging line for yogurts, a printing press, and 200 Ford Transit vans to a taxi operator.
Baltiyskiy Leasing was founded in June 1990 in Saint Petersburg. Its major founder is Promyshlenno Stroitelnyi Bank (Saint Petersburg) which holds a 48% ownership interest. The Company leases construction, office, agricultural, industrial, and medical equipment, means of transportation, and equipment for supermarkets. The company has entered into 70 financial leases in six years and experienced payment delays in only two of them. In 1999, the company commenced a retrofitting project for Admiralteyskiye Verfi with a value of $38 million.
Likostroy Leasing Company was founded in July 1995. Its major shareholders include the Moscow Government and Mosstroyekonombank. The authorized capital was originally $300,000 and rose to $840,000 two years later. The company may extend credit under favorable terms and conditions for a term of up to 6 years and at an interest rate of half the discount rate set by the Central Bank of the Russian Federation.
The company was among the first companies in Russia to specialize in financial leases of construction equipment and supplies such equipment to Moscow construction companies. The company offers leases of machinery and equipment including equipment for construction and special operations, special-purpose trucks, and equipment and production lines for a building materials plant. Non-Russian-made equipment accounts for 40% of acquisitions by value. The company maintains a business relationship with Caterpillar, Peter Gris, Liebher, Hitachi, etc. It is planned that such companies will receive commercial credits secured by Mosstroyekonombank’s guarantees confirmed by the Moscow Government. For some contracts the leasing company succeeded in obtaining a commercial credit from the supplier for a term of up to 2 years.
Most of the contracts executed by the company have a contract price of $170,000 to $200,000 each, while the price of some contracts is as high as $5 million. The company enters into 40 to 50 financial leases each year. In 1999 Likostroi was awarded by the State Customs Committee of Russia a contract for the disposition under leasing arrangements of equipment seized by the customs authorities and worth $500 million. The implementation of that contract will enhance the company’s ability to provide financing for other leasing projects.