39586 Published by the Leasing Development Group of the International Finance Corporation (IFC), a Member of the World Bank Group, with financial support from the Canadian International Development Agency TION INFORMA BULLETIN C O N T E N T S : http://www.ifc.org/russianleasing JULY-AUGUST 2001, Issue 4 (16) THEORY AND PRACTICE SNEZHINKA BATHWORKS, Comparing the Financial Terms of Lease KRASNODAR Agreements pg. 2 T How Leasing Companies he municipal enterprise Snezhinka (snow-flake) was Can Minimize Risks founded in 1999, when the city of Krasnodar decided to pg. 6 revamp its public baths and laundries. The company took over the largest bath-house in the city, situated in a historic EXPERT OPINION 19th-century building, and added seven more establishments Leasing and Russian Antitrust Laws that were scattered throughout the suburbs of Krasnodar. All of pg. 10 them were in a dilapidated state, and some had actually been Additional Guarantees for Leasing closed for several years. The idea of reorganizing the city's Transactions: Expert Opinions pg. 13 bath-houses and laundries originated with the Department of Municipal Services. Their goal was not just to help the run- LEGISLATION down establishments survive, but to make them profitable. Various Aspects of Confiscationg and Snezhinka's director, Anna Vasilevna Olkhovaya, told us how Selling Pledged Assets her company managed to turn the local public bath and laundry pg. 16 giant around. «Our complex of bath-houses and laundries was operating at a loss, since our average client simply could not LEGISLATIVE NEWS afford to pay the full cost of the public baths. The actual cost of The Tax Code's Draft Chapter serving each bather in the year 2000 was 32 rubles, yet our on Profit Tax clients paid only 12 rubles (6 for pensioners and the disabled). pg. 19 Themunicipalgovernmenthasbeenfootingthedifference,since it established prices for the public baths. OUR PROJECT Announcement. Seminar in Nizhny Continued on page 23 Novgorod pg. 20 Leased automobiles allowed this commercial laundry to widen its drop-off network and LEASING IN REGIONS create 27 new jobs Leasing in the Nizhny Novgorod Region pg. 21 SMALL AND MEDIUM-SIZED «Snezhinka» President A.V. Olkhovaya BUSINESS Snezhinka Bathworks, Krasnodar pg. 23 NEWS Press Digest pg. 24 QUESTIONS AND ANSWERS pg. 26 2 THEORY AND PRACTICE July-August 2001 COMPARING THE FINANCIAL TERMS OF LEASE AGREEMENTS Veronika Shtelmakh, Economist IFC Leasing Development Group Continued from Issue #3 (15) 2001 I n the last edition of the Leasing Courier, we discussed the leasing compa- ny's commission. We left off in the middle of a hypothetical example, where a certain company, Vidgets, Inc., asked three separate leasing companies for an estimate as to the total sum of their lease payments. All three companies quoted the same amount: 17,573,600 rubles.1 Does this mean that the leases are financially equivalent? Not at all. Even if the total sum of the lease payments is identical in all three cases, there are several other factors that will affect the lessee's cash flow: 1) The distribution of the payments over time; Veronika Shtelmakh, Economist IFC Leasing Development Group 2) The payment due dates (at the beginning or end of each fiscal period); 3) The frequency of the payments. We can see the effects of these three factors when we discount the projected flow of the lease payments. Before we continue with our example, we should say a few words about the discounting process. The Discounting Process2: Time Value of Money T he time value of money is the «actual» value of the funds that you expect to receive or spend in the future. In other words, money has a different value at different times - and you can't compare apples and oranges. We need to convert the amounts so that they are comparable, which is done by discounting. Financial analysts list the following reasons for discounting money, all of which imply that money now is worth more than money in the future: · inflation · the risk of not receiving future income · opportunity costs (existing funds might have been better invested in some other profitable enterprise) In order to compare different cash flows correctly, one has to reduce them all to one particular moment in time - that is, to discount them. This is done in the following way: the nominal sum of each lease payment is multiplied by 1 (1+r)n where r equals the discount rate and n equals the number of the payment period. By adding up the dis- counted values of the lease payments, we obtain the lease payments' total discounted value (see Diagram 1). In English this is called «present value,» but several different terms are used in Russian, such as «reduced value,» «current value» and «discounted value». We assumed that the lessee did not incur any additional expenses in connection with the lease, apart from the lease payments 1 themselves. A great deal of research and a number of textbooks have been written on this subject. This article does not pretend to offer a 2 complete analysis of the topic. If you are interested in learning more about discounting, we suggest using a textbook on finan- cial management, such as V.V. Kovalyov's «Introduction to Financial Management,» Moscow, «Finance and Statistics,» 1999 July-August 2001 THEORY AND PRACTICE 3 Step 1. Obtain the lease payment schedule from the leasing company. In addition to inquiring about the total sum of the lease payments, the lessee must also find out about the lease payment schedule - i.e., how the total sum is broken down over the term of the lease. Proposed Lease Payment Schedules Payment Number Aurora Babochkin & Co. Monolizing 1 1,558,700 1,815,365 1,207,800 2 1,494,900 1,751,565 1,207,800 3 1,431,100 1,687,765 1,207,800 4 1,367,300 1,623,965 1,207,800 First-Year Total 5,852,000 6,878,660 4,831,200 5 1,303,500 1,560,165 1,207,800 6 1,239,700 1,496,365 1,207,800 7 1,175,900 1,432,565 1,207,800 8 1,112,100 1,368,765 1,207,800 Second-Year Total 4,831,200 5,857,860 4,831,200 9 1,048,300 1,304,970 1,207,800 10 984,500 1,241,170 1,207,800 11 920,700 1,177,370 1,207,800 12 856,900 1,113,570 1,207,800 Third-Year Total 3,810,400 4,837,080 4,831,200 Redemption Payment 3,080,000 0 3,080,000 Contract Total 17,573,600 17,573,600 17,573,600 As you can see from the table, all three companies have proposed the same periodicity (quarterly payments) and contract length (three years). In both the first and the third examples, the lessee redeems (purchases) the leased asset at its residual value (3,080,000) when the lease expires. In the second example, the lessee redeems the asset in full through his quarterly lease payments (and is assumed to acquire the asset at the end for a nominal sum of one kopeck, which we have left out of the calculations). Step 2 Calculate all additional expenses that will arise in connection with the lease, apart from the lease payments themselves (insurance, property tax, transportation, installation, etc.). After obtaining the lease payment schedule, the lessee must compare the payments to his expected income. That is, he must determine whether he will have enough cash at each stage of the agreement to meet his obligations. Step 3 Calculate your future cash flow and determine how well the proposed payment schedule suits your company's needs. Let's assume that the lessee in our example has enough financial resources to accept any one of the three proposed payment schedules. He must consider how great his actual expenses will be under each of the plans. Although the total sum of the lease payments is identical in all three cases, the distribution of these payments over time is different, which means that the lessee's actual expenses will also vary. The way for the lessee to determine his actual expenses is by comparing the discounted cash flows under each plan. 4 THEORY AND PRACTICE July-August 2001 Step 4 If your expected cash flow allows you to choose between several leasing plans, you must compare the lease payment schedules in terms of: · distribution of payments over time · payment due dates · periodicity and choose the option that best suits your company's needs. You can determine that by dis- counting your cash flow and comparing the present values. Diagram 1. Discounting Cash Flow under a Leasing Plan LP LP LP LP LP LP LP LP Actual Expenses LP LP Where: LP = Lease payment per period r = discount rate The following are the figures we obtain by discounting the lease payments for the beginning of each pay- ment period at a discount rate of 28%.3 Company Present Value of Lease Payments Aurora 12,064,664 Babochkin & Co. 12, 878,430 Monolizing 11,632,256 Monolizing's offer is clearly the most attractive: the lease payments are uniform and equal, and the leased asset is redeemed at its residual value when the lease expires. How Various Aspects of the Lease Payments Affect Present Value L et's use Monolizing's lease payment schedule as an example to see how certain features of the lease payments can affect their present value. For the purposes of this example, we will focus exclusively on changes in the present value of the lease payments, ignoring all of the lessee's other expenses. How the Payment Due Date Affects Present Value4 If the lease payments were made at the end of each payment period, rather than at the beginning, this would lower the lessee's actual expenditures. The present value of the lease payments for the entire three- year term of the lease would fall to 10,960,733 (671,523 less than if payments are made at the beginning of each period). There are many different methods for determining the discount rate, but since this lies beyond the scope of our current discus- 3 sion we will not focus on it here. We have simply chosen 28% based on a hypothetical interest rate for the lessee's bank loan. We use a discount rate of 28% to calculate the present value in each example. 4 July-August 2001 THEORY AND PRACTICE 5 How Payment Frequency Affects the Present Value If Monolizing wished to receive the lease payments at the beginning of each month, rather than on a quar- terly basis (in which case the lease payments would be 402,600 each), this would lower the lessee's real expenditures. The present value of the lease payments would fall to 11,302,869 (329,387 less than with quarterly payments). The Combined Effects of the Payment Due Dates and Payment Frequency on Present Value Real expenditures would be lower still if the lease payments were made on a monthly basis and at the end of the payment period. The present value of the lease payments would fall to 11,075,061 (557,195 less than for quarterly payments made at the beginning of the period) How Changing the Terms of the Lease Payments Affects the Lessee's Real Expenditures (Based on the Monolizing Example) Plan Lease Payment Terms Present Value of Savings Number Payment Frequency Payment Due Date Lease Payments Over Plan #1 1 Quarterly Beginning of Term 11,632,256 2 Quarterly End of Term 10,960,733 671,523 3 Monthly Beginning of Term 11,302,869 329,287 4 Monthly End of Term 11,075,061 557,195 Establishing a Hard-Currency Equivalent When Calculating the Lease Payments Leasing companies often «peg» the lease payments to a hard-currency equivalent if they have taken out foreign-currency loans to finance the lease. However, they may also do so simply to protect themselves against sudden changes in the ruble exchange rate. Whenever the lease payments are pegged to a foreign currency, the lessee should realize that he is bear- ing the full brunt of the currency risks (i.e., the risk of unfavorable changes in the ruble exchange rate). Let's consider what happens to the lessee's real expenditures in such cases. Example: Let's imagine that the lessee has signed a three-year lease under which he is required to make twelve quarterly payments of $100 in rubles at the prevailing exchange rate at time of payment. At the beginning of the lease, the exchange rate is 28 rubles to the dollar. If the exchange rate does not change over the course of the lease, each payment will be 2,800 rubles. If the ruble depreciates over the course of the lease, then the lessee ends up paying more in ruble terms, even if the dollar equivalent remains the same (in the following chart, the exchange rate has gone up to 36 rubles by period #12, thus increasing the payments by 800 rubles). Changes in the Ruble Value of Lease Payments Pegged to a Foreign Currency Equivalent Ruble Constant Ruble Falls 6 THEORY AND PRACTICE July-August 2001 If, on the contrary, the ruble exchange rate should appreciate (as happened in the year 2000, when the ruble rose from 28.87 to the dollar on February 2 to 28.16 on July 27), then the lessee will obviously benefit. The parties must take into account the nature of the lessee's business before deciding to peg the lease payments to a foreign currency. Most Russian lessees sell their products for rubles on the Russian market, where prices have generally failed to keep up with exchange rates. This means that under extreme condi- tions, the parties may have to restructure the lease by altering the payment schedule, allowing the lessee to defer his payments or take other measures to ensure that the lease reaches its full term. In this article we have shown how the profitability of a lease agreement can depend on the specific char- acteristics of the lease payments. We would like to emphasize once again that the lessor and the lessee have considerable freedom in determining the sum, structure and schedule of the lease payments. Therefore, the lessee may (and should) make clear demands regarding the nature of the lease payments and their distribution over time. For example, by making sure that the leasing company takes into account the cyclical nature of his business, the lessee will actually be helping the leasing company to structure the lease appropriately and avoid any unnecessary delays in the lease payments. We hope that this article will help you conduct more effective negotiations with potential leasing companies. Good luck! HOW LEASING COMPANIES CAN MINIMIZE THEIR RISKS BY CONDUCTING A COMPLETE ANALYSIS OF THEIR POTENTIAL LESSEES Analyzing the Lessee's Current Finances and Projected Cash Flow Elena Degtiareva, Financial Analyst IFC Leasing Development Group In this article we continue our discussion of risk management for leasing companies, which we began in issues #14-15. I n our last article we discussed the various sources of information from which a leasing company can safely draw conclusions about a potential lessee's financial situation. We focused on one aspect of this analysis in particular: analyzing the lessee's balance sheet. This time we shall consider the main principles of analyzing the lessee's liq- uidity and financial soundness. We should note that many of these measures use ratios that tend to be quite different between industries, and should not be considered absolute. Elena Degtiareva, Financial Analyst IFC Leasing Development Group Analyzing the Lessee's Liquidity Liquidity is one of the most important elements of an enterprise's financial condition, as it determines the enterprise's ability to meet its current obligations on time. There are many different methods for evaluating a company's liquidity, but the most common is the ratio method, which takes into account the following factors: · Current Ratio · Acid Test Ratio (Quick Ratio) · Cash Ratio July-August 2001 THEORY AND PRACTICE 7 Current Ratio This ratio indicates whether a company has enough current assets to meet all of its short-term obliga- tions. It is calculated as follows: Current Assets (total from balance sheet section II, line 290) Current Ratio = Current Liabilities (total from balance sheet section V, line 690) One should bear in mind that using this formula to calculate the current ratio does not necessarily give you a realistic view of a company's financial situation. The only way that this can serve as a reliable gauge of the lessee's solvency is if all of the assets listed under section II are fully liquid - i.e., if they can be read- ily converted into cash at their stated value. In addition, several of the liabilities recorded under «Short-term liabilities» are not really payable on-demand or in the next twelve months, and some are not even liabilities per se (such as future income). Therefore, in order to obtain a realistic estimate of a company's liquidity, one has to adjust the data in the following manner: · Exclude the following illiquid assets from the enterprise's total current assets (line 290 in the balance sheet): - accounts receivable that are not expected to be paid within the next 12 months (line 230) - unrecoverable accounts receivable (based on balance sheet supplement #5) - stock of raw materials, unfinished and «frozen» production, illiquid inventory (based on expert analysis) · Exclude the following non-payable liabilities from the enterprise's total current liabilities (line 690): - income from future periods (line 640) - reserves for future expenditures (line 650) Once we make these adjustments, our liquidity ratio looks like this: Line 290 - Line 244 - Line 230 - Line 221 of Form #5 Current Ratio = Line 690 - Line 640 - Line 650 The prevailing view is that current assets should exceed current liabilities by at least two times. The Federal Insolvency Board suggested this norm back in 1994 within its Methodological Statutes for Evaluating the Financial Condition of Enterprises and Revealing Their Unstable Balance Structure. According to these statutes, a company may be declared insolvent if its current liquidity ratio at the end of a fiscal period is less than 2. Although this document is no longer in effect,1 the opinion still prevails among analysts that assets should exceed liabilities by at least two times. One should also bear in mind, however, that large amounts of cur- rent assets can strain working capital, and may not be an efficient use of financial resources. A more appro- priate minimum current ratio would therefore be 1, in our view. This means that current assets should not be lower than short-term liabilities, and that the enterprise will be able to pay off its existing obligations with working capital. Quick Ratio (or `Acid Test') This ratio indicates an enterprise's ability to meet its short-term obligations with highly liquid assets. The most highly liquid assets include cash (line 260), short-term investments (line 250), accounts receivable (line 240 minus line 244, «members' payable contributions to charter capital») and finished products (line 214). Thus, the formula for calculating the quick ratio is as follows: It has been replaced by the Methodological Instructions for Analyzing the Financial Condition of Organizations, confirmed by 1 Order N 16 (January 23, 2001) of the Russian Federal Service for Financial Recovery and Bankruptcy. This document mere- ly contains principles for calculating various indicators. It is not regulatory in nature. 8 THEORY AND PRACTICE July-August 2001 Line 260 + Line 250 + Line 240 - Line 244 + Line 214 Quick Ratio = Line 690 - Line 640 - Line 650 Experts recommend a quick ratio of 0.7 - 0.8. Cash Ratio This ratio indicates the degree to which a company can meet its short-term obligations with cash and short-term investments - i.e., its most liquid assets. Line 260 + Line 250 Cash Ratio = Line 690 - Line 640 - Line 650 Both Russian and foreign analysts recommend a cash ratio of at least 0.2. The higher a company's liquidity measures, the more solvent it is considered to be; i.e., the easier it will be for the company to meet its short-term obligations, such as lease payments. However, one should remember that a high level of liquidity also means that an enterprise's current assets outstrip its current lia- bilities, which usually increases its working capital needs. Furthermore, a high level of liquidity may indicate that the enterprise is doing a poor job of managing its working capital, i.e., accumulating excess stock of raw materials or finished products, overdue accounts receivable, etc. A high level of liquidity indicates that a potential lessee should be able to meet his current obligations in full and on time. This means that there is a lower risk that he will default on his lease payments. However, one also has to remember that high levels of liquidity may indicate poor management of working capital and a potential contraction in cash flow if cash cannot be realized for the accumulated assets. There is one rather interesting method for calculating the current liquidity ratio of an enterprise, accord- ing to which the necessary amount of current liabilities is based on the turnover rate for accounts payable and receivable, the size of the enterprise's least liquid assets and the value of its material resources. The actual value of the enterprise's current assets is then correlated to the calculated value of its current liabil- ities, which reveals the current liquidity ratio that is necessary for that particular enterprise.2 When analyzing an enterprise's liquidity, one should take a close look at how the enterprise's liquidity indi- cators have evolved over time. One should also try to determine what has caused these indicators to change: changes in the enterprise's current assets or current liabilities, changes in its long-term assets, etc. Analyzing an Enterprise's Financial Soundness T he purpose of analyzing a potential lessee's financial soundness is to determine how much he depends on external sources of finance. Several financial indicators can be used to characterize an enterprise's financial soundness, but two are particularly important: the correlation between the enterprise's equity capital and borrowed funds (equi- ty/total assets ratio), and its level of working capital. You can learn more about methods of calculating standard liquidity factors in M.N. Kreinina's «The Financial Condition of 2 Enterprises: Calculation Methods,» Moscow, 1997 July-August 2001 THEORY AND PRACTICE 9 Equity/Total Assets Ratio The equity/total assets ratio is calculated as the correlation between equity capital (the total under sec- tion III, Capital and Reserves, line 490) and the total sum of equity + liabilities or, equivalently, assets (lines 490, 590 and 690, or lines 190 and 290). Line 490 Equity/Total Assets Ratio = Line 490 + Line 590 + Line 690 The lower the ratio, the higher the sum of debt financing - and the higher the risk of insolvency. Moreover, companies with large amounts of debt financing generally have large interest payments to make, which means they will have fewer funds left over to make their lease payments. There are no strict rules about the minimum acceptable equity/total assets ratio (it's a hot topic in corporate finance), but the prevailing view is that it should not be less than 0.5. We derive this figure by a trans- formation of the formula for calculating the equity/total assets ratio: since the denominator is calculat- ed as the sum of equity capital and debt financing, if equity capital exceeds debt financing, then the autonomy ratio will be greater than 0.5. The main principle behind a lessee's financial soundness is that his long-term assets, as well as his illiquid working capital, should be financed through long-term sources of credit. If an enterprise's illiquid assets are financed through short-term obligations, this increases the risk that the enterprise's current assets, and even its long-term assets, will lack essential financing if anything changes in its relationships with its main partners (e.g., if its suppliers curtail payment deferrals). This in turn will heighten the risk that the lessee will default on his lease payments. The structure of an enterprise's assets and liabilities depends in part upon its particular industry. Manufacturing and construction firms, for example, tend to have a large share of non-working capital, which means that they require more long-term sources of finance to maintain their financial stability than, say, a retailer, whose assets consist primarily of working capital with high turnover. Enterprises that are high- ly profitable or that have a high turnover rate of current assets can afford to maintain relatively high levels of debt financing. Furthermore, a manufacturer's working capital consists primarily of inventory and accounts receivable, while a retailer's assets consist largely of cash and relatively liquid inventory; thus, current assets have varying degrees of liquidity. Therefore, the `standard' equity/total assets ratio of 0.5 should be considered a rough guide. Applying the same norm to different types of enterprises would be highly inappropriate. Net Working Capital As we mentioned above, the main principle behind an enterprise's financial soundness is that its long- term sources of finance must fully cover its non-liquid assets. Therefore, net working capital, which is calculated as the difference between long-term sources of finance (long-term loans and equity capital) and long-term assets, must be greater than zero. Net working capital = = (Equity capital + Long-term liabilities) - Long-term assets = = (Line 490 + Line 590) - (Line 190 + Line 230). Negative net working capital means that some of the enterprise's long-term assets are financed through short-term liabilities. This in turn means a greater risk that the enterprise will fail to meet its current obliga- tions in a timely fashion. 10 EXPERT OPINION July-August 2001 On the other hand, a very high level of net working capital, like high levels of liquidity, may indicate that the enterprise is not managing its resources efficiently. The optimum level of net working capital depends on the enterprise's specific nature, particularly its size, sales volume, and inventory and accounts receiv- able turnover periods. The optimum level of a company's liquidity and financial soundness depend on its type of business, asset structure and current asset turnover rate. It is therefore impossible to apply the same standards to every company. Analyzing a potential lessee's financial soundness, in conjunction with his liquidity, will give you some idea of his overall financial condition. If both indicators appear to be weak, the lessee may be headed towards bankruptcy, and there is a considerable risk that he will fail to meet his current obligations, including his lease payments. We will continue our series on analyzing a potential lessee's finances in the next issue of the Leasing Courier. Our next article will explain how to analyze a potential lessee's profitability. In the «Expert Opinion» section we publish materials sent to the editorial board by participants in the leasing sector. The purpose of this section is to show the diversity of existing opinions. The opinions of the authors published in this section do not necessarily represent the official opinions of the International Finance Corporation. IFC does not guarantee the accuracy or reliability of the information presented in these articles or bear any responsibility for the consequences of its use. BEFORE YOU START NEGOTIATING A LEASE, TAKE A CLOSE LOOK AT RUSSIA'S ANTITRUST LAWS Leonid Prilutsky General Director of INFONALADKA I t would be fair to say that in the early days of There are two Russian laws that contain antitrust Russian leasing (and perhaps even today) most regulations pertinent to leasing: Law #948-1 on Russian businesses were not even aware that Competition and the Restriction of Monopolies in lease agreements could be subject to approval by the Commodities Markets (03/22/91) and Law the antitrust authorities. This is largely because #117-F on Preserving Competition in the Financial most of our attention has been focused on tax, cus- Services Markets (09/23/99). toms and currency regulations -- as well, of course, One of the most important antitrust regulations as leasing laws. Until now, researchers have largely for the leasing industry is Article 18, Clause 1 of neglected antitrust laws. This is actually a mistake, the Law on Competition, which states: «enterpris- since lease agreements that fail to comply with es may not transfer assets worth more than 10% of these laws can be declared null and void. It is my the book value of their fixed business assets and hope that this article will help both leasing compa- non-material assets to another enterprise without nies and lessees understand the implications of the prior approval of the Federal Antitrust Russian antitrust laws. Authorities.» July-August 2001 EXPERT OPINION 11 Prior approval is only required if the enterprises balance fails to bring it below the 10% barrier, while combined assets are worth more than 100,000 times driving the parties' combined assets over 50,000 the minimum wage (MROT), if either of them appears times the minimum wage, thereby forcing the lessee in the Register of Businesses with Market Share of to turn to the antitrust authorities. More than 35%, or if the recipient has managerial Let's suppose, for example, that the leased asset control over the sender's commercial activities. is worth 200,000 rubles, the lessor's fixed business If the enterprises' total assets are valued at more assets and non-material assets are valued at 1.7 than 50,000 times the minimum wage, but less than million rubles and the book value of the lessor's 100,000 times, then they merely have to notify the assets (not including the leased asset) is 2.8 million Federal Antitrust Authorities of their lease agree- rubles, while the lessee's assets are worth 2.1 mil- ment within 15 days. lion rubles.1 If the leased asset is not included in the Thus, the lessee must notify or get prior approval balance, there will be no need to turn to the antitrust from the Federal Antitrust Authorities when the fol- authorities, even though the leased asset accounts lowing two circumstances occur simultaneously: for more than 10% of the lessor's assets, since the First, if the leased asset is worth more than 10% of parties' combined assets are valued at less than the book value of the lessor's fixed business assets 50,000 times the minimum wage (5 million rubles2). and non-material assets; and second, if either the If, on the other hand, the leased asset is included in lessee or the lessor has total assets worth more the lessor's balance, it will still account for more than 50,000 times the minimum wage or one of than 10% of the lessor's assets and will also drive them is included in the Register of Businesses with the parties' combined assets over the 5 million ruble Market Shares of More than 35%. mark, obliging the lessee to notify the antitrust Although it is the lessee's responsibility to contact authorities about the lease. the antitrust authorities, the lessor also plays an Let's consider a few more examples: important role, since he must inform the lessee 1. A leased asset is valued at 10 million rubles. The when the leased asset is worth more than 10% of his lessor's fixed business assets and non-material fixed business assets and non-material assets. The assets were worth 40 million rubles during the last fis- lessee should require some kind of written state- cal period, while his active balance is 50 million rubles. ment on this matter from the lessor, and should The lessee's active balance is 70 million rubles. The make sure that the statement has been signed by leased asset is worth more than 10% of the lessor's the lessor's chief executive officer, since the lessee fixed and non-material assets, so we have to look at may be held legally responsible for any violation of the second indicator: the combined active balance of antitrust laws. the lessor and the lessee, which totals 120 million Leasing companies might ask the following ques- rubles in this case. This is more than 100,000 times tion: should we include the value of the leased asset in the minimum wage (10 million rubles), so the lessee the total value of our assets? Since this total is based must obtain prior approval from the Federal Antitrust on the results from the previous quarter, the leased Authorities before taking out the lease. asset is not usually included in the total - although it 2. A leased asset is valued at 1 million rubles. The may be to both parties' advantage to do so. lessor's fixed business assets and non-material Imagine, for example, that the lessor's fixed assets assets were worth 3 million rubles during the last fis- are worth 54.2 million rubles, while the leased asset is cal period, while his active balance is 5 million rubles. valued at 6 million rubles. If the leased asset is not The lessee's active balance is 4 million rubles. The included in the lessor's total balance, the value of the leased asset is worth more than 10% of the lessor's leased asset will exceed 10% of the lessor's fixed fixed and non-material assets, so we have to look at business assets and non-material assets, and the the second indicator: the combined active balance of lessee will have to notify or seek prior approval from the lessor and the lessee, which totals 9 million rubles the antitrust authorities if the second condition is also in this case. This is more than 50,000 times the mini- met. If, on the other hand, the lessor includes the mum wage, but less than 100,000 times, so the value of the leased asset in his total balance, then the lessee must notify the Federal Antitrust Authorities lessee will not have to apply to the antitrust authori- within 15 days after signing the lease. ties, since the leased asset will constitute less than 10% of the lessor's assets and the second condition will no longer matter. The book value of a company's assets is defined as the sum 1 One can easily imagine the opposite scenario, of lines 190+290 in the balance sheet, minus losses. where including the leased asset in the lessor's total Based on the current minimum wage of 100 rubles per month. 2 12 EXPERT OPINION July-August 2001 3. A leased asset is valued at 1 million rubles. The company under systematic observation to ensure lessor's fixed business assets and non-material that it does not abuse its dominant position. assets were worth 3 million rubles during the last According to the Antitrust Ministry's Order # 342 fiscal period, while his active balance is 5 million of 05/06/00, a company may be found to have a rubles. The lessee's active balance is 4 million dominant position in the leasing industry based on rubles. The lessee is listed in the Register of information obtained from the Russian State Businesses with Market Shares of More than 35%. Committee for Statistics, leasing organizations, The leased asset is worth more than 10% of the consumers groups and state, social, scientific, com- lessor's fixed and non-material assets, so we have mercial or non-profit organizations and experts. to look at the second indicator: the combined active In spite of this long list, the antitrust authorities balance of the lessor and the lessee, which totals 9 are unlikely to base their rulings on any sources million rubles in this case. This is more than 50,000 other than the government statistics agencies' times the minimum wage, but less than 100,000 assessment of leasing volumes in Russia. times. Nevertheless, because the lessee is includ- Unfortunately, this is a rather depressing situation. ed in the Register of Businesses, it is not enough for The State Committee for Statistics calculated the him to merely notify the Federal Antitrust total volume of Russian leasing transactions in the Authorities; he must obtain their approval before year 2000 as 5.8 billion rubles.3 According to the signing the lease. Russian Association of Leasing Companies Organizations that violate Article 18 of the Law on (Roslizing), the figure had already reached 13,321 Competition may be fined up to 5,000 times the billion rubles in 1999. minimum wage, while their directors may be fined Since Russian leasing companies are so reluctant up to 80 times the minimum wage. to disclose their real financial results, the State According to the Russian State Antitrust Committee for Statistics, which is responsible for Committee's Letter N NF/187 of 01/18/99, the Law gathering this information, must join forces with on Competition also applies to subleases, guaran- Roslizing, the Ministry of Justice's State tee agreements for leasing transactions, and the Registration Chamber, and the Ministry of transfer of any rights or obligations under a lease Economic Development, all of which have data on agreement to a third party. the Russian companies holding leasing licenses. The Law on Preserving Competition in the This would make the official statistics on the Financial Services Markets has somewhat less Russian leasing industry far more accurate, which importance for the leasing industry, since, first of would benefit the entire industry. all, it is up to the antitrust authorities to define what constitutes a dominant position in the leasing industry. Second, even if a leasing company is found to have a dominant position, this in itself does 3 Principle Indicators of Investment and Construction not constitute a violation of antitrust laws; it only Activity in the Russian Federation in the Year 2000. State means that the antitrust authorities may place the Committee for Statistics N 12 (52, 2001, pp. 9) OUR COMMENTARY Olga Shishlyannikova, Attorney IFC Leasing Development Group T his article certainly raises some very impor- courts may do so. The only thing that the antitrust tant issues. However, there are several points authorities can do is initiate an inquiry into a deal if that require further comment: it violates antitrust regulations in such a way as to · This article only deals with antitrust regulation in create or strengthen a dominant market position the context of lease agreements. In some cases, and/or hinder competition - and only if the parties the same regulations may also apply to the sales have refused or neglected to meet the authorities' agreement for a leased asset. demands in terms of restoring competitive condi- · Most importantly, the antitrust authorities do tions. As far as we know, the courts have not estab- not have the power to annul agreements. Only the lished any procedures for annulling agreements July-August 2001 EXPERT OPINION 13 that fail to comply with the antitrust regulations ations to a third party). According to Article 18, Clause mentioned in Mr. Prilutsky's article. 1 of this law, antitrust regulation only applies to trans- · It may be true that the Statute on the actions involving the transfer of ownership or usage Procedures for Petitioning or Notifying the Antitrust rights to fixed business assets or non-material assets Authorities requires an entity to calculate the value from one party to another. A mortgage agreement of its business assets and non-material assets on does not entail the actual transfer of ownership or the basis of the preceding fiscal quarter, in accor- usage rights. The ownership rights to a mortgaged dance with Articles 17 and 18 of the Russian Soviet asset do not actually change hands unless the mort- Socialist Republic's Law on Competition and the gagee seizes the asset. Even when a mortgaged Restriction of Monopolistic Activity in the asset is seized, the ownership rights are often trans- Commodities Markets (confirmed by the Russian ferred to parties other than the mortgagee, so it clear- Antitrust Ministry's Order #276 of 08/13/99). ly does not make sense to require the mortgagor to However, the Statute over-generalizes the provi- obtain prior approval from the antitrust authorities sions of the Law on Competition: the law itself does before signing a mortgage agreement. not indicate that asset value should be calculated · Finally, we cannot agree with Mr. Prilutsky's on the basis of the preceding fiscal quarter. opinion that the Federal Law on Preserving Therefore, lessors and lessees may also use cur- Competition in the Financial Services Market rent data to define their asset values. applies only to leasing companies that have a dom- · The legality of the State Antitrust Committee's inant position in the leasing industry. According to Letter #NF/187 of 01/18/99, which Mr. Prilutsky Article 16 of this law, antitrust regulations also apply refers to in his article, is also rather dubious. There are to transactions where entities cede their rights to no grounds for thinking that the Law on Competition claim a share of a financial institution's assets (leas- and the Restriction of Monopolistic Activity in the ing companies are also considered financial institu- Commodities Markets applies to either mortgage tions). At the same time, the law does not limit these agreements or cession agreements (where one of the statutes to financial institutions with a dominant parties to an agreement transfers his rights and oblig- position in the financial services market. ADDITIONAL GUARANTEES FOR LEASING TRANSACTIONS: EXPERT OPINIONS The Leasing Development Group's team of experts have often dealt with the subject of additional guarantees for leasing transactions in the course of their consulting work. In developed leasing markets, the leased asset itself usually serves as a sufficient guarantee for the lease. Therefore, leas- ing companies do not generally require any additional guarantees against the lessee's financial obligations. In Russia, the situation is completely different. Leasing companies often feel that their property rights to the leased asset are not a suffi- cient guarantee, and they may therefore require additional guarantees, such as additional collateral,third-party sureties, guarantees that the supplier will buy back the leased asset, and so forth. This is perfectly legal, but for lessees it makes the process of taking out a lease far more complicated, while for start-ups it can make leasing virtually impossible. We decided to find out what Russian leasing practitioners thought about guarantees: are they really necessary, and if so, why? In this issue we have published several letters that we received from lessees and leasing companies. We invite all of our readers to take part in this discussion. Konstantin Merkulov, lease, I need to have assets -- so that I can offer Financial Director, Pro-Invest-IT (Lessee): them as collateral. At least this is the problem that my own company faces. L easing has been advertised as an excellent solution for small and medium-sized business- As difficult as it is to repossess a leased asset es. Unfortunately, these firms are rarely able to offer from an insolvent lessee, seizing a pledged asset is the kind of collateral that is required for a lease. The not any easier. Let's suppose, for example, that I result is a Catch-22: in order to obtain new assets, I want to lease some new computers. The only thing want to take out a lease; but in order to take out a that I can offer as collateral is a set of similar com- 14 EXPERT OPINION July-August 2001 puters -- and only on the condition that I can keep than by taking matters to court or trying to confis- using them in the meantime, even after I have mort- cate the lessee's assets. gaged them, since I cannot operate my business without them. From the lessor's perspective, how We generally need to have some additional form are the mortgaged computers any more secure of guarantee from the lessee in order to ensure that than the leased ones? Confiscating collateral is we will be able to recover our investment, but guar- actually even more difficult than repossessing a antees are not an obligatory condition for every leased asset, since the lessor does not have any lease agreement. ownership rights. If the contract value is relatively small, and the I have done a bit of Internet research into the kinds lessee appears to be financially sound, then we of terms offered by different leasing companies. It may decide not to require any additional forms of turns out that the nature and size of the guarantee guarantee. If the contract is large, then we have to hardly depends on the nature of the leased asset. require additional guarantees. This is standard For example, the Moscow Leasing Company practice. requires a 100% guarantee on all real estate leases, even though they are unlikely to have any difficulties repossessing a piece of real estate if the lessee Valeriy Aleksandrovich Pryadko, defaults (unless, of course, the property burns Leasing Director, Municipal Investment Company down or caves in - but for that we have insurance). (Krasnodar): O I believe that the problem of guarantees needs to ur company takes the following approach to be discussed more widely as a serious obstacle to guarantees. First of all, we have to require the development of leasing in Russia. additional guarantees on our leases in order to protect ourselves against the risk of lessee default. It is sometimes difficult to determine the Maksim Yurevich Kalinkin, financial condition of our potential lessees, since Acting Legal Director, Moscow Leasing Company: some of our applicants are private entrepreneurs who tend to conduct most of their transactions in W hen the Moscow Leasing Company negoti- cash and do not have any documentation to prove ates a new lease agreement, we ask the their solvency. In such cases, it makes sense to lessee to provide us with a guarantee on our invest- sign a guarantee agreement with a legal entity that ment, such as a surety, a bank guarantee or some can provide the necessary documents and form of collateral, depending on the size of the con- demonstrate its own solvency. tract and the lessee's financial situation. The second kind of guarantee is collateral. We Acceptable forms of collateral include commodi- require some form of collateral from every legal ties, any kind of highly liquid equipment or vehicle, entity that wants to take out a lease, since we have and real estate. The value of the collateral does not already had cases where repossessing and selling usually exceed the value of the lease agreement. the leased asset was not enough to help us recov- er our investment expenses, not to mention our The Moscow Leasing Company does everything it lost profits. By requiring the lessee to give us prop- can to bring their lease agreements - even the most erty or commodities as collateral, we can be rela- problematic ones -- to their logical conclusion, with- tively sure that we will recover our investment out confiscating the lessee's collateral. The only expenses, including lost profits, if the lease agree- time we would resort to seizing a lessee's assets is if ment goes wrong. he committed grave violations of the agreement. Lessees are often put off by bank loans, with Although we can recover our investment by con- their rigid application procedures and strict fiscating and selling off the lessee's collateral, this requirements in terms of guarantees and insur- would obviously terminate our relationship with the ance for mortgaged assets. Lease agreements, by lessee, and we have a vested interest in seeing that contrast, are much more lenient and flexible where our clients succeed with their leases. We therefore collateral is concerned, which makes the whole try to resolve our disputes by negotiation, rather process that much easier and attractive to the July-August 2001 EXPERT OPINION 15 lessee. Lessees occasionally propose their own Grigory Yurevich Vorobeychuk, forms of guarantees, which sometimes include General Director, KNK-lizing: bank guarantees -- but this is a rather expensive luxury. Nevertheless, thanks to the leasing compa- Leasing is a form of credit, and every creditor ny's relatively flexible approach, 90% of our needs to have guarantees. Leasing companies are potential lessees do not see additional guarantees unlikely to insist on collateral specifically, since col- as an obstacle to taking out a lease. lateral is generally one of the least liquid forms of guarantee. There are plenty of other kinds of guar- antees for traditional credit transactions: bank Irina Mikhailovna Chuvilyova, guarantees, sureties from financial agents, etc. Director of Credit Analysis, RG Lizing: The leased asset can also serve as a guarantee, U nfortunately, there are a number of factors that but only under one condition: it has to be liquid. If prevent us from accepting the leased asset as the leased asset is a unique piece of equipment that the sole form of guarantee under a lease agree- nobody but the lessee could possibly use, then it ment. Repossessing a leased asset can be difficult will obviously be difficult to sell if it has to be repos- not only because of bad faith on the part of the sessed. Furthermore, most leasing companies do lessee, but also because of the technical features not really have the right sort of personnel to sell of the leased asset itself. Some of our leased used equipment. Therefore, considering its liquida- assets are highly specialized to suit the needs of a tion value, leased equipment can only serve as a particular lessee; others are actually «built in» to partial guarantee, and the rest has to be covered in the lessee's production facilities and cannot func- some other way. tion on their own. Economic instability and a weak second-hand equipment market increase the risk In my opinion, a company's liquidity ratio is one of that we will not be able to sell a repossessed asset the most important factors defining its potential for to recover our expenses. In addition, we are con- development. The liquidation value of a lessee's strained by the requirements of the lenders that property is a resource that can be used to cover the finance our leases. gap between the leased asset's liquidation value and its original book value. This is a standard situa- The Russo-German Leasing Company (RG Lizing) tion when planning a lease. Life would be much currently uses almost every acceptable form of easier for all of us if the guarantee mechanisms for guarantee, including collateral (equipment, real leasing improved. For example, if the Russian bank- estate, etc.), insurance against financial risks, third- ing sector would become more sophisticated, we party guarantees and so on. We take an individual might see new kinds of guarantees, such as credit approach to each guarantee plan, based on the liq- against turnover. uidity of the leased asset and the particular features of each lessee, as well as the specific characteris- As for potential lessees that are starting up from tics of each investment project. scratch, I would strongly recommend that they form a clear idea about what kind of equipment they We understand that requiring additional guaran- need, and how much. They should then calculate tees puts leasing out of reach for many Russian the liquidation value of the equipment they are plan- companies. RG Leasing has always striven to create ning to lease. They shouldn't attempt to do this new financial products, including those that would independently; rather they should do it in conjunc- allow companies to take out leases without provid- tion with the lessor and the lending bank. Finally, ing additional guarantees as long as they could ful- they should calculate the difference between the fill certain criteria. A perfect example is our suc- leased asset's purchase price and its liquidation cessful partnership with KhGS Center, one of value: this is the amount that they will have to provide Russia's leading suppliers of printing equipment. in guarantees. These guarantees will have to come Our risk-sharing agreement makes it possible for us from the newly formed company's capital stock. to work together without requiring any additional guarantees, which means that we can also work out Leasing is a very convenient way to acquire new new projects much more quickly. This kind of equipment - the most convenient, in my opinion. arrangement is especially attractive to small and But as with any kind of business transaction, one medium-sized businesses. has to be prepared to meet certain requirements. 16 LEGISLATION July-August 2001 VARIOUS ASPECTS OF CONFISCATING AND SELLING PLEDGED ASSETS Stanislav Kovynyov, Attorney IFC Leasing Development Group O ne of the Since the law does not make any such provisions most com- for confiscating moveable assets, the parties must mon means be careful to define the precise grounds for confis- of guaranteeing the cating the pledged asset. If they fail to do so, even lessee's obligations the slightest violation of the lease payment sched- under a lease agree- ule, which technically entails a violation of the oblig- ment is obtaining a ations guaranteed by the pledge, could serve as pledge of the lessee's grounds for confiscating the pledged asset. assets. If we take a close look at court When defining the grounds for confiscating a practice, we find that pledged asset, the parties may choose to adopt the Stanislav Kovynyov, Attorney, many of the conflicts provisions of the Law on Mortgage, or any other rel- IFC Leasing Development Group that arise over the evant law; or they may come up with their own pro- course of the execu- visions to suit their particular needs. In our opinion, tion of a pledge agreement have to do with the spe- the pledge contract should allow the recipient of the cific procedures for confiscating and selling off pledge to confiscate a pledged asset if the lessee pledged assets. In this article, we would like to fails to make his lease payments for three or more focus on several of these issues. consecutive periods, since these are currently the legal grounds for annulling a lease agreement.1 However, we should emphasize that the parties are When does the lessor have the right to free to define whichever criteria they prefer. confiscate the lessee's pledged assets? T he grounds and procedures for confiscating The Procedures for Confiscating pledged assets are defined under Articles 348 Pledged Assets and 349 of the Russian Civil Code. According to T Article 348, the beneficiary of the pledge may con- here are different procedures for confiscating fiscate an asset when the lessee's obligations are pledged assets, depending on whether these not fulfilled or if they are fulfilled improperly. assets are classified as real estate or moveable Considering the relatively long duration of leases assets. Article 349 of the Russian Civil Code stipu- and the periodic nature of lease payments, it is lates the following procedures for confiscating important to determine just how far the lessee must pledged assets: fall behind on his obligations before the leasing company has the right to confiscate an asset. Real Estate Current legislation only provides an answer to this As a general rule, pledged real estate must be question if the pledged asset is a piece of real confiscated by court proceedings. The only excep- estate. According to Article 50 of Law #102-FZ on tion to this rule is if the parties agree to settle out of Real Estate Mortgages (07/16/98): court. Out of court settlements must meet the fol- lowing requirements: If an asset was pledged as a guarantee against a) The agreement must be notarized liabilities that must be settled by means of period- b)The agreement must be signed after the onset of ic payments, the recipient of the pledge has the the grounds for confiscation right to confiscate the asset in the event that the borrower systematically reneges on his obligations We can illustrate this principle with the following - i.e., if he fails more than three times in a twelve- example. The lessee reneges on two consecutive month period to make his payments in full and on time - unless otherwise stipulated in the pledge agreement. Article 13 of the Federal Law on Leasing. 1 July-August 2001 LEGISLATION 17 lease payments, which, according to the pledge most likely refuse to include any provisions for court agreement, gives the lessor (i.e. the pledge holder) proceedings within the pledge agreement; and even the right to confiscate the pledged asset. The if he does allow for such provisions, he will probably lessee recognizes the lessor's right to confiscate try to make up for the heightened risks by raising the pledged asset and agrees to let him do so with- the overall cost of the lease. The lessee will have to out any court proceedings. The parties sign a nota- decide whether the increased cost is justified by the rized agreement to that effect. reduction in risk. Moveable Assets Legal Measures Protecting the Rights If the pledged asset consists of moveable assets, and Interests of Companies and rather than real estate, then the parties must agree Individuals Pledging Assets on the procedures for confiscation. Russian law A does not stipulate a time frame for this agreement, ccording to Article 250, Clause 2 of the Russian so the parties may either include it in the original Civil Code, the courts may defer the sale of a pledge agreement, or they may draft a separate pledged asset by public auction for up to one year. agreement after the guaranteed liabilities have However, this deferral does not release the debtor gone into effect. If the parties fail to reach an agree- from the obligations that were guaranteed by the ment on the procedures for confiscating the pledge or from compensating the claimant for fur- pledged asset, then the lessor will only be able to ther losses or damages incurred during the deferral confiscate the asset through the courts. period. If the parties wish to write these procedures into No less important, the courts may decide to the pledge agreement itself, they should keep the reassess the value of the pledged asset.2 This can following points in mind. First, it is clearly to the be crucial for lessees, since lessors usually require leasing company's advantage to allow for confisca- the pledge contract to state an artificially low value tion out of court, since court proceedings will only for the pledged assets. The courts derive their increase the time it takes to obtain compensation. authority to reassess the value of a pledged asset On the other hand, if the lessor has the right to con- from Article 350 of the Russian Civil Code, accord- fiscate the pledged asset without resorting to the ing to which the arbitration courts are to fix the start- courts, this obviously puts the lessee at greater risk, ing sales price of a pledged asset up for public auc- since his lawful rights can only be defended in court. tion. The court's decision to reassess a pledged asset is based on evidence presented by both par- For example, the court may defer the sale of the ties. The parties are also free to submit evidence pledged asset for up to one year, revise the asset's demonstrating that the asset's assessed value cor- assessed value or reject the lessor's claim altogeth- responds to its real market value. On the basis of the er on the grounds that it is disproportionate to the evidence, the arbitration court may allow the parties value of the pledged asset. These legal rights obvi- to reach a mutually acceptable agreement, or it may ously make court proceedings the more attractive simply determine the asset's starting sales price in option from the lessee's perspective. At the same accordance with the evidence, regardless of the fig- time, the longer the court proceedings drag on, the ure stated in the pledge agreement.3 more the lessor will suffer as the lessee's principal obligations remain unfulfilled. On the other hand, if Another positive aspect of the legal procedures the court rules in favor of the lessor, the lessee will for confiscating a pledged asset is the fact that the have to cover all of the court expenses, which will courts may, in accordance with Article 348 of the increase his indebtedness even further. Russian Civil Code, prohibit the lessor from confis- Considering that the parties may agree at any time to settle out of court anyway, we believe that it is in Under certain circumstances, it may be to the lessor's advan- 2 the lessee's best interests to stipulate in-court set- tage to reassess the value of the pledged asset. In particular, tlement within the pledge agreement itself. If the considering the relatively long duration of a standard lease, lessee later chooses not to dispute the lessor's market factors may alter the value of the pledged asset. As a result, the asset's market value may end up being dramatical- claims, he can always draft an agreement authoriz- ly lower than its original sales price, making it far less liquid. ing the lessor to confiscate the pledged asset. At See Informational Letter #26 of the Plenary of the High 3 the same time, we should note that the lessor will Arbitration Court, January 15, 1998, Clause 6. 18 LEGISLATION July-August 2001 cating the pledged asset if the lessee has commit- allocated to the lessor before other creditors. ted only a very minor violation of the agreement However, this rule only applies to cases where the and the lessor's claims are disproportionately pledged asset was forfeited by law. When a pledged severe. However, lessees should remember that asset is sold by order of the arbitration courts, the three violations of the lease payment schedule in courts have generally given precedence to the the course of one year, no matter how insignificant, claims defined under Article 78 of the Law on the will serve as sufficient grounds for confiscating the Execution of Writs,4 particularly compensation for pledged asset. damages and any unpaid taxes or duties. If the revenue from the sale of the pledged asset Selling off a Pledged Asset exceeds the lessor's claim against the lessee, the T he procedures for selling off pledged assets lessor must refund the difference to the lessee. (whether real estate or moveable assets) are defined under Article 350 of the Russian Civil Code. If, on the other hand, the revenue from the sale of According to this article, pledged assets must be the pledged asset is insufficient to cover the sold by auction in accordance with established pro- lessor's claims, the lessor may, unless otherwise cedures, unless otherwise stipulated by law. The stipulated by law or the pledge contract itself, only law that contains different provisions is the Law recover the remaining sum from the lessee's other on Mortgage (Article 55), which allows the recipient assets, though these assets can only be seized by of the pledge to assume ownership of the pledged normal procedures, not the special procedures stip- asset or transfer it to a third party after deducting ulated for pledged assets. This statute does not the asset's purchase price from the outstanding apply in cases where the party pledging the assets debt. However, if the parties do not agree to this is a third party, rather than the principal debtor (the arrangement beforehand, then the pledged asset lessee).5 In such cases, the lessor's claims are lim- can only be sold by auction, in accordance with ited to the sum of revenue from the sale of the established procedures. pledged asset. He may only recover the remaining sum from the principal debtor (the lessee), and only The procedures for public auctions are defined by normal procedures, not the special procedures under Articles 447-449 of the Russian Civil Code. stipulated for pledged assets. Whether the pledged asset is a moveable asset or a piece of real estate, the auction procedures will Termination of the Pledge Agreement largely depend on the manner in which the asset Due to Termination of the Principal was confiscated. If it was confiscated through the Obligations When the Parties Agree to courts, then court bailiffs will oversee the sale, Indemnification or Novation except for cases where a specialized agency over- C sees the auctioning of a piece of real estate. onsidering that current legislation does not allow the lessor to assume ownership of the If the pledged asset was seized out of court, then pledged asset (any agreement to the contrary being the parties must agree on the terms of the auction. subject to annulment), and the fact that selling off a According to Article 447 of the Civil Code, the auc- pledged asset is a rather complicated procedure, it tion may be overseen by either the owner of the is very important that the parties have the option of asset or a specialized agency. The asset must be terminating the obligations guaranteed by the sold to the highest bidder. If the auction is declared pledged asset by concluding an agreement for invalid, the lessor may, with the lessee's consent, indemnification or novation. The courts have gener- purchase the pledged asset and deduct its purchase ally allowed parties to terminate the obligations price from the lessee's debt. If the parties cannot secured by the pledge agreement using such an reach such an agreement, the asset must be auc- arrangement. tioned a second time. If the second auction is also declared invalid, the lessor may keep the asset after crediting the lessee with at least 90% of the starting sales price established at the second auction. See the Federal Arbitration Court of the Northwest Region's 4 ruling on case #A52/2072/99/1 of May 30, 2000. According to Article 334 of the Russian Civil Code, See Informational Letter #26 of the Plenum of the High 5 the money received for the pledged asset must be Arbitration Court, January 15, 1998, Clause 7. July-August 2001 LEGISLATIVE NEWS 19 In this context, compensation means the provision Conclusion of money, property, etc., in lieu of fulfilling the prin- I cipal obligation, while novation means replacing the n spite of the complicated nature of pledge agree- original obligation with a new obligation, between ments and all of the difficulties associated with the same parties, allowing for a different subject confiscating and selling off pledged assets, pledges matter or means of fulfillment (Articles 409 and 414 are still the most attractive form of guarantee for of the Russian Civil Code). According to Article 352 Russian leasing companies. A pledge contract gives of the Civil Code, terminating the obligations guar- the leasing company a guarantee in the form of tan- anteed by the pledge agreement automatically can- gible assets that might be sold off to recover at least cels the pledge agreement itself. part of its losses, if not all of them. Since pledges are amongst the most effective forms of guarantees Russian law does not place any restrictions on the available in Russia today (and nothing better is likely terms of an indemnification or novation agreement. to appear in the near future), we advise lessors and Therefore, these two options are clearly an effective lessees to pay very close attention to the questions way to avoid the complications associated with con- raised in this article and to be very thorough in draft- fiscating and selling off a pledged asset. ing the provisions of their pledge agreements. INFORMATION The Tax Code's Draft Chapter on Profit Tax On June 6, 2001, the draft Chapter on Profit Tax (Part II of the Russian Tax Code) passed its third reading in the State Duma. The bill will now be sent to the Federation Council, and then to the President, for final approval. The whole pro- cedure will take about one month. The Key Points for the Leasing Industry ments, less depreciation charges, in expenses (hence reducing profits) 1) Depreciation policy: · Depreciation is charged normally · The bill preserves the right to record the leased asset on either party's balance sheet (the lessor's 3) Including loan interest in total expenditures or the lessee's) · Russian leasing companies may not include · Taxpayers may choose to depreciate the leased loan interest in their total expenses if the loan was asset using either the straight-line method (calcu- provided by a foreign company or organization with lated as 1/n, where n equals months of useful ser- a stake of 20% or more in the leasing company and vice life, applied to the asset's original value) or a the leasing company owes more than 12.5 times3 its declining-balance method (calculated as 2/n, equity on the loan. applied to the asset's residual value)1 · If the loan is 12.5 times greater than the leasing · Taxpayers may depreciate leased assets using an company's equity acceleration factor of up to 3, regardless of the depre- ciation method (straight-line or declining balance)2 Provisions Affecting All Enterprises, includ- · The leased asset's original value is defined as the ing the Leasing Industry amount that the lessor spent on its acquisition (that is, including related costs such as transportation) · The new chapter introduces a profit tax of · If an asset is already under lease when the new 24%, of which 7.5% will go to the federal govern- chapter on profit tax goes into effect, it may be ment, 14.5% to regional governments and 2% to depreciated according to the procedures that were in effect when the lease agreement was signed (i.e., the new regulations will not be applied retroactively) Except for assets with a useful service life of more than 20 years, 1 which can only be depreciated using the straight-line method. Except for fixed assets with a useful service life of less than five 2 2) Including lease payments in expenses years that are depreciated using the declining balance method. · If the leased asset is recorded on the lessee's This ratio only applies to leasing companies and lending institu- 3 balance sheet, the lessee should include lease pay- tions; for all other organizations, the ratio is 3 times equity. 20 OUR PROJECT July-August 2001 local governments. Regional governments may, if quarterly sales revenue over the last four quarters they wish, reduce the regional tax by up to 4% was less than 1 million rubles; otherwise the accru- (i.e., to 10.5%). al method must be used) · The new chapter eliminates many exemptions · Losses may be carried over for ten years follow- from profit tax, including the exemption for organi- ing the period in which they were incurred. zations making capital investments · The new chapter restricts the use of the cash In future issues of the Leasing Courier we will take method for calculating revenue and expenditures a closer look at the Chapter on Profit Tax and its (it can only be used if an enterprise's average implications for the Russian Leasing Industry. ANNOUNCEMENT The Leasing Development Group plans to hold the following seminars in the near future: MID-SEPTEMBER EARLY OCTOBER Urals Region Yuzhno-Sakhalinsk,Vladivostok, Leasing as a Means of Acquiring Fixed Assets Khabarovsk (Yekaterinburg) Leasing as a Means of Acquiring Fixed Assets Principles of Leasing (Chelyabinsk Region) Mini-seminar for Women Entrepreneurs THE LEASING DEVELOPMENT GROUP VISITS NIZHNY NOVGOROD Eleanora Veitsman, Public Relations Expert IFC Leasing Development Group the following day, June 22, the Group held an introductory seminar on the Effectiveness of Leasing for 37 local female entrepreneurs. The Nizhny Novgorod Women's Society helped orga- nize the event. To popularize leasing in Nizhny Novgorod, the IFC Leasing Development Group held a press conference for local media on the development of leasing in the region. Speakers included the Group's own team of experts; Deputy Governor of Nizhny Novgorod Oblast and Director of the Department for Business Press briefing on the leasing industry in Nizhny Novgorod Development, V.A. Bulanov; the General Director of the Nizhny Novgorod Leasing Company, A.V. Blinov; I n late June of this year, the Leasing and the General Director of Datavision-CIS, A.V. Timin. Development Group traveled to the city of Leasing began to develop in the Nizhny Novgorod Nizhny Novgorod to promote leasing and pro- region in 1996. According to Deputy Governor vide training. On June 21, the Group held a semi- Bulanov, it was Boris Nemtsov, former governor of nar on Leasing as an Effective Means of Acquiring Nizhny Novgorod, who gave the first real impetus to Fixed Assets for local entrepreneurs. More than the development of the local leasing industry by 60 people attended the seminar, including both obtaining relatively cheap funding from Sberbank of potential and experienced lessees. The Novgorod Moscow. Ever since then, the Nizhny Novgorod Chamber of Commerce and Trade and the Nizhny region has included a leasing development program Novgorod Regional Department for Business within its small-business development program. The Development provided organizational support. On leasing development program aims to facilitate leas- July-August 2001 LEASING IN REGIONS 21 ing in a variety of ways, including direct financial support. There are cur- rently two active leasing compa- nies in the Nizhny Novgorod region, the Nizhny Novgorod Leasing More than 60 businesses attended the Leasing for Lessees seminar Company and the Volgo-Vyatsky also in the neighboring regions of Mordovia, I n t e r r e g i o n a l Chuvashia, Mariy El and Kirov. Leasing Center, The most important industry in the Nizhny although this may Novgorod region is the automobile industry, led by be changing. The the giant Gorky Auto Plant (GAZ). Several other s t a t e - o w n e d industries, such as machine building, food pro- Nizhny Novgorod cessing, chemicals and petroleum, also play an Small Business important role in the local economy. Local leasing D e v e l o p m e n t companies reflect the preponderance of these Advertisements for leasing services are Fund also holds a industries in their lease portfolios. For example, the increasingly common in Nizhny leasing license, Nizhny Novgorod Leasing Company's portfolio Novgorod and Delta Leasing breaks down as follows: 40% GAZ automobiles, has recently opened an office and plans to offer MAZ and KAMAZ trucks and buses, 15% food-pro- leasing services to local entrepreneurs. In spite of cessing equipment (baking ovens and production the small number of active leasing companies, more lines for dumplings and pasta), and 10% shop and more of the region's enterprises are beginning equipment. The remaining 35% consists of com- to appreciate the advantages of leasing over other puters, printing equipment, and equipment for gas forms of finance. By the beginning of this year, the stations and dry cleaners. Nizhny Novgorod Small Business Development The general director of the Nizhny Novgorod Fund had financed more than 700 leases, while the Leasing Company, A.V. Blinov, concluded the press Nizhny Novgorod Leasing Company had financed conference by pointing out that «Nizhny Novgorod's more than 100 projects worth a total of 50 million leasing industry has begun to develop more active- rubles. The Volgo-Vyatsky Interregional Leasing ly, but that development could be greatly accelerat- Center, which opened relatively recently, serves ed if some way could be found to give local leasing clients not only in the Nizhny Novgorod region, but companies greater access to funding». LEASING IN THE NIZHNY NOVGOROD REGION Information from the Nizhny Novgorod Regional Department for Business Development T he Nizhny Novgorod Department for Business three-year period, the federal government did not allo- Development runs a small-business lending cate any funds to us for business development in the program that consists of three main parts: a region; the last time we received funding from Moscow leasing program, a guarantee fund, and a micro-cred- was in 1997, when the Federal Fund for Business it program. The Department is funded by the Nizhny Development allocated 5 million rubles to our region. Novgorod regional government, which allocated 6 mil- lion rubles for business development in 1997, 11 mil- Our largest program is our leasing program, which lion in 1998 and 15 million in 2000. Over the same has already leased over 20 million rubles' worth of 22 LEASING IN REGIONS July-August 2001 automobiles and equipment to local enterprises. Over the last five years, since leasing first began That equipment has included wood-processing to develop in the Nizhny Novgorod region, the machinery, shoe-repair equipment, dental equip- Nizhny Novgorod Small Business Development ment, a production line for ceramic tiles, etc. Fund has financed over 700 leases. Table 1 Automobile Leases Year Number of Leases Value (in millions of rubles) Number of New Jobs Created 1996 115 4.63 n/a 1997 213 11.01 n/a 1998 68 4.15 204 1999 89 8.05 267 2000 99 14.8 273 Total 584 42.64 744 Table 2 Equipment Leases Year Number of Leases Value (in millions of rubles) Number of New Jobs Created 1996 3 1.16 n/a 1997 10 7.66 n/a 1998 5 0.943 60 1999 8 2.8 96 2000 11 3.0 108 Total 37 15.563 264 Table 3 Type of Lease Nizhny Novgorod Volgo-Vyatsky Inter- Leasing Company regional Leasing Center 1997 1998 1999 2000 1999 2000 Automobile 14 leases, 41 leases, 5 leases, 8 leases, 3 leases, 10 leases, 2.181m rub. 11.9m rub. 1.9m rub. 5.2m rub. 1.5m rub. 1.68m rub. Equipment 12 leases, 4 leases, 10 leases, 3.7m rub. 1.87m rub. 4.13m rub. The Nizhny Novgorod Leasing Company facilitat- its main form of activity. The main aspects of its ed the creation of 54 new jobs in 1999 and another leasing program are defined under the Statute on 105 in the year 2000. The Volgo-Vyatsky the Organization of Leasing, which was ratified by Interregional Leasing Center made it possible to the governor of Nizhny Novgorod. According to create 64 new jobs in 1999 and 83 in the year 2000. this document, priority should be given to the Average annual interest rates were as follows: consumer goods industry, the food-processing industry, rural transportation, day-to-day ser- · 1997: 27% vices and traditional crafts industries. The statute · 1998: 27% (pre-crisis) and 60% (post-crisis) also defines the basic financial and organization- · 1999: 37% al terms of our lease agreements. Most impor- · 2000: 34-35% tant, the statute requires the leasing program to award its funding on the basis of fair and open The Nizhny Novgorod Small Business competition. Development Fund is now focusing on leasing as July-August 2001 SMALL AND MEDIUM-SIZED BUSINESS 23 SNEZHINKA BATHWORKS, KRASNODAR Viktoria Struts, Public Relations Specialist IFC Leasing Development Group Continued from page 1 W e fully expect our bath-house to be «After that seminar we understood that leasing required to operate at a loss for the fore- would be the best way for us to renovate our facili- seeable future, so the only way for us to ties,» explained Ms. Olkhovaya. «The establishment turn the bath-house and laundry complex into a that we had inherited was virtually in ruins. The profitable enterprise is by improving our other ser- machinery was constantly breaking down; the laun- vices. Since our laundry service accounts for some dry equipment was 90% worn out; the vehicles had 40-50% of our total volume, we decided to focus on been in service for 20-25 years and were practically making that more cost-effective. We did some mar- falling apart. Moreover, our average employee was ket research and found that we could improve our owed six months' wages.» service dramatically Snezhinka's man- not only for individual agers analyzed leasing clients, but also for very carefully to deter- corporate clients (hos- mine whether it was pitals and clinics, right for their compa- kindergartens, etc.). ny, consulting with For example, we found experts from the that our aging vehicles Moscow Leasing often failed to make Company at every their deliveries on time stage of their calcula- for the simple reason tions. In the end they that they kept breaking came to the conclu- down. We began to sion that if they could realize that we would lease the equipment have to improve our they needed, they whole infrastructure. Historical Note: would be able to pay Based on the business Krasnodar's bath-house at Dlinnoy St. #120 was founded in 20-25,000 rubles per plan that our financial 1893 by a local merchant by the name of Likhatsky. It was one month in lease pay- experts had drafted in of the most advanced bath-houses in Russia, and was every bit ments, even as they 1998, we began to as luxurious as the famous «Sanduny» bath-houses in Moscow. paid off the outstand- develop a whole range During the Soviet era, the establishment changed its name, but ing arrears to their of services.» never stopped operating. employees. The company first In May 1999, decided to buy some new vehicles and some dry- Snezhinka signed a lease with the Moscow Leasing cleaning equipment on credit. These were the assets Company for a Sobol light pickup truck, and the fol- that would bring the quickest payoff, within a month or lowing September it took out another lease on a two. The city's small-business development program Moskvich 2141, both of which are used for deliver- provided the company with $200,000 in guarantees to ing dry-cleaning to individual clients, a new service. purchase some German-made dry-cleaning equip- Both leases were signed for two-year periods, and ment. Then came the August Crisis, and the company their total value was 400,000 rubles. By May 2001, had to alter its plans. The idea of purchasing some Snezhinka had finished paying off its first lease, and new vehicles was put on hold. it expects to finish paying off the second by this In 1999, the company's managers attended the IFC Leasing Development Group's seminar on the The Leasing Development Group held a second seminar on 1 Fundamentals of Leasing - the Group's first seminar Leasing as a Means of Acquiring Fixed Assets, designed in the Krasnodar region.1 specifically for lessees, in May of this year. 24 NEWS July-August 2001 August. The company has never missed a single machines (probably from the Vyazemsky Factory) as lease payment, and at the same time it actually wellassomeGermandryersandpresses,whichwould turned a profit last year (for the first time in several raise the laundry's productivity dramatically. It current- years) of 335,000 rubles. lytakesthecompanyabout30-40minutestodry10kg The new vehicles enabled Snezhinka to expand of laundry, whereas the new equipment would cut that and improve its services. Now that they were finally time to 4-5 minutes. The new equipment would allow able to pick up and deliver orders efficiently, they the company to save a great deal on electricity and opened several new receiving centers around the lower its production costs. city. This allowed them to raise their total volume by «It would be fair to say that Snezhinka is the lead- 159% and create 27 new jobs - 15 of them for peo- ing laundry and bathing establishment in the ple under the age of 20. The company now employs region,» explained Ms. Olkhovaya. «We currently a total of 275 people. The city of Krasnodar has have a well-functioning network of receiving centers named Snezhinka its «Business of the Year.» throughout the city. In the future, we would like to Since Snezhinka started working with the Moscow expand this network throughout the region. Our Leasing Company, the firm's Krasnodar branch has market studies have shown that several nearby developed into an independent company called the cities have no dry-cleaning services at all, and their Municipal Investment Company with its own leasing laundries are on the verge of collapse. Every time license. Snezhinka plans to continue working with the we draft our plans for the coming year, our goal is to newlyformedcompany.Itiscurrentlythinkingoftaking surge forward. In order to do so, we obviously need out a large new equipment lease. For its dry-cleaning to expand our production facilities. Leasing has service it plans to lease some German dyeing equip- already proven itself as an effective tool for acquir- ment, which will be the first of its kind in Krasnodar. For ing new equipment, and we plan to use it in the its laundry service it plans to buy some new washing future to modernize our business.» PRESS DIGEST EVENTS IN THE RUSSIAN LEASING INDUSTRY BUSINESS DEALS S istema Co. has just finished installing a new set of Wincor Nixdorf automatic teller machines at SberbankinAltay.Sistemawillbeleasingthemachinesto Sberbank, having won a tender in late 2000. As Sberbank's main supplier of bank equipment, Sistema has actually been serving Sberbank Altay since 1997. The new ATMs The total cost of the project is estimated at $221 million. will enable Sberbank Altay to provide automatic banking With $141.2 billion in sales and $3.5 billion in profits last services to their 60,000 card-holding customers. The bank year, Ford could easily have afforded to finance the new also plans to start issuing more cards in the near future. factory on its own, but it preferred to include the IFC, Vremya-MN which is expected to provide Ford with important techni- 16 June 2001 cal assistance, particularly in creating a network of local T suppliers. In time, Ford's partners will also be given he International Finance Corporation's board of access to credit lines and leasing plans. This will be one of directors has approved a $110m loan project for the IFC's largest projects in Russia. a new Ford auto plant in the city of Vsevolozhsk ITAR-TASS (Leningrad region). The IFC will provide half of this sum 19 June 2001 directly, and private banks will provide the rest through syndicated loans. Ford Motors, which has a 99% stake in T he Pervomayskaya Zarya Factory plans to invest the factory, will act as the project's guarantor and gener- $500,000 in new equipment by the end of 2002. al sponsor. St. Petersburg Banking House, a subsidiary of As part of this project, the company received some Promstroy Bank, holds the remaining 1% of shares in the German-made Veith machinery on June 21, under a lease Ford Vsevolozhsk Factory. The new factory will be used to agreement with Baltic Leasing and Ermako, the German assemble Ford's Focus model for the Russian market. Its manufacturer's Finnish distributor. The new equipment is projected capacity will be 27,000 automobiles per year. valued at $75,000. Pervomayskaya Zarya is one of The factory will train and employ some 1,000 Russians. In Russia's oldest producers of women's clothing. Last year addition, experts predict that ten times as many jobs will the company invested $200,000 in new equipment leases. be created among Ford's suppliers in Russia. July-August 2001 NEWS 25 This enabled it to acquire some high-tech sewing equip- plans is an effective way for the government to boost the ment, to automate its design process using the latest productivity, competitive strength and profitability of local developments in computer software and to reorganize its agriculture. Since 1996, Tuymaada Lizing has leased production facilities around individual steam-generators. 242,303,400 rubles' worth of equipment to local farmers, Rosbalt Information Agency including 880 Buran snow-tractors, 90 motor vehicles and 21 June 2001 548 tractors (178 DT-75s, 282 MTZ-82s and 88 T-25s and T-30s). It has also acquired 8 milk-processing units T he city of La Plata, a free economic zone in the from Sweden and 5 potato-cultivators from Holland. In the province of Buenos Aires, Argentina, has hosted year 2000, as part of the government's program to sup- an exhibition of Russian KamAZ trucks. Several of port family farms, Tuymaada also provided local farmers KamAZ's most popular models were shipped to Argentina with 600 Chinese mini-tractors fitted with mowers and with an eye to working out a long-term arrangement for plows, valued at 69,702,800 rubles. selling KamAZ trucks on the local market, as well as certi- Sakha-Yakutiya Information Agency fying the Russian vehicles in accordance with local legisla- 9 June 2001 tion and launching an advertising campaign for KamAZ A within Argentina. During a visit to Argentina last year, .I. Morozov, deputy director of the Nizhny KamAZ's general director, Ivan Kostin, signed a protocol of Novgorod Regional Department of Agriculture, has intentions with SEMARU to launch a pilot project that officially transferred eight Yesnisey and Don combines would return Russian trucks to the Argentinean market under lease to the region's top farms. The 900,000- (they were quite popular with local consumers during ruble machines were given to farms in the Pavlovsk, Soviet times). SEMARU, which stands for Centro de Vetluzhsky, Shakhunya, Shatki, Pilna, Vorotynets and maquinaria rusa, or the Center for Russian Equipment, has Buturlino districts. Regional farmers have already received been working with Soviet and Russian equipment suppli- 100 tractors since the beginning of this year through the ers for a quarter of a century. It is now KamAZ's official dis- federal government's leasing program. Forty-eight of these tributor in Argentina, providing not only sales services, but tractors were delivered in time for the sowing season, while also guarantee maintenance for the full service life of the the rest will arrive in time for the fodder harvest. trucks. During the exhibition, SEMARU actually signed Nizhegorodskie Novosti sales agreements for four of KamAZ's exhibition models. 27 June 2001 SEMARU expects to receive an initial shipment of 50 Russian trucks this October and to begin selling them in SMALL & MEDIUM-SIZED BUSINESS November. The company's experts believe that the current T market for KamAZ trucks in Argentina is about 300 trucks he Russian Agricultural Bank (Rosselkhozbank) per year. The company has already worked out a leasing and the Russian Central Union of Consumers' plan for the trucks with two major Argentinean banks Associations (Tsentrsoyuz) have signed a partner- ITAR-TASS ship agreement. The consumers' cooperative has exist- 25 June 2001 ed in Russia for 170 years. It focuses on agricultural trade, buying up produce from small plots and processing it at AGRICULTURE its own factories. The cooperative has more than 90,000 trading companies and 10,900 industrial factories at its T he Siberian Machine-Building Holding Company disposal, in addition to a well developed network of small- (Krasnoyarsk Territory) and Ukragrotekhnika scale food processing plants. It currently has 11.4 million Leasing and Manufacturing Company plan to open a shareholders united into 32,000 consumers' unions. The Yenisey grain-harvester factory in Ukraine. The new new partnership agreement between Tsentrsoyuz and factory will be built on the existing Ozyryansky Agro Rosselkhozbank calls for joint efforts to attract additional Technical Service Plant, which currently specializes in sources of finance and to create special investment pro- repairing Yenisey, Niva and Don combines. The joint ven- grams for the development of the agricultural sector and ture is expected to produce up to 1,000 new combines the food-processing industry. The two partners will also per year. By using less costly Ukrainian components and cooperate on obtaining loans for Tsentrsoyuz's members, cutting down on transportation costs, the company will be including funding for leasing projects. able to reduce the cost of a Yenisey harvester in Ukraine RIA Novosti by about 10%. The company plans to sell the harvesters 19 June 2001 under leasing plans. Kommersant INFRASTRUCTURE 8 June 2001 S tate-owned Vodokanal of St. Petersburg has just T he government of Yakutiya has approved a received 59 million rubles' worth of new equip- Regional Program for the Development and ment under lease. Petrokonsalt Leasing Company pro- Expansion of Agricultural Leasing from 2001-2005. vided the equipment under a deal financed by St. The government will promote leasing in the region Petersburg Bank. According to Petrokonsalt's general through state-owned Tuymaada Agricultural Finance, director, E. Tulina, the leased equipment includes water which will act as a lender and guarantor on local leasing pumps and motor vehicles. The lease was signed for a projects, and state-owned Tuymaada Lizing, which will act period of more than three years. as the lessor. Experience has shown that providing agri- Delovoy Peterburg (St. Petersburg) cultural producers with new equipment through leasing 6 June 2001 26 QUESTIONS & ANSWERS July-August 2001 T EVENTS IN THE FOREIGN LEASING MARKET he International Leasing Finance Corp (ILFC) of Los Angeles has placed a record-breaking order A merica's Metromedia Fiber Network, which spe- for 111 aircraft, worth a total of $8.7 billion, with cializes in the development of municipal fiber- Europe's Airbus Industrie. ILFC will actually pay some- optic cable networks based on Internet protocol, has what less for the aircraft, since Airbus has agreed to a dis- signed an agreement with Germany's Deutsche count of an undisclosed amount. According to ILFC's Telekom. According to this agreement, which was signed chief executive officer, Steven Udvar-Hazy, the company for a period of 20 years, Metromedia will provide has now ordered a total of 376 aircraft from Airbus. ILFC is Deutsche Telekom with fiber-optic networks in the north- a subdivision of American International Group Inc. Last eastern United States, as well as Washington, DC, and will year Airbus received orders for 520 aircraft. So far this also provide the German company with operating, admin- year, it has received orders for 299. The total value of istrative and technical services. According to these orders, according to WSJ, has reached $13 billion Metromedia, its cable network will give Deutsche ($15.23 billion euros). Telekom's clients access to virtually unlimited wide-band UNIAN Information Agency connections with a high level of security. 20 June 2001 Foreign Business Information Agency (Alliance Media) 7 June 2001 I FC will lend $6 million to ORIX Leasing Egypt, SAE G eorgia's Minister of the Economy, Industry and (OLE), a Cairo-based leasing company that spe- Trade, Ivane Chkhartishvili, has signed an agree- cializes in providing medium-term finance to SMEs. ment in Italy for the creation of a joint Italian-Georgian OLE will use IFC's investment to expand its lending to leasing company. The new company is expected to foster SMEs, thereby supporting their growth and boosting job the development of small and medium-sized business in creation. The investment is in line with IFC's global strat- Georgia. The Italians have agreed to invest $350,000 into egy of strengthening domestic financial institutions and the company's charter capital. Minister Chkhartishvili has increasing the access to medium and long-term finance urged the Georgian parliament to act quickly to pass a new by local SMEs. OLE is an unlisted joint stock company law on leasing. The Georgian-Italian joint venture's established in 1997 by the National Bank of Egypt, founders include BNL Bank of Italy (11%), SIMEST Commercial International Investment Company, ORIX Investment Company of Italy (20%), FINEST (20%), the Corporation-Japan, ORIX Leasing Pakistan, Ltd., and IFC. International Finance Corporation (25%), a consortium of IFC Press Room, Georgian commercial banks (24%) and the Georgian 27 June 2001 Development Fund for Small and Medium-Sized Business, which will invest around 1 million lari in the new company. PRIME NEWS Information Agency (Tbilisi), 12 June 2001 QUESTIONS & ANSWERS I f a lessee purchas- documented market value.1 The difference arising from es a leased asset the reassessment should be included in the organiza- at a nominal price tion's additional paid-in capital. The property is then reap- of 1 ruble, as stipulat- praised on a regular basis so that the value of the fixed ed under the lease assets in the bookkeeping records does not differ signifi- agreement, does it cantly from the current market value. have the right to An organization's ability to include depreciation charges in reassess its fixed itsexpensesintheeventofareassessmentisexplainedinthe assets? Can the TaxMinistry'sLetter#VG-6-02/288@of04/17/00.According depreciation charges tothisletter,«whenanorganizationreassessesitsfixedassets using the reassessed inaccordancewiththeAccountingStandardsandreflectsthis value be included in reassessed value in its bookkeeping records, the reassess- Elena Degtiareva, financial ana- production costs? Will ment should be used for calculating property tax, as well as lyst with the IFC Leasing the reassessed value profit tax (in particular, when calculating depreciation Development Group, answers ques- also be applied for the charges).» Furthermore, the Tax Ministry's Letter of 11/15/00 tions from our readers. purposes of property on Amendments and Additions to the State Tax Service's tax? Instruction #33 of 06/08/95 on the Procedures for Paying An organization may reassess groups of similar fixed assets no more than once per year (at the beginning of Accounting Standards Statute PBU 6/01 on Recording 1 the fiscal year) according to their current value, either by indexation or by direct recalculation, based on the assets' Fixed Assets, confirmed by Ministry of Finance Order #26n of 03/30/2001. July-August 2001 QUESTIONS & ANSWERS 27 Property Tax also confirmed that the taxpayer should use the individual entrepreneurs and paid for by means other than results of a voluntary reassessment of fixed assets when cal- cash are subject to normal sales tax.3 However, the Tax culating the taxable base for property tax. Ministry admits that this puts private entrepreneurs at a dis- Thus, an enterprise may reassess a fixed asset at the advantage in relation to legal entities and suggests amend- beginning of the fiscal year (on the basis of documented ing Federal Law #150-FZ on Amendments and Additions to market prices) and include the depreciation charges in Article 20 of the Law on the Principles of the Russian Tax his production costs. Moreover, the enterprise must use System (07/31/98). Until this law is amended, however, the the results of the reassessment when calculating his tax- Tax Ministry believes that the sale of goods or services to able base for property tax. private entrepreneurs in exchange for payment by bank Nevertheless, in our opinion, it is not clear that reassess- transfer should be subject to sales tax. ing a depreciated asset is entirely legal, even if it is not TheMinistryofFinanceholdstheoppositeview,writingthat explicitly prohibited, and it should certainly not be attempt- «goods purchased by private entrepreneurs for commercial, ed without the permission of the local tax authorities. For non-personaluseandpaidforbymeansotherthancash(i.e., example, if the leased asset was recorded on the lessee's by bank transfer), should not be subject to sales tax.»4 balance sheet, its value was already included in production Furthermore, the Constitutional Court's Ruling #2-P of costs in the form of depreciation charges over the course of 01/30/01 established that Article 20, Clause 3 of the Law the lease. The tax authorities may therefore reject any on the Principles of the Russian Tax System violates the attempt to reassess a leased asset and include its depreci- Russian Constitution and shall anyhow go out of force by ation charges in production costs a second time. January 1, 2002. Furthermore, one has to bear in mind that since an We should also point out that since sales tax is a region- asset may only be reassessed at the beginning of the fis- al tax, the regional authorities are free to define their own cal year, if the lessee assumes ownership of the leased procedures for paying the tax. For example, until asset in, say, February 2001, the reassessment cannot 04/01/00, the city of Moscow did not levy sales tax on take place until January 1, 2002. And if the asset is non-cash or barter transactions between legal entities redeemed at a price of 1 ruble, it will depreciate fully with- and private entrepreneurs.5 However, the city was forced in the first month. to abandon this policy on April 1, 2000, in compliance with a new letter from the Board of the Russian Tax Ministry.6 Therefore, private entrepreneurs should turn to their D oes the leasing company have to pay sales tax if local branch of the Russian Tax Ministry for the final word the lessee is a private entrepreneur and the on this matter. lease payments are made by bank transfer directly from the entrepreneur's account? We should note that Russian law does not contain the concept of 2 According to Article 20, Clause 3 of Law #2118-1 on the wholesale or retail sale of services. This might serve as grounds Principles of the Russian Tax System (12/27/91), sales tax for doubting whether Clause 3 should apply to leasing companies, is levied on the wholesale or retail sale of goods or services which provide a service in the form of financial leasing.. in exchange for cash payment.2 In this context, bank trans- Russian Tax Ministry Letter #AP-8-03/1176 of March 13, 2000. 3 fers by individuals are also considered a form of cash set- Ministry of Finance Letter #04-03-13 of June 8, 2000 4 tlement. Since private entrepreneurs are individuals, a bank The Board of the Russian Tax Ministry, Letter #11-14/17391 5 transfer from a private entrepreneur must be considered a of 06/23/99 (08/02/99 redaction) on the Introduction of Sales form of cash payment. Therefore, a private entrepreneur's Tax within the City of Moscow. lease payments are subject to sales tax. The Tax Ministry The Board of the Russian Tax Ministry, Letter #02-14/10266 6 also states that goods or services sold by legal entities to of 03/23/00 I s it possible to the unfinished construction will cease to exist, legally lease unfinished speaking. Consequently, the leased asset will also construction? cease to exist. On the other hand, the Federal Law on Real Estate and Unfortunately, Russian Real Estate Transactions defines unfinished construction legislation does not pro- as a kind of real estate, and current legislation places no vide a clear answer to restrictions or bans on the leasing of real estate. this question. Adherents to this view believe that if the lessee completes On the one hand, the construction project, this should merely be consid- unfinished construction ered as an enhancement of the leased asset. The state cannot be considered a inspection agencies support this view.1 However, we « n o n - c o n s u m a b l e maintain that any lease on an unfinished construction Olga Shishlyannikova, an attorney thing,» since the asset project is likely to be problematic and to result in legal with the IFC Leasing Development will become a full- proceedings. Group, answers questions from our fledged piece of real readers. estate (building, struc- ture, etc.), subject to official registration, once it is completed. As soon as the For example, this was the view expressed by Tax Service 1 completed construction project is officially registered, advisor P.P. Gruzin in his letter of 02/22/99. CHIEF EDITOR: I f a leasing company takes out a loan from a private individual or a Viktoria Struts private entrepreneur, is it violating the regulation that says that only lending institutions may accept deposits from individuals? ARTICLES PREPARED BY: No, since these are two separate kinds of agreement. The main dif- Irina Chuvilyova ference is that a bank deposit agreement is public by nature; that is, the Elena Degtiareva bank must sign the same agreement on equal terms with anyone who Maksim Kalinkin wishes to make a deposit. Thus, the bank offers an unlimited group of people the opportunity to deposit money on certain specified terms. A Stanislav Kovynyov loan agreement, by contrast, involves one specified individual or group Konstantin Merkulov of individuals and does not aim to attract investment (deposits) from an Valery Pryadko unlimited number of people. Viktoria Struts Olga Shishlyannikova Veronica Shtelmakh Eleonora Veitsman P art I of the Tax Code con- tains a provision about 20% Grigory Vorobeychuk deviations from the market price. How exactly does this apply TRANSLATION BY: to a lease agreement where the total contract value far exceeds Daniel Kohn the value of the leased asset? Comments, proposals, questions and The statute in question appears to submissions may be sent to: be Article 40, «Defining the Value of Goods, Labor or Services for Tax IFC Leasing Development Group Purposes.» Clause 1 of Article 40 Moscow 103009, ul. Bolshaya Veronika Shtelmakh, an attorney states that unless otherwise stipulat- with the IFC Leasing Development Dmitrovka, d. 7/5, str. 2. ed under this article, the price of Group, answers questions from our e-mail: Leasing-RussiaProject@ifc.org goods, labor or services that was readers. http://www.ifc.org/russianleasing agreed between the parties is the Telephone: (095) 755-8818 price that should be used for tax pur- poses. Clause 2 lists the cases in which the tax authorities have the fax: (095) 755-8292/8299 right to verify the appropriateness of the agreed price. There are four Articles from the Leasing Courier may be such cases: transactions between interdependent parties, barter reprinted in full or part if credited to the IFC transactions, foreign trade agreements and cases where the stated Leasing Development Group price is more than 20% higher or lower than the taxpayer charged for identical (similar) goods, labor or services within a short period of time. The Leasing Courier information bulletin is dis- Indeed, the total cost of a lease usually exceeds the cost of the tributed free of charge as a part of the Leasing equipment by more than 20%. However, it would be inappropriate to Development Project, implemented by the compare the cost of a sales agreement to the total cost of a lease, even International Finance Corporation with financial for identical assets. Under a lease agreement, the leasing company support from the Canadian International provides the lessee with financial services; consequently, the lease Development Agency (CIDA) payments include compensation for these services.. Therefore, the tax authorities can only compare the cost of a lease to the cost of another lease for analogous equipment involving the same services. Circulation: 200 copies (English) I N T H E N E X T I S S U E S O F « L C » THEORY & PRACTICE LEGISLATION LEASING IN RUSSIA Guarantees in Leasing Our comments to the «Deutsche Leasing Vostok» Amendments to the Second Leasing Company Part of the Tax Code FOREIGN LEASING NEWS QUESTIONS AND Kazakhstan Leasing Press Digest ANSEWERS Sector Survey AND MUCH MORE...