Charge of Lessor in Cross-Border Financial Lease Agreements

Under Turkish law, cross-border financial lease agreements must be registered by the Association of Financial Leasing, Factoring and Financing Companies (“Association“). The same authority registers any amendment made to the prior registered leases. The Association recently changed the practice of their legal predecessors, namely, Banking Regulation and Supervision Agency (“BRSA“).

Last year, the registration of “Novation and Amendment Agreements of cross-border leases“, which only changed the lessor of existing registered cross-border financial lease agreements was rejected by the Association. The Association established a new practice and started seeking for the submission of those agreements with the title “Assignment, Assumption and Transfer Agreements.”

How to Identify Whether It is a Novation?

Under the Turkish Code of Obligations’¹ (“TCO“), the term “novation” (novatio) stands for ending an existing obligation by replacing it with a new one. Termination of an existing obligation by establishing a new one, can only take place with the explicit statement of wills of the parties to a contract. The term “novation” of a contract, which basically terminates an existing obligation by starting a new one is used for the cases where the subject matter of the obligation, its term or the parties thereto, i.e. the essential parts of an agreement, are amended.

Novation and amendment of an existing agreement, by changing either one or more of its parties is actually quite similar to the concept of assignment of receivables or debts under Turkish law. In case of a novation and amendment of an agreement, the existing debtor-creditor relationship between the parties comes to an end and an entirely new legal relationship between the existing debtor/creditor and the new one is established.

What is the Main Distinction between the Novation and an Assignment?

In case of a novation, upon termination of the existing contractual relationship, any associated/ancillary rights in relation to the existing legal relationship, such as a mortgage, personal/corporate guarantees, penalty clauses, etc. come to end as well. Thus, the new party, entering into the subject contractual relationship, will not be able to enjoy those associated/ancillary rights. Any agreements/arrangements providing for the continuation of them will not be valid under Turkish law. However, this is not the case for assignment of contracts. In case of an assignment or transfer of an agreement, any ancillary rights/obligations of the assignor (except for individual rights) are also assigned/transferred to the transferee pursuant to Article 189 of the TCO. This is the most important difference between the assignment of agreements to third parties and novation and amendment of them.

Where Can We See the Effects of this New Practice?

The foregoing distinction becomes especially important in case of high-volume financing transactions and common demand of requiring solid securities, to be established in the form of mortgage, assignment of insurance or receivables, corporate or personal guarantees, issuing L/Cs, promissory notes, etc.

To give an example, if an agreement providing for a lessor change is made in the form of an “assignment and transfer agreement“, then the securities attached to the underlying primary legal obligation will be deemed to have automatically assigned to the new party. In practice, this kind of an assignment requires complementary legal steps to be taken, in case of for instance the assignment of a mortgage. Under Turkish law a brand new mortgage agreement must be signed between the mortgagor and the new mortgagee and registered with the pertinent registry, e.g. title deed registry, Aircraft Registry,etc.

Therefore, in case of a change of lessor, if the intention of the parties is not to continue the ancillary obligations attached to an existing lease relationship, then a novation agreement must be executed among the parties. Because, essential element of an existing agreement is being amended, a brand new legal relationship is being established and automatic assignment/transfer of ancillary rights to the new agreement party is not the intended outcome.

How About Tax?

There is not difference between the two transaction types in terms of their stamp tax and transactional charge consequences. Pursuant to Article 37 of the Financial Leasing, Factoring and Financing Companies Law² (“FLL“), documents which are issued for financial leasing, transfer or amendment of the same are exempt from stamp tax and applicable charges. Therefore, amendment agreements amending an existing financial lease agreement to change the lessor thereof must enjoy the stamp tax and exemption. In parallel with this understanding, the Advance Ruling as issued by the Ministry of Finance³ provides that the novation and amendment agreement which provides for the change of the lessor with the condition that the financial lease agreement will continue with all the rights and duties thereunder must be exempt from stamp tax and charges as well. Thus for both transaction types the applicable stamp tax rate will be 0% and no different tax implementations should occur between change of a party of a financial lease agreement, be it made by means of a novation and amendment; or an assignment/transfer agreement.

What Will the Parties Do in Practice?

It is the parties mutual commercial decision whether the ancillary rights attached to an underlying obligation shall survive or not, following a replacement of the lessor with a new one. Especially in the case of asset financing transactions, change of a party usually requires for a novation, given the fact that the security package designed to be obtained in favour of the lessor from a lessee is not likely to be same with the security package that the same lessor may seek from another lessee. Needless to say, the assignment/transfer transaction will be preferred if the parties aim for the continuous of the ancillary rights with the new transaction party. Therefore, the transaction type to be used must be determined considering the commercial desire of the parties.