Industrial Dispute Act 1947 Awards, Settlement

As per the definition of Industrial Dispute, disputes of following Parties also come under Industrial Dispute.

  • Employer and employer
  • Employer and workmen
  • Workmen and workmen

The Industrial Dispute Act, 1947 which extends to the whole of India came into operation on the first day of April 1947. As per Preamble of the said Act, it is enacted to make a provision for the investigation and settlement of the dispute and certain other purposes such as recovery of money from the employer in terms of Settlement or Award by making an application to the appropriate government. The purpose and aim of the Industrial Disputes Act 1947 is to minimize the conflict between labour and management and to ensure, as far as possible, Economic and Social Justice. The act has made comprehensive provisions both for this settlement of disputes and prevention of disputes in certain Industries.

Definition of Award:

Section 2(b) of the Industrial Dispute Act,1947 defines Award as follows:

According to Section 2(b) of the Industrial Disputes Act, 1947 ‘Award’ means an interim or a final determination of any Industrial Dispute or of any question relating thereto by any Labour Court, Industrial Tribunal or National Industrial Tribunal and includes an arbitration award made under section 10A.

Ingredients of Award:

To constitute Award under Section 2(b) of the Industrial Dispute Act, 1947 the following ingredients are to be satisfied:

  • An Award is an interim or final determination of an industrial dispute.
  • It is an Interim or final determination of any question relating to such dispute.
  • Such interim or final determination is made by any Labour Court, Industrial Tribunal or National Industrial Tribunal.
  • Award (Judgement) of Arbitrators under section 10A is an Award.

Method of settlement of Industrial Dispute:

In the interests of the industry in particular and the national economy in general, cordial relations between the employer and employees should be maintained. To ensure cordial labour management relations and to achieve industrial harmony, the following methods of settlement of industrial disputes are provided under the Act:

  1. Collective Bargaining: Collective Bargaining or Negotiation is one of the methods for settlement of an industrial dispute. It plays significant role in promoting labour management relations and in ensuring industrial harmony

Collective Bargaining is a process/Method by which problems of wages and conditions of employment are settled amicably, peacefully and voluntarily between labour and management. In collective bargaining, the parties to the dispute I.e., the employer and the employees/workmen settle their disputes by mutual discussions and agreements without the intervention of a third party. Such settlements are called “bipartite settlement”. Therefore, settlement of labour disputes by direct Negotiation or settlement through collective bargaining is always preferable as it is the best way for the betterment of labour disputes. Collective Bargaining is recognized as a right of social importance and greater emphasis is placed on it by India’s five-year plans. The term ‘Collective Bargaining’ was coined for the first time by Sidney and Webb in their famous book ‘Industrial Democracy’ published in 1897. It means

Negotiation between an employer and group of workers to reach agreement on working conditions. N. W. Chamberlain (in his ‘Source Book on Labour: 1958 p. 327) described collective bargaining as “the process whereby management and Union agree on the terms under which workers shall perform their duties”. In simple word, collective bargaining means “Bargaining between an employer or group of employers and a bonafide Labour Union”.

2) Conciliation:

Conciliation is a process, by which a third party persuades the parties to the industrial dispute to come to an amicable settlement. Such third party is called ‘Conciliation Officer’ of Board of Conciliation. Sections 4 and 5 of the act provide for the appointment of Conciliation Officer and the constitution of the Board of Conciliation respectively.

3) Voluntarily Arbitration: The expression ‘Arbitration’ simply means “the settlement or determination of a dispute outside the court”. Parties to the dispute, without going to the Court of law, may refer the dispute/Matter to a person in whom they have faith, to suggest an amicable solution. Such person, who acts as a mediator between the disputants to settle the dispute is called “Arbitrator”. The decision given by the parties, which is binding on the parties, is called “Award”. Therefore, Arbitration is a judicial process under which one or more outsiders render a binding decision based on the merits of the dispute. Section 10-A of the industrial dispute act, 1947 confers on parties, power to enter into Arbitration agreement. The agreement must be in prescribed form and must specify the name/names of the arbitrator or arbitrators.

4) Adjudication:

When an industrial dispute could not be settled either through bipartite negotiations or through the Conciliation machinery or through the voluntary Arbitration, the final stage resorted to, for settlement of an industrial dispute is Adjudication or compulsory Adjudication, which envisages Governmental reference to statutory bodies such as Labour Court or Industrial Tribunal or National Tribunal. Section 7, 7-A and 7-B of the Industrial disputes Act, 1947 provide for the constitution of Labour Court, Industrial Tribunal and Labour Tribunal respectively.

Mediator

Conciliation, a form of mediation refers to the act of making a passive and indirect effort in order to bring two conflicting parties to a compromise. It is the “practice by which the services of a neutral party are used in a dispute as a means of helping the disputing parties to reduce the extent of their differences and to arrive at an amicable settlement of agreed solution.”

The conciliator or mediator tries to remove the difference between the parties by persuading the parties to rethink over the matter with a give and take the approach but does impose his or her own viewpoint. The conciliator is at liberty to change his or her approach from case to case as he or she deems fit depending on other factors.

The Industrial Disputes Act, 1947 provides for conciliation, and can be utilised either by the appointment of conciliation officers; permanently or for a limited period or via the constitution of a board of conciliation. This conciliation machinery is at liberty to either take note of the dispute or apprehend dispute on its own or when approached by a party.

In order to expedite proceedings, time-limits have been prescribed. It is 14 days in the case of conciliation officers and 2 months for a board of conciliation. The settlement so arrived upon during the course of conciliation is binding upon the parties for the period that has been agreed upon by the parties or for the period of 6 months. It shall continue to be binding until revoked by either of the parties. During the pendency of the conciliation proceedings, before a Board and for seven days after the conclusion of such proceedings, the Act prohibits strike and lock-out.

Compulsory arbitration

Compulsory arbitration is arbitration of labor disputes which laws of some communities force the two sides, labor and management, to undergo. These laws mostly apply when the possibility of a strike seriously affects the public interest. Some labor contracts make specific provisions for compulsory arbitration should the two sides fail to reach agreement through the regular system of collective bargaining.

In cases where the government instructs the two parties to opt for the process of arbitration. The judgement produced by the arbitrator is binding on both the parties.

Memorandum of Settlement (MOS)

When both the Parties represent themselves before the Conciliation Officer then after reaching a conclusion persuaded by the conciliation officer, both parties enter into a Memorandum of Settlement which shall be binding on both the parties for the period. The settlement as mentioned in Section 2 (P) includes a written agreement signed by both the parties and executed copy be sent to the appropriate government. As per Rule 59 of The Industrial Dispute (Central) Rules,1957, MOS must be executed in Form H.(4). The settlement shall come into force on the date of signing of MOS between the Parties and shall come to end as mentioned in the MOS or after expiry of 2 months’ notice, where no date is mentioned in MOS.

Industrial Dispute Act 1947 Definition, Authorities

The Industrial disputes Act 1947, was enacted in the post-independence era with a view to regulate the relationships of the employer and employee and to maintain peace and harmonious relations between the two.

The Industrial Disputes Act, 1947 extended to the whole of India and regulated Indian labour law so far as that concerns trade unions as well as Individual workman employed in any Industry within the territory of Indian mainland. Enacted on 11th March 1947 and It came into force 1 April 1947. It was replaced by the Industrial Relations Code, 2020.

Employer

The term employer has been defined under the industrial dispute act of 1947 under section 2(g) the employer according to the definition is the person authorized to do the work in the capacity as an employer under the leadership of either the Central Government or the state government or the local authority.

Industry

The term Industry is defined under section 2(j) of the act as any business, trade or undertaking manufacture or calling and includes any calling, service, employment, handicraft or industrial occupation or avocation of workmen.

an industry exists only where there is a relationship between the employer and the employee and where the former is engaged in business trade or undertaking and the latter is engaged in any calling service employment or handicraft.

Workmen

The term workmen have been defined under section 2(s) of the act which states that workmen mean a person who is employed in any industry to carry put skilled, unskilled, manual, technical, operational, clerical or supervisory work.

” appropriate Government” means

In relation to any industrial dispute concerning any industry carried on by or under the authority of the Central Government, or by a railway company 6 or concerning any such controlled industry as may be specified in this behalf by the Central Government] or in relation to an industrial dispute concerning.

“Average pay” means the average of the wages payable to a workman:

  • in the case of monthly paid workman, in the three complete calendar months,
  • in the case of weekly paid workman, in the four complete weeks,
  • In the case of daily paid workman, in the twelve full working days, preceding the date on which the average pay becomes payable if the workman had worked for three complete calendar months or four complete weeks or twelve full working days, as the case may be, and where such calculation cannot be made, the average pay shall be calculated as the average of the wages payable to a workman during the period he actually worked.

“Award” means an interim or a final determination of any industrial dispute or of any question relating thereto by any Labour Court, Industrial Tribunal or National Industrial Tribunal and includes an arbitration award made under section 10A.

” Banking Company” means a banking company as defined in section 5 of the Banking Companies Act, 1949 (10 of 1949 ), having branches or other establishments in more than one State, and includes the Export- Import Bank of India 4 , the Industrial Reconstruction Bank of India,] the Industrial Development Bank of India,] 6 the Small Industries Development Bank of India established under section 3 of the Small Industries Development Bank of India Act, 1989 (39 of 1989 ),] the Reserve Bank of India, the State Bank of India a corresponding new bank constituted under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 (5 of 1970 ), a corresponding new bank constituted under section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1980 (40 of 1980 ), and any subsidiary bank]] as defined in the State Bank of India (Subsidiary Banks) Act, 1959 (38 of 1959 );]

“Board” means a Board of Conciliation constituted under this Act;

“Closure” means the permanent closing down of a place of employment or part thereof.

“Conciliation officer” means a conciliation officer appointed under this Act;

“Conciliation proceeding” means any proceeding held by a conciliation officer or Board under this Act.

” controlled industry” means any industry the control of which by the Union has been declared by any Central Act to be expedient in the public interest.

“Court” means a Court of Inquiry constituted under this Act.

“Industrial dispute” means any dispute or difference between employers and employers or between employers and workmen, or between workmen and workmen, which is connected with the employment or non- employment or the terms of employment or with the conditions of labour, of any person;

“Industrial establishment or undertaking” means an establishment or undertaking in which any industry is carried on: Provided that where several activities are carried on in an establishment or undertaking and only one or some of such activities is or are an industry or industries,

The Act also lays down:

  • The provision for payment of compensation to the workman on account of closure or lay off or retrenchment.
  • The procedure for prior permission of appropriate Government for laying off or retrenching the workers or closing down industrial establishments
  • Unfair labour practices on part of an employer or a trade union or workers.

Scope and Extent of the Industrial Disputes act 1947

The Industrial disputes act of 1947 extends to the whole of India. it came into enforcement on 1st April 1947.

Principal objects as stated by the supreme court in the case of Workmen of Dimakuchi Tea Estate vs Management of Dimakuchi Tea Estate AIR 1958 SC

1) the act aims to promote the measures which are helpful in securing good and amity relations between the employer and the employee.

2) An investigation and settlement of disputes between an employer and the employee, employer and workmen, workmen and workmen and giving them the right of representation in the trade unions.

3) the legislation also tries to do away with illegal strikes and lockouts.

4) it also helps to provide the relief to the workmen in the matter of lay off, retrenchment, closure of undertaking, etc.

5) it helps to do Collective Bargaining.

The Industrial disputes act is social legislation which tries to maintain a balance between the interest of the important pillars of the industrial establishment.

Objectives of the Industrial disputes act 1947

The Industrial dispute act of 1947 was enacted with the following objectives:

a) To promote industrial peace

b) To do economic justice to the workmen

The objective according to the preamble of the Industrial disputes act 1947 are:

a) To make provisions for investigation and settlement of industrial disputes.

b) The objective of all the labor legislation is to ensure fair wages and to prevent industrial disputes.

Authorities under the act:

There are various authorities under the act such as the works committee, conciliation officer, conciliation board, courts of inquiry, labour court, tribunal, national tribunal.

Works Committee:

This has been defined under section 3 of the act which says that each industrial establishment should have a works committee and the works committee will have equal representations from both the employer and the employee. it is to try to settle the dispute in the first instance through the process of mediation in the initial stage of the dispute. The works committee also time to time comments upon the matters in dispute.

Conciliation officer:

Section 4 of the Industrial disputes act 1947 talks about the provisions of the conciliation officer. it states that the appropriate government i.e. the central government, state government or the local authority will appoint such number of persons to be the conciliation officer as it thinks fit.

it is the duty of the conciliation officer to mediate and promote the settlement of industrial dispute. The conciliation officer can be appointed either permanently or for some point of time.

Board of Conciliation:

The board of conciliation are constituted under section 5 by the appropriate government.

The board of conciliation s constituted in order to promote the settlement of industrial dispute.

The board appointed consists of the chairman and two or four other members. under the board the chairman is the independent person and the other persons appointed in equal numbers which represents the parties in disputes and the person who represents the party shall be appointed by the party . the party needs to appoint such representatives within the time prescribed and if the party fails to appoint the representatives within the time then the appropriate government can appoint the person to be the representative of the party.

A board needs to work according to the quorum prescribed but if the chairman or the other member as the case may be ceased to be available the board shall not act until a new chairman or member as the case may be has been appointed.

Courts of Inquiry:

the section 6 of the act further talks about the constitution of the court of inquiry in order to conduct inquiry upon the matter in dispute.the court of inquiry to be run by the independent person or persons as the appropriate government thinks fit. where the court consists of two or more persons then any one of them shall be appointed to be chairman.

Labour Court:

Section 7 of the act talks about the constitution of the labor court by the appropriate government. it can create one or more labor court as it thinks fit for the adjudication of industrial dispute as specified under schedule II. it consists of one person to be appointed by the appropriate government. the qualifications of the presiding officer of the court shall be as follows:

a) If he is or has been a judge of the high court

b) He has for a period of not less than 3 years being a district judge or an additional district judge

c) Has held judicial office for not less than 7 years

d) He has been the presiding officer of a Labor Court constituted under any Provincial Act or State Act for not less than five years.

e) He is or has been a Deputy Chief Labor Commissioner (Central) or Joint Commissioner of the State Labor Department, having a degree in law and at least seven years’ experience in the labor department including three years of experience as Conciliation Officer.

f) He is an officer of Indian Legal Service in Grade I with years’ experience in the grade.

Tribunal:

section 7A deals with the provision of constitution of the one or more tribunal for the adjudication of dispute relating to the aspects as mentioned in schedule second or third. tribunal to consist of one person who shall be appointed by appropriate government.

The qualifications of the presiding officer of the tribunal are as follows:

a) He is, or has been, a Judge of a High Court;

b) He has, for a period of not less than three years, been a District Judge or an Additional District Judge;

c) He is or has been a Deputy Chief Labor Commissioner (Central) or Joint Commissioner of the State Labor Department, having a degree in law and at least seven years’ experience in the labor department including three years of experience as Conciliation Officer:

d) He is an officer of Indian Legal Service in Grade III with three years’ experience in the grade.

The appropriate government to appoint two persons as assessors to advise the tribunal.

National Tribunal:

section 7B deals with the national tribunal which is appointed by the central government constitute one or more national tribunal for the adjudication of industrial disputes which in the opinion of the central government involves questions of national importance or are of such a nature that industrial establishments situated in more than one state are likely to be interested in or affected by such disputes. the national tribunal shall be consisted of one person only to be appointed by the central government. in order to be appointed as the presiding officer of a national tribunal he should be or has been a judge of a high court. the central government can also appoint two persons as assessors to advise the national tribunal in the proceeding before it.

Disqualifications for appointment of the presiding officer of labor court, tribunal and national tribunal:

Section 9 c of the act talks about the provision relating to the disqualification of the presiding officer which states that if the person is not an independent person or if he has attained the age of 65 years then he cannot be appointed as the presiding officer of the labor court or tribunal or national tribunal by the central government.

Industrial Dispute Act 1947 Lay Offs, Retrenchment and Closure

The term ‘lay-off’ has been defined under section 2 (kkk) of the Industrial Disputes Act, 1947, thus lay-off means the failure, refusal or inability of an employer on account of the shortage of coal, power or raw materials or the accumulation of stocks or the breakdown of machinery or natural calamity or for any other unconnected reason to give employment to a workman whose name is borne on the muster rolls of his industrial establishment and who has not been retrenched.

Essentials of lay-off:

(i) There must be failure, refusal or inability on the part of the employer to give employment to a workman.

(ii) The failure, refusal or inability should be on account of shortage of coal, power or raw materials or accumulation of stocks or breakdown of machinery, or natural calamity, or any other connected reason.

(iii) The workman’s name should be on the muster rolls of the industrial establishment.

(iv) The workman should not have been retrenched.

Lay-off is a measure to cope with the temporary inability of an employer to offer employment to a workman to keep the establishment as going concern. It results in immediate unemployment though temporary in nature. It does not put an end to the employer-employee relationship, nor does it involve any alteration in the conditions of service.

Further, lay-off occurs only in a continuing business. When the industrial establishment is closed permanently or it lock-out is declared by the employer, the question of lay-off has no relevance. Lay-off is justified only when it is in conformity with the definition given under Section 2 (kkk) of the Industrial Disputes Act.

Compensation for Lay-Off (Rights of Workmen):

According to Section 25 C of the Industrial Disputes Act, a workman who is laid-off is entitled to compensation equivalent to 50 per cent of the total basic wages and dearness allowance for the period of lay-off.

This right of compensation is, however, subject to the following conditions:

(i) He is not a badli or a casual workman.

(ii) His name should be borne on the muster rolls of the establishment.

(iii) He should have completed not less than one year of continuous service under the employer.

A badli workman means a workman who is employed in place of another workman whose name is borne on the muster rolls of the establishment. However, such a workman ceases to be a badli workman on his completion of one year of continuous service in the establishment.

A workman is entitled to lay-off compensation at the rate equal to fifty per cent of the total of the basic wage and dearness allowance for the period of his lay off except for weekly holidays which may intervene. Compensation can normally be claimed for not more than forty-five days during any period of twelve months.

Even if lay-off exceeds forty-five days during any period of twelve months no compensation is required to be paid for the excess period if there is an agreement to that effect between the workman and the employer.

If the period of lay-off exceeds forty-five days, the employer has two alternatives before him, namely:

(i) to go on paying lay-off compensation for such subsequent periods

(ii) to retrench the workman.

Duties of the Employer in Connection with Lay-Off:

The following duties are laid down for the employer in connection with a lay-off:

(a) The employer must maintain a muster roll of workmen and to provide for the making of entries therein by workmen who may present themselves for work at the establishment at the appointed time during normal working hours notwithstanding that workman in any industrial establishment have been laid off.

(b) The lay-off must be for the reasons specified in Section 2(kkk).

(c) The period of detention of workmen if stoppage occurs during working hours should not exceed two hours after the commencement of the stoppage.

(d) The compensation for lay-off must be at the rate and for the period specified in Section 25-C of the Industrial Disputes Act.

Retrenchment

The term “Retrenchment” has been given a very wide meaning under Section 2(oo) of the ID Act to include termination by the employer for any reason whatsoever, other than a punishment given in disciplinary proceeding.

The provision further states that Retrenchment does not include:

  • Voluntary retirement;
  • Retirement on reaching age of superannuation;
  • Termination of service of workman as a result of non-renewal of contract of employment;
  • Termination of workman due to continuous ill-health

Conditions have to be fulfilled for retrenchment

Section 25F of the ID Act is a very essential provision for law relating to retrenchment.

If the conditions or requirements given in this provision are not followed by the employer, then the retrenchment of employee will be illegal and invalid.

According to this provision, a workman employed in any industry who has been in continuous service for not less than one year under an employer cannot be retrenched unless:

  • The workman has been given one month’s notice in writing indicating the reasons for retrenchment and the period of notice has expired, or the workman has been paid in lieu of such notice, wages for the period of the notice;
  • The workman has been paid compensation at the time of retrenchment;
  • Notice in the prescribed manner is served on the appropriate Government.

Retrenchment of White-Collar Employees

The term white collar employees have nowhere been expressly defined under the Indian Law. However, white collar employees are those who work in the managerial capacity.

Thus, the employees who don’t fall under the definition of “workman” under Section 2(s) of ID Act are white collar employees. The definition of workman any person (including an apprentice employed in any industry to do any manual, unskilled, skilled, technical, operational, clerical or supervisory work for hire or reward, whether the terms of employment be express or implied, and for the purposes of any proceeding under this Act in relation to an industrial dispute, includes any such person who has been dismissed, discharged or retrenched in connection with, or as a consequence of, that dispute, or whose dismissal, discharge or retrenchment has led to that dispute.

The definition of “workman” specifically excludes those persons who are employed in managerial or administrative capacity.

Closure

The Act defines “Closure” as the permanent closing down of a place of employment or part thereof. Here, the employer is constrained to close the establishment permanently. Nonetheless, the due procedure has to be complied with when it comes to rolling out a plan of closure; the said procedure, as set out by the Act, has been detailed below. These procedures, nonetheless, do not apply to an undertaking set up for the construction of buildings, bridges, roads, canals, dams or for other construction work.

Sec. 25FFF. Compensation to workmen in case of closing down of undertakings.

(1) Where an undertaking is closed down for any reason whatsoever, every workman who has been in continuous service for not less than one year in that undertaking immediately before such closure shall, subject to the provisions of sub- section (2), be entitled to notice and compensation in accordance with the provisions of section 25F, as if the workman had been retrenched: Provided that where the undertaking is closed down on account of unavoidable circumstances beyond the control of the employer, the compensation to be paid to the workman under clause (b) of section 25F shall not exceed his average pay for three months.

1 Explanation. An undertaking which is closed down by reason merely of

(i) financial difficulties (including financial losses); or

(ii) accumulation of undisposed of stocks; or

(iii) the expiry of the period of the lease or licence granted to it; or

(iv) in a case where the undertaking is engaged in mining operations, exhaustion of the minerals in the area in which such operations are carried on; shall not be deemed to be closed down on account of unavoidable circumstances beyond the control of the employer within the meaning of the proviso to this sub- section.

Special Provisions: The employer intending to do a closure of his establishment has to necessarily apply at least ninety days in advance to the appropriate government. A copy of the said application has to be given to the representatives of the workmen as well. The said application will be considered and a reasonable opportunity to be heard shall be given to the employer as well as the workmen. After considering the same, the appropriate government may or may not grant the employer to close down. Even here, if the government does not respond within sixty days from application, the permission will be deemed to have been granted. A similar provision for review of the decision exists even here.

Continuous Service

One year of continuous service entails an entitlement for compensation under the Industrial Disputes Act. A workman is said to be in continuous service if he is for that period in uninterrupted service. Interruption owing to sickness authorised leave, an accident, a strike which is not illegal, a lock and a cessation of work which is not due to the fault of the workman will not be taken into consideration for calculating the period of continuous service.

A workman could be deemed to have had one year of continuous service even if the worker hasn’t had a year of continuous service if the worker was in employment for twelve calendar months preceding the date with reference to which calculation is to be made, and in the course of these twelve months, he actually worked for not less than one hundred and ninety days in the case of employment in a mine and two hundred and forty days in any other case.

The said continuous service shall also include the days laid off, days on earned leave and days taken off owing to temporary disablement owing to accident arising out of or in the course of employment. Maternity leave taken, not exceeding twelve weeks shall also be counted in continuous service in case of female workers.

Industrial Dispute Act 1947 Strikes, Lockout

A strike is a powerful weapon used by trade unions or other associations or workers to put across their demands or grievances by employers or management of industries. In another way, it is the stoppage of work caused by the mass refusal in response to grievances. Workers put pressure on the employers by refusal to work till fulfilment of their demands. Strikes may be fruitful for workers’ welfare or it may cause economic loss to the country.

For strike, the industrial dispute act under 2 (q) defines strikes as “a cessation of work by a body of persons employed in any industry acting in combination, or a concerted refusal, or a refusal, under a common understanding of any number of persons who are or have been so employed to continue to work or to accept employment”.

Common Reasons for Strike

Strikes generally occur in industries due to disputes between employees and employers, employees and employees or among employers and employers mostly due to the following issues:

  • Working hours
  • Working Conditions
  • Salary, Incentive etc
  • Time payment of wages
  • Reduction in salary/wages
  • Issue related Minimum wages
  • Leave/Holidays
  • Dissatisfaction with the company policy
  • PF, ESI, Profit Sharing etc
  • Retrenchment of workmen and closure of establishment
  • Any other issue.

Under the following situation as given under section 22, on these grounds the strikes can be considered as illegal:

  • Without giving to employer notice of strike within six weeks before striking.
  • Within fourteen days of giving such notice.
  • Before the expiry of the date of strike specified in any such notice as aforesaid.
  • During the pendency of any conciliation proceedings before a conciliation officer and seven days after the conclusion of such proceedings.

Further, the provisions under section 23 are general in nature. It imposes general restrictions on declaring strike in breach of contract in both public as well as non- public utility services in the following circumstances mainly:

  • During the pendency of conciliation proceedings before a board and till the expiry of 7 days after the conclusion of such proceedings;
  • During the pendency and 2 months after the conclusion of proceedings before a Labour Court, Tribunal or National Tribunal;
  • During the pendency and 2 months after the conclusion of the arbitrator, when a notification has been issued under subsection 3 (a) of section 10 A;
  • During any period in which a settlement or award is in operation in respect of any of the matter covered by the settlement or award.

Types of Strike

Primary Strike: The strikes that are directly projected against the employer are known as Primary Strikes. Below are types of Primary strikes which workers adapt to push the employer to get them on terms agreed to workers.

  • Gherao is adopted by the factory workers to push the management to agree to their demand by restricting access to office or factory premises where nobody could move in or out.
  • Picketing is the process of highlighting their issues on playcard or banners to show their demand to the public at large and media. In this union members are being talked to resolve the issue peacefully.
  • Boycott is a process where no worker is allowed to carry out any work and union members push other workers not to do work and participate in their strike.
  • Pen down strike where workmen come to work on a regular basis but do not do any work and sit idle for whole office hours.
  • Go Slow Strike is also a very harmful way of strike where workmen intentionally work very slow to slow down operation. This harms the employer where order has strict timelines to deliver.
  • Hunger Strike is the most common and oldest method used by workmen where they go for indefinite fasting and sit around factory or employer residence to project their demand.

Secondary Strikes: The other name for the secondary strike is the sympathy strike. In this, the force is applied against the third person having sound trade relations with the organization to indirectly incur a loss to the employer and the business. The third person does not have any other role to play in such a strike.

Nowadays third kind of strikes have also become popular which are adopted by the General Public to show their anger or objections against Government Policies for roll back of government policies. Recently we have seen outrage over Farmer’s bill where Bharat Bandh, No Purchase at Government Mandis kind of actions has been adopted at various states.

Consequences of illegal Strike

Economic Consequences: Losses incurred by strikes are humungous and serious, in some cases can even lead to the bankruptcy of the industry. The economic losses caused by the strike may be serious for the employer. During strikes, production stops, sales go down, due to which rival companies use this opportunity to capture their market and industry loses its consumers and their trust, strikes badly affects the market goodwill of the company.

Both parties i.e, employer and employee are at loss; for employers the quick losses capital loss, loss of profits, the delaying of orders and loss of goodwill as well as the possible incurring of insurance or strike-breaking expenses while on the worker’s side there is the loss of wages, the contracting of debts and all the personal hardships that may be involved.

The losses incurred by a strike are difficult to be calculated economically. Strike can have adverse effect leading to an unstable foreign investment in an economy. Furthermore, the negative effects on international trade include the hindrance of economic development and creating great economic uncertainty especially as the global media continues to share details, images and videos of violence, damage to property and ferocious clashes between strikers and security.

Social Consequences: the social consequences of the strike are serious, and mostly affect the employees; as they are the ones who are losing their wages, they are at greater risk of losing their jobs. Loss of wages or loss of jobs will directly affect in curtailing their consumption and expenses and further strikes in essential utility services effects the tripod of any industry i.e, suppliers, manufactures ( both employer and employees ) & customers. 

A hostile attitude on the part of the employer towards their employees lead Dismissal of workmen.

Legal consequences: The legitimateness of a strike may rely upon the article, or reason, of the strike, on its planning, or the direction of the strikers. The article, or items, of a strike and whether the articles are legitimate are matters that are not in every case simple to decide A strike, legal or illegal, justified or unjustified does not dissolve the employer-employee relationship.

Normally taking part in the illegal strike amounts to misconduct on the part of a workman for which they invite the punishment of dismissal. Whether the employer is free to punish dismissal from services in such cases has been subject to regular domestic enquiry to determine the quality of misconduct and quantum of punishment by finding out whether they were peaceful strikes or violent strikers. It is only after complying with these requirements, a workman if found guilty of the charges may be dismissed.

Lockouts

This is the only method adopted by the Employers against employees to make employees agree to their new rules and procedures. In lockouts, the employer temporarily closes the workplace or stops the work or takes action like suspending the workers to force them to follow the new terms and conditions.

The Trade Union Act 1926

The trade Unions Act, 1926 provides for registration of trade unions with a view to render lawful organisation of labour to enable collective bargaining. It also confers on a registered trade union certain protection and privileges.

The Act extends to the whole of India and applies to all kinds of unions of workers and associations of employers, which aim at regularising labour management relations. A Trade Union is a combination whether temporary or permanent, formed for regulating the relations not only between workmen and employers but also between workmen and workmen or between employers and employers.

The different legislation on labour in the country are as follows:

  • Apprentices Act, 1961: The object of the Act was the promotion of new manpower at skills and improvement and refinement of old skills through practical and theoretical training.
  • Contract Labour (Regulation and Abolition) Act, 1970: The object of the Act was the regulation of employment of contract labour along with its abolition in certain circumstances.
  • Employees’ provident funds and misc. Provision Act, 1952: The Act regulated the payment of wages to the employees and also guaranteed them social security.
  • Factories Act, 1948: The Act aimed at ensuring the health of the workers who were engaged in certain specified employments.
  • Minimum wages Act, 1948: The Act aimed at fixing minimum rates of wages in certain employments.
  • Trade Union Act, 1926: The Act provided for registration of trade unions and defined the laws relating to registered trade unions.

Registration of Trade Unions

The Trade Union Act of 1926 was passed in the year 1926 but it came into effect in the year 1927. The Act contains the provisions related to registration, regulation, benefits, and protection for trade unions. Section 3 to Section 14 of Chapter 2 of the Act deals with the registration of trade unions in the territory of India.

Section 3: Appointment of Registrars

Section 3 of the Act empowers the appropriate government to appoint a person as the registrar of a trade union. The appropriate government can also appoint as many additional and deputy registrars in a trade union as it deems fit for carrying on the purposes of the Act.

Section 4: Mode of Registration

Section 4 of the Act provides for the mode of registration of the trade union. According to the Section, any seven or more than seven members of a trade union may by application apply for the registration of the trade union subject to the following two conditions:

  • At Least 7 members should be employed in the establishment on the date of the making of the application.
  • At Least 10% or a hundred members whichever is less, are employed in the establishment should be a part of it on the date of making the application.

Section 6: Provisions to be contained in the rules of a Trade Union

Section 6 of the Act enlists the provisions which should be contained in the rules of trade union and it provides that no trade union shall be recognized unless it has established an executive committee in accordance with the provisions of the Act and its rules specify the following matters namely:

  • Name of the trade union;
  • The object of the establishment of the trade union;
  • Purposes for which the funds with the union shall be directed;
  • A list specifying the members of the union shall be maintained. The list shall be inspected by office bearers and members of the trade union;
  • The inclusion of ordinary members who shall be the ones actually engaged or employed in an industry with which the trade union is connected;
  • The conditions which entitle the members for any benefit assured by the rules and also the conditions under which any fine or forfeiture may be imposed on the members;
  • The procedure by which the rules can be amended, varied or rescinded;
  • The manner within which the members of the manager and also the alternative workplace bearers of the labour union shall be elective and removed;
  • The safe custody of the funds of the labour union, an annual audit, in such manner, as may be prescribed, of the accounts thereof, and adequate facilities for the inspection of the account books by the workplace bearers and members of the labour union, and;
  • The manner within which the labour union could also be dissolved.

Section 7: Power to call for further particulars and require alteration of the name

Section 7 of the Act furnishes upon the registrar power to call for information in order to satisfy himself that any application made by the trade union is in compliance with the Section 5 and 6 of the Act. in matters where the discrepancy is found the registrar reserves the right to reject the application unless such information is provided by the union.

This Section also confers power to the registrar to direct the trade union to alter its name or change the name if the registrar finds the name of such union to be identical to the name of any other trade union or if it finds its name to so nearly resemble the name of any existing trade union which may be likely to deceive the public or members of either of the trade union.

Section 8: Registration

According to Section 8 of the Act, if the registrar has fully satisfied himself that a union has complied with all the necessary provisions of the Act, he may register such union by recording all its particulars in a manner specified by the Act. 

Section 9: Certificate of Registration

According to Section 9 of the Act, the registrar shall issue a registration certificate to any trade union which has been registered under the provision of Section 8 of the Act and such certificate shall act as conclusive proof of registration of the trade union.

Section 9A: Minimum requirement related to the membership of a Trade Union

Section 9A of the Act lays down the minimum number of members required to be present in any union which has been duly registered, the Sections mandates that a trade union which has been registered must at all times should continue to have not less than 10% or one hundred of the workmen, whichever is less, subject to a minimum of seven, engaged or utilized in an institution or trade with that it’s connected, as its members.

Section 10: Cancellation of Registration

The registrar, according to Section 10 of the Act has the power to withdraw or cancel the registration certificate of any union in any of the following conditions:

  • On an application made by the trade union seeking to be verified in such manner as may be prescribed;
  • If the registrar is satisfied with the fact that the trade union has obtained the certificate by means of fraud or deceit;
  • If the trade union has ceased to exist;
  • If the trade union has wilfully and after submitting a notice to the Registrar, has contravened any provision of the Act or has been continuing with any rule which is in contravention with the provisions of the Act;
  • If any union has rescinded any rule provided under Section 6 of the Act.

Section 11: Appeals

According to Section 11 of the Act, any union which is aggrieved by a refusal to register or withdrawal of registration made by the registrar can file an appeal:

  • In any High Court, if the head office of the trade union is located in any of the presidency towns;
  • In any labour court or industrial tribunal, if the trade union is located in such a place over which the labour court or the trade union has jurisdiction;
  • If the head office of the trade union is situated in any other location, an appeal can be filed in any court which is not inferior to the Court of an additional or assistant choose of a principal Civil Court of original jurisdiction.

Section 12: Registered office

Section 12 of the Act lays down that all communications and notices to any trade union must be addressed to its registered office. If a trade union changes the address of its registered office, it must inform the same to the registrar within the period of fourteen days in writing and the registrar shall record the changed address in the register mentioned under Section 8 of the Act.

Section 13: Incorporation of Registered Trade Union

Section 13 of the Act states that every trade union which is registered according to the provisions of the Act, shall:

  • Be corporate by the name under which it is registered.  
  • have perpetual succession and a common seal.
  • Power to contract and hold and acquire any movable and immovable property.
  • By the said name can sue and be sued.

Rights and Liabilities of Registered Trade Unions

Section 15 to Section 28 elucidates the rights which a registered trade union has and also the liabilities which can be imposed against it.

Section 15: Objects on which general funds may be spent

Section 15 of the Act lays down the activities only on which a registered trade union can spend its funds. These activities include:

  • Salaries to be given to the office-bearers.
  • The cost incurred for the administration of the trade union.
  • Compensation to the workers due to any loss arising out of any trade dispute.
  • Expenses incurred in the welfare activities of the workers.
  • Benefits conferred to the workers in case of unemployment, disability, or death.
  • The cost incurred in bringing or defending any legal suit.
  • Publishing materials with the aim of spreading awareness amongst the workers.
  • Education of the workers or their dependents.
  • Making provisions for medical treatment of the workers.
  • Taking insurance policies for the welfare of the workers.

The Section also provides that the reason of non-contribution to the said fund and also a contribution to the fund can not be made as a criterion for admission into the union.

Section 16: Constitution of a Separate Fund for Political purposes

Section 16 provides that a trade union, in order to promote the civic and political interests of its members can constitute a separate fund from the contributions made separately for the said purposes. No member of the union can be compelled to contribute to the fund. 

Section 17: Criminal conspiracy in Trade Disputes

Section 17 of the Act states that no member of a trade union can be held liable for criminal conspiracy mentioned under subSection 2 of Section 120B regarding any agreement made between the members of the union in order to promote lawful interests of the trade union.

Section 18: Immunity from civil suits in certain cases

Section 18 of the Act immunes the members of trade union from civil or tortious liabilities arising out of any act done in furtherance or contemplation of any trade disputes. 

For example. in general, a person is subject to tortious liability for inducing any person to breach a contract. But, the trade unions and its members are immune from such liabilities provided such inducement is in contemplation or furtherance of any trade disputes. Further, the inducement should be awful and should not involve any aspect of any violence, threat or any other illegal activity.

Section 19: Enforceability of agreement

According to Section 25, any agreement in restraint of trade is void. But under Section 19 of the Trade Unions Act, 1926 any agreement between the members of a registered trade union in restraint of trade activities is neither void nor voidable. However such right is available only with the registered trade unions as the unregistered trade unions have to follow the general contract law.

Section 20: Right to inspect the books of Trade Union

According to Section 20 of the Act, the account books and the list of the members of any registered trade union can be subjected to inspection by the members of the trade union at such times as may be provided under the rules of the trade union.

Section 21: Rights of minors to membership of Trade Union

Section 21 provides that a person who is above 15 years of age can be  a member of any trade union and if he becomes a member he can enjoy all the rights conferred upon the members of the trade union subject to the conditions laid down by the trade union of which he wants to be a part of.

Section 21-A: Disqualifications of office-bearers of Trade Union

Section 21A of the Act lays down the conditions the fulfilment of which disqualifies a person from being a member of the trade union. The conditions laid down in the Act are as follows:

  • If the member has not attained the age of majority
  • If he has been convicted by any of the courts in India for moral turpitude and has been sentenced to imprisonment unless a period of five years has elapsed since his release. 

Section 22: Proportion of office-bearers to be connected with the industry

Section 22 of the Act mandates that not less than half of the members of the trade union should be employed in the industry or work with which the trade union is connected. For example trade union is made for the welfare of the agricultural labourers then, as per this Section half of the members of such a trade union should be employed in agricultural activities. 

Section 23: Change of name

Section 23 states that any registered union is free to change its name provided it does so with the consent of not less than 2/3rd of its members and subject to the fulfilment of the conditions laid down in Section 25 of the Act.

Section 24: Amalgamation of Trade Unions

Section 24 lays down that two or more trade unions can join together and form one trade union with or without dissolution or division of the fund. Such amalgamation can take place only when voting by half of the members of each trade union has been effectuated and that sixty per cent of the casted votes should be in favour of the proposal.

Section 25: Notice of change of name or amalgamation

Section 25 of the Act provides that: 

  • A notice in writing of every change of name and of every amalgamation which is duly signed by the Secretary and by seven members of the Trade Union changing its name, and, in the case of an amalgamation, by the Secretary and by seven members of each and every Trade Union which is a party thereto, should be sent to the Registrar.
  • If the Registrar feels that the proposed name is identical with the name of any other existing Trade Union or, it so nearly resembles such name as it is likely to deceive the public or the members of either Trade Union, the Registrar may refuse to register the change of name.
  • If the Registrar of the State in which the head office of the amalgamated Trade Union is situated is satisfied that the provisions of this Act have complied with the amalgamation shall be given effect from the date of such registration.

Section 27: Dissolution

Section 27 of the Act talks about the dissolution of a firm as follows:

  • If a registered trade union has been dissolved, a notice of such dissolution which must be signed by seven members and by the Secretary of the Trade Union should be served to the registrar within 14 days of such dissolution and if the registrar is satisfied that the dissolution has been effected in accordance with the rules laid down by the trade union may register the dissolution.
  • Where a union has been dissolved but its rules do not lay down the way in which the fund is to be distributed after its dissolution, the registrar may distribute the funds in any prescribed manner.

Section 28: Returns

Section 28 provides that each trade union should send the returns to the registrar annually on or before such a day as may be prescribed by the registrar. The return includes:

  • General statement 
  • Audit report
  • All the receipts and expenditure incurred by the trade union
  • Assets and liabilities of the firm on the 31st day of December

Sub-Section 2 of the Section provides that along with the general statement a copy of the rules of the trade union corrected up to the date of dispatch thereof and a statement indicating all the changes made by the union in the year to which the statement is referred to be sent to the registrar.

Whenever any registered trade union alters its rules, such alterations should be conveyed to the registrar in a period of not less than 15 days from making such alterations.

Regulations

Section 29 to Section 30 of Chapter 4 of the Act lays down the regulations which shall be imposed on the trade union.

Section 29: Power to make regulations

Section 29 of the Act confers the right on the appropriate government to make provisions in order to ensure that the provisions of the Act are fairly executed. Such regulations may provide for any or all of the matters, which are as follows:

  • The manner in which a trade union or its rules shall be registered;
  • The manner in which the registration of a trade union has to be transferred which has changed its head office;
  • The manner of appointment and qualification of the person who shall audit the accounts of the registered trade union; 
  • Circumstances under which the documents kept by the registrar shall be allowed to be inspected and also the fees that shall be levied in lieu of the inspection so made.

Section 30: Publication of Regulations

Section 30 states that:

  • The power of making regulations conferred to the government is subject to the condition that such regulation has been made after the previous publication.; 
  • The date from which the regulation shall be given effect shall be specified in accordance with clause (3) of Section 23 of the General Clauses Act, 1897, and the date should not be less than three months from the date on which the draft of the proposed regulations was published for general information;
  • The regulations which are made must be specified in the official gazette of India and it shall have the effect of an enacted law.

Penalties and Procedure

Section 31 to Section 33 of the Trade Union Act lays down the penalties and the procedure of its application upon a trade union which is subject to such penalty.

Section 31: Failure to submit returns

Section 31 states that:

  • If any trade union was required to send any notice, statement or any document to the registrar under the Act and if the rule did not prescribe a particular person in the union to provide such information then in case of default each member of the executive shall be imposed with the fine extendible to five rupees. In case of continuing default, the fine may be extended to five rupees a week.
  • If any person willfully makes or causes to be made any false entry or omission in the general statement required under Section 28 of the Act shall be punishable with fine extendible to 500 rupees.

Section 32: Supplying false information regarding Trade Unions

Article 32 states, the following:

  • Any person who in order to deceive a member of any trade union or any other person who purports to be the part of the trade union, 
  • Gives a copy of the document with the pretext of it containing the rules of a trade union. 
  • Which he knows or has reason to believe that it is not a correct copy of such rules and alteration and,
  • Any person with the like intent give the copy of any document purporting it to be a copy of the rules of a registered trade union which in reality is an unregistered union,
  • Shall be imposed with fine which may extend to two hundred rupees.

Section 33: Cognizance of offences

Section 33 contains the provisions with respect to the cognizance of offence. It says that no court which is inferior to presidency magistrate or magistrate of the first class shall try an offence under the Act. courts can take cognizance of the offences under the Act only in the following cases:

  • When the complaint has been made with the previous sanction of the registrar
  • When a person has been accused under Section 32 of the Act, he shall be tried within six months of the commission of the alleged offence.

Collective Bargaining and Trade Disputes

When an organized body negotiates with the employer and fixes the terms of employment by means of bargaining is known as Collective Bargaining. The essential element of Collective Bargaining is that it is between interested parties and not from outside parties.

International labour organization in its manual in the year 1960 defined the meaning of collective bargaining as:

“Negotiations about working conditions and terms of employment between an employer, a group of employees or one or more employers organization on the other, with a view to reaching an agreement.” the terms of agreement are used to ascertain the rights and obligations by which each party is bound towards one another during the course of employment.

Section 8 of the Industrial Relations Act 1990 define trade dispute, according to the Act, industrial dispute refers to any dispute which arises between the employers and the workers and it is usually in connection with any one of the following:

  • employment or non-employment, 
  • the terms or conditions of the employment,
  • Something which affects the employment of any person.

Essential conditions for collective bargaining

  • Favourable political and social climate: all the collective bargaining which took place in the past bears the testimony to the fact that favourable political and social climate is the prerequisite of collective bargaining. The reason for the same is quite obvious as almost all the trade unions in India subscribe to one or the other political view and therefore, trade unions usually favour the employees not on the basis of the merit of the issues they raise but on the basis of their political considerations.
  • Trade union: in any democratic country like India which recognizes the right to speech as a fundamental right, the right to form a trade union is a direct consequence of it and so all the employers should recognize the trade unions and its representative.
  • Problem-solving attitude: it means that both the parties while negotiating a bringing up their relative concerns should adopt a problem-solving attitude and should aim at amicably solving the problem without trying to put the opposite party into a loss.
  • Continuous dialogue: the dialogue between the employer and the workers may sometimes end up without any fruitful negotiation or there may arise a bargaining impasse, in such a case the free flow of dialogue between the employer and employee should not be stopped and sometimes keeping aside the bone of contention helps bring up a better solution.

Purposes of collective bargaining

  • To provide an opportunity for the workers to voice their complaints and grievances regarding the working conditions.
  • To pave the way for the employer and workers to reach an amicable solution peacefully without having any ill will towards one another.
  • To sort out all the disputes and conflicts between the employer and worker.
  • To prevent any dispute which is likely to take place in the future by mutually agreeing on the contract.
  • To foster a peaceful and stable relationship between the workers and the organization.

Forfeiting, Parties to Forfeiting, Costs of Forfeiting

Forfaiting in French means to give up one’s right. Thus, in forfaiting the exporter hands over the entire export bill with the forfaiter and obtains payments. The exporter has given up his right on the importer which is now taken by the forfaiter. By doing so, the exporter is benefited as he gets immediate finance for his exports. The risk of his exports is now borne by the forfaiter. In case if the importer fails to pay, recourse cannot be made on the exporter.

Forfaiting is the provision of medium-term financial support for the import and export of capital goods. The forfaiter can be thought of as a third party to transactions in the import and export industry. The forfaiter operates similarly to a central clearing counterparty in the OTC markets, where they take on risks from importers and exporters in return for a margin.

Forfaiting process or Parties involved in forfaiting

  1. Before resorting to forfaiting, the exporter approaches the forfaiting company with the details of his export and the details of the importer and the importing country.
  2. On approval by the forfaiter, along with the terms and conditions, a sale contract is entered into between the exporter and importer.
  3. On execution of the export, the exporter submits the bill to the forfaiter and obtains payment. In this way, the three parties involved in the forfaiting process are the exporter, the importer and the forfaiter.
  4. If the exports are done against Document Acceptance Bill, it has to be signed by the importer and since the importer’s bank has guaranteed through the L/C, it will be easy for the forfaiter to collect payment.
  5. All the trade documents, connected with exports, are handed over by the exporter to his bank which in turn hands over the documents to the importer’s bank.
  6. The proof of all these documents will be submitted by the exporter to the forfaiter who will make payment for the export.
  7. The cost of forfaiting is included in the bill. The exporter may not lose much as the interest will be included in the invoice and recovered from the importer. However, the forfaiter is exposed to the risk of fluctuations in the exchange rate, interest rate and commercial risk, and to cover these risks, he charges suitably.

Advantages of forfaiting

  1. It provides immediate funds to the exporter who is saved from the risk of the defaulting importer.
  2. It is an earning to commercial banks who by taking the bills of highly valued currencies can gain on the appreciation of currencies.
  3. The forfaiter can also discount these bills in the foreign market to meet more demands of the exporters.
  4. There is very little risk for the forfaiter as both importer’s bank and exporter’s banks are involved.
  5. Letter of Credit plays a major role for the forfaiter. Moreover, he enters into an agreement with the exporter on his terms and conditions and covers his risks by separate charges.
  6. As forfaiting provides 100% finance to exporter against his exports, he can concentrate on his other exports.

Disadvantages or Drawbacks of Forfaiting

  1. Forfaiting is not available for deferred payments especially while exporting capital goods for which payment will be made on a deferred basis by the importer.
  2. There is discrimination between Western countries and the countries in the Southern Hemisphere which are mostly underdeveloped (countries in South Asia, Africa and Latin America).
  3. There is no International Credit Agency which can guarantee for forfaiting companies which affects long-term forfaiting.
  4. Only selected currencies are taken for forfaiting as they alone enjoy international liquidity.

Forfaiting in India

For a long time, Forfaiting was unknown to India. Export Credit Guarantee Corporation was guaranteeing commercial banks against their export finance. However, with the setting up of export-import banks, since 1994 forfaiting is available on liberalized basis.

The exim bank undertakes forfaiting for a minimum value of Rs. 5 lakhs. For this purpose, the exporter has to execute a special Pronote in favor of the exim bank. The exporter will first enter into an agreement with the importer as per the quotation given to him by the exim bank. The exim bank on its part, gets quotation from the forfaiting agency abroad. Thus, the entire forfaiting process is completed by exporter agreeing to the terms of the exim bank and signing the Pronote.

Forfaiting business in India will pick up only when there is trading of foreign bills in international currencies in India for which the value of domestic currency has to be strengthened. This would be possible only with increasing exports. At present, India’s share stands at 1.7 percent in the world exports. Perhaps, this will bring a push to the forfaiting market.

Information Does a Forfaiter Need

  • The identity of the buyer
  • Buyer’s nationality
  • Nature of goods sold
  • Detail of the value
  • Currency of contract
  • Date and duration of the contract
  • Credit terms
  • Payment schedule
  • Interest rate
  • Know what evidence of debt will be used, e.g., promissory notes, bills of exchange, letter of credit, etc.
  • The identity of the guarantor of payment

Benefits of Forfeiting for Exporters and Importers

Documents Required by the Forfaiter from the Exporter

  • Copy of supply contract, or its payment’s terms
  • Copy of shipping documents, including airway bill, bill of lading, certificates of receipt, railway bill, or equivalent documents
  • Copy of signed commercial invoice
  • Letter of assignment and notification to the guarantor
  • Letter of guarantee

Forfeiting and factoring are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers. The basic difference between the forfeiting and factoring is that forfeiting is a long term receivables (over 90 days up to 5 years) while factoring is a shorttermed receivables (within 90 days) and is more related to receivables against commodity sales.

The terms forfeiting is originated from a old French word ‘forfait’, which means to surrender ones right on something to someone else. In international trade, forfeiting may be defined as the purchasing of an exporter’s receivables at a discount price by paying cash. By buying these receivables, the forfeiter frees the exporter from credit and the risk of not receiving the payment from the importer.

How forfeiting Works in International Trade

The exporter and importer negotiate according to the proposed export sales contract. Then the exporter approaches the forfeiter to ascertain the terms of forfeiting. After collecting the details about the importer, and other necessary documents, forfeiter estimates risk involved in it and then quotes the discount rate.

The exporter then quotes a contract price to the overseas buyer by loading the discount rate and commitment fee on the sales price of the goods to be exported and sign a contract with the forfeiter. Export takes place against documents guaranteed by the importer’s bank and discounts the bill with the forfeiter and presents the same to the importer for payment on due date.

Documentary Requirements

In case of Indian exporters availing forfeiting facility, the forfeiting transaction is to be reflected in the following documents associated with an export transaction in the manner suggested below:

  • Invoice: Forfeiting discount, commitment fees, etc. needs not be shown separately instead, these could be built into the FOB price, stated on the invoice.
  • Shipping Bill and GR form: Details of the forfeiting costs are to be included along with the other details, such FOB price, commission insurance, normally included in the “Analysis of Export Value “on the shipping bill. The claim for duty drawback, if any is to be certified only with reference to the FOB value of the exports stated on the shipping bill.

Forfeiting

  1. Commitment fee, payable by the exporter to the forfeiter ‘for latter’s’ commitment to execute a specific forfeiting transaction at a firm discount rate within a specified time.
  2. Discount fee, interest payable by the exporter for the entire period of credit involved and deducted by the forfaiter from the amount paid to the exporter against the availised promissory notes or bills of exchange.

Benefits to Exporter

  • 100 per cent financing: Without recourse and not occupying exporter’s credit line That is to say once the exporter obtains the financed fund, he will be exempted from the responsibility to repay the debt.
  • Improved cash flow: Receivables become current cash inflow and its is beneficial to the exporters to improve financial status and liquidation ability so as to heighten further the funds raising capability.
  • Reduced administration cost: By using forfeiting, the exporter will spare from the management of the receivables. The relative costs, as a result, are reduced greatly.
  • Advance tax refund: Through forfeiting the exporter can make the verification of export and get tax refund in advance just after financing.
  • Risk reduction: forfeiting business enables the exporter to transfer various risk resulted from deferred payments, such as interest rate risk, currency risk, credit risk, and political risk to the forfeiting bank.
  • Increased trade opportunity: With forfeiting, the export is able to grant credit to his buyers freely, and thus, be more competitive in the market.

Benefits of forfaiting to importers:

  • The Importer can match repayments to projected revenues, allowing for grace periods.
  • The Importer can obtain 100% financing, and avoid paying out cash in advance.
  • The Importer can pay interest on a fixed rate basis for the life of the credit, which will make budgeting simpler and safer.
  • The Importer can access medium to long term financing which may be prohibitively expensive or completely unavailable locally.
  • The Importer may be able to take advantage of export subsidy schemes which are often available from the Exporter’s government.

Sale and Lease Back

Sale and Leaseback is a simple financial transaction which allows a person to lease an asset to himself after selling it. Under the transaction, an asset previously owned by the seller is sold to someone else and is leased back to the first owner for a long term. The transaction thus allows a person to be able to use the asset and not own it. One usually makes a leaseback transaction for high value fixed assets such as real estate and goods like airplanes and trains. Sale and leaseback is shortly called as leaseback.

Leaseback, short for “sale-and-leaseback”, is a financial transaction in which one sells an asset and leases it back for the long term; therefore, one continues to be able to use the asset but no longer owns it. The transaction is generally done for fixed assets, notably real estate, as well as for durable and capital goods such as airplanes and trains. The concept can also be applied by national governments to territorial assets; prior to the Falklands War, the government of the United Kingdom proposed a leaseback arrangement whereby the Falklands Islands would be transferred to Argentina, with a 99-year leaseback period, and a similar arrangement, also for 99 years, had been in place prior to the handover of Hong Kong to mainland China. Leaseback arrangements are usually employed because they confer financing, accounting or taxation benefits.

For example, X owns a land. Under the leaseback transaction, X will sell the land to Y and will get a lease on the same land from Y for a long term.

Advantages of Sale & Lease Back financing

  1. Financing of the full investment amount

In the case of classic bank loans, it is usually expected that the investment will be partially financed by the company’s own funds. Banks value the asset based on “loan-to-value” calculations and thus only finance between approx. 60-80% of the acquisition costs. With a sale and leaseback, on the other hand, 100% of the investment costs are usually borne by the lessor.

  1. Continued access to the sold asset

Even after the asset has been sold, the company retains the full value in use through the simultaneous signing of a lease agreement, i.e. the company continues to have full access to the asset sold.

  1. Flexible conditions of the leasing contract

Both the term of the leasing contract and the retransfer of the asset at the end of the leasing period can be agreed individually. In the case of real estate, for example, expansion investments in the property as well as subleases can also be arranged together with the Lessor.

  1. Matching maturities

When an investment is financed by means of classic bank loans, the credit period and the useful life of the asset usually diverge. As a result, the loan is regularly repaid long before the actual end of the asset’s useful life, i.e. the redemption payments on the loan exceed the depreciation. In a sale and leaseback, on the other hand, the financing payments (repayment component) and imputed costs (depreciation based on the useful life of the asset) are balancing if the leasing period is chosen accordingly.

  1. No financial covenants

In contrast to traditional bank loans, a sale & lease back does not contain any financial covenants that have to be observed. The lessor obtains ownership rights by purchasing the leased asset and is the lessor through the leasing contract, but not a lender.

A company usually enters a leaseback transaction for accounting and taxation purposes. For example, a company may transfer its asset to the holding company but still will be able to use it. Also, transferring to holding company will allow the parent company to track the assets’ worth and profitability. Another example is, that in case of financial distress or when a company needs money for some purpose, instead of getting a loan or raising money from outside, a company can sell the asset. The buyer of the asset is someone who is only interested in a securing a long term investment and will lease the asset back to the company. This way the company gets the cash influx and will still be able to use the asset.

Advantages to the Lessee

Enables Expansion of the Business

If a company doesn’t have funds to own the asset, it can purchase the asset and enter a leaseback transaction. This way the company can get back 100% of the investment and still be able to use the asset. Similarly, in case when a company already owns an asset but wants some cash for expansion or even regular business use, the leaseback agreement will allow the company to get cash influx. This will also enable the company the to use the asset as before, by paying rent under the lease agreement.

Improve Company’s Balance Sheet

An asset purchased on debt affects the company’s balance sheet. The company can reduce its debt and improve balance sheet health by entering a leaseback transaction. This will improve the balance sheet in three ways. First, the liability on the balance sheet will reduce. Second, there will be an increase in current assets in the form of cash and lease agreement. Third, the asset turnover of the company will improve. The asset turnover will improve as the fixed assets will reduce but the revenue generating capability of the asset will still be in the hands of the company.

Reduction in Tax Liability

This works in two ways, the company which has now sold the asset and has it on lease, does not have to pay tax on any appreciation of the asset and also the rent outlet will reduce the profit in the profit and loss (p&l) account which will in-turn reduce the tax liability. Depreciation charge on the asset would has a similar impact on the p&l account. However, the depreciation amount will be lower than the lease amount. Also, there is no depreciation is charge on real estate assets like land.

One can avoid paying tax on the sale of asset, by re-investing the sale proceeds in the business or by buying another asset.

Limited Risk

Once sold, the company is free from volatility risks of the asset that has to be borne in case of cyclical market variations.

Advantages to the Investor

Fair Return on Investment

The investor is buying an asset which the seller will be using in the future. The buyer’s interest will ensure that the asset is a fair investment which will provide a decent return on the investment.

Regular Stream of Income

The buyer does not have to worry about the return, as they have a reliable tenant for a long term. This ensures that the investment earns a fixed return on the property and has a continuous stream of cash flow.

Problems and Scope of Merchant Banking in India

“Merchant Banking refers to the financial intermediary services provided by specialised banks called Merchant Bank (other than commercial banks) for business corporates and individual with high net worth.”

Merchant banks act as an intermediary/ middleman between business corporates and investors. In other words, merchant banking is financial intermediation between the business entities which require funds and the investors who possess ready capital and seeking an opportunity for investment so that they can make a return. 

Problems

You may have added reporting requirements to meet.

A merchant bank will help you make sure that you’re aware of your regulatory requirements. What they will not do is create the reports for you. When you begin working with a merchant bank, there may be a need for added disclosure to any stakeholders that are associated with your business. There are almost always additional costs associated with added reporting and compliance requirements.

These merchant banking advantages and disadvantages help to show the power of investments within a portfolio. Some investments involved tangible assets, while others involve smart decision-making with stocks, bonds, and mutual funds. When you can put together a diverse portfolio for yourself or your company, a merchant bank will help you find ways to grow your assets, so you can reach your overall business goals.

Your account will be more expensive than a traditional bank account.

Merchant banks tend to charge higher fees for their services compared to traditional banking services and products. You may be required to have a minimum net worth to work with the bank, have a specific portfolio already developed, or have a strong credit profile with a history of project development to qualify for the bank’s services. Although you may receive the initial consultation or evaluation for free, there is no guarantee your company will be accepted.

You do not have a guarantee of a renewal or extension.

When funds are made available through merchant banking, they are generally accessible for a short time period only. Receiving an extension of the agreement, or a renewal, may be uncertain if not impossible. Long-term funding is sometimes available through merchant banking, but most of the projects that are approved are based on a 5-year period or less. The only exception to this rule involves those who use merchant banks for investment purposes instead of funding purposes.

You will be investigated as part of the funding process.

It may be marketed as a free evaluation, but what a merchant bank is really doing is a detailed investigation of all your business affairs. They will look at your financial structure, evaluate the security of your assets, and even judge your personal sureties. If something is found to be out-of-order during their investigation, it could impact the credit profile of the company. At the very least, the terms and conditions requested of you may be nearly impossible to meet, which means either changing the structure of your business or looking for funding elsewhere.

You may not have access to every potential product.

Traditional banks may be willing to lend money to you when a merchant bank does not. That is because traditional banks tend to offer a variety of products which lowers their overall risk profile internally, which is a practice that not every merchant bank may follow. If you’re thinking about creating CD ladders and other conservative investments, it may be worthwhile to see what your local bank or credit union could offer, even if your business is classified as a large corporation.

You may not receive complete funding.

One way that merchant banks help to spread risk levels around is to provide incomplete funding for leases, expansions, and other investment needs. That forces your company to work with multiple merchant banks instead of one. They benefit because each new contributor lowers their overall risk. You’re stuck making multiple payments for multiple products or paying duplicate fees for similar services until your risk profile can be lowered.

You have no control over your interest rates or returns.

This issue may be the biggest disadvantage of working with a merchant bank. Most will not provide a guaranteed return if you have them managing your investment portfolio. If you take on a lending product to expand the physical assets of your company, then you have little control over the interest rates assigned to the lending product. Your profile is based on the perceived and real risks that the bank feels are present when working with you. If your company is seen as high-risk, even if it turns out to be a low-risk venture, you’re going to pay more for the services received.

You’re not going to receive start-up funding.

Most merchant banks are in the business of helping your company scale upward. The focus is usually on international markets, but in the United States, moving into a new state or community may qualify for banking support. What you’re not going to receive is start-up funding. Your business must have an established record of some success to take advantage of the services which are being offered. And, if you are approved and your business is still young, you’ll have strict repayment guidelines and smaller amounts offered for funding.

You will always have the risk of a mixed chance for success.

Merchant banks might decide to work with you on a financing package, but that is only one step toward eventual success. Assets are often required for the underwriting process, especially when a business is new to an industry, first getting started, or entering into their first international market. Those assets might need to come from the personal assets of the C-Suite to secure some financing. Merchant banks are like all other banks they like to invest when they know there is a good chance for a return.

You have size considerations which must be met.

Thanks to the Internet, any startup or SMB has the potential to enter into an international market. Just because you are present somewhere internationally does not mean that you’re going to qualify for the services a merchant bank provides. There are usually size considerations that must be met, which may include revenue minimums, business structure, and more. If you’re structured as a partnership or sole proprietor, you’re less likely to get the chance to work with a merchant bank on a project unless you’re trying to expand the portfolio of the company.

Scope

1) Underwriting of Debt and Equity:

Underwriting/ management of debt securities such as debentures and share capital is one of the most important functions of a merchant banker. The merchant banks act as middlemen between the issuer of debt securities and individual or institutional investor and assists the companies in raising funds from the market. Merchant banks evaluate the value of the business and the number of shares or debentures is to be issued.

2) Placement and Distribution:

The merchant bankers facilitate in distributing various securities like equity shares, debt instruments, mutual funds, fixed deposits, insurance policies, commercial papers and distribution network of the merchant banker can be classified as institutional and retail.

3) Corporate Advisory Services:

Merchant bankers offer customised solutions to their clients’ financial problems and financial structuring includes determining the right debt-equity ratio and gearing ratio for the client and appropriate capital structure theory is framed as well.

Merchant banker explores the refinancing alternatives for the client and evaluates cheaper sources of funds. It also provides Rehabilitation, Turnaround and Risk management services such as designing a revival package in coordination with banks and financial institutions for sick industrial units, appropriate hedging strategies to reduce the risk associated.

4) Project Advisory Services:

Merchant bankers help their clients in various stages of the project undertaken by the clients:

  • They assist them in conceptualising the project idea in the initial stage
  • Once the idea is formed, they conduct feasibility studies to examine the viability of the proposed project
  • They also assist the client in preparing different documents like a detailed project report

5) Loan/ Credit Syndication:

Merchant bankers arrange tie-up loans for their clients. This takes place in a series of steps. Firstly, they analyse the pattern of the client’s cash flows, based on which the terms of borrowings can be defined. Then the merchant banker prepares a detailed loan memorandum, which is circulated to various banks and financial institutions and they are invited to participate in the syndicate. The banks then negotiate the terms of lending based on which the final allocation is done.

6) Provide Venture Capital and Mezzanine Financing:

Merchant bankers help companies in obtaining venture capital financing for financing their new and innovative strategies. They also help small organisations and entrepreneurs to obtain initial funding, other business ideas and opportunities, Government policies and incentives.

In addition, merchant bankers also provide various other services as well.

7) Portfolio Management Services:

Merchant banks offer portfolio management service to their clients. They guide their clients regarding profitable, easy liquid and less risky investment avenue. They also update their clients with important and crucial news and updates regarding investment opportunities and market fluctuations.

8) Interest/ Dividend Management:

Merchant bankers also facilitate their client on computing, declaration and allocation of interest on debt securities such as debentures and dividend of shares/stocks.

9) Brokerage Services:

Merchant banks also act as a broker in the stock exchange. They purchase or sell the shares on behalf of their clients and also provide guidance on which or when to buy or sell shares.

10) Manage Money Market Instruments:

Merchant bankers also manage money market instruments like Government bonds, Treasury bills, commercial papers, certificate of deposits for the Government entities as well as large companies and financial institutions.

Leasing Definition, Features, Types, Steps, Advantages, Disadvantages

Leasing is a contractual agreement in which the lessor (owner) allows the lessee (user) to use an asset for a specified period in exchange for periodic rental payments. The leased asset can include equipment, real estate, vehicles, or machinery. Leasing is typically used to avoid the high upfront costs of purchasing assets and offers flexibility, as the lessee can return or purchase the asset at the end of the lease term. There are two main types of leases: operating leases (short-term) and finance leases (long-term with ownership transfer options). It benefits both businesses and individuals by conserving capital.

Features of Leasing:

  • Ownership Retention

In leasing, the lessor retains ownership of the asset, while the lessee gains the right to use it. The lessee does not own the asset but pays periodic rent for its usage over a specified term. At the end of the lease, the asset is returned to the lessor or can be purchased at an agreed price (in case of finance leases). This feature allows businesses to access high-value assets without the burden of ownership, making leasing an attractive alternative to purchasing assets outright.

  • Lease Term

Leasing agreements are typically based on a fixed lease term that specifies the duration of the lease. The term can range from short-term (for equipment or vehicles) to long-term (for real estate or specialized machinery). During the lease period, the lessee is required to make regular rental payments. The length of the lease term is usually designed to correspond with the asset’s useful life, allowing the lessee to fully utilize the asset for business operations. Once the lease term ends, options like renewing, purchasing, or returning the asset may be available.

  • Payment Structure

The payment structure in leasing generally consists of periodic rental payments that the lessee makes to the lessor. These payments are typically fixed, but they can also be structured based on usage (in the case of operating leases). The rental amount depends on the value of the asset, the lease term, and the agreed interest rate or depreciation of the asset. Payments may cover the asset’s cost, maintenance, and insurance. Leasing provides businesses with predictable expenses, helping them manage cash flow more effectively.

  • Maintenance and Repairs

The responsibility for maintenance and repairs varies depending on the lease type. In operating leases, the lessor usually retains responsibility for the upkeep of the asset. However, in finance leases, the lessee often assumes responsibility for maintenance and repairs. This arrangement allows the lessor to minimize the cost of managing the asset while enabling the lessee to directly control the use and condition of the asset. Leasing arrangements can be customized, ensuring both parties agree on the terms of maintenance, thus reducing operational disruptions.

  • Tax Benefits

Leasing offers tax benefits for lessees. In many cases, lease payments can be deducted as business expenses, reducing the taxable income of the lessee. In operating leases, the lessee does not capitalize the asset on their balance sheet, which can lead to better financial ratios. On the other hand, in finance leases, the lessee may be able to claim depreciation and interest deductions, similar to owning the asset. These tax advantages make leasing a popular choice for companies looking to optimize their tax planning strategies.

  • Flexibility

Leasing provides flexibility to businesses in terms of both asset usage and financial planning. Lessees have the option to upgrade or change assets at the end of the lease term, ensuring they stay competitive and current with technological advancements. This flexibility is particularly beneficial for businesses that require assets that may quickly become obsolete, such as computers or specialized equipment. Additionally, leasing terms can be tailored to meet the specific needs of businesses, including options for renewal, buyout, or returning the asset once the lease expires.

  • Risk Mitigation

Leasing helps mitigate the financial risks associated with asset ownership. Since the lessee does not own the asset, they are typically not responsible for its resale value or potential market depreciation. This protects the lessee from the risk of an asset losing value during the lease term. Additionally, in many leasing agreements, the lessor assumes the risk of maintenance and asset obsolescence, especially in operating leases. This risk-sharing feature makes leasing a safer and more attractive option for businesses looking to minimize exposure to volatile markets.

Types of Leasing:

1. Operating Lease

An operating lease is a short-term agreement where the lessor retains the risks and rewards of ownership. The lessee pays to use the asset but does not record it as an asset on their balance sheet. Maintenance and repair responsibilities often remain with the lessor. At the end of the lease, the asset typically returns to the lessor. This type of lease is common for equipment, vehicles, or office machines where the lessee wants flexibility without the burden of ownership.

2. Financial Lease (Capital Lease)

A financial lease, also called a capital lease, is a long-term agreement where the lessee assumes most of the risks and rewards of ownership. The lease period usually covers the asset’s major useful life, and the lessee may gain ownership at the end. The lessee records the asset and the lease liability on their balance sheet. It’s commonly used for heavy machinery, property, or high-value equipment where the user plans long-term use.

3. Sale and Leaseback

In a sale and leaseback arrangement, a company sells an owned asset (like a building or machinery) to a leasing company and then leases it back. This allows the business to free up capital locked in the asset while still continuing to use it for operations. It’s often used to improve liquidity and balance sheets without disrupting operations. Both financial and operating lease terms can apply depending on the contract.

4. Leveraged Lease

A leveraged lease involves three parties: the lessor, the lessee, and a lender. The lessor finances the asset partly using borrowed funds from a lender. The lessor makes a small equity contribution, while the majority of funding comes from debt. The lessee makes lease payments, which the lessor uses to repay the lender. This structure is common for financing large, expensive assets like aircraft, ships, or heavy industrial equipment.

5. Cross-border Lease

A cross-border lease is a leasing arrangement between parties located in different countries. It is often used for tax advantages, risk management, or to access foreign financial markets. These leases typically involve complex legal, tax, and regulatory considerations due to differences between jurisdictions. Cross-border leasing is widely used in industries such as shipping, aviation, or large infrastructure projects that require international funding and asset movement.

6. Synthetic Lease

A synthetic lease is designed to give the lessee the benefits of both operating lease accounting (off-balance-sheet) and ownership for tax purposes. While the lease is structured as an operating lease for financial reporting, it’s treated as a financing transaction for tax deductions. This allows companies to improve their financial ratios while still claiming depreciation tax benefits. Synthetic leases are typically used for real estate, aircraft, or large equipment financing.

7. Direct Lease

In a direct lease, the lessor buys the asset from the manufacturer or supplier and leases it directly to the lessee. There’s no prior ownership by the lessee. This type of lease can be structured as either an operating or financial lease, depending on the specific terms. It’s common for companies that want to acquire new assets without paying upfront but don’t already own the asset.

8. Single Investor Lease

A single investor lease is a leasing arrangement where the lessor finances the entire cost of the leased asset using only its own funds, without any external debt or lenders involved. This type of lease is simpler than leveraged leases and is typically used for smaller or medium-sized asset financing, where the lessor has sufficient capital to cover the purchase price without third-party loans.

9. Full-service Lease

A full-service lease is one where the lessor not only provides the asset but also covers additional services such as maintenance, repairs, insurance, and sometimes even replacement during the lease term. This type of lease is common in vehicle leasing or equipment rental where the lessee prefers a hassle-free experience and predictable monthly payments that include all associated costs.

10. Net Lease

In a net lease, the lessee agrees to pay not just the lease rental but also additional costs such as insurance, maintenance, and taxes associated with the asset. The lessor receives only the basic rent and shifts all operating costs and responsibilities to the lessee. Net leases are often used in commercial real estate, where tenants cover many ongoing expenses related to the leased property.

Steps of Leasing:

Step 1. Identifying the Need for Leasing

The first step is to evaluate the need for an asset and determine whether leasing is a viable option compared to purchasing. Businesses assess the financial benefits, flexibility, and duration of the need for the asset. If the asset is required for a short to medium term and purchasing would involve significant capital outlay, leasing is a practical choice.

Step 2. Selecting the Asset

Once the decision to lease has been made, businesses identify the specific asset(s) required for their operations. This could include machinery, vehicles, real estate, or technology. The lessee evaluates the available options in the market, considering factors such as functionality, quality, and cost, to select the most suitable asset for their needs.

Step 3. Choosing a Leasing Company

Businesses then search for a leasing company or lessor that provides suitable terms and conditions. This involves comparing different leasing providers to assess their rates, lease terms, and other relevant factors. Companies can choose from banks, financial institutions, or specialized leasing companies, depending on the type of asset and leasing requirements.

Step 4. Negotiating Lease Terms

After selecting the leasing company, the lessee negotiates the terms of the lease. This includes the lease duration, payment schedules, interest rates, responsibilities for maintenance and insurance, and the end-of-lease options (such as buyout, renewal, or asset return). The lessee and lessor mutually agree on the terms to ensure both parties are satisfied with the arrangement.

Step 5. Signing the Lease Agreement

Once the terms are finalized, both parties sign the lease agreement. The agreement legally binds the lessee to the conditions set forth in the contract, including making regular rental payments and adhering to any usage restrictions. The lease agreement also outlines the responsibilities of both the lessor and lessee regarding maintenance, insurance, and the asset’s condition during the lease period.

Step 6. Asset Delivery and Usage

After the lease agreement is signed, the lessor delivers the asset to the lessee. The lessee can then use the asset for the agreed period, making periodic lease payments as specified in the contract. During this time, the lessee is required to ensure that the asset is maintained and used according to the terms of the lease agreement.

Step 7. Lease Period and Payments

During the lease term, the lessee makes regular payments as per the agreed schedule. These payments are typically fixed and include interest or charges for the asset’s depreciation. The lessee must ensure that payments are made on time to avoid penalties or legal issues. At the end of the lease period, the lessee has the option to return the asset, renew the lease, or purchase the asset if the lease terms allow.

Step8. End of Lease Options

When the lease term ends, the lessee can choose from several options:

    • Return the Asset: The lessee returns the asset to the lessor, and the lease is concluded.

    • Renew the Lease: The lessee may extend the lease term, often with renegotiated terms.

    • Purchase the Asset: In some cases, the lessee has the option to purchase the asset at a predetermined price.

Advantages Of Leasing

  • Capital Conservation

Leasing allows businesses to conserve capital by avoiding large upfront costs typically associated with purchasing assets. Instead of tying up valuable funds in buying equipment or property, companies can allocate their financial resources to other critical business needs. This leads to improved cash flow management, allowing businesses to invest in growth opportunities, R&D, or marketing campaigns. Leasing also frees up capital for day-to-day operations, helping companies maintain financial flexibility and operational efficiency without large capital expenditures.

  • Access to Upgraded Technology

Leasing provides businesses with the opportunity to access the latest technology and equipment without the need to own them. As assets become outdated, lessees can upgrade to newer models at the end of the lease term, ensuring that they always have access to state-of-the-art technology. This is particularly beneficial in sectors like IT and manufacturing, where technology evolves rapidly. By leasing, businesses can stay competitive, avoid obsolescence, and maintain productivity without investing in the depreciation of old assets.

  • Improved Cash Flow

Leasing offers predictable and manageable monthly payments, which helps improve cash flow management. Businesses can plan their expenses better by spreading the cost of acquiring assets over time rather than bearing the full upfront cost. Additionally, leasing does not require the substantial capital expenditure that purchasing an asset would. This financial flexibility enables businesses to allocate resources for other operational needs, investments, or expansion plans. Leasing ensures stable cash flow and reduces the risk of liquidity issues in businesses.

  • Tax Benefits

Leasing provides significant tax advantages for businesses. Lease payments made by the lessee are often considered operating expenses and can be deducted from taxable income, reducing the company’s overall tax liability. In the case of finance leases, the lessee may also be able to claim depreciation on the asset, further enhancing tax benefits. These tax incentives help businesses reduce the cost of leasing, making it a more affordable option compared to outright asset ownership, especially for small and medium-sized enterprises.

  • Off-Balance-Sheet Financing

Leasing provides off-balance-sheet financing, meaning the leased asset does not appear as a liability on the lessee’s balance sheet. This keeps the company’s debt-to-equity ratio low, which can be advantageous for maintaining a strong financial position. For businesses looking to secure additional loans or raise capital, having fewer liabilities can help them present a more attractive financial profile to investors and creditors. This feature is particularly important for companies that want to preserve their borrowing capacity for future expansion.

  • Risk Mitigation

Leasing helps businesses mitigate the risks associated with asset ownership, particularly depreciation and maintenance costs. Since the lessor retains ownership of the asset, they bear the risks related to asset obsolescence, loss of value, and potential repair costs. In many cases, the lessor is responsible for the upkeep and servicing of the leased asset. This risk-sharing aspect reduces the financial burden on the lessee, who can focus on their core operations without worrying about the asset’s residual value or maintenance needs.

Disadvantages of Leasing

  • Higher Total Cost

One significant disadvantage of leasing is that, over the long term, leasing can be more expensive than purchasing an asset outright. The lessee makes regular payments throughout the lease term, and when compounded with interest and administrative fees, the total cost of leasing may exceed the upfront cost of buying the asset. Additionally, since the asset is owned by the lessor, the lessee does not benefit from any appreciation in value or resale proceeds once the lease term concludes.

  • No Ownership

With leasing, the lessee does not own the asset at the end of the lease term, unlike buying an asset. Although the lessee can use the asset during the lease period, ownership remains with the lessor. This means that at the end of the lease, the lessee may have no residual value to recoup. If the asset is still in good condition and could be useful long-term, the lessee may feel they have wasted money on payments without acquiring any lasting asset.

  • Limited Flexibility

Leasing can have certain restrictions on usage and modifications of the asset. Most lease agreements include clauses that limit how the asset can be used or altered, and failing to comply with these terms could result in additional fees or penalties. Moreover, if the business needs to change the asset during the lease term, early termination or modification of the lease agreement can be difficult, expensive, or impossible. This lack of flexibility can restrict a business’s operations or adaptability.

  • Obligation for Regular Payments

Even if the leased asset is no longer needed, the business is still required to make regular payments throughout the lease term. If the business faces financial difficulties, these fixed costs could become a significant burden. In contrast, owning an asset means that payments are completed upfront or over a short term, leaving the business without ongoing liabilities. This can be particularly challenging for businesses with unstable cash flows or those experiencing a downturn in their operations.

  • Asset Depreciation

When leasing, the lessee does not benefit from the depreciation of the asset. For purchased assets, businesses can claim depreciation deductions, lowering their taxable income. In leasing, however, the lessor typically benefits from depreciation, which reduces the tax burden on the lessor, not the lessee. This means businesses that lease assets miss out on the tax advantages associated with ownership. For businesses seeking to reduce their tax liability, leasing can be less advantageous than purchasing the asset.

  • Lease Renewal Costs

At the end of the lease term, renewing the lease or extending it for continued use may come with higher costs, particularly if the market value of the asset increases. In many cases, lease renewal agreements include clauses that adjust rental payments based on inflation or the asset’s updated value. As a result, the cost of renewing a lease can rise significantly over time. This can make long-term leasing less predictable and potentially more expensive than initially planned.

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