Municipal leases are financial transactions similar in function to installment sale contracts. Through these financing mechanisms, governing bodies acquire equipment on an installment basis. But, as the lessee is a local government or agency thereof, some conditions are different from commercial leases.
One different characteristic is that interest is tax exempt. Another difference is that at the end of the financial term full ownership is transferred. A third major distinction is that each agreement contains a non-appropriation clause. Non-appropriation language relieves this type of lessee from the obligation to pay, if the funds are not appropriated for any legal reason, in any subsequent budget period. It distinguishes this financing mechanism from bond issues, which are subject to certain stringent conditions such as voter approval. This distinguishing clause allows the municipalities to treat their lease obligations as current expenses and bypass restrictions on bond obligations.
Choosing this option has certain advantageous benefits. Municipalities have more financial flexibility when they utilize such funding. Using a lease is a thriftier alternative. The equipment is acquired on favorable terms. Documentation is less cumbersome. Cash management is easier. Typically payment terms extend over two and ten years. Both principal and interest are paid off within the prescribed payment periods. Each payment builds ownership equity.
The financing method is a reasonable choice. Funding remains within the normal budget cycle. Approval procedures are simpler and faster than the bond alternative. This method does not disturb credit lines and avoids recourse to bonds. Unlike bond obligations, cost is spread over a shorter time period. A shorter time period makes the payments a closer match to the useful life of purchased material.
A non-appropriation condition classes payments as expenses rather than debts. It takes away the need for any reserve or emergency fund. Use a lease is the simpler alternative to bonds. The buying cycle is faster and professional fee expenses are avoidable when voter approval is not a requirement. Local governments with tighter finances prefer the payment cycle permissible with this option. When revenues are reduced, the need to stretch cost over a term period is a useful tool. Flexibility is a friend of stressed budgets. When it is easier to match revenues with expenses, funding is less burdensome.
Local governments often face a backlog of capital replacement needs. The backlog is something to live with, but it makes necessary purchases too large to finance in one year. As many governments do not have the revenue to make the purchase, an installment arrangement allows them to use an asset without a full purchase.
Financing contracts can be match funded or advance funded depending on financial objectives of lessees. Payment frequency can be tailored to match the availability of municipal funding. Although the underlying financing structure typically incorporates a fixed rate, graduated payment, variable rates, and deferred payment plans could be offered as well. Flexibility can be designed to maximize possible alternatives available with such financing.
Lessors must keep in mind that municipal leases are tax exempt contracts governed by special laws. The laws governing the authority of local governments and their agencies to enter into such agreements are different from those applicable to nongovernmental entities. Failure to accommodate this difference increases the possibility of entering into an invalid contract.
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