6. Provisions for the sale or substitution of prop erty covered by the lease.—In long-term leases of permanent properties, sale or substitution of property covered must be allowed. Operating conditions, rights-of-way and forms of equipment change with time, and a way must be left open for keeping the properties up to date. The lease usually provides that the proceeds of property sold shall go to the trustee, to the lessor, or back into the property itself.
7. Leasing of business pro perties.—Entirely aside from its utility in purchasing equipment, the lease has many advantages as a method of acquiring permanent producing properties. When the lessee corporation is powerful, its guarantee of a steady rental, sufficient to pay good dividends to the stock holders of the lessor company, is very attractive to the latter. The payment of such dividends at an agreed rate is frequently the measure of the rental charged. Such an arrangement, accompanied by adequate provisions for the maintenance of the prop erty in good condition by the lessee corporation, stabilizes the security values of the lessor, without any active effort on its part. In addition to the earning power of their property, the stockholders of the lessor now have the contract of the lessee corporation to guarantee dividends.
The advantage to the lessee is equally evident. It secures immediate possession of a fully equipped, organized and running business property without awaiting the construction of a plant or the tedious process of building up a new business. There is the additional advantage that the negotiations for the lease are simple and require but little capital. The lease merely needs the ratification of the boards of directors of both companies. The directors in turn usually secure the consent of the stockholders without difficulty, especially if the lessor company has had a checkered career, which the stockholders are glad henceforth to escape.
The lessee corporation makes a small payment down, assumes the payment of all future maintenance and fixed charges upon the property, and promises certain periodic dividend payments to the stockhold ers of the lessor. These payments may begin at a low level and gradually increase to a maximum divi dend rate, which is often six per cent. The lessee expects to earn enough from the operation of the leased property to make all these future payments and in addition a margin of profit for itself. It is expected that the lease will pay for itself and there fore very little financing is required.
If the property were to be acquired without a lease, it would be done ordinarily by purchasing the con trolling interest, or perhaps the entire capital stock, of the acquired company. This requires considerable financing. Even if this money is raised by deposit ing the stock as security for an issue of collateral trust bonds, the bonds themselves must be sold, where as, in the case of a lease, the cash to be raised imme diately consists only of the hand payment at the time the lease is signed.
8. Financing improvements on leased property.— When plant assets are conveyed, corporate leases usually provide that portions of the property which become obsolete, or are no longer useful, may be sold by the lessee and the proceeds applied to improve ments upon the property. It is obviously to the in terests of both parties that this should be done.
With a short-term lease, naturally the lessee hesi tates to make improvements upon the property, know ing that it may revert to the lessor at the expiration of the lease without any compensation for the im provement made. If the lease is renewed, it may be that the lessor, because of the improved value of the property, will increase the rental, actually penalizing the lessee for a gratis improvement upon the property of the lessor.
Sometimes the lessee finds himself unable to finance necessary improvements without pledging the prop erty itself or utilizing the credit of the lessor. Of course, this cannot be done unless provided in the lease or consented to by the lessor. For instance, if the lessee of a street railway should find it necessary to electrify the line, elevate the track, or instal a subway system upon a franchise controlled by the lessor, all of which improvements might be necessary to uphold the value and income of the properties, the lessee corporation undoubtedly would be justified in expecting the lessor to lend his assistance in raising new capital.
This may be done in various ways. The lessor may loan certain securities to the lessee to be deposited be hind an issue of collateral trust bonds, which are the obligations of the lessee; or the lessor itself may bor row upon such collateral trust bonds, advancing to the lessee the funds thereby secured to be expended upon the property. Mortgage bonds may be issued against the property, with the consent of both parties, either as the obligation of the lessee or of the lessor, provided the property is good security for a mortgage. Some times the lease gives the lessee the option of requiring the lessor to issue additional stocks or bonds for the purpose of improving the property, as in the case of the Boston Elevated Railroad Company. Here again arbitrators may be necessary to determine when such advances shall be made under the terms of the lease.
In any event, if the funds, credit or property of the lessor are used to finance improvements which may immediately enhance the earnings of the lessee, the funds so advanced are never used for anything except permanent additions and improvements. If there is an open mortgage or a bond reserve, secured by a mortgage upon the property, at the time the lease is made, it is possible, of course for the lessee, under carefully drawn restrictions, to acquire the right to sell these unissued bonds without further recourse to the lessor, subject only to such restrictions as the mortgage may impose.