BLM00655 - Primary and secondary periods

Operating leases, like finance leases, may have primary and secondary (and even tertiary etc) periods.

Unlike finance leases, the rentals payable in the secondary period are likely to be based on market rate for the asset concerned. For example, an airline might lease an aircraft for 5 years at $1m a month. At the end of the 5 year primary period, the lessee may have an option to extend the lease into a secondary period. The rents for this period might be fixed at (say) $800,000 a month to reflect the age of the aircraft. There would be no expectation, let alone compulsion, for the lessee to enter into the secondary period.

The structure of an operating lease designed to perform a financing function may also contain primary and secondary (or more) periods. If the option to extend the lease into the secondary (or later) periods is exercised the rentals payable in each period will be designed (broadly speaking) to give the lessor a financial return. There are, however, likely to be complex arrangements which ensure that, in the event the lessee does not exercise the option to extend the lease term, the lessor faces minimal risks consistent with the lease being correctly classified as an operating lease.