What's New in the Law

Ability to Collect Rentals

In re Rafter Seven Ranches L.P. (Rafter Ranches L.P. v. C.H. Brown Company), 2008 WL 4787106 (U.S.Ct.App. 10th Cir. Nov. 4, 2008). A divided Tenth Circuit panel affirms the decisions of a bankruptcy court and bankruptcy appellate panel that a lessee of irrigation sprinkler systems was liable for unpaid rentals on its leases despite the facts that the systems supplied by a company chosen by the lessee did not conform to specifications of the equipment in the leases and, in the case of some of the equipment, was never used after the lessee inspected it and determined it to be “junk.” The primary basis for finding liability with respect to the unused equipment was that the lessee failed to notify the lessor of its rejection of the equipment in a reasonable period of time as required by Article 2A ' letting the equipment sit in the fields for six weeks before notifying the lessor. The dissent argues, to the contrary, that a reasonable opportunity to inspect should include an opportunity to test, which in the case of the “junk” would have been futile. The majority had also noted that the lessee authorized the lessor to pay the supplier before the equipment was delivered and agreed that it would look only to the supplier in the event the equipment was defective. Whether such promises would obligate the lessee to make all lease payments owing under the leases ' under contract law if not under Article 2A finance lease provisions requiring a reasonable opportunity to inspect ' even if prompt notice of nonconformity was given, is not made clear.

Frontier Leasing Corp. v. Bowlers Country Club, Inc., 2008 WL 4725183 (Iowa App. Oct. 29, 2008) (final publication decision pending). In a case with a factual background similar to, and decided by the same court as, C and J Leasing Corp. v. Hendren Golf Management, Inc., 2007 WL 257955 (Iowa App. Jan. 31, 2007), this appellate court affirms a lower court's grant of summary judgment for the lessor based upon the “hell and high water” provision in the lease notwithstanding a vendor's financial inability to pay for advertising on golf carts in amounts sufficient for the lessee to make the payments owing on the lease. The court notes that since “hell and high water” provisions are enforceable in Iowa and since the lessee had every opportunity to read the lease, there was no genuine issue of material fact to support a claim that the lease was unconscionable.

IFC Credit Corp. v. Burton Industries, Inc., 536 F.3d 610 (7th Cir. 2008). A NorVergence lessee had signed both NorVergence's standard Equipment Rental Agreement as well as another NorVergence-generated document titled “Hardware Application.” Notwithstanding the lease's provisions for “hell or high water” payment obligations, a waiver of defenses in favor of assignees, and ' of special relevance to this decision ' a merger clause stating that the lease terms were the complete and exclusive statement of the agreement and that terms not contained in the lease would not be legally enforced, the Seventh Circuit found that the Hardware Application's provision that the lease was not binding until the equipment was installed was applicable (as a contemporaneous written document whose admission into evidence did not violate Illinois' parol evidence rule) to the facts of this case. Although the equipment was delivered and the lessee signed a delivery and acceptance receipt, since the equipment was never installed, the lease was held never to have existed, leaving the assignee with no legal right to collect. Whether or not the facts of this case are common to other NorVergence lease situations, this ruling should give pause to any assignee of any well-drafted lease that has not somehow assured itself that the lessee had not signed some other document simultaneously that could call into question the existence of the lease.

National City Commerce Capital Corp. v. Blackledge Country Club, Inc., 2008 WL 2797010 (Conn.Super. June 25, 2008) (unpublished opinion). This brief denial of a lessor's motion for summary judgment illustrates the potential difficulty of enforcing even a “hell or high water” lease when there exists a service agreement to be fulfilled by other parties that is necessary for the proper functioning of the equipment. Although the facts are not entirely clear, the lessor may have taken this lease of GPS equipment to be used at the defendant's golf course by assignment from a company that had relations with other companies responsible for installing and servicing the equipment. The court denied the lessor's summary judgment motion before a factual examination of the defendant's claims concerning the purported agency relationship between the plaintiff and parties that were alleged to have improperly serviced the equipment and/or alleged to have improperly induced the defendant to sign the lease.

True Lease vs. Security Interest: TRAC Leases and TRAC Statutes

In re Brankle Brokerage & Leasing, Inc. (Brankle Brokerage & Leasing, Inc. v. Volvo Financial Services), 2008 WL 4470061 (Bankr.N.D.Ind. Sept. 18, 2008). Applying the choice of law provision in the lease ' calling for North Carolina law ' this bankruptcy court finds a way around a statute that apparently was intended to safeguard the true lease status of TRAC leases. In North Carolina's Article 2A, “lease” is defined to include a motor vehicle operating agreement that is considered a lease under '7701(h) of the Internal Revenue Code (regarding TRAC leases). However, the court states that this does not resolve the issue in itself and goes on to consider the provisions of Article 1 distinguishing a true lease from a security interest. It then applies the same kind of analysis found in many early (i.e., prior to the adoption of TRAC lease statutes in nearly all states) TRAC lease cases to find that since the lessee has all of the downside risk and upside potential (and thus the lessor has no meaningful residual interest), the transaction is actually a security agreement. The court does indicate that if North Carolina had enacted the same kind of TRAC statute found in most other states ' i.e., by amending Article 1's true lease/security interest distinction instead of amending the definition of “lease” in Article 2A ' this decision would have gone the other way.

Measures of Lessors' Damages

Giant Eagle, Inc. v. Phar-Mor, Inc., 528 F.3d 455 (6th Cir. 2008). Reversing in part prior Bankruptcy and District Court decisions, the Sixth Circuit holds that under Pennsylvania law, a lessor's claim in bankruptcy for damages following the lessee's rejection of a lease does not disappear as soon as the lessor mitigates its damages by successfully re-leasing the equipment to another party. In this case, the other party (i.e., the new lessee) itself filed for bankruptcy shortly after entering into the new lease and subsequently rejected that lease. This decision indicates that since the lessor's attempt at mitigation proved to be less than completely successful, the lessor retained an unsecured claim in the initial bankruptcy for its losses. The court does affirm the holding of the lower courts that the lessor was entitled to administrative expenses in the form of post-petition rent payments from the date the lessee filed its petition in bankruptcy until the date it rejected the lease.

Lessors' Liability for Equipment-Related Injuries and Damages

Garcia v. Vanguard Car Rental USA, Inc., 540 F.3d 1242 (11th Cir. 2008). This Eleventh Circuit decision holds that the federal Graves amendment pre-empts Florida law ' a common law “dangerous instrumentality” doctrine coupled with statutory recognition of that doctrine which places caps on motor vehicle lessor liability ' under which motor vehicle lessors can be held vicariously liable for the negligence of their lessees. The decision rejects the plaintiffs' arguments that their lawsuits fall instead within the Graves amendment's savings clause, which concerns non-pre-emption of state financial responsibility and insurance standards. According to the court, to accept this interpretation of the savings clause would result in the exception swallowing the whole. The court also undertakes an extensive analysis of the Graves amendment's constitutionality under the Commerce Clause and finds it to be constitutional.

Vendor Issues

T-M Vacuum Products, Inc. v. TAISC, Inc., 2008 WL 4093684 (U.S.Dist.Ct. S.D.Tex. Aug. 28, 2008). The court found in favor of a vendor who sued a lessor for the balance of payments owing to the vendor for furnaces to be leased by the lessor to a lessee. The lessor claimed that because the vendor had delivered the furnaces after the original delivery deadline, 1) the lessor was not obligated to pay the balance to the vendor, and 2) the lessor was entitled to a return of the conditional payments made by the lessor to the vendor prior to delivery. Noting that the lessee had agreed to extend the delivery deadline and that the lessee had made all payments owing to the lessor under the lease, the court granted the vendor's motion for summary judgment.

Robert W. Ihne is an attorney with 25 years of experience in commercial financing, primarily in the areas of secured transactions and equipment leasing. Such experience has included drafting, negotiating and providing advice related to direct transactions, syndications, vendor financing arrangements, and various forms of credit enhancements such as guaranties and letters of credit. He may be reached at [email protected]. The author gratefully acknowledges the assistance of Erin Staton and Ed Gross of Vedder Price Kaufman & Kammholz, P.C. in the preparation of this update.

Ability to Collect Rentals

In re Rafter Seven Ranches L.P. (Rafter Ranches L.P. v. C.H. Brown Company), 2008 WL 4787106 (U.S.Ct.App. 10th Cir. Nov. 4, 2008). A divided Tenth Circuit panel affirms the decisions of a bankruptcy court and bankruptcy appellate panel that a lessee of irrigation sprinkler systems was liable for unpaid rentals on its leases despite the facts that the systems supplied by a company chosen by the lessee did not conform to specifications of the equipment in the leases and, in the case of some of the equipment, was never used after the lessee inspected it and determined it to be “junk.” The primary basis for finding liability with respect to the unused equipment was that the lessee failed to notify the lessor of its rejection of the equipment in a reasonable period of time as required by Article 2A ' letting the equipment sit in the fields for six weeks before notifying the lessor. The dissent argues, to the contrary, that a reasonable opportunity to inspect should include an opportunity to test, which in the case of the “junk” would have been futile. The majority had also noted that the lessee authorized the lessor to pay the supplier before the equipment was delivered and agreed that it would look only to the supplier in the event the equipment was defective. Whether such promises would obligate the lessee to make all lease payments owing under the leases ' under contract law if not under Article 2A finance lease provisions requiring a reasonable opportunity to inspect ' even if prompt notice of nonconformity was given, is not made clear.

Frontier Leasing Corp. v. Bowlers Country Club, Inc., 2008 WL 4725183 (Iowa App. Oct. 29, 2008) (final publication decision pending). In a case with a factual background similar to, and decided by the same court as, C and J Leasing Corp. v. Hendren Golf Management, Inc., 2007 WL 257955 (Iowa App. Jan. 31, 2007), this appellate court affirms a lower court's grant of summary judgment for the lessor based upon the “hell and high water” provision in the lease notwithstanding a vendor's financial inability to pay for advertising on golf carts in amounts sufficient for the lessee to make the payments owing on the lease. The court notes that since “hell and high water” provisions are enforceable in Iowa and since the lessee had every opportunity to read the lease, there was no genuine issue of material fact to support a claim that the lease was unconscionable.

IFC Credit Corp. v. Burton Industries, Inc. , 536 F.3d 610 (7th Cir. 2008). A NorVergence lessee had signed both NorVergence's standard Equipment Rental Agreement as well as another NorVergence-generated document titled “Hardware Application.” Notwithstanding the lease's provisions for “hell or high water” payment obligations, a waiver of defenses in favor of assignees, and ' of special relevance to this decision ' a merger clause stating that the lease terms were the complete and exclusive statement of the agreement and that terms not contained in the lease would not be legally enforced, the Seventh Circuit found that the Hardware Application's provision that the lease was not binding until the equipment was installed was applicable (as a contemporaneous written document whose admission into evidence did not violate Illinois' parol evidence rule) to the facts of this case. Although the equipment was delivered and the lessee signed a delivery and acceptance receipt, since the equipment was never installed, the lease was held never to have existed, leaving the assignee with no legal right to collect. Whether or not the facts of this case are common to other NorVergence lease situations, this ruling should give pause to any assignee of any well-drafted lease that has not somehow assured itself that the lessee had not signed some other document simultaneously that could call into question the existence of the lease.

National City Commerce Capital Corp. v. Blackledge Country Club, Inc., 2008 WL 2797010 (Conn.Super. June 25, 2008) (unpublished opinion). This brief denial of a lessor's motion for summary judgment illustrates the potential difficulty of enforcing even a “hell or high water” lease when there exists a service agreement to be fulfilled by other parties that is necessary for the proper functioning of the equipment. Although the facts are not entirely clear, the lessor may have taken this lease of GPS equipment to be used at the defendant's golf course by assignment from a company that had relations with other companies responsible for installing and servicing the equipment. The court denied the lessor's summary judgment motion before a factual examination of the defendant's claims concerning the purported agency relationship between the plaintiff and parties that were alleged to have improperly serviced the equipment and/or alleged to have improperly induced the defendant to sign the lease.

True Lease vs. Security Interest: TRAC Leases and TRAC Statutes

In re Brankle Brokerage & Leasing, Inc. (Brankle Brokerage & Leasing, Inc. v. Volvo Financial Services), 2008 WL 4470061 (Bankr.N.D.Ind. Sept. 18, 2008). Applying the choice of law provision in the lease ' calling for North Carolina law ' this bankruptcy court finds a way around a statute that apparently was intended to safeguard the true lease status of TRAC leases. In North Carolina's Article 2A, “lease” is defined to include a motor vehicle operating agreement that is considered a lease under '7701(h) of the Internal Revenue Code (regarding TRAC leases). However, the court states that this does not resolve the issue in itself and goes on to consider the provisions of Article 1 distinguishing a true lease from a security interest. It then applies the same kind of analysis found in many early (i.e., prior to the adoption of TRAC lease statutes in nearly all states) TRAC lease cases to find that since the lessee has all of the downside risk and upside potential (and thus the lessor has no meaningful residual interest), the transaction is actually a security agreement. The court does indicate that if North Carolina had enacted the same kind of TRAC statute found in most other states ' i.e., by amending Article 1's true lease/security interest distinction instead of amending the definition of “lease” in Article 2A ' this decision would have gone the other way.

Measures of Lessors' Damages

Giant Eagle, Inc. v. Phar-Mor, Inc. , 528 F.3d 455 (6th Cir. 2008). Reversing in part prior Bankruptcy and District Court decisions, the Sixth Circuit holds that under Pennsylvania law, a lessor's claim in bankruptcy for damages following the lessee's rejection of a lease does not disappear as soon as the lessor mitigates its damages by successfully re-leasing the equipment to another party. In this case, the other party (i.e., the new lessee) itself filed for bankruptcy shortly after entering into the new lease and subsequently rejected that lease. This decision indicates that since the lessor's attempt at mitigation proved to be less than completely successful, the lessor retained an unsecured claim in the initial bankruptcy for its losses. The court does affirm the holding of the lower courts that the lessor was entitled to administrative expenses in the form of post-petition rent payments from the date the lessee filed its petition in bankruptcy until the date it rejected the lease.

Lessors' Liability for Equipment-Related Injuries and Damages

Garcia v. Vanguard Car Rental USA, Inc. , 540 F.3d 1242 (11th Cir. 2008). This Eleventh Circuit decision holds that the federal Graves amendment pre-empts Florida law ' a common law “dangerous instrumentality” doctrine coupled with statutory recognition of that doctrine which places caps on motor vehicle lessor liability ' under which motor vehicle lessors can be held vicariously liable for the negligence of their lessees. The decision rejects the plaintiffs' arguments that their lawsuits fall instead within the Graves amendment's savings clause, which concerns non-pre-emption of state financial responsibility and insurance standards. According to the court, to accept this interpretation of the savings clause would result in the exception swallowing the whole. The court also undertakes an extensive analysis of the Graves amendment's constitutionality under the Commerce Clause and finds it to be constitutional.

Vendor Issues

T-M Vacuum Products, Inc. v. TAISC, Inc., 2008 WL 4093684 (U.S.Dist.Ct. S.D.Tex. Aug. 28, 2008). The court found in favor of a vendor who sued a lessor for the balance of payments owing to the vendor for furnaces to be leased by the lessor to a lessee. The lessor claimed that because the vendor had delivered the furnaces after the original delivery deadline, 1) the lessor was not obligated to pay the balance to the vendor, and 2) the lessor was entitled to a return of the conditional payments made by the lessor to the vendor prior to delivery. Noting that the lessee had agreed to extend the delivery deadline and that the lessee had made all payments owing to the lessor under the lease, the court granted the vendor's motion for summary judgment.

Robert W. Ihne is an attorney with 25 years of experience in commercial financing, primarily in the areas of secured transactions and equipment leasing. Such experience has included drafting, negotiating and providing advice related to direct transactions, syndications, vendor financing arrangements, and various forms of credit enhancements such as guaranties and letters of credit. He may be reached at [email protected]. The author gratefully acknowledges the assistance of Erin Staton and Ed Gross of Vedder Price Kaufman & Kammholz, P.C. in the preparation of this update.