What's New in the Law

True Lease vs. Security Interest: In General

Cobra Capital, LLC v. Pomp's Services, Inc., 2010 WL 680947 (U.S.Dist.Ct. N.D.Ill. Feb. 23, 2010)

This decision denies a defendant/lessee's motion for partial summary judgment predicated in part on the claim that its lease with the plaintiff/lessor was a “disguised sale” (i.e., a secured transaction). After briefly summarizing Illinois law by stating that a purported lease will be recharacterized as a secured transaction if it satisfies one of two tests (the “per se” test or the “economic realities” test), the court finds that there were disputed issues of fact as to whether a $1 purchase option was intended (which would satisfy the “per se” test) and whether the lessor did not retain a meaningful reversionary interest in the equipment at the end of the lease (which would satisfy the economic realities test).

In re Uni Imaging Holdings, LLC, 2010 WL 148422 (Bankr.N.D.N.Y. Jan. 12, 2010)

In deciding whether the lessee in bankruptcy met its burden of demonstrating that a purported lease was actually a secured transaction, the court initially describes the negotiation of rental amounts and a fixed-price purchase option in the context of the parties' intentions and expectations, and then examines the facts in light of the statutory requirements and case law (including numerous citations to the In re Gateway Ethanol case discussed below). Without always clearly distinguishing between two meanings taken on by the term “nominal additional consideration” (one provided in the statutory language itself ' i.e., that the cost of the purchase option may be less than the cost of completing the other requirements of the lease such as removing and returning the equipment ' and another discussed in various cases and commentary ' i.e., a comparison of the purchase option price with the expected value of the equipment at the end of the lease to determine whether a bargain purchase price provides an economic compulsion on the part of the lessee to exercise the option) ' the court discusses both meanings and concludes that the lessee has not met its burden.

In re Gateway Ethanol, L.L.C., 415 B.R. 486 (Bankr.D.Kan. 2009)

The purchaser of certain equipment from a debtor in bankruptcy sought to have a lease recharacterized as a security agreement inasmuch as such recharacterization would mean that the purchaser was not required to make future payments owing under the lease. In order to determine whether such purchaser met its burden of proof, the court focuses much of its discussion on the amount of the fixed-price purchase option under the lease and whether it amounts to “nominal additional consideration” under the Article 1 statutory language distinguishing between true leases and secured transactions. This provision states that a purchase option will be considered nominal if the lessee's predictable cost of completing performance under the lease (without exercising the option) would be greater than the cost of exercising the option. Since the purchaser was unable to demonstrate that the cost to remove and return the equipment approached the amount of the purchase option, it failed to prove the creation of a security interest under this per se portion of the statutory criteria. The court goes on to consider other arguments advanced by the purchaser that the lessor did not retain a meaningful residual interest ' a concept referenced in various cases and commentaries ' and also rejects them. For instance, the court compares the purchase option price to the anticipated value of the equipment at the end of the lease and opines that it cannot conclude that such purchase option was nominal. (In this connection, a footnote references the opinion of White & Summers in their treatise that any option price above 50% of the predicted fair market value at lease termination cannot be nominal.) 4 White & Summers, Uniform Commercial Code ' 30-3 (5th ed. 2002 & 2008 Supp.) After considering other economic factors (as intended by the drafters of the statutory criteria for making the true lease-security interest distinction), the court mentions that even if the parties' intent may have some relevance, all evidence was that the parties originally intended the transaction to be a true lease.

Measures of Lessors' Damages

Columbus Bank and Trust Company v. Granger, 2010 WL 99055 (U.S.Dist.Ct. M.D.Georgia Jan. 6, 2010)

A lessor's motion for summary judgment is denied regarding the amount owed to it by the lessee after the equipment had been sold by the lessor following a lessee default. The court finds that there is a genuine issue of material fact as to whether the sale price was fair and, therefore, whether the sale was commercially reasonable. While the court is clearly applying Article 9 requirements and language (e.g., “collateral,” “debt,” “secured party”) to the lease transaction, it does not explain how it concluded that the lease created a security interest (evidently the lessor did not contest this issue). The case serves as an illustration that a lessor's rights after default can be considerably different depending upon whether its lease is a true lease or not.

National City Healthcare Finance v. Refine, 360, LLC, 607 F.Supp.2d 881 (N.D.Ill. April 9, 2009)

In this case, the lessor had moved for a default judgment against both a lessee in default and an individual guarantor. This court denies the motion without prejudice to reassertion of a revised motion ' but in a manner consistent with the court's views on the unenforceable penalty nature of the remedies set forth in the lease that were being requested by the lessor. Without citing Article 2A, the court asserts that American law (apparently, at least, case law) is universal in its condemnation of remedy provisions that provide for receipt of more than the sum of past-due rents and the present value of both future rents and anticipated end-of-term fair market value of the leased property and then subtracting the current value of such property. Here, the lease contained what the court refers to as “a prototypical penalty provision of the type that to this Court's knowledge no court will enforce” ' the lease's definition of “Stipulated Loss Value” (an amount that the lease permitted the lessor to demand) provided for no discounting to present value of either future rents or the estimated fair market value of the property. The court is apparently so outraged by the lessor's request that it suggests that it may not be inclined to enforce another lease provision requiring the lessee to pay the lessor's attorneys' fees.

Liability of Motor Vehicle Lessors for Equipment-Related Injuries and Damages

Wilson v. Camrac, Inc., 2010 WL 532450 (Conn.Super. Jan. 11, 2010) (unpublished opinion ' check rules before citing)

This court grants a motion to strike a complaint against a car rental company, finding the federal Graves Amendment to be applicable to prevent a vicarious liability claim and rejecting the plaintiff's argument that the federal statute was an unconstitutional violation of the Commerce Clause of the U.S. Constitution.

Babiuk v. Lake, 2009 WL 4728010 (U.S.Dist.Ct. M.D.Fla. Dec. 3, 2009)

In a vicarious liability action against a motor vehicle lessor, the lessor argued for dismissal based upon lack of federal diversity jurisdiction insofar as federal law limits liability to an amount below the dollar threshold for such diversity jurisdiction. This court dismisses the claim against the lessor ' not for lack of jurisdiction based upon a dollar limit on liability, but because the federal statute (the Graves Amendment) entirely pre-empts Florida vicarious liability law.

Robert W. Ihne, a member of this newsletter's Board of Editors, 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

Faust Printing, Inc. v. Man Capital Corp., 2009 WL 5210847 (U.S.Dist.Ct. N.D.Ill. Dec. 23, 2009)

After the lessee executed a lease with a financing company affiliate of a manufacturer of printing presses (there apparently was some confusion on the part of the lessee as to which company was to sign the lease as lessor) and received a printing press that allegedly did not function as expected, the lessee brought a fraud action against both the manufacturer and its finance company claiming that it had been fraudulently induced to sign the lease with representations that the lessee would have recourse against the manufacturer in the event of problems with the press. This court denies a summary judgment motion by the defendants, which motion argued that the hell-or-high-water clause in the lease precluded a fraudulent inducement claim. Without any explanation, the court mentions a previous summary judgment opinion holding that the hell-or-high-water clause was preceded by “ambiguous” language. In the “Net Lease” language quoted in the opinion, the only such language seems to be “Except as otherwise specifically provided herein or in any Schedule hereto,” but the court fails to point to any provision elsewhere which might modify the lessee's absolute and unconditional obligations.

True Lease vs. Security Interest: In General

Cobra Capital, LLC v. Pomp's Services, Inc., 2010 WL 680947 (U.S.Dist.Ct. N.D.Ill. Feb. 23, 2010)

This decision denies a defendant/lessee's motion for partial summary judgment predicated in part on the claim that its lease with the plaintiff/lessor was a “disguised sale” (i.e., a secured transaction). After briefly summarizing Illinois law by stating that a purported lease will be recharacterized as a secured transaction if it satisfies one of two tests (the “per se” test or the “economic realities” test), the court finds that there were disputed issues of fact as to whether a $1 purchase option was intended (which would satisfy the “per se” test) and whether the lessor did not retain a meaningful reversionary interest in the equipment at the end of the lease (which would satisfy the economic realities test).

In re Uni Imaging Holdings, LLC, 2010 WL 148422 (Bankr.N.D.N.Y. Jan. 12, 2010)

In deciding whether the lessee in bankruptcy met its burden of demonstrating that a purported lease was actually a secured transaction, the court initially describes the negotiation of rental amounts and a fixed-price purchase option in the context of the parties' intentions and expectations, and then examines the facts in light of the statutory requirements and case law (including numerous citations to the In re Gateway Ethanol case discussed below). Without always clearly distinguishing between two meanings taken on by the term “nominal additional consideration” (one provided in the statutory language itself ' i.e., that the cost of the purchase option may be less than the cost of completing the other requirements of the lease such as removing and returning the equipment ' and another discussed in various cases and commentary ' i.e., a comparison of the purchase option price with the expected value of the equipment at the end of the lease to determine whether a bargain purchase price provides an economic compulsion on the part of the lessee to exercise the option) ' the court discusses both meanings and concludes that the lessee has not met its burden.

In re Gateway Ethanol, L.L.C., 415 B.R. 486 (Bankr.D.Kan. 2009)

The purchaser of certain equipment from a debtor in bankruptcy sought to have a lease recharacterized as a security agreement inasmuch as such recharacterization would mean that the purchaser was not required to make future payments owing under the lease. In order to determine whether such purchaser met its burden of proof, the court focuses much of its discussion on the amount of the fixed-price purchase option under the lease and whether it amounts to “nominal additional consideration” under the Article 1 statutory language distinguishing between true leases and secured transactions. This provision states that a purchase option will be considered nominal if the lessee's predictable cost of completing performance under the lease (without exercising the option) would be greater than the cost of exercising the option. Since the purchaser was unable to demonstrate that the cost to remove and return the equipment approached the amount of the purchase option, it failed to prove the creation of a security interest under this per se portion of the statutory criteria. The court goes on to consider other arguments advanced by the purchaser that the lessor did not retain a meaningful residual interest ' a concept referenced in various cases and commentaries ' and also rejects them. For instance, the court compares the purchase option price to the anticipated value of the equipment at the end of the lease and opines that it cannot conclude that such purchase option was nominal. (In this connection, a footnote references the opinion of White & Summers in their treatise that any option price above 50% of the predicted fair market value at lease termination cannot be nominal.) 4 White & Summers, Uniform Commercial Code ' 30-3 (5th ed. 2002 & 2008 Supp.) After considering other economic factors (as intended by the drafters of the statutory criteria for making the true lease-security interest distinction), the court mentions that even if the parties' intent may have some relevance, all evidence was that the parties originally intended the transaction to be a true lease.

Measures of Lessors' Damages

Columbus Bank and Trust Company v. Granger, 2010 WL 99055 (U.S.Dist.Ct. M.D.Georgia Jan. 6, 2010)

A lessor's motion for summary judgment is denied regarding the amount owed to it by the lessee after the equipment had been sold by the lessor following a lessee default. The court finds that there is a genuine issue of material fact as to whether the sale price was fair and, therefore, whether the sale was commercially reasonable. While the court is clearly applying Article 9 requirements and language (e.g., “collateral,” “debt,” “secured party”) to the lease transaction, it does not explain how it concluded that the lease created a security interest (evidently the lessor did not contest this issue). The case serves as an illustration that a lessor's rights after default can be considerably different depending upon whether its lease is a true lease or not.

National City Healthcare Finance v. Refine, 360, LLC, 607 F.Supp.2d 881 (N.D.Ill. April 9, 2009)

In this case, the lessor had moved for a default judgment against both a lessee in default and an individual guarantor. This court denies the motion without prejudice to reassertion of a revised motion ' but in a manner consistent with the court's views on the unenforceable penalty nature of the remedies set forth in the lease that were being requested by the lessor. Without citing Article 2A, the court asserts that American law (apparently, at least, case law) is universal in its condemnation of remedy provisions that provide for receipt of more than the sum of past-due rents and the present value of both future rents and anticipated end-of-term fair market value of the leased property and then subtracting the current value of such property. Here, the lease contained what the court refers to as “a prototypical penalty provision of the type that to this Court's knowledge no court will enforce” ' the lease's definition of “Stipulated Loss Value” (an amount that the lease permitted the lessor to demand) provided for no discounting to present value of either future rents or the estimated fair market value of the property. The court is apparently so outraged by the lessor's request that it suggests that it may not be inclined to enforce another lease provision requiring the lessee to pay the lessor's attorneys' fees.

Liability of Motor Vehicle Lessors for Equipment-Related Injuries and Damages

Wilson v. Camrac, Inc., 2010 WL 532450 (Conn.Super. Jan. 11, 2010) (unpublished opinion ' check rules before citing)

This court grants a motion to strike a complaint against a car rental company, finding the federal Graves Amendment to be applicable to prevent a vicarious liability claim and rejecting the plaintiff's argument that the federal statute was an unconstitutional violation of the Commerce Clause of the U.S. Constitution.

Babiuk v. Lake, 2009 WL 4728010 (U.S.Dist.Ct. M.D.Fla. Dec. 3, 2009)

In a vicarious liability action against a motor vehicle lessor, the lessor argued for dismissal based upon lack of federal diversity jurisdiction insofar as federal law limits liability to an amount below the dollar threshold for such diversity jurisdiction. This court dismisses the claim against the lessor ' not for lack of jurisdiction based upon a dollar limit on liability, but because the federal statute (the Graves Amendment) entirely pre-empts Florida vicarious liability law.

Robert W. Ihne, a member of this newsletter's Board of Editors, 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.