When Is a Lease of Personal Property a 'True Lease'?

Just because a document is labeled a lease may not make it so under commercial law. One of the more heavily contested issues under the Uniform Commercial Code (“UCC”) is whether an agreement transferring use and possession of personal property from one party to another is actually a lease as opposed to a sale subject to a security agreement. Here, we discuss the advantages and disadvantages of a “true lease” versus a security agreement, the legal considerations in determining how an agreement should be characterized under the UCC, and some interesting recent decisions in this area.

Lease or Security Agreement

There are many reasons from the legal perspective why a creditor may want to characterize the transaction as a lease and not a sale subject to a security interest. A lease affords protections to a lessor that a holder of a security interest does not have. For example, a “true lease” of goods is governed by Article 2A of the UCC. A creditor not in the business of leasing goods may be able to benefit from the Article 2A provisions dealing with “finance leases.” See, e.g., N.Y. U.C.C. ” 2A-209, 2A-211(2), 2A-212(1), 2A-213, 2A-407 and 2A-517. Under those provisions, the lessor is not responsible for the condition of the goods and does make implied warranties of fitness or merchantability. Those provisions also make the lessee's obligations to the lessor under the lease irrevocable and independent of the lessor's obligations or the condition of the leased goods (the latter being known as “hell or high water” obligations).

More critical are the advantages under the federal Bankruptcy Code, 11 U.S.C. ” 101, et seq. A lessor who repossesses leased equipment prior to bankruptcy will not be subject to a turnover proceeding under ' 542 of the Bankruptcy Code. Under ' 365(d)(10) of the Bankruptcy Code, the debtor or trustee in a Chapter 11 reorganization case must begin performing the debtor's obligations under an unexpired true lease (other than for consumer goods) within 60 days after the bankruptcy filing and continue to do so until the lease is assumed or rejected. In a Chapter 7 liquidation case, a lease not assumed or rejected within 60 days is deemed rejected under
' 365(d)(1).

In general, the debtor or trustee must either assume or reject the lease in its entirety; it cannot assume parts of the lease favorable to it and reject the balance, nor can it modify the lease without the lessor's consent. Of course, a debtor or trustee will likely seek to reject a true lease that has rentals above then-prevailing market rates. Accordingly, while the bankrupt estate may not be able to modify a true lease, given the risk and expense of remarketing the leased equipment, the lessor on an above market-rate true lease will be motivated to agree to modifications rather than accept return of its equipment when prevailing rates are below the rate in the rejected lease. On the other hand, a debtor in bankruptcy has the ability (subject to the facts and circumstances of the debtor and the case) to change the terms of a contractual agreement that is not a true lease, which may result in the modification of the creditor's rights, including payment terms, under the “cram down” provisions of ' 1129(b) of the Bankruptcy Code.

If there has been a default under a true lease, the lease cannot be assumed unless the debtor or trustee cures the default, compensates the lessor for pecuniary loss, and provides adequate assurance of its future performance under the lease. See 11 U.S.C. ' 365(b). Any default in payment under an assumed true lease becomes an administrative expense of the bankruptcy estate, entitled to priority ahead of unsecured creditors. See 11 U.S.C. ' 5.03(b). The rejection of an unexpired lease is treated as a breach of contract. [Note, the non-debtor party may have a breach of contract claim against the bankruptcy estate that would be treated as an unsecured claim.]

Additionally, in a true lease, the non-debtor party (lessor) continues to own any goods leased to the debtor (lessee) and such goods will not be subject to claims by creditors of the debtor's bankruptcy estate. In a transaction characterized as a sale, conversely, the ownership interest in the goods is transferred to the debtor and the goods would be part of the debtor's bankruptcy estate, subject to claims of all creditors of the bankruptcy estate.

Relevant UCC Provisions

State law governs whether an agreement is a true lease or a disguised security agreement. [It should be noted that Article 9 looks to non-UCC law in two other instances: whether there has occurred a true sale of receivables and whether there has occurred a true consignment.] UCC ' 2A-103 states that a lease is “a transfer of the right to possession and use of goods for a term in return for consideration, but a sale, including a sale on approval or a sale or return, or retention or creation of a security interest is not a lease.”

UCC ' 1-201(37) sets forth the definition of “security interest.” [Note, in most jurisdictions the provisions found in ' 1-201(37) of New York's UCC are instead found in UCC ' 1-203.] Prior to the 1987 amendments to the UCC, ' 1-201(37) required a subjective determination as to whether a lease was “intended as security.” An amended version of that section was part of the UCC amendments that adopted Article 2A (Leases). The current version of ' 1-201(37) relies on a much more objective analysis of the economic realities of the transaction and establishes what courts have now labeled a “bright-line” test for determining whether a transaction, whether or not in the form of a lease, creates a security interest, rather than a true lease.

This bright-line test has two parts, and the focus is generally on the lessee. First, the transaction must be non-terminable, meaning that the purported lessee must be obligated for the full term of the agreement. Second, one of the following four “residual value factors” must be present in the agreement: 1) the original term of the lease is equal to or greater than the remaining economic life of the goods, 2) the lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods, 3) the lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease, or 4) the lessee has an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the agreement. If the transaction is non-terminable and one of the residual value factors is present, the transaction is per se a security interest rather than a true lease.

One of the most frequently litigated parts of the bright-line test is the determination of nominality in regard to the additional consideration referred to in the last two residual value factors. UCC Section 1-201(37)(c) provides that additional consideration is not nominal if, when the parties enter into the agreement, the price to exercise the option is stated in the agreement to be the fair market value of the goods or the fair market value for the use of the goods for the renewal term, as applicable. It also states that additional consideration is nominal if it is less than the lessee's reasonably predictable cost of performing under the lease agreement if the option is not exercised. Nominality must be determined by the parties' expectation of value of the goods at the time of entering into the agreement and not at the time the option to renew or purchase is exercisable.

The value of the option alone does not establish nominality. See, e.g., Gangloff Indus., Inc. v. Generic Fin. & Leasing Corp., No. 09A02-0809-CV-797, 2009 WL 1674976 (Ind. Ct. App. June 16, 2009); Park W. Fin. Corp. v. Phoenix Equip. Co. (In re Phoenix Equip. Co.), No. 2:08-bk-13108, 2009 WL 3188684 (Bankr. D. Ariz. Sept. 30, 2009) (not for publication ' electronic docketing only). Generally speaking, the additional consideration is nominal if the price of exercising the option is so low in comparison to the remaining value of the goods that a reasonable lessee will certainly exercise the option. See In re Phoenix Equip., 2009 WL 3188684 at *10. The emphasis here is clearly on the lessee and its cost of performance.

However, if nominal additional consideration is not found, and the bright-line test is not satisfied, courts do not conclude that an agreement is a lease simply because it is not a per se security agreement. Most courts have agreed that attention must turn to the lessor, and to facts of the case to determine whether or not the lessor retained a meaningful reversionary interest in the leased goods. Id. (citing Addison v. Burnett, 41 Cal. App. 4th 1288, 49 Cal. Rptr. 2d 132 (1996)). This next analysis also relies heavily upon the economic realities of a transaction, but recent decisional law illustrates the difficulty courts continue to have once they reach beyond the bright-line test.

Recent Decisions

Two recent bankruptcy cases, In re Gateway Ethanol, L.L.C., 415 B.R. 486 (Bankr. D. Kan. 2009) and In re Uni Imaging Holdings, LLC, 2010 WL 148422 (Bankr. N.D.N.Y. Jan. 12, 2010) show the factors that judges and commentators examine in determining whether an agreement is a security agreement or a lease once it fails the bright-line test.

In Gateway Ethanol, a five-year lease for a $5 million boiler with a $600,000 purchase option at the end of the lease term was held to be a true lease. The transaction failed the bright-line test of UCC ' 1-201(37) based on the court's finding that the option price was not “nominal.” The court compared the purchase option price ($600,000) to the anticipated value of the equipment at the end of the lease. The cost of returning the boiler was only $200,000 to $250,000, and the expected value of the boiler was $600,000. Moreover, after the end of the lease term the boiler was projected to have a useful life of 15 to 20 years, and the lessor would have been able to market the boiler had the lessee returned it.

In its analysis, the court focused on the “economic substance” of the agreement and, in particular, whether the lessor retained a “reversionary interest” in the equipment. In considering the economic substance of the transaction, the court noted that there is not a defined test or consistent set of factors for determining whether a meaningful reversionary interest exists. See In re Gateway Ethanol, 415 B.R. at 504 (stating that “[t]he UCC does not provide an explicit test for reservation of a meaningful reversionary interest. ' Court decisions likewise have not adopted a consistent set of factors for identifying a lessor's residual interest.”). Focusing on the overall economic terms of the agreement, it based its determination that the agreement was a true lease on several considerations, including that, after the end of the lease term, the boiler had a long useful life and could be remarketed by the lessor; that the lessor would be able to market the equipment for other uses at the end of the lease term; that the boiler was not unique, and the long-term operation of the debtor's business did not require possession of the equipment; and that both the debtor and the party challenging the recharacterization of the lease (the debtor's financial adviser and the stalking-horse bidder for the debtor's assets) benefited economically by structuring the transaction as a lease and not a sale of the boiler.

Although, as mentioned above, the 1987 UCC amendments were designed to move courts away from looking to the intent of the parties, here the court also focused on the specific intent of the parties at the time they negotiated and entered into the transaction. [Note, the court expressly provided that
"[t]he role of intent when distinguishing between a lease and a security agreement under all the facts and circumstances test of the 1987 version of the UCC is not certain. It seems clear that the drafters intended economic factors to predominate, but it is not clear that they intended intent of the parties to be irrelevant.”]

The debtor initially contemplated purchasing the boiler, but leasing it allowed the debtor to reduce its construction costs and maintain a 45/55 equity-to-debt ratio that the debtor's financial adviser recommended to raise capital from potential investors. The court noted that the recommendations of the adviser (the party challenging the recharacterization of the lease) regarding the debt-to-equity ratio was the reason the transaction was changed from a purchase, as initially contemplated, to a lease. The court specifically held that the “[adviser] had to believe that the transaction had the financial characteristics of a true lease in order to market loan participations to the banks, because to believe otherwise would have meant that [adviser] knew the 45/55 equity to debt ratio was not true.” In re Gateway Ethanol, 415 B.R. at 507.

Uni Imaging involved a motion by a bankrupt lessee debtor seeking to characterize as a secured transaction an agreement identified as a “capital lease” for $1.3 million of magnetic resonance imaging equipment. In this case, the purchase option for the equipment was $175,000 compared with an estimated fair market value at end of lease term of approximately $329,000.

The court began its analysis by noting that the question of whether an agreement is a true lease or a security agreement “is one of the most vexatious and oft-litigated issues” under the UCC. In determining that the lessee had not satisfied its burden of establishing that the agreement was a secured transaction, the court considered the economic realities of the transaction and the expectation of the parties concerning the projected value of the equipment when they entered into the transaction. The court focused on whether the amount of the purchase option constituted nominal consideration. Having found that the purchase option was not nominal, the court then, taking its lead from the Gateway Ethanol decision, turned to determining whether the lessor retained a reversionary interest. Then the court examined in turn each of the following factors: 1) the anticipated useful life of the equipment; 2) the ability of the lessor to market the equipment at the end of the lease term; 3) the amount of lease payments over the term in relation to the equipment's initial value; 4) whether the equipment is unique; 5) whether at the time of the agreement the debtor's facility required continued possession of the equipment; and 6) the economic benefit to the debtor in having the transaction structured as a lease rather than a sale. Based on those factors, it concluded that the lessee had failed to establish that the reversionary interest of the lessor was insignificant, and accordingly the transaction was indeed a lease.

Conclusion

The drafters of the UCC were clearly trying to reduce the volume of litigation as to whether a transaction constituted a secured transaction or lease when they enacted the “bright-line” test of UCC ' 1-201(37). However, the Gateway Ethanol and Uni Imaging cases illustrate that courts continue to struggle with the notion of what constitutes a security agreement once they find themselves outside the bright-line test. In these instances, they have relied upon a complex and wide-ranging list of factors, mostly dependent on trying to ascertain the overall “economic substance” of a purported lease. That analysis appears to rely heavily on whether the lessor has retained a “reversionary interest” in the leased goods. See also In re Grubbs Constr. Co., 319 B.R. 698 (Bankr. M.D. Fla. 2005); Gibraltar Fin. Corp. v. Prestige Equip. Corp., No. 20A03-0910-CV-495, 2010 WL 1486887 at *6 (Ind. App. Apr. 14, 2010) (citing In re QDS Components, Inc., 292 B.R. 313 (Bankr. S.D. Ohio 2002)).

This article first appeared in the New York Law Journal, a sister publication of this newsletter.

Alan M. Christenfeld is senior counsel at Clifford Chance US. Barbara M. Goodstein, a member of this newsletter's Board of Editors, is a partner at Dewey & LeBoeuf LLP. Kaleb H. Sanchez, an associate at Dewey & LeBoeuf, assisted in the preparation of this article.

Just because a document is labeled a lease may not make it so under commercial law. One of the more heavily contested issues under the Uniform Commercial Code (“UCC”) is whether an agreement transferring use and possession of personal property from one party to another is actually a lease as opposed to a sale subject to a security agreement. Here, we discuss the advantages and disadvantages of a “true lease” versus a security agreement, the legal considerations in determining how an agreement should be characterized under the UCC, and some interesting recent decisions in this area.

Lease or Security Agreement

There are many reasons from the legal perspective why a creditor may want to characterize the transaction as a lease and not a sale subject to a security interest. A lease affords protections to a lessor that a holder of a security interest does not have. For example, a “true lease” of goods is governed by Article 2A of the UCC. A creditor not in the business of leasing goods may be able to benefit from the Article 2A provisions dealing with “finance leases.” See, e.g., N.Y. U.C.C. ” 2A-209, 2A-211(2), 2A-212(1), 2A-213, 2A-407 and 2A-517. Under those provisions, the lessor is not responsible for the condition of the goods and does make implied warranties of fitness or merchantability. Those provisions also make the lessee's obligations to the lessor under the lease irrevocable and independent of the lessor's obligations or the condition of the leased goods (the latter being known as “hell or high water” obligations).

More critical are the advantages under the federal Bankruptcy Code, 11 U.S.C. ” 101, et seq. A lessor who repossesses leased equipment prior to bankruptcy will not be subject to a turnover proceeding under ' 542 of the Bankruptcy Code. Under ' 365(d)(10) of the Bankruptcy Code, the debtor or trustee in a Chapter 11 reorganization case must begin performing the debtor's obligations under an unexpired true lease (other than for consumer goods) within 60 days after the bankruptcy filing and continue to do so until the lease is assumed or rejected. In a Chapter 7 liquidation case, a lease not assumed or rejected within 60 days is deemed rejected under
' 365(d)(1).

In general, the debtor or trustee must either assume or reject the lease in its entirety; it cannot assume parts of the lease favorable to it and reject the balance, nor can it modify the lease without the lessor's consent. Of course, a debtor or trustee will likely seek to reject a true lease that has rentals above then-prevailing market rates. Accordingly, while the bankrupt estate may not be able to modify a true lease, given the risk and expense of remarketing the leased equipment, the lessor on an above market-rate true lease will be motivated to agree to modifications rather than accept return of its equipment when prevailing rates are below the rate in the rejected lease. On the other hand, a debtor in bankruptcy has the ability (subject to the facts and circumstances of the debtor and the case) to change the terms of a contractual agreement that is not a true lease, which may result in the modification of the creditor's rights, including payment terms, under the “cram down” provisions of ' 1129(b) of the Bankruptcy Code.

If there has been a default under a true lease, the lease cannot be assumed unless the debtor or trustee cures the default, compensates the lessor for pecuniary loss, and provides adequate assurance of its future performance under the lease. See 11 U.S.C. ' 365(b). Any default in payment under an assumed true lease becomes an administrative expense of the bankruptcy estate, entitled to priority ahead of unsecured creditors. See 11 U.S.C. ' 5.03(b). The rejection of an unexpired lease is treated as a breach of contract. [Note, the non-debtor party may have a breach of contract claim against the bankruptcy estate that would be treated as an unsecured claim.]

Additionally, in a true lease, the non-debtor party (lessor) continues to own any goods leased to the debtor (lessee) and such goods will not be subject to claims by creditors of the debtor's bankruptcy estate. In a transaction characterized as a sale, conversely, the ownership interest in the goods is transferred to the debtor and the goods would be part of the debtor's bankruptcy estate, subject to claims of all creditors of the bankruptcy estate.

Relevant UCC Provisions

State law governs whether an agreement is a true lease or a disguised security agreement. [It should be noted that Article 9 looks to non-UCC law in two other instances: whether there has occurred a true sale of receivables and whether there has occurred a true consignment.] UCC ' 2A-103 states that a lease is “a transfer of the right to possession and use of goods for a term in return for consideration, but a sale, including a sale on approval or a sale or return, or retention or creation of a security interest is not a lease.”

UCC ' 1-201(37) sets forth the definition of “security interest.” [Note, in most jurisdictions the provisions found in ' 1-201(37) of New York's UCC are instead found in UCC ' 1-203.] Prior to the 1987 amendments to the UCC, ' 1-201(37) required a subjective determination as to whether a lease was “intended as security.” An amended version of that section was part of the UCC amendments that adopted Article 2A (Leases). The current version of ' 1-201(37) relies on a much more objective analysis of the economic realities of the transaction and establishes what courts have now labeled a “bright-line” test for determining whether a transaction, whether or not in the form of a lease, creates a security interest, rather than a true lease.

This bright-line test has two parts, and the focus is generally on the lessee. First, the transaction must be non-terminable, meaning that the purported lessee must be obligated for the full term of the agreement. Second, one of the following four “residual value factors” must be present in the agreement: 1) the original term of the lease is equal to or greater than the remaining economic life of the goods, 2) the lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods, 3) the lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease, or 4) the lessee has an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the agreement. If the transaction is non-terminable and one of the residual value factors is present, the transaction is per se a security interest rather than a true lease.

One of the most frequently litigated parts of the bright-line test is the determination of nominality in regard to the additional consideration referred to in the last two residual value factors. UCC Section 1-201(37)(c) provides that additional consideration is not nominal if, when the parties enter into the agreement, the price to exercise the option is stated in the agreement to be the fair market value of the goods or the fair market value for the use of the goods for the renewal term, as applicable. It also states that additional consideration is nominal if it is less than the lessee's reasonably predictable cost of performing under the lease agreement if the option is not exercised. Nominality must be determined by the parties' expectation of value of the goods at the time of entering into the agreement and not at the time the option to renew or purchase is exercisable.

The value of the option alone does not establish nominality. See, e.g., Gangloff Indus., Inc. v. Generic Fin. & Leasing Corp., No. 09A02-0809-CV-797, 2009 WL 1674976 (Ind. Ct. App. June 16, 2009); Park W. Fin. Corp. v. Phoenix Equip. Co. (In re Phoenix Equip. Co.), No. 2:08-bk-13108, 2009 WL 3188684 (Bankr. D. Ariz. Sept. 30, 2009) (not for publication ' electronic docketing only). Generally speaking, the additional consideration is nominal if the price of exercising the option is so low in comparison to the remaining value of the goods that a reasonable lessee will certainly exercise the option. See In re Phoenix Equip., 2009 WL 3188684 at *10. The emphasis here is clearly on the lessee and its cost of performance.

However, if nominal additional consideration is not found, and the bright-line test is not satisfied, courts do not conclude that an agreement is a lease simply because it is not a per se security agreement. Most courts have agreed that attention must turn to the lessor, and to facts of the case to determine whether or not the lessor retained a meaningful reversionary interest in the leased goods. Id. ( citing Addison v. Burnett , 41 Cal. App. 4th 1288, 49 Cal. Rptr. 2d 132 (1996)). This next analysis also relies heavily upon the economic realities of a transaction, but recent decisional law illustrates the difficulty courts continue to have once they reach beyond the bright-line test.

Recent Decisions

Two recent bankruptcy cases, In re Gateway Ethanol, L.L.C., 415 B.R. 486 (Bankr. D. Kan. 2009) and In re Uni Imaging Holdings, LLC, 2010 WL 148422 (Bankr. N.D.N.Y. Jan. 12, 2010) show the factors that judges and commentators examine in determining whether an agreement is a security agreement or a lease once it fails the bright-line test.

In Gateway Ethanol, a five-year lease for a $5 million boiler with a $600,000 purchase option at the end of the lease term was held to be a true lease. The transaction failed the bright-line test of UCC ' 1-201(37) based on the court's finding that the option price was not “nominal.” The court compared the purchase option price ($600,000) to the anticipated value of the equipment at the end of the lease. The cost of returning the boiler was only $200,000 to $250,000, and the expected value of the boiler was $600,000. Moreover, after the end of the lease term the boiler was projected to have a useful life of 15 to 20 years, and the lessor would have been able to market the boiler had the lessee returned it.

In its analysis, the court focused on the “economic substance” of the agreement and, in particular, whether the lessor retained a “reversionary interest” in the equipment. In considering the economic substance of the transaction, the court noted that there is not a defined test or consistent set of factors for determining whether a meaningful reversionary interest exists. See In re Gateway Ethanol, 415 B.R. at 504 (stating that “[t]he UCC does not provide an explicit test for reservation of a meaningful reversionary interest. ' Court decisions likewise have not adopted a consistent set of factors for identifying a lessor's residual interest.”). Focusing on the overall economic terms of the agreement, it based its determination that the agreement was a true lease on several considerations, including that, after the end of the lease term, the boiler had a long useful life and could be remarketed by the lessor; that the lessor would be able to market the equipment for other uses at the end of the lease term; that the boiler was not unique, and the long-term operation of the debtor's business did not require possession of the equipment; and that both the debtor and the party challenging the recharacterization of the lease (the debtor's financial adviser and the stalking-horse bidder for the debtor's assets) benefited economically by structuring the transaction as a lease and not a sale of the boiler.

Although, as mentioned above, the 1987 UCC amendments were designed to move courts away from looking to the intent of the parties, here the court also focused on the specific intent of the parties at the time they negotiated and entered into the transaction. [Note, the court expressly provided that
"[t]he role of intent when distinguishing between a lease and a security agreement under all the facts and circumstances test of the 1987 version of the UCC is not certain. It seems clear that the drafters intended economic factors to predominate, but it is not clear that they intended intent of the parties to be irrelevant.”]

The debtor initially contemplated purchasing the boiler, but leasing it allowed the debtor to reduce its construction costs and maintain a 45/55 equity-to-debt ratio that the debtor's financial adviser recommended to raise capital from potential investors. The court noted that the recommendations of the adviser (the party challenging the recharacterization of the lease) regarding the debt-to-equity ratio was the reason the transaction was changed from a purchase, as initially contemplated, to a lease. The court specifically held that the “[adviser] had to believe that the transaction had the financial characteristics of a true lease in order to market loan participations to the banks, because to believe otherwise would have meant that [adviser] knew the 45/55 equity to debt ratio was not true.” In re Gateway Ethanol, 415 B.R. at 507.

Uni Imaging involved a motion by a bankrupt lessee debtor seeking to characterize as a secured transaction an agreement identified as a “capital lease” for $1.3 million of magnetic resonance imaging equipment. In this case, the purchase option for the equipment was $175,000 compared with an estimated fair market value at end of lease term of approximately $329,000.

The court began its analysis by noting that the question of whether an agreement is a true lease or a security agreement “is one of the most vexatious and oft-litigated issues” under the UCC. In determining that the lessee had not satisfied its burden of establishing that the agreement was a secured transaction, the court considered the economic realities of the transaction and the expectation of the parties concerning the projected value of the equipment when they entered into the transaction. The court focused on whether the amount of the purchase option constituted nominal consideration. Having found that the purchase option was not nominal, the court then, taking its lead from the Gateway Ethanol decision, turned to determining whether the lessor retained a reversionary interest. Then the court examined in turn each of the following factors: 1) the anticipated useful life of the equipment; 2) the ability of the lessor to market the equipment at the end of the lease term; 3) the amount of lease payments over the term in relation to the equipment's initial value; 4) whether the equipment is unique; 5) whether at the time of the agreement the debtor's facility required continued possession of the equipment; and 6) the economic benefit to the debtor in having the transaction structured as a lease rather than a sale. Based on those factors, it concluded that the lessee had failed to establish that the reversionary interest of the lessor was insignificant, and accordingly the transaction was indeed a lease.

Conclusion

The drafters of the UCC were clearly trying to reduce the volume of litigation as to whether a transaction constituted a secured transaction or lease when they enacted the “bright-line” test of UCC ' 1-201(37). However, the Gateway Ethanol and Uni Imaging cases illustrate that courts continue to struggle with the notion of what constitutes a security agreement once they find themselves outside the bright-line test. In these instances, they have relied upon a complex and wide-ranging list of factors, mostly dependent on trying to ascertain the overall “economic substance” of a purported lease. That analysis appears to rely heavily on whether the lessor has retained a “reversionary interest” in the leased goods. See also In re Grubbs Constr. Co., 319 B.R. 698 (Bankr. M.D. Fla. 2005); Gibraltar Fin. Corp. v. Prestige Equip. Corp., No. 20A03-0910-CV-495, 2010 WL 1486887 at *6 (Ind. App. Apr. 14, 2010) (citing In re QDS Components, Inc., 292 B.R. 313 (Bankr. S.D. Ohio 2002)).

This article first appeared in the New York Law Journal, a sister publication of this newsletter.

Alan M. Christenfeld is senior counsel at Clifford Chance US. Barbara M. Goodstein, a member of this newsletter's Board of Editors, is a partner at Dewey & LeBoeuf LLP. Kaleb H. Sanchez, an associate at Dewey & LeBoeuf, assisted in the preparation of this article.