What's New in the Law

De Lage Landen Financial Services, Inc. v. Perkins Rowe Associates, Inc., 2011 WL 1466157 (U.S.Dist.Ct. M.D.La. April 18, 2011)

After the lessee defaulted on its lease and was sued by the assignee of the lease, the lessee brought various claims against the original lessor, including with regard to improper installation of the equipment and failure to notify the lessee that it had assigned the lease to the assignee. The court grants the original lessor's motion for summary judgment, holding that the lease's provisions setting forth the lessee's absolute and unconditional obligations to pay rent precluded most of the lessee's claims and also finding that the lessor had no obligation to notify the lessee of an assignment.

K.E.L. Title Insurance Agency, Inc. v. CIT Technology Financing Services, Inc., 2011 WL 1326230 (Fla.App. April 8, 2011)

This appellate court affirms summary judgment in favor of the lessor on a lease which stated that: 1) the lessee was responsible for any service or maintenance with respect to the equipment, and 2) the equipment supplier/servicer was not an agent of the lessor. The lessee had attempted to argue that the lessor had breached an obligation to service the equipment.

Allen & Company, LLC v. Sanford USD Medical Center, 2011 WL 941195 (U.S.Dist.Ct. N.D.Ill. March 15, 2011)

Notwithstanding the lessee's claim that it never received and accepted the equipment that was the subject of a lease, the court grants the summary judgment motion of the original lessor's assignee. The court rejects the lessee's arguments that the assignee was not entitled to enforce the lease's hell-or-high-water clause because the assignee allegedly was aware of a license agreement between the lessee and the equipment vendor, and therefore was not a holder in due course. For one thing, holder-in-due-course status is relevant to enforcement of waivers of defenses ' not hell-or-high-water provisions. Secondly, the lease was a lease of equipment, not of services, and there was no evidence that the assignee had knowledge of any lessee defenses with respect to that lease. In addition, the lessee had made monthly payments under the lease for more than three years and thus was estopped from asserting defenses against an assignee that had relied on the lessee having signed the lease and an acceptance certificate.

True Lease vs. Security Interest: In General

In re Turner, 2011 WL 2490600 (Bankr.W.D.Mo. June 22, 2011)

This very brief and simple case serves to demonstrate that if a lessee (in this case of an automobile) has the right to terminate the lease and return the goods at any time without penalty or further payment (the only requirement being to return the automobile in its original condition, reasonable wear and tear excepted), the lease cannot be said to create a security interest. A necessary condition listed in the statute for creating a security interest is that the lessee's obligation be for the full term of the lease and not be subject to termination by the lessee.

Gibralter Financial Corp. v. Prestige Equipment Corp., 2011 WL 2493771 (Ind. June 21, 2011)

This decision by the Supreme Court of Indiana contains an excellent general discussion of the law distinguishing true leases from security interests. The court reverses decisions by lower courts that had granted summary judgment in favor of a lessor against a secured creditor claiming that a purported lease in fact created a security interest. Since the lessor had not filed a financing statement, if the lease was deemed to be a secured transaction, repossession and sale of the equipment by the lessor following the lessee's default would have been subject to the secured creditor's security interest. Although the supreme court agrees with the lower courts that the secured creditor had not been able to show that the provisions of an early buyout option constituted nominal additional consideration (therefore not satisfying one of the “bright-line” tests for creating a security interest), this decision also notes that the burden of winning its summary judgment motion and proving that the lease was a true lease was the lessor's burden. Even if no bright-line test had been satisfied, since the lessor had not provided any evidence that other “economic realities” did not serve to create a security interest, this court refuses to affirm the lower courts' grant of summary judgment in favor of the lessor.

In re Kentuckiana Medical Center LLC (Kentuckiana Medical Center LLC v. The Leasing Group Pool II, LLC), 2011 WL 1750769 (Bankr.S.D.Ind. May 6, 2011)

In granting a motion for summary judgment in favor of a debtor in bankruptcy finding that three purported leases in fact created security interests, this court evaluates lease end options giving the lessee either: 1) a fair market value purchase option of not less than 10% of the lessor's original cost for the equipment, 2) a one-month renewal for a given amount after which title would be transferred to the lessee, or 3) an option to return the equipment along with a guaranty that the equipment could be sold by the lessor for not less than 10% of original cost (and paying all costs of return, storage and sale by the lessor). Although the stated facts are less than totally clear, apparently the one-month renewal option would amount to the same payment to the lessor as the purchase option with title being transferred to the lessee in both cases. Turning its focus to the last option ' for return ' the court concludes that the costs to return under such option would likely exceed the cost of purchase ' thus making purchase the only sensible choice for the lessee. The court cites In re Grubbs Construction Company, 319 B.R. 698 (Bankr. M.D. Fla. 2005), and concludes that the economic realities of the situation call for a conclusion that the leases create security interests.

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

In re Lash, 2010 WL 5141760 (Bankr.M.D.N.C. Dec. 9, 2010) (slip copy)

In connection with various motions in bankruptcy proceedings of a lessee of a truck, the court decides that a lease with a standard TRAC provision created a security interest. The lease provided that it was governed by Utah law. Indicating that Utah courts have interpreted UCC 1-203 consistently with the majority of courts in other jurisdictions, this court finds it appropriate to look to cases from other jurisdictions to help decide the issue at hand. Although the lessee argued that the TRAC amount was nominal additional consideration (thus satisfying the “bright-line” test for creating a security interest), the court finds that since there was no evidence presented regarding either the present or projected value of the truck, the court would not be able to come to a conclusion regarding nominality and must instead consider the economic realities of the transaction. In doing so, the court finds the reasoning of a Florida bankruptcy court decision, In re Grubbs Construction Company, convincing ' i.e., that the TRAC lease closely resembles a loan with a balloon payment at the end and that the lessor, which could realize neither upside nor downside from the sale of the truck at the end of the lease, had no meaningful reversionary interest in the truck. Overlooked by this decision is the existence in Utah of a TRAC statute in the state's motor vehicle code stating that motor vehicle lease agreements with terminal rental adjustment clauses do not create a security interest.

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 Cristina Richards and Ed Gross of Vedder Price P.C. in the preparation of this update.

Ability to Collect Rentals

GreatAmerica Leasing Corp. v. Wahoo Productions of Florida, Inc., 2011 WL 1559935 (U.S.Dist.Ct. N.D.Iowa April 21, 2011)

Notwithstanding the fact that not all of the equipment subject to a lease had been delivered and accepted, this court finds that the lessor was entitled to collect all of the scheduled lease payments. The court initially states that it need not resolve the issue as to whether a relatively brief lease provision regarding non-cancelability constituted a hell-or-high-water obligation because the parties agreed that the lease is an Article 2A finance lease. This conclusion seems a bit strange since, as the court itself recites, acceptance of the goods is a prerequisite for satisfying the statutory meaning of “finance lease.” In any event, the court's conclusion of full liability rests primarily on a lease addendum, signed by the lessee to induce the lessor's payment to the supplier of the goods, in which the lessee promises to make all payments under the lease even if some or all of the goods are not delivered and/or installed.

De Lage Landen Financial Services, Inc. v. Perkins Rowe Associates, Inc., 2011 WL 1466157 (U.S.Dist.Ct. M.D.La. April 18, 2011)

After the lessee defaulted on its lease and was sued by the assignee of the lease, the lessee brought various claims against the original lessor, including with regard to improper installation of the equipment and failure to notify the lessee that it had assigned the lease to the assignee. The court grants the original lessor's motion for summary judgment, holding that the lease's provisions setting forth the lessee's absolute and unconditional obligations to pay rent precluded most of the lessee's claims and also finding that the lessor had no obligation to notify the lessee of an assignment.

K.E.L. Title Insurance Agency, Inc. v. CIT Technology Financing Services, Inc., 2011 WL 1326230 (Fla.App. April 8, 2011)

This appellate court affirms summary judgment in favor of the lessor on a lease which stated that: 1) the lessee was responsible for any service or maintenance with respect to the equipment, and 2) the equipment supplier/servicer was not an agent of the lessor. The lessee had attempted to argue that the lessor had breached an obligation to service the equipment.

Allen & Company, LLC v. Sanford USD Medical Center, 2011 WL 941195 (U.S.Dist.Ct. N.D.Ill. March 15, 2011)

Notwithstanding the lessee's claim that it never received and accepted the equipment that was the subject of a lease, the court grants the summary judgment motion of the original lessor's assignee. The court rejects the lessee's arguments that the assignee was not entitled to enforce the lease's hell-or-high-water clause because the assignee allegedly was aware of a license agreement between the lessee and the equipment vendor, and therefore was not a holder in due course. For one thing, holder-in-due-course status is relevant to enforcement of waivers of defenses ' not hell-or-high-water provisions. Secondly, the lease was a lease of equipment, not of services, and there was no evidence that the assignee had knowledge of any lessee defenses with respect to that lease. In addition, the lessee had made monthly payments under the lease for more than three years and thus was estopped from asserting defenses against an assignee that had relied on the lessee having signed the lease and an acceptance certificate.

True Lease vs. Security Interest: In General

In re Turner, 2011 WL 2490600 (Bankr.W.D.Mo. June 22, 2011)

This very brief and simple case serves to demonstrate that if a lessee (in this case of an automobile) has the right to terminate the lease and return the goods at any time without penalty or further payment (the only requirement being to return the automobile in its original condition, reasonable wear and tear excepted), the lease cannot be said to create a security interest. A necessary condition listed in the statute for creating a security interest is that the lessee's obligation be for the full term of the lease and not be subject to termination by the lessee.

Gibralter Financial Corp. v. Prestige Equipment Corp., 2011 WL 2493771 (Ind. June 21, 2011)

This decision by the Supreme Court of Indiana contains an excellent general discussion of the law distinguishing true leases from security interests. The court reverses decisions by lower courts that had granted summary judgment in favor of a lessor against a secured creditor claiming that a purported lease in fact created a security interest. Since the lessor had not filed a financing statement, if the lease was deemed to be a secured transaction, repossession and sale of the equipment by the lessor following the lessee's default would have been subject to the secured creditor's security interest. Although the supreme court agrees with the lower courts that the secured creditor had not been able to show that the provisions of an early buyout option constituted nominal additional consideration (therefore not satisfying one of the “bright-line” tests for creating a security interest), this decision also notes that the burden of winning its summary judgment motion and proving that the lease was a true lease was the lessor's burden. Even if no bright-line test had been satisfied, since the lessor had not provided any evidence that other “economic realities” did not serve to create a security interest, this court refuses to affirm the lower courts' grant of summary judgment in favor of the lessor.

In re Kentuckiana Medical Center LLC (Kentuckiana Medical Center LLC v. The Leasing Group Pool II, LLC), 2011 WL 1750769 (Bankr.S.D.Ind. May 6, 2011)

In granting a motion for summary judgment in favor of a debtor in bankruptcy finding that three purported leases in fact created security interests, this court evaluates lease end options giving the lessee either: 1) a fair market value purchase option of not less than 10% of the lessor's original cost for the equipment, 2) a one-month renewal for a given amount after which title would be transferred to the lessee, or 3) an option to return the equipment along with a guaranty that the equipment could be sold by the lessor for not less than 10% of original cost (and paying all costs of return, storage and sale by the lessor). Although the stated facts are less than totally clear, apparently the one-month renewal option would amount to the same payment to the lessor as the purchase option with title being transferred to the lessee in both cases. Turning its focus to the last option ' for return ' the court concludes that the costs to return under such option would likely exceed the cost of purchase ' thus making purchase the only sensible choice for the lessee. The court cites In re Grubbs Construction Company, 319 B.R. 698 (Bankr. M.D. Fla. 2005), and concludes that the economic realities of the situation call for a conclusion that the leases create security interests.

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

In re Lash, 2010 WL 5141760 (Bankr.M.D.N.C. Dec. 9, 2010) (slip copy)

In connection with various motions in bankruptcy proceedings of a lessee of a truck, the court decides that a lease with a standard TRAC provision created a security interest. The lease provided that it was governed by Utah law. Indicating that Utah courts have interpreted UCC 1-203 consistently with the majority of courts in other jurisdictions, this court finds it appropriate to look to cases from other jurisdictions to help decide the issue at hand. Although the lessee argued that the TRAC amount was nominal additional consideration (thus satisfying the “bright-line” test for creating a security interest), the court finds that since there was no evidence presented regarding either the present or projected value of the truck, the court would not be able to come to a conclusion regarding nominality and must instead consider the economic realities of the transaction. In doing so, the court finds the reasoning of a Florida bankruptcy court decision, In re Grubbs Construction Company, convincing ' i.e., that the TRAC lease closely resembles a loan with a balloon payment at the end and that the lessor, which could realize neither upside nor downside from the sale of the truck at the end of the lease, had no meaningful reversionary interest in the truck. Overlooked by this decision is the existence in Utah of a TRAC statute in the state's motor vehicle code stating that motor vehicle lease agreements with terminal rental adjustment clauses do not create a security interest.

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 Cristina Richards and Ed Gross of Vedder Price P.C. in the preparation of this update.