What's New in the Law

True Lease vs. Security Interest: In General

In the matter of Del-Maur Farms, Inc., 2011 WL 2847709 (Bankr.D.Neb. July 14, 2011) (slip copy)

In evaluating whether a lessee's end-of-lease options cause a lease to create a security interest, this court mentions a variety of previous cases comparing the purchase option price to the original price and to the total rental payments. Although the court concludes its discussion by stating that a purchase option price equal to 10% of the original purchase price or 9% of the total rental payments is “nominal additional consideration” under the statute, the court appears in fact to rely primarily on an analysis of whether the exercise of the option would be the only sensible alternative for the lessee. Since a failure to exercise the option under the terms of this lease would require the lessee to renew for an additional one-year period and make payments aggregating more than the option price along with the choice of either returning the equipment or paying fair market value to purchase the equipment, the court holds that the lease creates a security interest.

Measures of Lessors' Damages

Canal Air, LLC v. McCardell, 2011 WL 5075724 (U.S.Dist.Ct. E.D. Mich. Oct. 26, 2011)

After the lessor and lessee entered into a lease of an aircraft as a part of a sale/leaseback transaction, the lessee defaulted and relinquished the aircraft to the lessor, which thereupon sold it and brought suit against the lessee for the deficiency. Objecting to the lessor's motion for summary judgment, the lessee argued that the lessor: 1) had not demonstrated that its sale of the aircraft had been commercially reasonable, and 2) had not provided the lessee with reasonable notice of the sale. The court agrees with the lessee and cites various sections of Article 9 to explain the obligations of the lessor in conducting such a sale. What is curious about this decision is that there is no discussion concerning whether Article 9 should apply at all ' i.e., whether the lease of the aircraft was a true lease (in which case the default provisions of Article 2A would apply) or whether the lease instead created a security interest (in which case the provisions of Article 9 cited by the court would apply).

TFG-North Carolina, L.P. v. Performance Fibers, Inc., 2011 WL 3040275 (U.S.Dist.Ct. D.Utah July 22, 2011)

In this brief decision, the court carefully examines the terms of a lease to determine various portions of a plaintiff's damages claim. After finding that the lessee was liable for three unpaid base term payments (not to be reduced by the amount of interim rent payments made by the lessee, but reduced by the amount of the last month's rent paid as a security deposit) and for a 12-month extension triggered by the lessee not having given the required notice, the court finds against the lessor's claim for an additional six-month period following the 12-month extension inasmuch as the lessor was on notice that the lessee would not be extending due to its default. The court also finds against the lessor with respect to an ambiguous lease provision for interest at 18% per annum ' since it was worded to apply only to payment and expenses incurred by the lessor, rather than the entire amount due.

GATX Corporation v. Appalachian Fuels, LLC, 2011 WL 3104070 (U.S.Dist.Ct. E.D.Ky July 8, 2011)

This case illustrates a number of possible sources of law necessary to conclude whether a grant of attorneys' fees is appropriate after a lessee default and what methods should be used to calculate the amount of such fees. According to the court, whether fees may be awarded at all is a matter of state law, but whether state or federal law determines the amount to be awarded is a closer call. The facts of this case ' two equipment leases, one governed by California law and one by Kentucky law ' afford an opportunity to observe how state laws may differ on this subject. Issues discussed include how to determine a reasonable hourly rate and how to calculate the number of hours reasonably expended.

Liability of Lessors for Equipment-Related Injuries and Damages

Lewandowski v. Adelberg, 2011 WL 4424391 (Conn.Super. Sept. 6, 2011) (unpublished opinion; check court rules before citing)

This very brief decision illustrates that as long as a claim against a motor vehicle lessor alleges negligence (in this case, alleged failure to properly maintain the vehicle), a motion to strike based on the Graves Amendment's pre-emption of vicarious liability claims will not succeed.

Product Liability of Lessors

Jenks v. New Hampshire Motor Speedway, Inc., 2011 WL 3627290 (U.S.Dist.Ct. D.N.H. Aug. 17, 2011)

Following an accident involving a golf cart being used to carry people doing charity work at a motor speedway event, the plaintiff's representative brought suit against a number of defendants, including a strict product liability claim against the manufacturer of the cart. During the proceedings, the financing subsidiary of the manufacturer, which had purchased the cart in order to lease it for use at the speedway, was brought into the suit on the same theory. In this decision, that subsidiary is granted summary judgment on this claim. The court finds the reasoning of other cases persuasive in determining that financing companies are outside the chain of distribution and are not in the business of selling carts to the public.

Vendor Issues

U.S. Express Leasing, Inc. v. Elite Technology (N.Y.), Inc., 928 N.Y.S.2d 696 (N.Y.App.Div. Aug. 25, 2011)

The plaintiff/lessor and defendant/vendor were parties to a Master Purchase Agreement & Assignment of Leases (“MPA”) pursuant to which the vendor would lease equipment to its customers and then sell both the equipment and the lease to the lessor. However, with respect to one particular customer, the lessor entered into a lease directly with the customer after having been provided by the vendor with what was apparently an inaccurate and unsigned accountant's report. After the customer defaulted, the lessor sued the vendor for breach of representations and warranties made in the MPA and also for fraud. This appellate court agrees with the trial court's decision to dismiss the claim for breach of representations and warranties ' which were never triggered since the MPA did not apply inasmuch as the financing did not take the form contemplated by that agreement ' but disagrees with the trial court's dismissal of the fraud claim (finding that the lessor had alleged enough facts to satisfy the elements of such a claim).

End-of-Term Lease Provisions

TFG-Illinois, L.P. v. United Maintenance Company, Inc., 2011 WL 5239728 (U.S.Dist.Ct. D.Utah Nov. 1, 2011)

In a case involving a number of claims by both the lessor and lessee, the primary issue involved whether the lessor had a right to claim the payments owing under the lease for an automatic 12-month renewal term, which renewal term resulted from the failure by the lessee to provide the requisite prior notice of its election among the stated end-of-term options. Agreeing with the lessor that the lessee was liable for these renewal term payments, the court rejects arguments by the lessee (characterized by the court as a sophisticated party assisted by counsel) that certain e-mails between the parties constituted substantial compliance with the notice requirement. The decision also deals with whether an assignment agreement between the plaintiff and the previous lessor needed to be in writing and, even if the unwritten assignment was invalid (the court held it was valid), whether the plaintiff had standing as a servicer of the lease. One of the other claims raised by the lessee was that the lease was actually a security agreement, although it was not made clear how the lessee would benefit from such a finding. In any event, the court denied the lessee's summary judgment motion in this regard, stating that it could not decide as a matter of law that the lessor did not retain any residual interest in the equipment subject to the lease.

Forum Selection, Jurisdiction and Choice of Law

National City Commercial Capital Corp. v. Bullard, 2011 WL 5419747 (Ohio App. Nov. 7, 2011) (check Ohio Supreme Court rules for reporting of opinions and weight of legal authority)

In upholding a trial court's decision in favor of a NorVergence lessee that the assignee could not bring suit in Ohio based on the lease's floating forum selection clause, this appellate court finds that the facts of this case were similar enough to apply the holding from Ohio's Supreme Court in Preferred Capital, Inc. v. Power Engineering Group, Inc., 112 Ohio St.3d 429, 2007-Ohio-257. The majority decision disagrees with the arguments of the plaintiff and of a dissenting judge on this appellate panel that the fact that the leases were not assigned until a month after they were executed was enough to distinguish this case from Preferred Capital, where the Supreme Court emphasized the “superior knowledge” of the assignor with respect to its almost immediate assignment to an assignee unknown to the lessee.

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 Kaufman & Kammholz, P.C. in the preparation of this update.

Ability to Collect Rentals Under Article 2A Finance Leases

Tri-States Utility, Inc. v. Infinity Metering Company, Inc., 2011 WL 2634291 (U.S.Dist.Ct. W.D.Mo. July 5, 2011)

After the lessee entered into a lease agreement for water metering equipment, the original lessor assigned the lease to a bank/assignee, which then acquired the equipment selected by the lessee. After the lessee discovered that the meters were defective, it stopped making payments under the lease and brought suit against the bank contending that the bank had breached its duty under the lease when it acquired defective equipment. Citing language in the lease disclaiming warranties by the lessor and indicating that the lessor's role was only to provide financing for the lessee's use of the equipment and also citing Article 2A's finance lease provisions, the court granted the bank's summary judgment counterclaim motion that the lessee was liable under the lease notwithstanding the condition of the equipment.

True Lease vs. Security Interest: In General

In the matter of Del-Maur Farms, Inc., 2011 WL 2847709 (Bankr.D.Neb. July 14, 2011) (slip copy)

In evaluating whether a lessee's end-of-lease options cause a lease to create a security interest, this court mentions a variety of previous cases comparing the purchase option price to the original price and to the total rental payments. Although the court concludes its discussion by stating that a purchase option price equal to 10% of the original purchase price or 9% of the total rental payments is “nominal additional consideration” under the statute, the court appears in fact to rely primarily on an analysis of whether the exercise of the option would be the only sensible alternative for the lessee. Since a failure to exercise the option under the terms of this lease would require the lessee to renew for an additional one-year period and make payments aggregating more than the option price along with the choice of either returning the equipment or paying fair market value to purchase the equipment, the court holds that the lease creates a security interest.

Measures of Lessors' Damages

Canal Air, LLC v. McCardell, 2011 WL 5075724 (U.S.Dist.Ct. E.D. Mich. Oct. 26, 2011)

After the lessor and lessee entered into a lease of an aircraft as a part of a sale/leaseback transaction, the lessee defaulted and relinquished the aircraft to the lessor, which thereupon sold it and brought suit against the lessee for the deficiency. Objecting to the lessor's motion for summary judgment, the lessee argued that the lessor: 1) had not demonstrated that its sale of the aircraft had been commercially reasonable, and 2) had not provided the lessee with reasonable notice of the sale. The court agrees with the lessee and cites various sections of Article 9 to explain the obligations of the lessor in conducting such a sale. What is curious about this decision is that there is no discussion concerning whether Article 9 should apply at all ' i.e., whether the lease of the aircraft was a true lease (in which case the default provisions of Article 2A would apply) or whether the lease instead created a security interest (in which case the provisions of Article 9 cited by the court would apply).

TFG-North Carolina, L.P. v. Performance Fibers, Inc., 2011 WL 3040275 (U.S.Dist.Ct. D.Utah July 22, 2011)

In this brief decision, the court carefully examines the terms of a lease to determine various portions of a plaintiff's damages claim. After finding that the lessee was liable for three unpaid base term payments (not to be reduced by the amount of interim rent payments made by the lessee, but reduced by the amount of the last month's rent paid as a security deposit) and for a 12-month extension triggered by the lessee not having given the required notice, the court finds against the lessor's claim for an additional six-month period following the 12-month extension inasmuch as the lessor was on notice that the lessee would not be extending due to its default. The court also finds against the lessor with respect to an ambiguous lease provision for interest at 18% per annum ' since it was worded to apply only to payment and expenses incurred by the lessor, rather than the entire amount due.

GATX Corporation v. Appalachian Fuels, LLC, 2011 WL 3104070 (U.S.Dist.Ct. E.D.Ky July 8, 2011)

This case illustrates a number of possible sources of law necessary to conclude whether a grant of attorneys' fees is appropriate after a lessee default and what methods should be used to calculate the amount of such fees. According to the court, whether fees may be awarded at all is a matter of state law, but whether state or federal law determines the amount to be awarded is a closer call. The facts of this case ' two equipment leases, one governed by California law and one by Kentucky law ' afford an opportunity to observe how state laws may differ on this subject. Issues discussed include how to determine a reasonable hourly rate and how to calculate the number of hours reasonably expended.

Liability of Lessors for Equipment-Related Injuries and Damages

Lewandowski v. Adelberg, 2011 WL 4424391 (Conn.Super. Sept. 6, 2011) (unpublished opinion; check court rules before citing)

This very brief decision illustrates that as long as a claim against a motor vehicle lessor alleges negligence (in this case, alleged failure to properly maintain the vehicle), a motion to strike based on the Graves Amendment's pre-emption of vicarious liability claims will not succeed.

Product Liability of Lessors

Jenks v. New Hampshire Motor Speedway, Inc., 2011 WL 3627290 (U.S.Dist.Ct. D.N.H. Aug. 17, 2011)

Following an accident involving a golf cart being used to carry people doing charity work at a motor speedway event, the plaintiff's representative brought suit against a number of defendants, including a strict product liability claim against the manufacturer of the cart. During the proceedings, the financing subsidiary of the manufacturer, which had purchased the cart in order to lease it for use at the speedway, was brought into the suit on the same theory. In this decision, that subsidiary is granted summary judgment on this claim. The court finds the reasoning of other cases persuasive in determining that financing companies are outside the chain of distribution and are not in the business of selling carts to the public.

Vendor Issues

U.S. Express Leasing, Inc. v. Elite Technology (N.Y.), Inc. , 928 N.Y.S.2d 696 (N.Y.App.Div. Aug. 25, 2011)

The plaintiff/lessor and defendant/vendor were parties to a Master Purchase Agreement & Assignment of Leases (“MPA”) pursuant to which the vendor would lease equipment to its customers and then sell both the equipment and the lease to the lessor. However, with respect to one particular customer, the lessor entered into a lease directly with the customer after having been provided by the vendor with what was apparently an inaccurate and unsigned accountant's report. After the customer defaulted, the lessor sued the vendor for breach of representations and warranties made in the MPA and also for fraud. This appellate court agrees with the trial court's decision to dismiss the claim for breach of representations and warranties ' which were never triggered since the MPA did not apply inasmuch as the financing did not take the form contemplated by that agreement ' but disagrees with the trial court's dismissal of the fraud claim (finding that the lessor had alleged enough facts to satisfy the elements of such a claim).

End-of-Term Lease Provisions

TFG-Illinois, L.P. v. United Maintenance Company, Inc., 2011 WL 5239728 (U.S.Dist.Ct. D.Utah Nov. 1, 2011)

In a case involving a number of claims by both the lessor and lessee, the primary issue involved whether the lessor had a right to claim the payments owing under the lease for an automatic 12-month renewal term, which renewal term resulted from the failure by the lessee to provide the requisite prior notice of its election among the stated end-of-term options. Agreeing with the lessor that the lessee was liable for these renewal term payments, the court rejects arguments by the lessee (characterized by the court as a sophisticated party assisted by counsel) that certain e-mails between the parties constituted substantial compliance with the notice requirement. The decision also deals with whether an assignment agreement between the plaintiff and the previous lessor needed to be in writing and, even if the unwritten assignment was invalid (the court held it was valid), whether the plaintiff had standing as a servicer of the lease. One of the other claims raised by the lessee was that the lease was actually a security agreement, although it was not made clear how the lessee would benefit from such a finding. In any event, the court denied the lessee's summary judgment motion in this regard, stating that it could not decide as a matter of law that the lessor did not retain any residual interest in the equipment subject to the lease.

Forum Selection, Jurisdiction and Choice of Law

National City Commercial Capital Corp. v. Bullard, 2011 WL 5419747 (Ohio App. Nov. 7, 2011) (check Ohio Supreme Court rules for reporting of opinions and weight of legal authority)

In upholding a trial court's decision in favor of a NorVergence lessee that the assignee could not bring suit in Ohio based on the lease's floating forum selection clause, this appellate court finds that the facts of this case were similar enough to apply the holding from Ohio's Supreme Court in Preferred Capital, Inc. v. Power Engineering Group, Inc. , 112 Ohio St.3d 429, 2007-Ohio-257. The majority decision disagrees with the arguments of the plaintiff and of a dissenting judge on this appellate panel that the fact that the leases were not assigned until a month after they were executed was enough to distinguish this case from Preferred Capital, where the Supreme Court emphasized the “superior knowledge” of the assignor with respect to its almost immediate assignment to an assignee unknown to the lessee.

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 Kaufman & Kammholz, P.C. in the preparation of this update.