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Auto-Renewals and the True Lease Question

By Robert W. Ihne
September 02, 2015

Whether a transaction called a lease is indeed a lease ' i.e., a true lease ' or instead a lease that creates a security interest is an issue that arises frequently in case law. It often comes up in the context of bankruptcy proceedings, where the treatment of true leases and secured transactions differs in very significant ways. Outside of bankruptcy, if the rights of a lessor against a lessee in default are to be enforced, there is likewise a very material difference in the rights and obligations of both parties depending upon whether the Uniform Commercial Code (UCC) Article to be applied is Article 2A governing true leases or Article 9 governing secured transactions.

Pacific Space Design

A recent case illustrates yet another context in which the true lease/security interest distinction can arise, and demonstrates how not fully appreciating this distinction can lead to a questionable result. In Pacific Space Design Corp. v. PNC Equipment Finance, LLC, 2014 WL 6603288, 2014 U.S.Dist. LEXIS 162274 (S.D.Ohio Nov. 19, 2014), the plaintiff/lessee had entered into a lease with an automatic renewal provision expressed as follows:

If no default exists under this Lease, you [the Lessee] will have the option at the end of the initial or any renewal term to purchase all (but not less than all) of the Equipment at the Purchase Option price shown at the front of this Lease, plus any applicable taxes. Unless the Purchase Option price is $1.00, you must give us [the Lessor] at least 60 days written notice before the end of the initial term that you will purchase the Equipment or that you will return the Equipment to us. If you do not give us such written notice or if you do not purchase or deliver the Equipment in accordance with the terms and conditions of the Lease, this Lease will automatically renew for an additional 12 month term and therefore [sic] renew for successive one month terms until you deliver the Equipment to us. During such renewal(s) the lease payment will remain the same ' . Upon payment of the Purchase Option price, we shall transfer our interest in the Equipment to you “AS IS, WHERE IS” without any representation or warranty whatsoever and the lease will terminate.

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