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Four Leasing Lessons to Consider in the New Year

Dispatches from the Trenches
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This edition of Dispatches from the Trenches discusses: 1.) a case with a detailed analysis of the distinction between true leases and secured transactions; 2.) the codification of the rebuttable presumption rule to be applied when lessors fail to provide proper notices of disposition to the extent required under Article 9; 3.) felony claims that can result from failure to return leased equipment; and 4.) the risks of accord and satisfaction.

In re Grubbs Construction Co., 319 B.R. 698 (Bankr. M.D. Fla. 2005)

The issue in Grubbs was whether the leases between Grubbs (Lessee) and Banc One (Lessor) were true leases or secured transactions. In 1998, Grubbs and Lessor entered into a master lease and this master agreement was incorporated into five separate schedules which each represented an individual stand-alone lease transaction. Four of these schedules contained early buyout options and renew-or-purchase addenda, which operated as a typical first amendment lease. The fifth schedule contained a terminal rental adjustment clause (i.e., it was a TRAC lease).

The court explicitly noted that the leases contained provisions which made Lessee unconditionally liable for payment of rent notwithstanding any defect in the equipment, placed the risk of loss on Lessee and required Lessee to indemnify Lessor for various tax benefits associated with ownership of the leased equipment. However, it rightfully refused to base its holding on such provisions and, instead, focused its analysis on the economic realities of the transactions.

When considering the leases with the early buyout options, the court focused on a variety of purchase and return options provided under those leases and considered the economic realities of such options. Under those leases, Lessee could exercise the early buyout at set time(s) prior to expiration of the term. If the EBO was not exercised, Lessee was required to purchase the equipment or renew the lease for more than a year. At the end of any renewal period, Lessee could return the equipment or purchase it for fair market value. The court analyzed the numbers and decided that the "only economically sensible course" for Lessee was to purchase the equipment under the Early Buyout Option. The court also added that "[i]t was the clear intent of [Lessee], based on the economics of the Leases at their inception, to exercise the Early Buyout Options as they became available."

When considering the TRAC Lease, the court described a TRAC provision that not only required Lessee to pay any deficiency but also allowed it to keep any surplus if the proceeds from the sale of the leased equipment at the end of the term did not equal the "Estimated Residual Value" specified in the lease. The court determined that "[t]he economic substance of the TRAC Lease is no different than a typical installment loan in which the lender has agreed to a balloon payment in lieu of a down payment." Indeed, the court even described the "Estimated Residual Value" that is part of the TRAC provision as a "Balloon Payment."

The court continued its analysis by considering the manner in which the casualty loss provisions in the leases operated. The court also noted that the default provisions in the leases provided that the lessor may repossess, but that the lessee’s equity was preserved by requiring the lessor to pay over to the lessee any surplus received from a sale of the repossessed equipment.

The court also went through a lengthy analysis of prior decisions discussing the differences between leases and secured transactions before officially declaring that it was going to take an "economic realities" approach. The court noted that "[t]he Economic Realities Test requires an analysis of all terms and conditions of a purported lease transaction to determine whether the lessee has no sensible alternative other than to exercise the purchase option." The court then concluded by holding that "the facts of this case clearly establish … that the transactions … are security agreements governed by U.C.C. Article 9."

In re Wilmington Hospitality LLC, 320 B.R. 73 (Bankr. E.D. Pa. 2005)

In this case, Lessee leased kitchen equipment from Lessor. Lessee made no payments and Lessor was granted relief from the automatic stay. For reasons that are unclear, the hotel where the equipment was located was transferred to Lessee’s secured lender. That lender then had the option of either purchasing the equipment from Lessor or requesting that Lessor remove it. The secured lender divided to notify Lessor that it desired removal of the equipment, but when Lessor attempted, it was blocked.

Without going into much detail, the end result of this situation was that the equipment was sold for less than what Lessee owed Lessor. When Lessor sought to receive the deficiency from Lessee, Lessee countered that the leased equipment was not disposed of in a commercially reasonable manner and that Lessor failed to provide the required Article 9 notices of disposition.

The court assumed that Article 9 applied to the transaction (which would not be the case if the underlying lease were a true lease rather than a secured transaction) but held that, nevertheless, failure to provide such notice does not necessarily absolve Lessee from its obligations with respect to any deficiency. The holding "hammered home" the point that the "rebuttable presumption rule" (which was the law of New Jersey prior to enactment of Revised Article 9) was essentially codified in Revised Article 9 and remained applicable. In essence, a failure to provide proper notices of disposition only creates a rebuttable presumption that the collateral was worth the value of the debt. The secured party then bears the burden of proving otherwise. The court then held that, in this case, Lessor had rebutted the presumption effectively. As such, the deficiency claim was allowed.

State v. Higby, 899 So. 2d 1269 (Fla. App. 2005)

Higby was charged by the State of Florida with violating Florida Statute § 812.155(3). The statute makes it a felony for a person who leases property valued at $300 or more to "without the consent of the [Lessor] and with the intent to defraud, abandon or willfully refuse to redeliver such personal property as agreed." Under subsection (4)(b) of that statute, a party can provide prima facie evidence of fraudulent intent required by proving that such property is not redelivered after a demand to redeliver is sent by certified mail.

It should be noted that this statute does not differentiate between consumer and commercial lending. In this particular case, the court held that §812.155(4)(b) creates a permissive inference of fraudulent intent, and not a mandatory presumption, and therefore the statute is not facially unconstitutional as a violation of the due process clauses of the United States or Florida Constitutions.

IFC Credit Corp. vs. Bulk Petroleum Corp., 403 F.3d 869 (7th Cir. 2005)

Lessor brought suit against Lessee alleging breach of a lease agreement under which Lessee leased gasoline tanks and other equipment from Lessor with an option to purchase at the end of the lease term. Lessee claimed that the lease had been concluded through an accord and satisfaction executed with the assignee of Lessor’s rights under the lease. Lessee entered into a lease with Lessor for a 72-month lease term beginning in 1995. Lessor assigned the lease to Finova Capital Corp. (Assignee) two weeks later.

Beginning in 2000, Lessee and Lessor began negotiations concerning the termination of the lease and Assignee instructed Lessee to conduct such negotiations with Lessor. Subsequently, Lessee sent a check and letter to Assignee stating that the check was in full satisfaction of both the lease agreement and purchase option. Assignee negotiated the check three days later. Lessor retained the money, claiming that it was only partial satisfaction of the lease and option, and filed suit against Lessee seeking damages for breach of the lease agreement. Lessee filed a motion for summary judgment, which was granted. Lessor appealed the district court’s decision.

The Appeals Court affirmed the Magistrate Courts ruling granting Lessee’s motion for summary judgment, ruling that a valid accord and satisfaction had taken place. The court noted that to constitute an accord and satisfaction there must be: 1.) a bona fide dispute; 2.) an unliquidated sum; 3.) consideration; 4.) a shared and mutual intent to compromise the claim; 5.) execution of the agreement; and 6.) the instrument or accompanying written communication contain a conspicuous statement to the effect that the instrument was tendered as full satisfaction of the claim. Additionally, under the UCC an otherwise valid tender to a claimant "organization" fails if A.) within a reasonable time before the tender, the claimant sent a conspicuous statement to the person against whom the claim is asserted stating the person, office, or place where communications should be directed, and B.) the instrument or accompanying communication was not received by that designated person, office, or place. The court noted that Lessee violated this portion of the UCC by sending the check to the wrong person at Assignee, however this issue was not raised at the district court level, and the court stated that it was a minor mistake. Since all of the other requirements were satisfied for accord and satisfaction, the court held that Lessee no longer had any obligation under the lease.


Article appeared in the January, 2006 issue of the Monitor.
For more articles/news regarding the equipment leasing and finance industry, visit http://www.monitordaily.com/

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