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From Proper Methods to Vicarious Liability

Dispatches from the Trenches

This issue of Dispatches from the Trenches discusses: (1) proper methods of paying vendors; (2) an unusual true lease analysis; (3) vicarious liability; (4) insurance policies; and (5) rules relating to security interests and buyers in the ordinary course.

Ace Leasing, Inc. v. Boustead, 55 P.3d 371 (Mt., 2002)

Ace Leasing, Inc. ("Lessor") entered into an equipment lease with Advantage Group, Inc. ("Lessee").  The lease contained a fixed-price-purchase option that was equal to an amount that exceeded ten percent of the cost of the equipment at the inception of the lease.  Lessee's obligations under the lease were guaranteed by Mary Boustead ("Guarantor").  Lessor did not file a financing statement covering the leased equipment.  When Lessee defaulted, Lessor tired to recover from Guarantor but Guarantor claimed that the original obligation of Lessee had been materially altered in a manner that increased her risk and that she was therefore exonerated from liability pursuant to §28-11-211 of the Montana Code.

The Court agreed, holding: (a) that the lease constituted a loan, rather than a true lease, and (b) that Lessor’s failure to properly perfect a security interest in the leased equipment materially altered the risk born by Guarantor.  The unusual part of the opinion is the Court's analysis of whether the lease was a true lease or a loan.  The Court noted that, contrary to the terms of the lease, Lessor sent money directly to Lessee and allowed Lessee to pay the vendor.  The Court also noted that none of the purchase orders mentioned Lessor or had been assigned to Lessor. The Court relied on provisions in the Uniform Commercial Code (the "UCC") which govern the passage of title and which define the term "lease".   According to §2-401 of the UCC, "title to goods passes to the buyer at the ‘time and place’ at which the seller completes performance with reference to physical delivery of the goods."  As such, the Court held that title passed directly to Lessee.  The UCC definition of "lease" is a "transfer of the right to possession of goods for a term in return for consideration." According to the court, "[a] lessor cannot transfer the right of possession of property unless the lessor first has title to the property [and as] a consequent of [Lessor] failing to obtain title by acting in conformance with the [lease (which specified that Lessor would pay the vendor directly),] the transaction effectively became a loan agreement between the parties."

This case serves as a reminder that lessors should pay vendors directly for equipment.  It is also advisable to have the vendor invoice the lessor directly. If an inexperienced vendor is wary of invoicing the lessor for equipment delivered pursuant to a purchase order between it and the lessee, lessors can ease the vendor's objection by making use of a purchase order assignment.  However, lessors should be careful that the purchase order assignment does impose any inappropriate obligations upon the lessor.

Oliveira v. Lomabardi, 794 A.2d 453 (R.I. Sup. Ct. 2002)

In this case, the Rhode Island Supreme Court consolidated two cases analyzing whether a long- term-lessor of motor vehicles could be held vicariously liable for the negligence of the drivers operating those vehicles. Section 31-33-6 of the Rhode Island code states that "whenever any motor vehicle is used .  .   .  by  a person who is not the owner, lessee or bailee but who has their express or implied consent, in the case of  an accident the driver is deemed to be the agent of the owner, or lessee or bailee [unless] the driver has furnished, prior to the accident, proof of financial responsibility."

In the cases at bar, leasing companies purchased automobiles, and held title to the vehicles, for the sole purpose of leasing them to individuals.  When the vehicles caused accidents, the injured parties sued the leasing company under the vicarious liability statute.  The Superior Court judge who originally heard the case found for the leasing companies, noting that "the Legislature did not intend to hold an owner and lessor liable for the negligence of motor-vehicle operators in the same manner as, for example, the owners of short-term rental vehicles, because the latter would possess the vehicle and assert control over it."  However, the Supreme Court reversed.  According to the Supreme Court, it was constrained to interpret the statute literally because the language contained in the statute was clear and unambiguous.  Since the statute clearly held "owners" vicariously liable unless the driver furnished proof of financial responsibility, the key issues were whether a long-term-lessor constituted an "owner" and whether the drivers furnished proof of financial responsibility prior to the accident.

In analyzing the first issue, the Court applied an earlier version of the vicarious liability statute because the law revisors rewrote the statute without first obtaining the specific approval of the Legislature and the Governor to do so.  That version of the statute stated: "the term ‘owner’ shall include [any person] having the lawful possession or control of a motor vehicle under a written sale agreement."  The Court held that the use of the word "include" did not limit the traditional definition of owner to be only those who were in possession or control of the vehicle.  Rather, the definition was meant as an expansion of the traditional understanding of the term "owner" which already included "[a] person who holds legal title to a vehicle."   The Court noted that this broad interpretation served "the manifest purpose" of the statute, which the Court described as: (1) making sure "that a victim of a car injury has an avenue of recovery;" and (2) protecting "an innocent victim from having to shoulder the expense of an injury."

The Court did not provide significant analysis with respect to the second issue of whether the drivers furnished sufficient proof of financial responsibility prior to the accident in order to absolve the leasing companies of liability.  Rather, the Court based its holding on the fact that "the record provides no indication that the drivers in these consolidated cases did so."   Nonetheless, the Court did emphasize that: (1) the leasing company in one of the cases was notified prior to the accident that the lessee’s insurance had lapsed; and (2) that the accident in the other case was caused by an individual who the lessee let drive the automobile.

Regardless, this case serves as a strong warning to leasing companies engaged in the business of leasing motor vehicles in or around Rhode Island.  Connecticut, Maine, Maryland and New York also take aggressive stances with respect to lessor liability.  If you are a leasing company and are entering into any vehicle leases that contain a mandatory or one dollar purchase option, or is otherwise not a true lease, you may want to consider: (a) using a promissory note and security agreement or other straight loan documentation; and (b) listing yourself as lienholder on the certificate of title.

Bossier Plaza Assocs. v. Nat’l Union Fire Ins. Co. of Pittsburgh, 813 So.2d 1114 (La. Ct. App. 2002).

The only way to know for certain what an insurance policy covers is to read the policy.  In this case, the lessee leased space in a mall from the lessor and was required pursuant to the terms of the lease: (a) to obtain comprehensive general liability insurance for injuries that occur on the leased premises; (b) to name the lessor as an additional insured on such policy; and (c) to indemnify and defend the lessor from and against all claims and/or liability resulting from the lessee’s use of the leased premises.  The lessee obtained this insurance coverage from National Union.

When the lessee's employee slipped and fell on an icy sidewalk outside the mall, the employee sued and named the lessor as a party to the suit. National Union refused to defend the lessor as an additional named insured, claiming that the policy did not provide liability coverage for this type of accident.  When the lessor sued National Union to enforce the policy, the trial court dismissed the lessor’s claim and this appeal followed. On appeal, the Court found for National Union, noting that language in the insurance policy expressly limited coverage for the lessor, an additional named insured, to liability arising out of the lessee’s use of the leased premises.  In the instant case, the accident occurred on the mall’s outside sidewalk, which was not part of the lessee’s leased premises.  Therefore, the insurance policy unambiguously excluded coverage for this particular accident and National Union did not have an obligation to defend the lessor.

Leasing One Corporation v. Caterpillar Financial Services Corp., 776 N.E.2d 408 (In. Ct. App.  2002)

Boston Equipment Corporation ("Lessee") leased equipment from Caterpillar Financial Services, Inc. ("Lessor") and Lessor properly filed a financing statement perfecting its interest in the equipment in case the lease was deemed to be a loan instead of a true lease.  Unbeknownst to Lessor, Lessee sold the equipment to R&D Homes & Supply, Inc. ("R&D").    This unauthorized purchase of the equipment was accomplished by way of a lease from Meridian Leasing that was subsequently assigned to Leasing One Corporation ("Leasing One").  When Lessee defaulted, Lessor attempted to repossess the equipment.

Leasing One objected, arguing that it took free of any security interest held by Lessor pursuant to §9-320 of the Uniform Commercial Code, which allows a buyer in the ordinary course of business to take free of a security interest created by the buyer’s seller even if the security interest is perfected and the buyer knows of its existence.  The Court disagreed, noting that: (a) Leasing One did not introduce sufficient evidence to show that it qualified as a buyer in the ordinary course; and (b) since the security interest was not created by the buyer’s seller, Leasing One would not take free of Lessor’s security interest even if it were a buyer in the ordinary course.

The Court was correct on its first holding since the only evidence that Leasing One provided was a copy of the check written to purchase the equipment.  This evidence is insufficient to show that Leasing One "in good faith and without knowledge that the sale to [it] is in violation of the ownership rights or security interest or leasehold interest of [Lessor, bought the equipment] in ordinary course from a person in the business of selling goods of that kind .  .  .  .”   Without any evidence to establish that Lessee regularly sold goods of that kind, Leasing One could not establish itself as a buyer in the ordinary course.

The Court's second conclusion is somewhat puzzling.  As the Court explained "[b]ecause Leasing One, as assignee of R&D’s commercial lease, purchased the [equipment] from [Lessee], it does not take free of [Lessor’s] security interest."  However, in the event the underlying lease between Lessor and Lessee was a conditional sale, Lessee would be the owner of the equipment.  As owner, it would be Lessee who granted Lessor a security interest in the equipment in order to secure Lessee’s obligations under the lease and, as such, the security interest would have been created by Lessee. Since Lessee was the entity that sold the equipment, it would appear that it was the "buyer’s seller."  The court cited National Shwamut Bank of Boston v. Jones as support for its holding.  However, in that case, the original grantor of a security interest sold the equipment to a dealer in violation of the original agreement and that dealer subsequently resold the equipment to a buyer in the ordinary course.  The Shawmut Court held that the ultimate buyer could not take free of the security interest created by the original grantor because the original grantor was not the entity that sold the equipment to the buyer in the ordinary course.  These facts are clearly distinguishable from the current case where the original grantor of the security interest, Lessee, is the same entity that sold the equipment to Leasing One.

The current case does not provide sufficient details to explain the Court’s conclusion.  Perhaps the mechanism of the transaction between R&D and Leasing One confused the court. For example, the Court’s holding would be more understandable if Leasing One entered into a sale-leaseback transaction with R&D instead of purchasing the equipment directly from Lessee. In any event, the Court came to the right conclusion by holding the Lessor had the right to repossess the equipment.

Article appeared in the January, 2003 issue of the Monitor.
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