In re Roberts

641 B.R. 613

IN RE: Fritz G. ROBERTS and Ashley D. Roberts, Debtors.

Case No. 22-20766-beh

United States Bankruptcy Court, E.D. Wisconsin.

Signed June 24, 2022

John A. Foscato, Green Bay, WI, for Debtors.

Rebecca R. Garcia, Oshkosh, WI, Trustee, Pro Se.

DECISION AND ORDER ON LEBAKKENS INC. OF WISCONSIN'S OBJECTION TO PLAN CONFIRMATION

Beth E. Hanan, United States Bankruptcy Judge

The issue before the Court is whether the rent-to-own agreements the debtors entered into with Lebakkens Inc. of Wisconsin ("Lebakkens") are true leases, or purchases. The nature of the contracts is consequential to the debtors’ plan under Chapter 13 of the Bankruptcy Code because their plan proposes to make payments on the goods subject to the agreements—a washer, dryer, and mattress—as if Lebakkens were a secured creditor, with a security interest in (rather than ownership of) the goods at issue. If the agreements are true leases, as Lebakkens argues, and not disguised security agreements, as the debtors contend, then the Court cannot confirm the debtors’ Chapter 13 plan as proposed, because it fails to comply with § 365 of the Bankruptcy Code, which governs executory contracts and unexpired leases. For the reasons that follow, the Court concludes that the agreements at issue are leases rather than security agreements and will sustain Lebakkens’ objection to confirmation of the debtors’ Chapter 13 plan.

FACTUAL BACKGROUND

On November 16, 2021, debtors Fritz and Ashley Roberts executed a "Rental Agreement with Ownership Provisions" with Lebakkens for the lease of a washer and dryer.¹ The agreement's "lease expiration (maturity) date" also was November 16, 2021, but the debtors had the option to renew the agreement on a monthly basis, on the following terms:

At your option, this lease may be renewed by paying an amount equal to the Renewal Rental Payment Amount above (the "Renewal Rental Payment") on or before the first day of each subsequent renewal rental period.... If renewed, the lease period under the Rental Agreement will mature and expire at the end of the Renewal Period (the Renewal Expiration Date), unless renewed again. If you do not make a Renewal Rental Payment, the lease will automatically expire at the end of the current Renewal Period and you will be obligated to return the Property to us immediately on or before the Renewal Expiration Date. You have no right to retain and use the Property if the lease expires and has not been renewed. If you do not renew this lease and you timely return the Property to us, you will not have any future payment obligations under this Rental Agreement.

ECF No. 25-1, at 1. The contract identified the "Renewal Rental Payment" as $168.96 and, with sales tax of $9.29 added, the "Total Renewal Payment Amount" was $178.25.

The agreement also provided that Lebakkens would continue to hold title to the appliances, but the debtors could obtain ownership of the property in one of two ways. First, the debtors could pay the "Total Amount of All Rental Payments to own the Property," which was defined as 24 months’ worth of the renewal rental payment of $168.96, or $4,055.04. Alternately, the debtors could exercise an option to purchase, by paying 50% of the remaining unpaid balance of the "Total Amount of All Rental Payments to own the Property," plus sales tax. The cash price of the appliances, according to the agreement, was $2,027.52.

Under the agreement, the debtors assumed liability if the property was stolen, lost, or damaged, while Lebakkens was responsible for maintaining and servicing the property. While the agreement stated that Wisconsin law applied, it specifically added that the Wisconsin Consumer Act ("WCA") did not apply to the transaction, unless the debtors had made payments in an amount equal to 75% of the "Total Amount of All Rental Payments to Own the Property"—in this case, $3,041.28—which the debtors do not argue they have done.²

The debtors entered into a second, and substantially similar, rent-to-own agreement for a mattress on February 6, 2022, with an effective date of February 7, 2022. ECF No. 25-2. Like the agreement for the appliances, the expiration date on the mattress agreement was the same as the contract date, February 7. The mattress agreement contained identical clauses governing renewal, liability, maintenance, ownership, the option to purchase, and limited applicability of the WCA. The "Renewal Rental Payment" identified in the mattress agreement was $160.28 (and, after sales tax of $8.81, the "Total Renewal Payment Amount" was $169.09), while the "Total Amount of All Rental Payments to own the Property," was $1,923.36 (equal to 12 months’ of the renewal rental payment of $160.28).³ The agreement listed the cash price of the mattress as $961.68.

Less than a month after executing the second rental agreement, on February 28, 2022, the debtors filed a petition under Chapter 13 of the Bankruptcy Code. ECF No. 1. In their schedules, they disclose Lebakkens as a secured creditor with a claim of $2,000 and having a purchase money security interest in "furniture/appliances" worth $1,500. Id. at 18. In their Chapter 13 plan, the debtors likewise treat Lebakkens as a secured creditor, rather than a lessor, and propose to make pre-confirmation adequate protection payments of $20, and to pay its secured claim of $2,000 in full at 5.00% interest, resulting in a total payout of $2,143.79 over the life of the 36-month plan. ECF No. 2, at 5.

Lebakkens objected to the plan, arguing that the rental agreements are true leases under Wis. Stat. § 401.203(2), and therefore executory contracts that must be assumed or rejected in their entirety. ECF No. 25.

DISCUSSION

The determination of whether the rental agreements here are leases or disguised security agreements is governed by state law. See Butner v. United States , 440 U.S. 48, 55, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979). As noted, each of the agreements provides that it is to be governed by Wisconsin law. According to Lebakkens, the applicable state law here is the Uniform Commercial Code, as codified at Wis. Stat. § 401.203. That section of the UCC instructs how to distinguish leases from security interests. It reads, in pertinent part:

(1) Whether a transaction in the form of a lease creates a lease or security interest is determined by the facts of each case.

(2) A transaction in the form of a lease creates a security interest if the consideration that the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease and is not subject to termination by the lessee, and if any of the following apply:

(a) The original term of the lease is equal to or greater than the remaining economic life of the goods.

(b) The lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods.

(c) The lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement.

(d) The lessee has an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement.

Wis. Stat. § 401.203.

As explained by the bankruptcy court in In re Action Transit, Inc ., this statute creates a two-pronged test: "The first prong asks whether ‘the consideration that the lessee is to pay ... for the right to [possess and use] the goods is an obligation for the term of the lease not subject to termination by the lessee,’ " while the second prong asks whether any of the four other conditions identified in the statute exist. Action Transit , Case No. 07-27904-PP, 2008 WL 533992, at *4–5 (Bankr. E.D. Wis. Jan. 10, 2008).⁴ "If the answer to the question i[n] the first prong is ‘yes,’ and the answer to any of the four sub-questions in the second prong is ‘yes,’ then the transaction creates a security interest, rather than a lease." Id. at *5.

Crucial to the difference between a lease and a disguised sale is the lessee's unilateral ability to cancel. As one bankruptcy court recently observed, however, if a lease can be terminated by the lessee (prong one), "courts are split on the significance of that fact." In re Roberts , 620 B.R. 336, 341 (Bankr. D.N.M. 2020). While some courts have held "that a lease terminable at will by the lessee is a true lease [and] no further analysis or weighing of factors is necessary," see id. (citing cases including In re Powers , 983 F.2d 88, 90 (7th Cir. 1993) (applying Illinois law and concluding "where a lessee has the right to terminate the lease before the option arises to purchase the property for no additional or nominal consideration, the lease is a true lease and cannot be a conditional sale")), other courts "have rejected the view that a lease terminable at will by the lessee at any time must perforce be a true lease" and instead consider all the facts of the case to determine whether the "economic realities" of the agreement indicate a lease or a security agreement, see id. (citing cases).

Under either approach, however, the agreements at issue in this case are leases, not security agreements. As Lebakkens notes, the debtors are free to terminate the agreements at any time simply by opting not to make payments and returning the property. See ECF No. 31, at 3. Although neither agreement contains a provision expressly setting forth the parties’ termination rights (at least in those words), the substance of the agreements reflects that the debtors maintain the ability to allow the leases to expire, and therefore "terminate," by choosing not to renew. See ECF No. 25-1, at 1 ("If you do not make a Renewal Rental Payment, the lease will automatically expire at the end of the current Renewal Period and you will be obligated to return the property to us immediately on or before the Renewal Expiration Date."); ECF No. 25-2, at 1 (same)...