Leases
By Edward K. Gross, Dominic A. Liberatore, and Stephen T. Whelan*
CASE LAW DEVELOPMENTS
This survey covers a number of cases decided in 2016 involving disputes be-
tween parties to equipment financing transactions or with third parties regarding
the transactions or the related equipment. The courts in these surveyed cases con-
sidered many of the issues that are fundamental to establishing the respective
rights, obligations, interests, and remedies associated with equipment financings.
These issues include, among others, whether a transaction documented as a lease
creates a true “lease” or a security interest, the rights of assignees of interests under
a lease, certainty of payment issues such as waivers of defenses and “hell-or-high
water” payment obligations, vicarious liability of a lessor, a lessor’s damages rem-
edies, and options reserved to lessees relating to the leased equipment.
TRUE LEASE
The characterization of a contract as a “true” lease or a lease that creates a se-
curity interest is typically raised by lessees and other parties in the context of
bankruptcy or enforcement cases, or priority disputes, for the purpose of achiev-
ing greater rights or protections in matters involving the purported lessor of the
related equipment.
The characterization analysis in In re Ajax Integrated, LLC
1
involved a lease
with end-of-term options that required the lessee either to purchase the equip-
ment for a fixed price, or return it to the lessor, at the lessee’s expense, to a lo-
cation designated by the lessor in the continental United States and in the same
condition and appearance as when delivered (reasonable wear and tear ex-
cepted), and to pay the full monthly rental from the expiration date until the
* Edward K. Gross is a member of the District of Columbia and Maryland bars and practices law
with Vedder Price LLP in Washington, D.C. Mr. Gross is the current chair of the Subcommittee on
Leasing of the Uniform Commercial Code Committee of the ABA Business Law Section. Dominic A.
Liberatore is a member of the New York, Pennsylvania, and New Jersey bars and is Deputy General
Counsel for DLL. Mr. Liberatore is a past chair of the Legal Committee for the Equipment Leasing and
Finance Association. Stephen T. Whelan is a member of the New York bar and practices law with
Blank Rome LLP in New York City. Mr. Whelan is a past chair of the Subcommittee on Leasing of
the Uniform Commercial Code Committee of the ABA Business Law Section.
1. 554 B.R. 568 (Bankr. N.D.N.Y. 2016).
1079
equipment was returned.
2
The court relied on “former” N.Y. U.C.C. § 1-201(37),
“which provides a two prong ‘Bright-Line Test’ that, if satisfied, calls for the lease
to be recharacterized as a secured transaction.”
3
Among other things, the court
noted that this statutory test looks to the substance, not the parties’ intent, and if
not satisfied, then the court “must apply a contextual analysis that examines the
facts and circumstances of the case to determine if a security interest was, in fact,
created.”
4
This contextual analysis, referred to as the “economic realities” test,
determines, “‘whether the lessor retains a meaningful residual interest’ at the
end of the lease term.”
5
The first prong of the statutory test was satisfied because the lessee could not
terminate the agreement without paying all of the amounts then due in addition
to the purchase option price.
6
The court then focused on whether the purchase
option price was “nominal” and concluded that the fixed purchase option price
of $16,900 was nominal compared to the expense of returning the equipment to
an unknown location in the continental United States, which was estimated by
the debtor to be “anywhere from $10,500 to $15,000,” in addition to any repair
expenses necessary to cause the equipment to be in the “as delivered” condition
(reasonable wear and tear excepted).
7
The court also conducted a contextual
analysis of the transaction and, based on the totality of the circumstances,
reached the same result.
8
As a result, the lessor was deemed to be a secured cred-
itor and was denied any recovery relating to the residual value of the equip-
ment.
9
Although many of the characterization cases turn on the nominality of
2. Id. at 575. The leases also contained early termination options, conditionedupon payment of all
amounts then due, all future rent, and the fixed purchase option price. Id.
3. See id. at 577–78 n.8 (“Since the Agreement was entered into on June 7, 2013, the court looks
to former N.Y. U.C.C. § 1-201(37), which is substantively similar to the current law per the current
law’s Official Comments.”); see also N.Y. U.C.C. § 1-203 (McKinney 2016) (codifying the same
bright-line rule test as N.Y. U.C.C. § 1-201(37)).
4. In re Ajax Integrated, 554 B.R. at 578.
5. Id. (quoting In re QDS Components, Inc., 292 B.R. 313, 333 (Bankr. S.D. Ohio 2002)).
6. In re Ajax Integrated, 554 B.R. at 579. As noted above, the early termination option required
payment by the lessee of all amounts due upon termination, together with all future rent and the
fixed purchase option price, not the “walk away” right that have been consistent with the lease
being terminable by the lessee as contemplated in N.Y. U.C.C. § 1-201(37)(b).
7. Id. at 581.
8. Id. at 582 (citing In re WorldCom, Inc., 339 B.R. 56, 65 (Bankr. S.D.N.Y. 2006)); see also In re
QDS Components, Inc., 292 B.R. at 333. The court explained that the “pivotal question” was whether
the transaction was structured in such a way that the lessor had an “objectively reasonable expecta-
tion that the equipment would be returned at lease expiration.” In re Ajax Integrated, 554 B.R. at 582
(citing In re Ecco Drilling Co., 390 B.R. 221, 227 (Bankr. E.D. Tex. 2008)). Among other consider-
ations, the court concluded that the lessor must have known that the lessee would exercise the op-
tion; otherwise it would have made little economic sense for the lessor to obligate itself to pay the
(back-leveraging) loan balance owed to its lender in an amount equal to the fixed purchase option
price. Id. The court also deemed noteworthy that “after forty-eight monthly payments, a mere four
more to become the owner of three pieces of John Deere Equipment seems more than reasonable
and likely.” Id.
9. Id. at 583. The case also included arguments by the trustee that the lessee took free of the de-
fendants’ interests because the lessee was a “buyer in the ordinary course” when it acquired the equip-
ment pursuant to this secured financing. Id. at 583–84. The issue was not fully analyzed or resolved,
but it is noteworthy that the trustee was intending to raise the issue as a defense to the defendants’
1080 The Business Lawyer; Vol. 72, Fall 2017
