What's New in the Law

Ability to Collect Rentals

The People ex rel. The Board of Trustees of Chicago State University v. Siemens Building Technologies, Inc., 900 N.E.2d 414 (Ill.App. 2008). While this case focuses more on the interpretation of a particular state statute ' the Illinois Public University Energy Conservation Act ' than on leasing law generally, it may be of interest to those contemplating financing for public entities. In connection with its attempt to obtain energy savings using equipment installed by Siemens Building Technologies, the state university entered into a master lease agreement with Siemens Financial Services (though the agreement is called a “lease,” the parties and court consider the substance of the transaction to be a security agreement). One of the issues decided here is whether the aforementioned Act prevents the use of “hell or high water” financing provisions under which the university must pay a lessor/financer for energy conservation measures even if the measures do not produce a savings to the university. In affirming a lower court decision that the Act does not prevent such a financing provision, this court states, “If we presume for purposes of this question that third-party financing was contemplated by the legislature, then the commercial reality of this type of lease makes it clear that the risk as between the lessee and lessor for defective equipment is to be placed on the lessee who has recourse against the supplier.”

OFC Capital v. AT Publishing, Inc., 2008 WL 4962942 (U.S.Ct.App. 9th Cir. Nov. 20, 2008) (not for publication in Federal Reporter; not precedent except as provided by Ninth Circuit rules). After a District Court in Alaska had ruled in favor of the lessor, holding among other things that a finance lessor has no obligation to provide conforming equipment and that the lessee had no right to revoke acceptance, the Ninth Circuit affirms. In particular, the decision indicates that since the lessee realized the equipment was nonconforming before acceptance, it could not rely on 2A-517, which requires that the lessee did not discover the nonconformity as a condition of valid revocation in the case of a finance lease (in addition to the condition ' not referenced by the court ' that the lessee's acceptance had been reasonably induced by the lessor).

Fieldtech Avionics & Instruments, Inc. v. Component Control.Com, Inc., 262 S.W.3d 813 (Tex.App. 2008). On the surface, the part of this case deciding the dispute between the lessor and lessee (lessee claims against a vendor were also being decided) seems to be a straightforward application of Article 2A statutory finance lease rules; however, it does not appear that the transaction qualifies for such treatment. The lessor is said to have acquired software from a vendor and then to have leased it to the lessee. Apart from questions regarding ownership of and possessory rights to the software (i.e., did the lessor itself have any right to transfer possession and use of the software to the lessee ' as opposed to merely advancing to the vendor the proceeds of a loan to the lessee as payment for the lessee's right to use the software), Article 2A defines “lease” as a transfer of the right to possession and use of goods, and “goods” is defined to include movable things and fixtures, but not information. Although Article 2A would not appear to apply to this transaction, both the lessor and lessee agreed that the lease between them was a statutory finance lease ' which probably explains the court's application of Article 2A law. Since the lease otherwise met the statutory requirements for being a statutory finance lease, the lessee's unhappiness with the performance of the software would generally not affect its unconditional obligation to make all rental payments. The lessee argued, however, that it had revoked acceptance of the software and that, according to an Official Comment to 2A-407, a lessee's irrevocable obligation to pay under a finance lease remains subject to the lessee's revocation of acceptance if the lessee has accepted without discovery of the nonconformity and the lessee's acceptance was reasonably induced by the lessor's assurances [see 2A-517(1)(b), numbered slightly differently in Texas]. Since the lease, however, also contained a general waiver of the lessee's rights under a number of sections of Article 2A, including 2A-517, the court affirms a lower court's finding of summary judgment in favor of the lessor. An interesting question that did not need to be decided, given the lessee's waivers, is the likelihood of a lessor under a finance lease giving its lessee assurances regarding the goods being leased if that lessor genuinely played no role in the selection, manufacture, or supply of the goods.

True Lease vs. Security Interest: In General

In re Ecco Drilling Company, Ltd., 390 B.R. 221 (Bankr.E.D.Tex 2008). This case provides an illustration of a potentially confusing mixture of one of the elements of the statutory criteria for distinguishing true leases from security interests found in Article 1 that itself leads to the conclusion that a security interest has been created (the existence of a nominal purchase option in the lease) and a concept used to fill in the statutory gaps (assessing the “economic realities” of the transaction). The lease contained a purchase option of an amount equal to 15% of the greater of: 1) the value of the equipment or 2) 60% of the going concern value of the lessee determined by a third party appraiser. The court cites other cases stating that the term “nominal” can be used in a relative, rather than an absolute sense, to conclude that sizable purchase options of even $1 million can be nominal. The court's determination that the lease creates a security interest, however, focuses primarily on the economic circumstances of the lessee and of the transaction when it concludes that the lessee was highly unlikely simply to walk away from the drilling rigs that were the subject of the lease without paying the option price to purchase them. According to the court, those economic realities indicated that neither the lessor nor the lessee expected ' nor would anyone else expect ' anything other than the lessee's exercise of its purchase option. Whether or not a purchase option amount qualifies as nominal, to the extent that the lessee can be reasonably predicted to exhaust the economic value of the goods, the transaction should be considered to create a security interest.

Lease Treatment for 'Software Leases'

Fieldtech Avionics & Instruments, Inc. v. Component Control.Com, Inc., 262 S.W.3d 813 (Tex.App. 2008). See discussion in “Ability to Collect Rentals” section above.

Indemnity Clauses

Lexington Insurance Company, 900 N.E.2d 536 (Mass.App. 2009) (opinion not published in printed volume ' only appears in a table; may be cited for persuasive value, but not as binding precedent). Lessee's insurer claimed that the lessor's negligence caused damage to property of the lessee and lessee's customer (for which damage the insurer paid). The Massachusetts Appeals Court affirms the trial court's grant of summary judgment in favor of the lessor based upon the indemnity provision in the lease. Although that provision did not explicitly include losses caused by the lessor's negligence, the court holds that its broad reference to “any and all claims” suffices to include such lessor-caused losses.

Assignments of Leases

Federal Deposit Insurance Corp. v. Kipperman (In re Commercial Money Center, Inc.), 392 B.R. 814 (Bankr.App.Panel 9th Cir. 2008). This case decides one of the issues left open by previous rulings in this interesting legal drama. Following a purported assignment of payment streams under equipment leases to a bank, the assignor (“CMC”) filed for bankruptcy, and its trustee sought to recover the rights to such payment streams from the bank by arguing both that the assignment of these payment rights was not an assignment of payment intangibles and thus could not have been automatically perfected according to the provisions of Article 9 ' even if the assignment qualified as a true sale ' and that the assignment was a loan (i.e., not a true sale), requiring a different means of perfection even if the assignment could be characterized as an assignment of payment intangibles. Overruling an earlier decision of the bankruptcy court, this bankruptcy appellate panel previously ruled that the transaction did involve an assignment of payment intangibles ' “stripped” away from the underlying equipment leases that are classified under Article 9 as chattel paper ' which assignment would have been automatically perfected under Article 9 if it qualified as a sale. (This particular decision has been questioned by various legal practitioners and scholars and is criticized in a draft of an amendment to the Official Comments to Article 9 being proposed for adoption by the Permanent Editorial Board of the UCC. If rental payments can be “stripped” away from leases and lose their character as chattel paper, the priority rules favoring purchasers of chattel paper could be in jeopardy.) But that panel also agreed with the lower court that the substance of the transaction was in fact a loan secured by the payment streams, in which case perfection could not be automatic. This panel now decides that the bank did not perfect its interest in the payment streams by taking possession of the leases through an agent ' the one remaining hope for the bank (in the case, represented by the FDIC ' the receiver for the bank) since there had been no UCC filing done by the bank listing either the leases or the payment streams as collateral.

Robert W. Ihne, a member of this newsletter's Board of Editors, is an attorney with 25 years of experience in commercial financing, primarily in the areas of secured transactions and equipment leasing. Such experience has included drafting, negotiating, and providing advice related to direct transactions, syndications, vendor financing arrangements, and various forms of credit enhancements such as guaranties and letters of credit. He may be reached at [email protected]. The author gratefully acknowledges the assistance of Erin Staton and Ed Gross of Vedder Price Kaufman & Kammholz, P.C. in the preparation of this update.

Ability to Collect Rentals

The People ex rel. The Board of Trustees of Chicago State University v. Siemens Building Technologies, Inc. , 900 N.E.2d 414 (Ill.App. 2008). While this case focuses more on the interpretation of a particular state statute ' the Illinois Public University Energy Conservation Act ' than on leasing law generally, it may be of interest to those contemplating financing for public entities. In connection with its attempt to obtain energy savings using equipment installed by Siemens Building Technologies, the state university entered into a master lease agreement with Siemens Financial Services (though the agreement is called a “lease,” the parties and court consider the substance of the transaction to be a security agreement). One of the issues decided here is whether the aforementioned Act prevents the use of “hell or high water” financing provisions under which the university must pay a lessor/financer for energy conservation measures even if the measures do not produce a savings to the university. In affirming a lower court decision that the Act does not prevent such a financing provision, this court states, “If we presume for purposes of this question that third-party financing was contemplated by the legislature, then the commercial reality of this type of lease makes it clear that the risk as between the lessee and lessor for defective equipment is to be placed on the lessee who has recourse against the supplier.”

OFC Capital v. AT Publishing, Inc., 2008 WL 4962942 (U.S.Ct.App. 9th Cir. Nov. 20, 2008) (not for publication in Federal Reporter; not precedent except as provided by Ninth Circuit rules). After a District Court in Alaska had ruled in favor of the lessor, holding among other things that a finance lessor has no obligation to provide conforming equipment and that the lessee had no right to revoke acceptance, the Ninth Circuit affirms. In particular, the decision indicates that since the lessee realized the equipment was nonconforming before acceptance, it could not rely on 2A-517, which requires that the lessee did not discover the nonconformity as a condition of valid revocation in the case of a finance lease (in addition to the condition ' not referenced by the court ' that the lessee's acceptance had been reasonably induced by the lessor).

Fieldtech Avionics & Instruments, Inc. v. Component Control.Com, Inc. , 262 S.W.3d 813 (Tex.App. 2008). On the surface, the part of this case deciding the dispute between the lessor and lessee (lessee claims against a vendor were also being decided) seems to be a straightforward application of Article 2A statutory finance lease rules; however, it does not appear that the transaction qualifies for such treatment. The lessor is said to have acquired software from a vendor and then to have leased it to the lessee. Apart from questions regarding ownership of and possessory rights to the software (i.e., did the lessor itself have any right to transfer possession and use of the software to the lessee ' as opposed to merely advancing to the vendor the proceeds of a loan to the lessee as payment for the lessee's right to use the software), Article 2A defines “lease” as a transfer of the right to possession and use of goods, and “goods” is defined to include movable things and fixtures, but not information. Although Article 2A would not appear to apply to this transaction, both the lessor and lessee agreed that the lease between them was a statutory finance lease ' which probably explains the court's application of Article 2A law. Since the lease otherwise met the statutory requirements for being a statutory finance lease, the lessee's unhappiness with the performance of the software would generally not affect its unconditional obligation to make all rental payments. The lessee argued, however, that it had revoked acceptance of the software and that, according to an Official Comment to 2A-407, a lessee's irrevocable obligation to pay under a finance lease remains subject to the lessee's revocation of acceptance if the lessee has accepted without discovery of the nonconformity and the lessee's acceptance was reasonably induced by the lessor's assurances [see 2A-517(1)(b), numbered slightly differently in Texas]. Since the lease, however, also contained a general waiver of the lessee's rights under a number of sections of Article 2A, including 2A-517, the court affirms a lower court's finding of summary judgment in favor of the lessor. An interesting question that did not need to be decided, given the lessee's waivers, is the likelihood of a lessor under a finance lease giving its lessee assurances regarding the goods being leased if that lessor genuinely played no role in the selection, manufacture, or supply of the goods.

True Lease vs. Security Interest: In General

In re Ecco Drilling Company, Ltd., 390 B.R. 221 (Bankr.E.D.Tex 2008). This case provides an illustration of a potentially confusing mixture of one of the elements of the statutory criteria for distinguishing true leases from security interests found in Article 1 that itself leads to the conclusion that a security interest has been created (the existence of a nominal purchase option in the lease) and a concept used to fill in the statutory gaps (assessing the “economic realities” of the transaction). The lease contained a purchase option of an amount equal to 15% of the greater of: 1) the value of the equipment or 2) 60% of the going concern value of the lessee determined by a third party appraiser. The court cites other cases stating that the term “nominal” can be used in a relative, rather than an absolute sense, to conclude that sizable purchase options of even $1 million can be nominal. The court's determination that the lease creates a security interest, however, focuses primarily on the economic circumstances of the lessee and of the transaction when it concludes that the lessee was highly unlikely simply to walk away from the drilling rigs that were the subject of the lease without paying the option price to purchase them. According to the court, those economic realities indicated that neither the lessor nor the lessee expected ' nor would anyone else expect ' anything other than the lessee's exercise of its purchase option. Whether or not a purchase option amount qualifies as nominal, to the extent that the lessee can be reasonably predicted to exhaust the economic value of the goods, the transaction should be considered to create a security interest.

Lease Treatment for 'Software Leases'

Fieldtech Avionics & Instruments, Inc. v. Component Control.Com, Inc. , 262 S.W.3d 813 (Tex.App. 2008). See discussion in “Ability to Collect Rentals” section above.

Indemnity Clauses

Lexington Insurance Company, 900 N.E.2d 536 (Mass.App. 2009) (opinion not published in printed volume ' only appears in a table; may be cited for persuasive value, but not as binding precedent). Lessee's insurer claimed that the lessor's negligence caused damage to property of the lessee and lessee's customer (for which damage the insurer paid). The Massachusetts Appeals Court affirms the trial court's grant of summary judgment in favor of the lessor based upon the indemnity provision in the lease. Although that provision did not explicitly include losses caused by the lessor's negligence, the court holds that its broad reference to “any and all claims” suffices to include such lessor-caused losses.

Assignments of Leases

Federal Deposit Insurance Corp. v. Kipperman (In re Commercial Money Center, Inc.), 392 B.R. 814 (Bankr.App.Panel 9th Cir. 2008). This case decides one of the issues left open by previous rulings in this interesting legal drama. Following a purported assignment of payment streams under equipment leases to a bank, the assignor (“CMC”) filed for bankruptcy, and its trustee sought to recover the rights to such payment streams from the bank by arguing both that the assignment of these payment rights was not an assignment of payment intangibles and thus could not have been automatically perfected according to the provisions of Article 9 ' even if the assignment qualified as a true sale ' and that the assignment was a loan (i.e., not a true sale), requiring a different means of perfection even if the assignment could be characterized as an assignment of payment intangibles. Overruling an earlier decision of the bankruptcy court, this bankruptcy appellate panel previously ruled that the transaction did involve an assignment of payment intangibles ' “stripped” away from the underlying equipment leases that are classified under Article 9 as chattel paper ' which assignment would have been automatically perfected under Article 9 if it qualified as a sale. (This particular decision has been questioned by various legal practitioners and scholars and is criticized in a draft of an amendment to the Official Comments to Article 9 being proposed for adoption by the Permanent Editorial Board of the UCC. If rental payments can be “stripped” away from leases and lose their character as chattel paper, the priority rules favoring purchasers of chattel paper could be in jeopardy.) But that panel also agreed with the lower court that the substance of the transaction was in fact a loan secured by the payment streams, in which case perfection could not be automatic. This panel now decides that the bank did not perfect its interest in the payment streams by taking possession of the leases through an agent ' the one remaining hope for the bank (in the case, represented by the FDIC ' the receiver for the bank) since there had been no UCC filing done by the bank listing either the leases or the payment streams as collateral.

Robert W. Ihne, a member of this newsletter's Board of Editors, is an attorney with 25 years of experience in commercial financing, primarily in the areas of secured transactions and equipment leasing. Such experience has included drafting, negotiating, and providing advice related to direct transactions, syndications, vendor financing arrangements, and various forms of credit enhancements such as guaranties and letters of credit. He may be reached at [email protected]. The author gratefully acknowledges the assistance of Erin Staton and Ed Gross of Vedder Price Kaufman & Kammholz, P.C. in the preparation of this update.