Opinion
Case No. 00-12773-7; Adversary No. 00-5277
June 26, 2001
MEMORANDUM OPINION AND ORDER DENYING TRUSTEE'S COMPLAINT TO AVOID LIEN OF DEALERS LEASING, INC .
The Trustee seeks to avoid what she contends are unperfected security interests in a truck and two trailers. Defendant Dealers Leasing, Inc. entered into "Commercial Vehicle Lease Agreements" with Debtor Bart Schweiterman. These leases are known in industry parlance as "TRAC" leases, that is, leases with a terminable rental adjustment clause. The parties submitted this on stipulation of facts and briefs; and, the matter is ready for decision. Because the Court concludes that these "TRAC" leases are true leases and not disguised security agreements, the Court denies the Trustee's Complaint.
STIPULATION OF FACTS
Debtor filed this Chapter 7 bankruptcy on July 20, 2000. Before he filed, on February 22, 2000, Dealers Leasing, Inc. took possession of a Wilson trailer; and on March 10, 2000, Dealers Leasing took possession of a Doonan trailer and a Peterbilt truck.
In 1998, the Debtor entered into three "Commercial Vehicle Lease Agreement(s)" with Dealers Leasing. On July 7, 1998, Dealers Leasing purchased a 1998 Doonan Flatbed Trailer from Northcutt Trailer Equipment Sales, Inc. for $25,016. The Doonan trailer became part of Dealers Leasing's inventory. On July 9, 1998, Debtor and Dealers Leasing entered into a lease agreement on this trailer. On August 19, 1998, the State of Kansas issued a Certificate of Title to Dealers Leasing, as the owner of the Doonan trailer. The title certificate noted a lien in favor of Intrust Bank, which had loaned Dealers Leasing the funds to purchase the Doonan trailer, as well as the Wilson trailer and the Peterbilt truck.
In the second transaction, on August 3, 1998, Dealers Leasing purchased a 1993 Wilson Trailer from Northcutt Trailer Equipment Sales, Inc. for $18,000. The Wilson trailer became part of Dealers Leasing's inventory. On August 6, 1998, Debtor and Dealers Leasing entered into a lease agreement on this trailer. On January 5, 1999, the State of Kansas issued a Certificate of Title to Dealers Leasing, as the owner of the Wilson trailer, noting a lien in favor of Intrust Bank.
In the third transaction, on August 3, 1998, Dealers Leasing purchased a 1996 Peterbilt truck from Northcutt Trailer Equipment Sales, Inc. for $70,000. The truck became part of Dealers Leasing's inventory. On August 6, 1998, Debtor and Dealers Leasing entered into a lease agreement on this truck. On September 7, 1998, the State of Kansas issued a Certificate of Title to Dealers Leasing, as the owner of the truck, noting a lien in favor of Intrust Bank.
The Commercial lease agreements, attached to the parties' Stipulation of Facts, are identical forms, but have different payment terms. The lease of the Doonan trailer states that it is an "open end lease," for a term of 48 months, until August 1, 2002, with $1280.77 due on delivery, "base monthly rentals" of $648.00, and a "lease end residual value" of $2525.00. The lease of the Wilson trailer states that it is an "open end lease," for a term of 48 months, until September 1, 2002, with $501.75 due on delivery, "base monthly rentals" of $479.00 and a "lease end residual value" of $1,800. The lease of the truck states that it is an "open end lease," for a term of 60 months, until September 1, 2002, with $1,248.16 due on delivery, "base monthly rentals" of $1,369.00 and a "lease end residual value" of $15,000.
Although no one addressed this internal inconsistency, it appears that the lease expiration date should be September 1, 2003; or the term of the lease should be 48 months, if the term of the lease expires on September 1, 2002.
All three leases provide that at the end of the lease, or in the event the lease is otherwise terminated, regardless of cause, the vehicle will be sold, and the sales price, the balance due on the lease, if any, and the residual value of the vehicle, will determine whether the lessee owes lessor additional monies, or whether the lessor owes the lessee monies. This language, in what is commonly called a terminable rental adjustment clause, states
At the termination of this lease, regardless of the cause, Lessor shall cause Vehicle to be sold at public or private sale, at Lessor's option, and the highest cash bid shall be accepted. Lessor and Lessee retain the right to bid at any such sale. If the Sales Price (after deducting reserve account balances) exceeds the Depreciated Value, the excess shall be paid to Lessee; if such net recovery is less than the Depreciated Value, Lessee shall pay such deficit to Lessor within ten (10) days of invoice date.
"DEPRECIATED VALUE" MEANS THE PRESENT VALUE OF THE UNPAID BALANCE OF THE TOTAL LEASE PAYMENTS FOR THE REMAINING TERM OF THIS LEASE PLUS THE LEASE END RESIDUAL VALUE, PLUS ANY OUTSTANDING BALANCES.
The leases also charge to the lessee any expenses lessor incurs in restoring the vehicle to "reasonable condition." The parties agree that the economic life of the truck and trailers was longer than the term of the respective leases.
CONCLUSIONS OF LAW
Are these lease agreements true leases or disguised security agreements? The nature and extent of a legal or equitable interest in property is determined by state law, which creates and defines property interests. The Uniform Commercial Code, as adopted in Kansas, defines security interests and leases, and addresses the distinction between true leases and disguised security interests. Security interest is defined as an interest in personal property which secures payment, and despite a seller's retention or reservation of title to the goods, as Dealers Leasing has, the seller's interest may be limited to a "security interest" rather than title ownership.
Butner v. United States, 440 U.S. 48, 54-55 (1979).
K.S.A. 84-1-201(37).
K.S.A. 2a-103(1)(j).
K.S.A. 84-1-201(37).
Id.
K.S.A. 84-1-201(37) provides substantial guidance in distinguishing true leases from disguised security agreements. As the Official Comment to K.S.A. 84-1-201(37) notes, one of the reasons Kansas adopted Article 2A on leases was to "resolve uncertainty about `whether a transaction creates a lease or a security interest disguised as a lease.'" While the former test under the U.C.C. and body of case law was the parties' intent, the test is now one of economics, rather than intent.
Now, K.S.A. 84-1-201(37) establishes a two part test for leases that are in reality disguised security interests. First, the lessee has no right to terminate the lease before the end of the lease term. Secondly, one of these four factors must be present:
(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 nominal additional consideration upon compliance with the lease agreement, or
(d) the lessee has an option to become the owner of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement.
Id.
K.S.A. 84-1-201(37) implies that a transaction is a true lease if the lessee has a right to terminate the lease with no further obligation. Here, the leases do not expressly state whether or not the lessee has a right to terminate; but the leases seem to contemplate a right to terminate, albeit with a possibility of further financial obligation by the lessee. The leases provide that in the event of termination, the lessee's payment obligation under the leases is not necessarily terminated. How much the lessee owes, if any, is dependent on what the lessor is able to sell the vehicle for, less the vehicle's residual value and the present value of any remaining payments due under the stated term of the lease. If the lessee terminates the lease before the end of the stated lease term, the lessee continues to be obligated for any remaining lease payments for the term of the lease, as well as the residual value of the vehicle, reduced by the sale proceeds of the vehicle. On the other hand, if the sale proceeds exceed the residual value and any balance due under the lease, the lessee is able to terminate the lease without owing additional monies. In fact, the leases state that in that circumstance, the lessor owes the lessee this "net recovery." This right to terminate means that the subject leases do not meet the first prong of the two part test for disguised security agreements.
Discounted to present value.
The Trustee argues that because the lessee is obligated to pay the full amount he agreed to pay at the inception of the lease, that is, all of the lease payments plus the residual value; in effect, the lessee has no real right to terminate. No matter whether the lessee fully complies with the lease terms, or whether the lessee terminates the lease in a manner that constitutes default, the lessee owes the same amount. But the Trustee's argument assumes that the lessee will owe money. Typically, if a lessee terminates the lease early, it will owe money because the sales price will be insufficient to offset the residual value and the balance of lease payments due. However, if a lessee terminates the lease near the end of the lease term, it is possible that the sales price might exceed the residual value plus the balance of lease payments. This is of course dependent on the condition of the vehicle. If the vehicle has not depreciated as rapidly as contemplated in the lease, such that its market value exceeds the stated residual value, then the lessee may owe nothing, or may even be owed the "net recovery" on the vehicle. In fact, the salient purpose of these "TRAC" leases is to encourage the lessee to provide good care and maintenance of the vehicle, so that at the end of the lease, the vehicle can be sold for at least its residual value. These leases give the lessee a financial incentive to take care of the vehicle. This benefits the lessor, as well as the lessee. Although there are cases that construe the lease to be a disguised security agreement when the risk of depreciation is borne solely by the lessee and not the lessor, these cases precede the amendment of K.S.A. 84-1-201(37), which changed the focus from the parties' intent to the economic reality of the transaction.
See In re Tulsa Port Warehouse Co., 690 F.2d 809 (10th Cir. 1982) (court noted that economic realities may demonstrate intent); In re Breece, 58 B.R. 379, 385 (Bankr.N.D.Okla. 1986); But see Sharer v. Creative Leasing, Inc., 612 So.2d 1191 (Ala. 1993); Carlson v. Tandy Computer Leasing, 803 F.2d 391 (8th Cir. 1986); In re Otasco, Inc., 196 B.R. 554 (N.D.Okla. 1991).
However, even if the lessee had no right to terminate, these leases do not meet any of the four alternative factors that comprise the second prong of the test for disguised security agreements. The original term of each lease is longer than the remaining economic life of the vehicle; the lessee is not bound to renew the lease, nor is the lessee bound to become the owner of the vehicle; the lessee has no option to renew the lease; and, the lessee has no "option to become the owner of the goods for no additional consideration or nominal additional consideration upon compliance with the lease."
First, the lessee does not have an option to purchase the vehicles in the truest sense of the word. Under the leases, the lessor may offer to sell the vehicle to the lessee; but, the lessor is also within its rights in auctioning the vehicle to the highest bidder. Thus, the lessee has no option, or first right of purchase.
Furthermore, if the lessor sells the vehicle to the lessee in a private sale, the lessee must pay at least the residual value to purchase the vehicle. While nothing in the language precludes the lessor from selling the vehicle to the lessee for less than the residual value, if it does, the lessee will still have to pay the balance of the residual value under the terms of the lease. In effect, if the lessee purchases the vehicle, the lessee will have to pay at least the residual value. And, if the lessor opts to auction the vehicle, the lessee may have to pay more than the residual value, because the sale will go to the highest bidder. Thus, whether by private sale or auction, the lessee must pay at least the residual value if not more.
The requirement that the lessee pay at least the residual value to purchase the vehicle, means that the lessee cannot acquire the vehicle for "no additional consideration" or "nominal additional consideration." The Trustee argues that the lessee would have to pay the residual value to comply with the lease terms, whether or not the lessee purchased the vehicle. But, the leases do not require the lessee to pay the residual value. If the lessee does not purchase the vehicle, the lessee is not required to pay the residual value. Rather, the lessee is required to pay the difference between the sales price and the residual value, if any. So, if the lessee wants to purchase the vehicle, the lessee is paying more than the lessee is required to pay under the terms of the lease. Unless the vehicle is sold for nothing, in no case would a non-purchasing lessee pay as much at the end of the lease as a purchasing lessee would.
The Trustee further argues that the residual values of these vehicles are nominal amounts, because the rule of thumb is that nominal consideration is something less than 25% of the original sales price. The residual value of the truck is 21%; and the residual value of the trailers is 10%. But, 25% is merely a rule of thumb. What is nominal versus what is real additional consideration is a function of the type of vehicle and the length of the lease. Some vehicles depreciate more rapidly than others. The trailers have an anticipated residual value of 10% after 48 months, which indicates that they probably depreciate faster than the truck, which has an anticipated residual value of 21%.
See Fruehauf Corp. v. International Plastics, Inc. (In re International Plastics, Inc.), 18 B.R. 583, 586 (Bankr.D.Kan. 1982);Percival Constr. Co. v. Miller Miller Auctioneers, Inc., 532 F.2d 166 (10th Cir. 1976); Matter of Fashion Optical, Ltd., 653 F.2d 1385 (10th Cir. 1981).
The Trustee proffers that the additional consideration is nominal, if any lessee would purchase the vehicle at the end of the lease, to preserve their economic investment in the vehicle. But, one cannot conclude that any lessee of these "TRAC" leases would think it economically advantageous to purchase the vehicle at the end of the lease. The lessee of a well maintained vehicle, or a vehicle that has depreciated more slowly than anticipated, might reasonably prefer to not purchase the vehicle, and instead obtain the net recovery due it under the terms of the lease.
The residual value represents the anticipated market value at the end of the lease. These vehicles have a market value at the end of the lease. This demonstrates that the lessee is not in effect purchasing the vehicle in a lease that is a disguised security agreement. The Trustee argues that Dealers Leasing fixes the residual value at an amount that will allow it to fully recover its cost of goods sold, that is, the original sales price, interest it paid to Intrust Bank, as well as its profit. But this argument is not mentioned or supported in the stipulations or record. The leases define residual value as the anticipated market value at the end of lease if the vehicle is in reasonable condition, with only normal wear and tear.
In short, these leases are not disguised security agreements. These "TRAC" leases are true leases with a terminable rental adjustment clause. This clause discourages the lessee from an early termination of the lease. If lessee terminates the lease early, lessee still owes remaining lease payments plus the residual value; and unless the vehicle sells for a price that exceeds the residual value and remaining lease payments, the lessee must pay the difference. These "TRAC" leases further encourage the lessee to take good care of the vehicle. Any wear and tear, and any depreciation beyond that anticipated, is an obligation borne by the lessee, to the extent that the vehicle sells for less than the residual value.
IT IS THEREFORE ORDERED BY THE COURT that the Trustee's Complaint to Avoid Lien of Dealers Leasing is DENIED.
This Memorandum shall constitute findings of fact and conclusions of law under Rule 7052 of the Federal Rules of Bankruptcy Procedure and Rule 52(a) of the Federal Rules of Civil Procedure. A judgment based on this ruling will be entered on a separate document as required by Rule 9021 of the Federal Rules of Bankruptcy Procedure and Rule 58 of the Federal Rules of Civil Procedure.
IT IS SO ORDERED.