Source: https://www.bakerdonelson.com/Lease-Vs-Loan-Analysis-Under-the-Uniform-Commercial-Code-07-01-2003
Timestamp: 2019-04-25 00:28:35+00:00

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Recent editions of this column have highlighted, and often criticized, the analyses that some courts have used to determine whether a transaction is a lease or a loan for state law purposes. For example: (1) in Amba-An v. Arias-Turecious,[ii] criticized in the October edition of this column, the court found a lease with a one dollar purchase option to be a "true lease" for purposes of applying Florida's dangerous instrumentality doctrine; (2) in In re Triplex Marine Maintenance, Inc,[iii] the court determined that a lease with a purchase option equal to the greater of ten percent or the fair market value of the Equipment was a loan under the "sensible person test" solely because the lease covered all of the lessee's assets and the court felt that the lessee's only sensible choice was therefore to exercise its purchase option; and (3) in Ace Leasing, Inc. v. Boustead,[iv] criticized in the January edition of this column, the court held that the transaction was a loan solely because the lessor dispersed funds directly to the lessee and allowed the lessee to pay the vendor--- the court reasoned that, since the lessor did not pay the vendor directly, the lessor never received title to the leased equipment and therefore could not "lease" the goods to the lessee.
The UCC test for distinguishing a lease from a loan provides a two-part test (the "Two-Part Test") and any transaction that satisfies the Two Part Test creates a security interest and is therefore a loan as matter of law.[x] The elements of the Two-Part Test generally focus on whether the alleged lessor retains some interest in the goods-- often referred to as a residual interest. If there is a realistic chance that the lessee will return something of value to the lessor, the lease will likely be deemed to be a true lease.
It is important to note, however, that the Two-Part test expressed in the UCC is not the end-all-be-all when determining if a transaction is a true lease. The UCC also provides Courts with flexibility by noting that "[w]hether a transaction creates a lease or security interest is determined by the facts of each case."[xi] As such, even if the Two-Part Test does not result in the transaction being characterized as a loan, some courts may still find the transaction to be a loan based on an analysis of the facts and circumstances of the particular case and the underlying economics of the transaction.[xii] Thus, the sensible person test applied by the court in In re Triplex Marine Maintenance was technically consistent with that state's UCC laws.
Part One: Does the Lessee have the Option of Terminating the Lease Early?
Part Two: Is the answer to any of the following questions yes?
Is the Lessee Required to Purchase the Goods?
If the lessee is required to purchase the goods, the lease is not a true lease.[xv] There is no chance that the leased equipment will be returned to the lessor.
Is the Lessee required to Lease the Goods for their Full Economic Life?
In summary, the tests used to determine if a transaction is a true lease or a loan varies and depends upon the reason the characterization is needed. For many state law purposes, the definitions of "lease" and "security interest" under the UCC provide the appropriate test. That test contains a bright line rule which states that a transaction which satisfies both elements of the Two-Part Test is a loan as a matter of law. Lessors desiring true lease treatment under state law should be careful that their transactions do not satisfy both prongs of this Two-Part Test. Lessors should also be aware that, notwithstanding the Two-Part Test, the UCC provides courts with broad discretion by noting that whether a transaction is a lease or a loan depends on the facts of each case. Due to the lack of certainty in this area of the law, prudent lessors should take precautions to protect their interests transactions that they consider to be true leases.
Article appeared in the July/August, 2003 issue of the Monitor.
[i] Hence the birth of "synthetic leasing."
[ii] 704 So. 2d 1093 (Fla. Ct. App. 1997).
[iii] 45 UCC Rep. Serv.2d 977 (Bankruptcy Ct., Texas, 2000).
[iv] 55 P.3d 371 (Mt., 2002).
[v] For example, the UCC test is used by state courts to determine whether a transaction is a loan and the lessor must comply with Article 9 of the UCC when disposing of leased assets after a lessee default. It is also used by bankruptcy courts to determine: (a) whether the lessor has rights under 365(d)(10) of the bankruptcy code (applicable only to true leases); and (b) whether the lessor must "perfect" a security interest in the leased equipment in order to avoid becoming an unsecured creditor. See Butner v. United States, 440 U.S. 48, 54-55 (1979)(the existence, nature and extent of a security interest in property is governed by state law); See also 11 U.S.C. §101, Historical and Statutory Notes ("Whether a . . . lease constitutes a security interest under the bankruptcy code will depend on whether it constitutes a security interest under applicable State or local law.") Courts also use the UCC test to determine whether state usury laws that apply to loans are applicable to transactions labeled as leases. See Bell v. Itek Leasing Co., 555 S.W.2d 1 (Ark. 1977).
[viii] These are the legal bodies responsible for drafting and promulgating the UCC.
[ix] Under Revised Article 1, the definition of security interest has been shortened substantially and the provisions used to determine whether a given transaction is a lease or a loan have been moved into Revised Section 1-203. Comments to that section note that the definition is "substantively identical" to UCC §1-201(37). As of June 20th, Revised Article 1 has only been adopted in Virginia. It is currently circulating in Connecticut, Massachusetts and Texas. It has been withdrawn from North Dakota and is being held for 2004 in Hawaii.
[x] See UCC §1-201(37)(a) through (d); See also e.g. In re Taylor, 209 B.R. 482, 484 (S.D Ill. 1997).
[xi] See UCC §1-201(37) and Revised UCC §1-203.
[xiv] See e.g. In re Taylor, 209 B.R. at 485.
[xviii] UCC §§1-201(37)(b)(3) and (4).

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