Opinion
Case No. 02-09721-H7, (Jointly Administered with Case No. 02-09720-H7), Adversary Case No. 03-90331-H7.
January 27, 2005
Oscar Garza, Esq., Jesse S. Finlayson, Esq., Solmaz Hamidian, Esq., Gibson, Dunn Crutcher LLP, Irvine, CA, Attorney(s) for Plaintiff.
John D. Berchild, Esq., Laura S. Taylor, Esq., Sheppard, Mullin, Richter Hampton, LLP, San Diego, CA, Attorney(s) for Defendant.
David E. Otero, Esq., Akerman, Senterfitt Eidson, P.A., Jacksonville, FL, Attorney(s) for Defendant.
Jeffrey S. Turner, Esq., Kaye Scholer, LLP, Los Angeles, CA, Attorney(s) for Defendant.
Richard M. Kipperman, chapter 7 trustee ("trustee"), filed a complaint against defendant NetBank, FSB ("NetBank") alleging claims for relief including, inter alia, declaratory relief that Commercial Money Center's ("CMC") assignment of payment streams under certain equipment leases to NetBank constituted a loan, and not a true sale, or alternatively, even if the assignment constituted a true sale, that NetBank failed to perfect its interests as required under the Uniform Commercial Code ("UCC").
The complaint alleges eleven claims for relief: 1) Declaratory Relief that Transactions Involving CMC-N Purportedly Transferred Assets and CMC-N Collateral Did Not Constitute a "True Sale" and that NetBank Did Not Perfect Any Interest Therein — 11 U.S.C. § 541 and F.R.B.P. 7001(9); 2) Alternative Declaratory Relief that Even if Transactions Involving CMC-N Purportedly Transferred Assets and CMC-N Collateral Constitute a "True Sale," For Such Sale to Be Effective, NetBank Was Required To, But Did Not, Perfect Its Interest Therein — 11 U.S.C. § 541 and F.R.B.P. 7001(9); 3) Order Directing NetBank to Turn Over Estate Assets — 11 U.S.C. §§ 542, 550 and 551; 4) Declaratory Relief that CMC-N Royal Bonds Were Not Assigned to NetBank, and Order Directing NetBank to Turn Over CMC-N Royal Bonds as Estate Assets — 11 U.S.C. §§ 542, 550, 551; 5) Judgment Voiding 90-Day Preferential Transfer — 11 U.S.C. § 547; 6) Judgment Avoiding Unperfected Interests in CMC-N Purportedly Transferred Assets and CMC-N Collateral — 11 U.S.C. §§ 544 and 551; 7) Recovery of Avoidable Transfers — 11 U.S.C. § 550; 8) Declaration of Rights to CMC-N Pool Account Funds and CMC-N Postpetition Collections — 11 U.S.C. § 541; 9) Objection to Claims — 11 U.S.C. § 502; 10) Avoidance and Recovery of Unauthorized Postpetition Transfers — 11 U.S.C. §§ 549 and 550; and 11) Recovery of Attorneys' Fees and Costs — Applicable Law.
NetBank filed a motion for partial summary judgment requesting the Court to determine 1) that CMC's assignment of certain insured payment streams to NetBank constituted a sale; and 2) that the payment streams are "payment intangibles" as that term is defined in the UCC and were automatically perfected when CMC sold the payment streams to NetBank. The trustee filed a cross-motion for partial summary judgment.
Two issues are involved: 1) whether CMC's assignment of the payment streams to NetBank constituted a sale or loan and 2) whether a payment stream under an equipment lease is considered chattel paper or a payment intangible under the UCC.
This Court has jurisdiction to determine this matter pursuant to 28 U.S.C. §§ 1334 and 157(b)(1) and General Order No. 312-D of the United States District Court for the Southern District of California. This is a core proceeding pursuant to 28 U.S.C. § 157(b) (2) (A) and (K).
I. FACTS
A. THE BANKRUPTCY PETITIONS
CMC and its wholly owned subsidiary, Commercial Servicing Corporation ("CSC"), commenced their respective voluntary chapter 11 cases in the Southern District of Florida. Both bankruptcy cases were converted to chapter 7 and subsequently transferred to the Southern District of California where they are being jointly administered.
B. THE TRANSACTIONS BETWEEN CMC AND NETBANK
CMC's business consisted of originating commercial equipment leases. CMC bought equipment and leased it to consumer end users with sub-prime credit on a nationwide basis. CMC typically obtained a surety bond guaranteeing the payment by each lessee of each individual lease. CMC paid the insurance carrier or surety a premium equal to 2% of the sum total of all payments due under the lease. CMC would then package these insured leases together into a "lease pool" and assign the payment stream due under the leases along with the surety bonds to third party "investors."
NetBank was such an investor. NetBank purchased a total of seventeen lease pools, but only seven pools are at issue in this adversary proceeding. NetBank paid CMC more than $47 million for the payment streams associated with the seven pools.
With respect to each of the seven pools, NetBank, CMC, and Amwest Surety Insurance Company ("Amwest") entered into a separate Sale and Servicing Agreement ("SSA") pursuant to which CMC transferred to NetBank certain rights associated with the pools. Each SSA was identical. Amwest issued surety bonds relating to the CMC-NetBank lease pools. In November 2000, Royal Indemnity Company issued new bonds to replace the surety bonds previously issued by Amwest in connection with the NetBank SSAs.
II. DISCUSSION
A. STANDARDS FOR SUMMARY JUDGMENT
Rule 56(c) of the Federal Rules of Civil Procedure, made applicable to adversary proceedings by Fed.R.Bankr.P. 7056, provides that summary judgment:
[S]hall be rendered forthwith if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.
"The moving party bears the initial responsibility of informing the district court of the basis for its motion, and identifying those portions of `the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any,' which it believes demonstrate the absence of a genuine issue of material fact." Hughes v. United States, 953 F.2d 531, 541 (9th Cir. 1992) citing Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 2553, 91 L.Ed.2d 265 (1986). "After the moving party has met its initial burden, Rule 56(e) . . . requires the nonmoving party to go beyond the pleadings and by her own affidavits, or by the `depositions, answers to interrogatories, and admissions on file,' designate `specific facts showing that there is a genuine issue for trial.'" Hughes, 953 F.2d at 541 (citation omitted).
"There is another important dimension to summary judgment practice: motions for summary judgment must be decided on the record as it stands, not on litigants' visions of what the facts might some day reveal. As we have warned, `[b]rash conjecture, coupled with earnest hope that something concrete will eventually materialize, is insufficient to block summary judgment.'"Maldonado-Denis v. Castillo-Rodriguez, 23 F.3d 576, 581 (1st Cir. 1994) (citation omitted).
B. THE PAYMENT STREAMS CONSTITUTE CHATTEL PAPER
Regardless of whether the transaction between CMC and NetBank constitutes a sale or a loan, if the payment streams assigned to NetBank under the equipment leases constitute chattel paper, NetBank was required to perfect its interests in the payment streams by either filing (UCC § 9-312 (a)), or taking possession (UCC § 9-313 (a)) of the underlying leases. It is undisputed that NetBank did not perfect by either method. The Court therefore first examines whether the payment streams are chattel paper within the contemplation of the UCC.
1. SUMMARY OF THE PARTIES' ARGUMENTS
Both parties acknowledge that the underlying equipment leases are chattel paper, but NetBank contends that it was not the equipment leases that were "sold," but only the payment streams associated with the individual leases. According to NetBank, the payment streams therefore fall within the collateral description of a payment intangible under the UCC.
NetBank points to Article II, Section 2.1 of the SSA which states:
Conveyance of Leases and Related Assets. (A) Subject to the terms and conditions of this Agreement, the Seller, pursuant to the mutually agreed upon terms contained herein, hereby sells, transfers, assigns and otherwise conveys to the Purchaser, without recourse (except as provided in this Agreement), as of the Closing Date, all of the right, title and interest, including any security interest, whether now owned or hereafter acquired, of the Seller in and to the following (the "Transferred Assets");
(i) All contract rights under each Lease to receive all Scheduled Payments commencing with such payments due. . . .
(ii) all funds on deposit from time to time in the Collection Account;
(iii) all rights under the Surety Bonds; and
(iv) any and all proceeds of the foregoing.
The Court views NetBank's argument that CMC transferred only the payment streams, and not the underlying leases, immaterial to the legal issue involved. Therefore, the Court need not resolve any factual dispute between the parties, to the extent there is one, regarding the extent of the Transferred Assets set forth in Section 2.1 of the SSA.
The trustee contends that payment streams flowing from chattel paper, such as the underlying equipment leases, are chattel paper as well. The trustee contends that the statutory definitions, the Official Comments of the UCC, and case law and commentary support his position.
2. STANDARDS FOR STATUTORY INTERPRETATION
In construing the meaning of a statute, the starting point is the language of the statute itself. United States v. Ron Pair Enters., Inc., 489 U.S. 235, 241, 109 S.Ct. 1026 (1989). The plain language of a statute is conclusive as to its meaning when the statutory scheme is coherent and consistent. Id. at 240-41. Any judicial inquiry into the purpose, background or legislative history of the statute is foreclosed unless a literal application of the statute produces "a result demonstrably at odds with the intent of its drafters." Id. at 242. Furthermore, silence should be accorded meaning when the plain language of a statute fails to address a particular situation. Patterson v. Shumate, 504 U.S. 753, 758, 112 S.Ct. 2242 (1992) (divining Congress's intent in drafting a statute by what was not said).
"Frequently, if the provisions of the UCC do not directly resolve a dispute, the Official Comments that accompany the statute provide general guidance to the courts." In re Wiersma, 283 B.R. 294, 300 (Bankr. D. Idaho 2002). Official Comments, while persuasive, are not binding on the court. In re Peregrine Entm't, Ltd., 116 B.R. 194, 198 n. 3 (C.D. Cal. 1990) (stating that "although legislative history generally is a poor source of guidance for statutory interpretation, official commentaries are persuasive") (citation omitted). The Court need not consider the legislative history of Revised Article 9 unless it first concludes that the language of the statute is ambiguous. In re Mike Hammer Prods., Inc., 294 B.R. 752, 754 (B.A.P. 9th Cir. 2003) (stating that "Because the statute [§ 303(i)] is ambiguous, we will consider the legislative history, any relevant cases and public policy considerations.") (Citation omitted).
A canon of statutory construction is that a definition which declares what a term "means" excludes any meaning that is not stated. See 2A Norman J. Singer, Sutherland Statutes and Statutory Construction, § 47.79 (6th ed. 2000); see also In re Yochum, 89 F.3d 661, 666 (9th Cir. 1996) ("[I]n statutes that contain statutory definition sections, it is commonly understood that such definitions establish meaning wherever the terms appear in the same Act.") (Citation omitted).
3. ANALYSIS
In determining whether the payment streams are chattel paper or payment intangibles, the Court first looks at the plain language of the definitions under the Revised Article 9 in Nevada, Nev. R. S. § 104.9102.
Hereinafter, all references to the UCC, and the Official Comments, are to the Revised Article 9 adopted in Nevada. Generally, property rights in bankruptcy are determined according to state law. Butner v. United States, 440 U.S. 48, 99 S. Ct. 914 (1979). The SSA contains a choice of law clause stating that the parties' rights shall be determined in accordance with Nevada law. The parties agree that Nevada law applies to issues of perfection or nonperfection.
(b) "Account," except as used in "account for," means a right to payment of a monetary obligation, whether or not earned by performance, for property that has been or is to be sold, leased, licensed, assigned, or otherwise disposed of; for services rendered or to be rendered; for a policy of insurance issued or to be issued; for a secondary obligation incurred or to be incurred; for energy provided or to be provided; for the use or hire of a vessel under a charter or other contract; arising out of the use of a credit or charge card or information contained on or for use with the card; or as winnings in a lottery or other game of chance operated or sponsored by a state, governmental unit of a state, or person licensed or authorized to operate the game by a state or governmental unit of a state. The term includes health-care-insurance receivables. The term does not include rights to payment evidenced by chattel paper or an instrument; commercial tort claims; deposit accounts; investment property; letter-of-credit rights or letters of credit; or rights to payment for money or funds advanced or sold, other than rights arising out of the use of a credit or charge card or information contained on or for use with the card (emphasis added).
(k) "Chattel paper" means a record or records that evidence both a monetary obligation and a security interest in or a lease of specific goods or of specific goods and software used in the goods, or a security interest in or a lease of specific goods and a license of software used in the goods. The term does not include charters or other contracts involving the use or hire of a vessel, or records that evidence a right to payment arising out of the use of a credit or charge card or information contained on or for use with the card. If a transaction is evidenced by records that include an instrument or series of instruments, the group of records taken together constitutes chattel paper. As used in this paragraph, "monetary obligation" means a monetary obligation secured by the goods or owed under a lease of the goods and includes a monetary obligation with respect to software used in the goods.
(pp) "General intangible" means any personal property, including things in action, other than accounts, chattel paper, commercial tort claims, deposit accounts, documents, goods, instruments, investment property, letter-of-credit rights, letters of credit, money, and oil, gas or other minerals before extraction. The term includes payment intangibles and software.
(iii) "Payment intangible" means a general intangible under which the account debtor's principal obligation is a monetary obligation.
Neither NetBank nor the trustee contend that the payment streams flowing from the underlying equipment leases constitute an account as that term is defined in the UCC. The definition of an account specifically excludes "rights to payment" evidenced by chattel paper.
The Court next examines the definition of chattel paper. The definition states three requirements before collateral is characterized as chattel paper: 1) a record; 2) that evidences both a monetary obligation; and 3) a security in or a lease of specific goods. A monetary obligation is defined as a monetary obligation secured by the goods or owed under a lease of the goods. The parties do not dispute that all three elements for chattel paper are met with respect to the underlying equipment leases, but NetBank seeks to characterize the "monetary obligation" owed under the lease as a "payment intangible." This proposition does not follow from the plain language of the statutory definition of chattel paper and such a reading would essentially delete the monetary obligation requirement from the definition. See Singer, Sutherland Statutes and Statutory Construction, § 47.79 (6th ed. 2000) (A canon of statutory construction is that a definition which declares what a term "means" excludes any meaning that is not stated). The Court finds that the monetary obligation (i.e., the payment streams) constitute chattel paper.
Having found that the payment streams fall within the definition of chattel paper, they cannot be general intangibles (the definition of "General intangible" clearly excludes chattel paper). If the payment streams are not general intangibles, they cannot be payment intangibles.
Although the Court believes the definitions discussed above are quite clear, an examination of the Official Comments, case law and commentary further demonstrates that NetBank's argument is unsupported.
One author noted that "[w]hether a true lease or a non-true lease, if the lessor is fully, partially or collaterally assigning all or any of its rights under a lease . . . then it is assigning `chattel paper.'" Edward K. Gross, Equipment Leasing-Leveraged Leasing, Practicing Law Inst., § 3A:11.1 (October 2001); See also Amelia Boss, Lease Chattel Paper: Unitary Treatment of a `Special' Kind of Commercial Specialty, Duke L.J. 69, 85 (Feb. 1983) (stating that the Code "considers the transfer of the right to payment under a lease to be chattel paper."); 1D Peter F. Coogan, Secured Transactions Under the Uniform Commercial Code § 28.05[1], at 28-39 n. 2 (2003) ("The right to the rentals [under a lease] is not to be conceptualized as a general intangible. . . .").
Several of the Official Comments imply that a transfer of the right to payment under a lease is chattel paper. Official Comment to 9-109 (5), entitled "Transfer of Ownership in Sales of Receivables", states "a `sale' of . . . chattel paper . . .includes a sale of a right in the receivable" (emphasis added). Therefore, the implication from this comment is that a sale of chattel paper operates to transfer the monetary obligation embodied in the paper.
Official Comment 9-313(2) provides that "no filing is required to perfect a security interest if the secured party takes possession of the collateral." The comment further elaborates that "a security interest in accounts and payment intangibles — property not ordinarily represented by any writing whose delivery operates to transfer the right to payment — may under this Article be perfected only by filing" (emphasis added). The implication from this comment is that delivery of a writing, such as the underlying leases in this adversary proceeding, transfers the right to payment embodied in the writing.
Official Comment to 9-102, 5(d), entitled "General Intangible"; "Payment Intangible" states that "Examples [of general intangibles] are various categories of intellectual property and the right to payment of a loan of funds that is not evidenced by chattel paper or an instrument" (emphasis added). This comment suggests that the definition of a general intangible, which includes a payment intangible, describes collateral that is not ordinarily represented by any writing such as the underlying leases in this adversary proceeding.
Besides the Official Comments, case law supports the trustee's position. Although the Nevada Supreme Court has not addressed the issue, the case of In re Commercial Mgmt. Serv., Inc., 127 B.R. 296 (Bankr. D. Mass. 1991) is persuasive to this Court's analysis because the underlying facts and legal issue is similar. There is no indication in the Revised Article 9, as adopted in Nevada, that a different outcome from that espoused in Commercial Management is warranted in this adversary proceeding.
In Commercial Management, the trustee, like NetBank in this adversary proceeding, argued to decouple the right to receive rental payments from the lease itself. The debtor was in the business of equipment leasing. The debtor entered into a Master Sale and Servicing Agreement with Jefferson Loan and Investment Bank ("Jefferson") whereby debtor sold the rights to payment under certain leases for $4.5 million. More than two hundred leases were then physically transferred to Jefferson.
Similar to NetBank's position in this adversary proceeding, the trustee focused on the fact that Jefferson only purchased the rental payments due under the leases. At issue in the case was whether Jefferson's purchase of the right to receive rental payments under an equipment lease was an interest that could be evidenced and perfected by possession of chattel paper. Id. at 302. In analyzing the issue, the court noted:
Although the Code does not specifically provide this,
[t]aking possession of the collateral, the chattel paper itself, would be meaningless unless the paper represented the underlying rights which were transferred by a transfer of the paper. Therefore, the necessary implication of Section 9-305 is that delivery of chattel paper operates to transfer the claim that the paper represents. . . .
. . . .
[S]ection 9-305 bestows on leases an important element of negotiability: a lease is treated as the embodiment of the rights it represents such that these rights are transferred by a transfer of the lease document.
The Revised Article 9 addresses perfection by possession of chattel paper in 9-313(a). The Official Comment to this section specifically excludes possession as a method of perfection for accounts or payment intangibles — "property not ordinarily represented by any writing whose delivery operates to transfer the right to payment." See Official Comment 9-313(2). As theCommercial Management court noted: "the necessary implication of Section [9-313] is that delivery of chattel paper operates to transfer the claim that the paper represents."
Id. at 302 (footnote and citation omitted).
The court also noted that the trustee's position was contrary to those views espoused by numerous commentators:
The drafters theoretically did not need to include true leases in the Code definition of chattel paper but could have included them within the definition of an account. Section 9-106 defines an account as `any right to payment for goods sold or leased . . . which is not evidenced by an instrument or chattel paper.' The right to payment under a lease fits within this definition and is excluded only by the existence of a writing, which usually transforms it into chattel paper. . . . The explicit exclusion of vessel leases from the definition of chattel paper demonstrates that a lease could easily and properly be treated as an account.
. . . .
Conceptually and functionally, the assignment of a true lease resembles an account far more than it resembles chattel paper. . . . The Code treats the transfer of the right to payment under a sales contract as an account, but considers the transfer of the right to payment under a lease to be chattel paper.
. . . .
Nothing in the concept of chattel paper calls for an embodiment of the reversionary right while the goods are in the lessee's hands, instead of the debtor's. Chattel paper exists to create the possessory-based advantages of negotiability that come from paperizing an intangible, an account receivable. Nothing . . . suggests chattel paper also exists to capture advantages associated with paperizing a right to tangible property such as goods, except insofar as those rights are inherently ancillary to the intangible rights being paperized.
Id. at 303-04 (internal citations omitted). The court found Jefferson's purchase of the right to receive rental payments under an equipment lease was an interest that could be evidenced and perfected by possession of chattel paper.
The trustee also cited In re the Bennett Funding Group, Inc., 203 B.R. 30 (Bankr. N.D.N.Y. 1996), aff'd in part, rev'd in part, 255 B.R. 616 (N.D.N.Y. 2000) in support of his position that the payment streams arising under the equipment leases are chattel paper. In Bennett, various banks had to establish the validity and perfection of their alleged security interest in certain leases and the income stream generated therefrom, including postpetition payments made to the trustee.
The debtor "was in the business of originating, purchasing and selling commercial leases of copy machines and other office equipment." 203 B.R. at 32. To finance its operations, the debtor compiled various leases into portfolios "designed to provide for the payment of loan principal and interest to the Banks. . . ."Id. The banks had various documents in their possession, including the originals of the leases. Id. at 33.
The bankruptcy court noted that "chattel paper in this case consists of individual leases of equipment and the monetary obligation payable at some time in the future by a lessee under the terms of a particular lease." Id. at 38. The bankruptcy court further explained that "once the lessee has made a payment, there has been a conversion of the lessee's `monetary obligation' and an ensuing reduction of the value of the chattel paper. At the same time, the actual payment represents new collateral in the form of `proceeds.'" Id.
Although Bennett Funding is not directly on point because it also involved the analysis of Bankruptcy Code §§ 546(b) and 552, its holding is relevant in that the court found that chattel paper "consists of individual leases of equipment and the monetary obligation payable at some time in the future by a lessee under the terms of a particular lease." Id. There is nothing in the Revised Article 9, as adopted in Nevada, that suggests the outcome in Bennett would be different under the new law. Therefore, the payment streams are not likely to be general intangibles as NetBank contends.
Finally, NetBank's argument for automatic perfection of the payment streams (in the case of a sale) undermines the primary purpose of including chattel paper in Article 9. As the trustee points out, a party would be able to obtain an automatically perfected interest in the monetary obligation due under a lease which is chattel paper, without providing any notice whatsoever. Further, since the automatic perfection of payment intangibles only occurs in a true sale situation, to include the right to payment under chattel paper in the definition of payment intangibles would "lead to endless debates over whether particular factoring transactions are true sales or, in substance, secured loans." NetBank's interpretation would undoubtedly lead to confusion in the equipment leasing and financing world.
Trustee's Memorandum of Points and Authorities in Opposition to Motion for Partial Summary Judgment by NetBank at 36:2-3 [Docket #85].
Based upon this Court's analysis of the statutory language, Official Comments, case law and other extrinsic commentary, the Court finds that the payment streams under the equipment leases are chattel paper. NetBank failed to perfect its interests in the payment streams by either filing (UCC § 9-312(a)), or taking possession of the leases (UCC § 9-313(a)). Therefore, regardless of whether this Court characterizes the transaction between the parties as a sale or a loan, NetBank's failure to perfect allows the trustee to use his strong-arm powers.
Interestingly, NetBank seems to imply that it was the sureties' responsibility under the SSA to protect NetBank's interests [See NetBank Memorandum of Points and Authorities in Support of Motion for Partial Summary Judgment at 34:8-11, Docket # 28 in Adversary Case No. 03-90329].
The Court denies NetBank's motion for summary judgment on this issue and grants the trustee's cross motion for summary judgment.
C. THE TRANSACTION BETWEEN NETBANK AND CMC UNDER THE SSA WAS A LOAN
1. SUMMARY OF THE PARTIES' ARGUMENTS
NetBank argues that the language in the SSA is clearly cast in terms of an outright sale. CMC is identified as the "seller" and NetBank is identified as the "purchaser." NetBank also points to section 2.1(c) of the SSA and argues that it demonstrates that the parties' intent was an outright sale and that the property was not intended to be part of the seller's bankruptcy estate. NetBank maintains that it had no direct recourse against CMC, but instead had to proceed against the surety bonds. Finally, NetBank contends that CMC's duty to act as sub-servicer for the loans shows that it was acting merely as an intermediary between the lessees and NetBank.
Section 2.1(c) provides:
The execution and delivery of this Agreement shall constitute an acknowledgment by each of the Seller and the Purchaser that they intend that each assignment and transfer contemplated constitute a sale and assignment outright, and not for security, of the property described in Section 2.1(a), conveying good title thereto free and clear of any Liens, from the Seller to the Purchaser, and that all such property shall not be a part of the estate of the Seller in the event of the bankruptcy, reorganization, arrangement, insolvency or liquidation Proceeding, or other Proceeding under any federal or state bankruptcy or similar law, of the occurrence of another similar event, of, or with respect to the Seller.
The trustee contends that the SSA "dressed up" the transaction to make it look like an outright sale, and sought to label it as such, but when one strips away the "dressing" and examines the economic substance of what took place, the transaction has all the characteristics of a loan. He also argues that CMC retained the risks of ownership because it was CMC that bore the risk that a lessee would default.
2. STANDARDS FOR DETERMINING THE SALE/LOAN DISTINCTION
Revised Article 9 of the UCC does not contain any definitional guidance on what is or is not a true sale or a disguised loan. The Official Comment to Nev. R.S. § 104.9109(4) states that "Although this Article occasionally distinguishes between outright sales of receivables and sales that secure an obligation, neither this Article nor the definition of `security interest' . . . delineates how a particular transaction is to be classified. That issue is left to the courts." Therefore, the Court looks to Ninth Circuit case law for guidance.
This issue is also determined according to Nevada law.See supra note 3.
In the Ninth Circuit, the two leading cases on the issue areIn re Golden Plan of Cal., Inc., 829 F.2d 705 (9th Cir. 1987) and In re Woodson Co., 813 F.2d 266 (9th Cir. 1986). Although the court in Golden Plan focused on the documentation and the intent of the parties, the court noted that whether "the parties intended outright sales or loans for security is determined from all the facts and circumstances surrounding the transactions at issue." Golden Plan, 829 F.2d at 709. Further, the Woodson court held that "[l]abels cannot change the true nature of the underlying transactions." Woodson, 813 F.2d at 272 (citations omitted). Therefore, while the Court will examine the documentation related to the transaction, the labels used by the parties are not dispositive. The Woodson court also considered in its analysis the extent to which the risks and benefits associated with ownership have either been retained or transferred. Id. (citations omitted). The risk/benefit analysis assists the Court in determining the economic substance of the transaction.
3. ANALYSIS
The Court concludes that it appears from the four corners of the SSA, the indemnity agreement and the surety bond, that the economic substance of the transaction between CMC and NetBank has the following attributes of a loan:
• NetBank was to be repaid its principal and interest at a stated rate;
• NetBank was given a security interest in, inter alia, the payment streams and the underlying equipment, which was to be released when NetBank was paid in full;
• CMC retained an interest in the Transferred Assets because under the SSA, once NetBank was fully paid, any remaining Transferred Assets were conveyed to CMC;
• CMC assumed the risk of default under the leases by purchasing the surety bonds that ran in favor of NetBank and by agreeing to indemnify the surety in the event it had to pay under the bonds; and
• The SSA provided that the transaction would be treated as a loan for income tax purposes.
The Court is not bound by the characterization set forth in the SSA. Woodson, 813 F.2d at 272. Even though the SSA is called a "Sales and Servicing Agreement" and calls CMC the "Seller" and NetBank a "Purchaser," the SSA is replete with loan language, including, inter alia, the definitions of the Original Principal Amount, Interest Rate, Interest Distributable Amounts, Monthly Interest Distributable Amount, Principal Balance, and Interest Carryover Shortfall.
Other provisions of the SSA indicate a loan rather than a sale. For example, CMC granted NetBank a security interest in various collateral under section 2.1(b), including a security interest in the payment streams, the underlying equipment, and rights under the bonds. The various interests granted to NetBank provided additional security against the risk of default by a lessee.
Further, those security interests granted to NetBank terminated under section 2.8, entitled "Termination of this Agreement," once NetBank was paid. See In re Evergreen Valley Resort, Inc., 23 B.R. 659, 661 (Bankr. D. Me. 1982) ("A security interest is also indicated when the assignee acknowledges that his rights in the assigned property would be extinguished if the debt owed were to be paid through some other source").
CMC also retained an interest in the Transferred Assets it allegedly sold to NetBank. Once NetBank was fully paid, under section 2.8 of the SSA, "[a]ny remaining Transferred Assets shall thence be conveyed to the Seller without recourse." See In re Hurricane Elkhorn Coal Corp. II, 19 B.R. 609, 619 (Bankr. W.D. Ky. 1982) aff'd in part, rev'd in part, 32 B.R. 737 (W.D. Ky. 1983), aff'd, 763 F.2d 188 (6th Cir. 1985) (finding alleged "absolute assignment" was a loan where debtor and bank had course of dealing that demonstrated debtor retained interest in the property it gave for security).
CMC also at all times retained the risk that an individual lessee would default under the lease, which suggests that the transaction was a loan. The combined obligations under the SSA, the surety bond, and the indemnity agreement running from CMC to the surety, demonstrate that the risk of ownership was never transferred to NetBank. In reality, CMC's purchase of the surety bonds demonstrates that NetBank was unwilling to lend money to CMC and take the risk of a lessee's default. The transaction was structured so that NetBank could never truly lose its "investment" because in the event of default, NetBank could always look to the bonds for payment.
Under the SSA, CMC, as sub-servicer was obligated to collect all lease payments from the lessees, and transmit those payments to NetBank. In the event the aggregate of the lessees' payments was less than the "principal" and "interest" due, CMC had the option under the SSA to pay any shortfall to NetBank as a "sub-servicer advance." If CMC did not cover the shortfall through a sub-servicer advance, NetBank could make a claim under the surety bonds. Under the indemnity agreement, if NetBank made a claim under the surety bonds, CMC was obligated to "hold harmless" the surety as against all "demands" and "claims," by either paying NetBank the shortfall, or reimbursing the surety if the surety had paid NetBank. Thus, in the event of a shortfall, CMC was ultimately responsible.
NetBank argues that absent a guarantee by CMC or direct recourse, the existence of the indemnities is irrelevant. This argument, however, focuses on form over substance. The surety bonds were purchased by CMC to guarantee the payment of each individual lease obligation so that NetBank did not have to take that risk. CMC paid a premium equal to 2% of the sum total of all payments due under the lease for this form of a guarantee and also was required to indemnify the surety. Thus, in essence, it was CMC who retained the risk of the individual lessee's default.
In this respect, the transaction is similar to that inWoodson:
. . . [The] permanent investors were not subject to any risk when they transferred funds to Woodson. They were paid monthly interest regardless of whether the original borrower paid Woodson. In the event of default, Woodson paid the investor the interest and the balance principal owed on the investor's "participation.". . . . Woodson did not merely guarantee a certain return, but effectively guaranteed against all risk of loss. . . . We conclude that the transactions with the permanent investors were loans. The permanent investors possessed none of the usual indicia of ownership. By contrast, Woodson retained all of the obligations of an owner and conducted itself throughout as owner. Simply calling transactions `sales' does not make them so.
In contrast, the risk of nonpayment was present in Golden Plan and the Ninth Circuit found there was an outright sale. Golden Plan, a loan brokerage company, extended loans and then assigned its interests in the notes and trust deeds relating to the loans to investors in exchange for cash payments. If the assigned loans went into default, the investors were not guaranteed payment from any source. Golden Plan could, but was not obligated to, make advances on the defaulted loans. 829 F.2d at 709-10. The court stated: "Such assumption of risk strongly suggests that the . . . Investors were not in a creditor-debtor relationship with Golden Plan." Id. at 709. But in Golden Plan there was no third party, such as the surety in this transaction, to make the Investors whole.
Finally, the trustee points out that under section 2.10 entitled "Income Tax Characterization," the SSA specifically provides that the transactions would be treated as loans for income tax purposes. This provision suggests that over the years NetBank has reported these transactions as loans on their income tax returns, but now contends the same transactions constitute a sale. The Court cannot, however, make any determination in this regard because no evidence was presented that demonstrated NetBank had in fact reported these transactions as loans on their income tax returns. Yet, the characterization of the transaction as a loan for tax purposes is relevant since "to ensure a lease securitization transaction is treated as a loan for tax purposes, the lessor must retain the benefits and burdens of ownership of the lease receivables." See Stuart M. Litwin and William A. Levy, Securitization of Equipment and Auto Leases, Practising Law. Inst., Comm. Law and Prac. Court Handbook Series, Tax Issues, § 30.3 (November 2003).
As discussed above, this is what CMC did — retained the benefits and burdens of ownership of the lease receivables. In sum, the Court concludes that the economic substance of the transaction between NetBank and CMC was a loan, and not a sale.
The Court denies NetBank's motion for summary judgment on this issue and grants the trustee's cross motion for summary judgment.
IV. CONCLUSION
For the reasons noted above, the Court finds that the payment streams transferred from CMC to NetBank constitute chattel paper and not payment intangibles. Therefore, NetBank was required to perfect its interests in the payment streams regardless of whether the transaction between CMC and NetBank constitutes a sale or a loan. The Court also finds that the transaction between CMC and NetBank constitutes a loan.
Accordingly, the Court denies NetBank's motion for partial summary judgment and grants the trustee's cross motion for summary judgment.
This Memorandum Decision constitutes findings of fact and conclusions of law pursuant to Federal Rule of Bankruptcy Procedure 7052. Counsel for the trustee is directed to file with this Court an order in conformance with this Memorandum Decision within ten (10) days from the date of entry hereof.