Opinion
CASE NO.: 02-16172, ADV. NO.: 02-1305
April 17, 2003
MEMORANDUM OF OPINION AND ORDER
The matter before the Court are cross-motions for partial summary judgment filed by the Plaintiff-Debtor, Level Propane Gases, Inc. (Debtor) and Defendant, Maxus Leasing Group, Inc. (Maxus). Each party has filed a timely objection to the respective motions. Core Jurisdiction of this matter is acquired under provisions of 28 U.S.C. § 157 (b)(2)(A), 28 U.S.C. § 1334, and General Order No. 84 of this District. After conclusion of the duly-noticed hearing, arguments of counsel, and a review of the court's record, the following factual findings and conclusions of law are hereby rendered:
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On or about June 19, 1995, the Debtor and Maxus entered into an agreement captioned Master Lease No. 1092 (Maxus Exh. 1). Pursuant to the Master Agreement, Maxus purportedly agreed to lease to Debtor certain equipment described in various schedules which are incorporated by reference in the Master Agreement. On or about December 8, 2000, Debtor and Maxus entered into Schedules No. 036, and 037 wherein Maxus purportedly agreed to lease certain equipment: 1,572 tanks of various sizes under Schedule No. 036 and 1,408 tanks of various sizes under Schedule No. 037.
The Debtor's reply memorandum dated January 3, 2003, notes that Interim Finance Agreement under Schedule No. 038 (Master Lease 1092-038) is no longer an contested issue.
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Debtor seeks partial summary judgment declaring that Master Lease Agreement, Schedule Nos. 036, and 037, (collectively the "purported leases")create security interests and not true leases. In its motion for partial summary judgment, Maxus seeks a declaration that the same create true leases and not security interests.
The motion for partial summary judgment includes a challenge to Schedule 028, but the Debtor has conceded that it previously rejected it, and, therefore the "law of the case" precludes it from recharacterizing the lease in this proceeding.
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The cross-motions for partial summary judgment filed by the parties address the identical issue presented to the Court at a duly noticed evidentiary hearing on December 11-12, 2002. Therein, the dispositive issue was whether the subject lease transactions were true (i.e. operating) leases or whether they were, in fact, disguised security interest. In a Memorandum of Opinion and Order entered by this Court on March 26, 2002, it was determined that the subject transactions were, indeed, disguised security interests.
As party of Maxus' argument in support of its cross motion for partial summary judgment, it argued that, notwithstanding the Court's aforesaid ruling on the contested matter, a ruling on its partial summary judgment motion remained appropriate as there exists an unadjudicated adversary proceeding.
The following comments were made, in part, by Maxus' counsel at the outset of the referenced evidentiary hearing:
MR. LEPENE: The only additional comment that I would make, Your Honor, is that the debtors here are seeking relief from the provisions of Section 365 D10 (sic) which require that payments be made on leases from and after the sixtieth day. The basis for that is that they have filed adversary proceedings challenging the characterization of those agreements as leases, which they are denominated on their face as leases, and they're seeking to recharacterize those as security agreements, and it's on that basis, the existence of these adversary proceedings that they say they should not be required to make these payments. We don't believe that there is any merit underlying the adversary proceedings that have been filed, Your Honor, and in light of the fact that they have the burden of proof with respect to that issue of recharacterization, we think that it is appropriate in the context of this proceeding to decide whether they are entitled to relief from Section 365 D10 (sic), that the court should address, not for purposes of making any final determination, but for the purposes of assessing the relative strength of the positions of the parties with respect to that issue . . .
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. . . It's not to make any final determination, but it is to assist the court in enabling the court to decide whether they can carry their burden of proof for relief from the requirements of Section 365 D10 (sic).
(Trans. at pg. 5, lines 13-25; pg. 6 Lines 1-17; pg. 7, Lines 18-23). Counsel's above-quoted comment that the purpose of the evidentiary hearing was ". . . not for the purposes of making any final determination, but the purposes of assessing the relative strength of the positions of the parties with respect to that issue" is without merit. A self-serving declaration by one or more parties that the litigants do not seek a final ruling, while invoking a federal forum, does nothing to negate the fact that they have, indeed, invoked the federal forum which leads to an adjudicated result. Litigants in a contested matter simply cannot use a contested matter's evidentiary hearing, which consumed a two-day period, as a testing ground for a pending adversary proceeding. At any rate, no supporting authority was given for such argument. Rule 7001 provides:
An adversary proceeding is governed by the rules of this Part VII. The following are adversary proceedings:
(1) a proceeding to recover money or property, other than a proceeding to compel the debtor to deliver property to the trustee, or a proceeding under S 554(b) or S 725 of the Code, Rule 2017, or Rule 6002;
(2) a proceeding to determine the validity, priority, or extent of a lien or other interest in property, other than a proceeding under Rule 4003(d);
(3) a proceeding to obtain approval under S 363(h) for the sale of both the interest of the estate and of a co-owner in property;
(4) a proceeding to object to or revoke a discharge;
(5) a proceeding to revoke an order of confirmation of a chapter 11, chapter 12, or chapter 13 plan;
(6) a proceeding to determine the dischargeability of a debt;
(7) a proceeding to obtain an injunction or other equitable relief, except when a chapter 9, chapter 11, chapter 12, or chapter 13 plan provides for the relief;
(8) a proceeding to subordinate any allowed claim or interest, except when a chapter 9, chapter 11, chapter 12, or chapter 13 plan provides for subordination;
(9) a proceeding to obtain a declaratory judgment relating to any of the foregoing; or
(10) a proceeding to determine a claim or cause of action removed under 28 U.S.C. § 1452.
F.R.Bankr.P. 7001. The express language of Rule 7001 is not to give vent to an unnecessary act. Although subsection (2) of Rule 7001 speaks of proceedings to determine the validity, priority, or extent of a lien or other interest in property as constituting an adversary proceeding, it does not require a futile act. Herein, the parties fully litigated an evidentiary hearing on the same issue of the proper characterization of the subject lease transactions, as stated above. A final, appealable ruling was issued thereon. Indeed, Maxus has appealed the ruling. Now Maxus asserts that the present cross motions for partial summary judgment addressing the same issue regarding the nature of the transactions, is still before the Court due to the pending adversary proceeding.
The purpose of the bankruptcy procedural rules is worth examination. In pertinent part Rule 1001 states, "these rules shall be construed to secure the just, speedy, and inexpensive determination of every case and proceeding." F.R.Bankr.P. 1001. There has occurred no total abridgment of the procedural concerns of Rule 7001(2), as seemingly suggested by Maxus. The referenced evidentiary hearing on the contested matter wherein a ruling was issued is covered under Part Nine of the procedural rules. Nevertheless, it is clear that even under Part Nine, specifically Rule 9014, several of the Part Seven rules apply to contested matters. Moreover, as the Advisory Committee Notes attendant to Rule 1001 explain, "[a]ny procedural matters contained in Title 11 or 28 U.S.C. with respect to cases filed under 11 U.S.C. would control.
See, Collier's on Bankruptcy ¶ 3.04[2][c](15th ed. 1980).
Therefore, the principal dispositive issue for determination of the cross motions for partial summary judgment is whether the subject transactions involve true leases or disguised security interests. Bankruptcy courts typically look to applicable nonbankruptcy law for guidance on this issue, and the characterization affixed by the parties is not necessarily controlling. Where states have adopted the Uniform Commercial Code (UCC), provisions of UCC § 1-201 (37) are considered in distinguishing a true lease from a disguised security transaction. This is of particular significance since, for various accounting and tax purposes, a transaction which is in substance a secured installment sale of equipment is sometimes documented as a lease. UCC § 1-201 (37) defines what is a "security interest" and sets forth the analysis for distinguishing a true lease from a security agreement. A "security interest" is an "interest in personal property or fixtures which secures payment or performance of an obligation." The UCC defines a "lease" as "transfer of the right to possession and use of goods for a term in return for consideration." UCC § 2A-103(1)(j).
Ohio has adopted the UCC, as codified under Ohio Revised Code § 1301.01 (KK)(2)(d).
UCC § 1-201 (37)
Under provisions of UCC § 1-201 (37), as codified in Ohio under Ohio Revised Code § 1301.01(KK)(2)(d), a transaction qualifies as a security interest and falls within the scope of Article 9 if the consideration the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease and is not subject to termination by the lessee. Once this threshold requirement is satisfied, then the transaction will be treated as a secured loan if any one of the following four standards are met:
(1) the original term of the lease is equal to or greater than the remaining economic life of the goods;
(2) 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;
(3) The lessee has an option to renew the lease for the remaining economic life of the goods for no or minimal consideration;
(4) The lessee has an option to become the owner of the goods for no or nominal consideration.
Section 1-201 (37) also provides that a transaction does not create a security interest merely because it provides that:
(a) the present value of the consideration the lessee is obligated to pay the lessor for the right to possession and use of the goods is substantially equal to or is greater than the fair market value of the goods at the time the lease is entered into,
(b) the lessee assumes risk of loss of the goods, or agrees to pay taxes, insurance, filing, recording, or registration fees, or service or maintenance costs with respect to the goods,
(c) the lessee has an option to renew the lease or to become the owner of the goods,
(d) the lessee has an option to renew the lease for a fixed rent that is equal to or greater than the reasonably predictable fair market rent for the use of the goods for the term of the renewal at the time the option is to be performed, or
(e) the lessee has an option to become the owner of the goods for a fixed price that is equal to or greater than the reasonably predictable fair market value of the goods at the time the option is to be performed.
Equally important, UCC § 1-201 (37) also provides for certain definitions to be applied to the above provisions. See UCC § 1-201 (37)(x-z).
The 1992 amendment to UCC § 1-201 (37) was designed to correct any confusion by eliminating reference to the "intent of the parties" in a purported lease agreement. The current test is whether the lease itself "creates" a security interest. UCC § 1-201 (37) and Article 2A seek to "draw a sharper line between leases and security interests disguised as leases to create greater certainty in commercial transactions" by focusing attention on the economics of the transaction rather than the "intent" of the parties. See UCC § 1-201 (37) Official Comment. The 1992 amendment to O.R.C. § 1301.01 (KK), also shifted the focus of the characterization issue to the economics of the transaction by deleting all references to the parties' intent. See Hanes v. Vital Prods. Co. (In re Vital Prods. Co.), 210 B.R. 109, 112 (Bankr. N.D.Ohio 1997) (applying Ohio law) ("[T]he present version of UCC § 1-201 (37) has shifted the focus from `the intent of the parties' to the economic realities of a given transaction. . . .").
Other Evaluative Standards
The Financial Accounting Standard Board's (FASB)FASB-13 requires that all capital leases (i.e. security leases) be capitalized. Specifically, the present value of the lease payments must be calculated and shown alongside debt on the right-side of the balance sheet. That same amount must be shown, correspondingly, as an asset on the left-hand side of the balance sheet. In order to implement this accounting rule, the FASB developed objective rules for distinguishing between true leases (otherwise known as operating leases) and capital (security) leases. Thereunder, generally, a finance lease is determined to exist where any of the following requirements are embodied in the lease:
(a) The lease agreement transfers ownership to the lessee before the lease expires;
(b) The lessee can purchase the asset for a bargain price when the lease expires;
(c) The lease lasts for at least 75 percent of the assets' estimated economic life;
(d) The present value of the lease payments is at least 90 percent of the assets' value.
Thusly, the FASB requirements for distinguishing between true leases and disguised security interests (i.e. capital leases, as addressed under UCC § 1-201 (37)), are determined in a nonconjunctive manner. All other leases are deemed to be true leases for accounting purposes.
The IRS also has its criteria to determine the true nature of a lease. Under its evaluative criteria, the IRS closely examines such transactions to discern whether the lease is a true operating lease or whether it is a capital lease. It (IRS) will not allow a lessee to deduct the entire lease payment unless it is satisfied that the transaction is indeed a true lease, as opposed to a disguised installment purchase (i.e., capital lease). Purported provisions which tip the IRS that the lease may, in fact, be a disguised security interest are the following;
1. Designating any part of the lease payment as "interest."
2. Giving the lessee the option to acquire the asset for a very nominal price when the lease expires.
3. Adopting a schedule of payments such that the lessee pays a large proportion of the cost over a short period and thereafter is able to use the asset for a nominal rent.
4. Including a so-called hell-or-high-water clause that obligates the lessee to make payments regardless of what subsequently happens to the lessor or the equipment.
5. Limiting the lessee's right to issue debt or pay dividends while the lease is in force. (i.e., negative covenants).
6. Leasing "limited use" property — for example, leasing a machine or production facility custom-designed for the lessee's operations, and which therefore would have scant secondhand value.
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THE MASTER LEASE
The document which is captioned "Master Lease" was executed on June 19, 1995 by William H. Maloof, President, on behalf of the Debtor, and by Chris A. Di Lillos, President, on behalf of Maxus. Remarkably, it contains, inter alia, the following provisions:
1. "Lessor and Lessee agree, and Lessee represents for the benefit of Lessor and its Assignee(s) that the Lease is intended to be a `finance lease' and not a "lease intended as security' as those terms are used in the Uniform Commercial Code and that the Lease is intended to be `true lease' as the term is commonly used under the Internal Revenue Code of 1986, as amended." (Section 9(b) of the Master Lease).
2. "Lessee has no interest in the Equipment except as expressly set forth in the Lease, and that interest is a lease-hold interest." (Section 9(b) of the Master Lease).
3. "The parties agree that this lease is a `Finance Lease' as defined by Section 2A-103(g) of the Uniform Commercial Code (`UCC'). Lessee acknowledges that either (a) that Lessee has reviewed and approved any written Supply Contract (as defined by UCC § 2A-103(y)) covering the Equipment purchased from the `Supplier' (ii) that the Lessee may have rights under the Supply Contract; and (iii) that the Lessee may contact the supplier for a description of any such rights Lessee may have under the Supply Contract." (Section 6 of Master Lease).
"Finance Lease" means a lease with respect to which:
(I) the lessor does not select, manufacture, or supply the goods;
(ii) the lessor acquires the goods or the right to possession and use of the goods in connection with the lease; and
(iii) one of the following occurs:
(A) the lessee receives a copy of the contract by which the lessor acquired the goods or the right to possession and use of the goods before signing the lease contract;
(B) the lessee's approval of the contract by which the lessor acquired the goods or the right to possession and use of the goods is a condition to effectiveness of the lease contract;
(C) the lessee, before signing the lease contract, receives an accurate and complete statement designating the promises and warranties, and any disclaimers of warranties, limitations or modifications of remedies, or liquidated damages, including those of a third party, such as the manufacturer of the goods, provided to the lessor by the person supplying the goods in connection with or as part of the contract by which the lessor acquired the goods or the right to possession and use of the goods; or
(D) if the lease is not a consumer lease, the lessor, before the lessee signs the lease contract, informs the lessee in writing (a) of the identity of the person supplying the goods to the lessor, unless the lessee has selected that person and directed the lessor to acquire the goods or the right to possession and use of the goods from that person, (b) that the lessee is entitled under this chapter to the promises and warranties, including those of any third party, provided to the lessor by the person supplying the goods in connection with or as part of the contract by which the lessor acquired the goods or the right to possession and use of the goods, and (c) that the lessee may communicate with the person supplying the goods to the lessor and receive an accurate and complete statement of those promises and warranties, including any disclaimers and limitations of them or of remedies.
O.R.C. § 2A-103(g) (West Supp. 2002).
4. "The Lease is a net lease, it being the intention of the parties that all costs, expenses, and liabilities associated with the Equipment or its lease shall be borne by Lessee." (Section 5 of the Master Lease).
5. "It is the express intention of the Lessor and Lessee that all rent and other sums payable to Lessee under the Lease shall be, and continue to be, payable in all events throughout the terms of the Lease. The Lease shall be binding upon the Lessee, its successors and permitted assigns . . ." (Section 5 of the Master Lease).
6. "Lessee's obligations under the Lease with respect to Assignee shall be absolute and unconditional and not be subject to any abatement, reduction, recoupment, defense, offset or counterclaim for any reason . . ." (Section 11 of the Master Lease).
7. "Lessee represents and warrants to Lessor and its Assignee(s)(i) that the execution, delivery and performance of this Master Agreement and Lease was duly authorized and that upon execution of this Master Agreement and the Lease by Lessee and Lessor, the Master Agreement and the Lease will be in full force and effect and constitute a valid legal and binding obligation of the Lessee, and enforceable against the Lessee in accordance with its respective terms . . ." (Section 16(a) of the Master Lease).
8. "The foregoing representations and warranties shall survive the execution and delivery of the Lease and any amendments hereto and shall upon the written request of Lessor be made to Lessor's Assignee(s)." (Section 16(a) of the Master Lease).
9. "The Master Agreement and the Lease constitute the entire and only agreement between Lessee and Lessor with respect to the lease of the Equipment, and the parties have only those rights and have incurred only those obligations as specifically set forth herein." (Section 19 of the Master Lease).
10. "Lessee acknowledges that Lessor shall be entitled to claim for federal income tax purposes (I) deductions (hereinafter called `Depreciation Deductions') on Lessor's cost of the Equipment for each of its tax years during the term of the Lease under any method of depreciation or other cost recovery formula permitted by the Internal Revenue Code . . . Lessee agrees to take no action inconsistent (including the voluntary substitution of Equipment) with the foregoing or which would result in the loss, disallowance, recapture or unavailability to Lessor of Depreciation. Deductions or Interest Deductions." (Section 18 of the Master Lease).
11. "The Lease constitutes the entire and final agreement between the Lessor and Lessee and may not be contradicted by evidence of prior, contemporaneous or subsequent oral discussions, negotiations or agreements of the parties." (Section 20 of the Master Lease). (See Maxus Exh. 1).
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The burden of proving whether a particular agreement is a true lease or a disguised security agreement is upon the party challenging the characterization of the lease at issue. In re Murray, 191 B.R. 309, 316 (Bankr. E.D. Pa. 1996 holding that debtor, who sought to characterize the lease agreement as a disguised security agreement, had the burden to "prove that the Lease is other than what it purports to be"); In re Zaleha, 159 B.R. 581, 586 (Bankr. D. Idaho 1993) (holding that "where the transaction is denominated a lease, the burden is upon the debtor [who sought to characterize it as otherwise] to demonstrate that the transaction is in fact a disguised security interest rather than a true lease");; In re Aspen impressions Inc., 94 B.R. 861, 866 (Bankr. E.D. Pa. 1989) (noting that burden of persuasion rests upon "the objector who desires to have the purported lease declared a security agreement"); In re Farrell, 79 B.R. 300, 303 (Bankr. S.D. Ohio 1987) (holding that debtor, who sought to characterize, had the burden to show that the purchase option would be nominal); Bank of New York v. Olympia York Florida Equity Corp. (In re Holywell Corp.), 51 B.R. 56, 58 (Bankr.S.D.Fla. 1985) (noting that the party seeking characterization had the burden of showing that the option price would be nominal). Herein that burden falls upon the Debtor who objected to the relief sought by Maxus upon the contention that the purported leases are disguised security agreements. Such burden must be borne by a preponderance of the evidence.
To meet its burden of proof, the Debtor must initially demonstrate that the Master Lease and the Lease Schedules gave no right of termination to it prior to the expiration of the base term. Then, the Debtor must establish one of the four standards embodied in UCC § 1-201 (37). It is undisputed that the Debtor had no right to terminate the purported lease prior to the expiration of the base term. (See Master Lease Sections 5 and 11). Thusly, the Court focuses its attention on the four factors under UCC § 1-201 (37).
UCC § 1-201 (37)(a) provides that a lease agreement should be characterized as creating a security interest if "the original term of the lease is equal to or greater than the remaining economic life of the goods." Debtor does not refute that § 1-201 (37)(a) is not applicable here.
Next, UCC § 1-201 (37)(b) provides that a lease agreement creates a security interest if "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." The Debtor contends that it has contractual options to become the owner of the subject tanks, and, based on the economic realities of the case, is bound to purchase the subject tanks. Yet, the Master Lease (Maxus Exh. 1) and the Lease Schedules (Maxus Exhs. 2 and 3) contain no provisions which bind the Debtor (Lessee) to either renew the leases for the remaining economic life of the tanks or become the owner of the tanks. Moreover, no evidence was presented by the Debtor (Lessee) that it was, in fact, bound to renew the leases or become the owner of the tanks at the end of the base term or at the end of any extension term. Therefore, that section is inapplicable herein.
UCC § 1-201 (37)(c) provides that a lease should be determined to be a security interest if "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." The only option to renew that was available to the Debtor (Lessee) under each of the Lease Schedules was at the end of the sixth year and was conditioned upon Level Propane's agreement to pay a "fair rental value", defined in the Lease Schedules as "the rental that would be obtained in an arm's length transaction between a willing lessor and a willing lessee, neither under a compulsion to lease." Debtor is not asserting the applicability of this factor in its objection to Maxus' motion. (Maxus Exhs. 2 and 3, Section 8).
UCC § 1-201 (37)(d) provides that a lease should be recharacterized as a security agreement if "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."
Schedule Nos. 036 and 037
Under each of the Lease Schedules, the option price at the end of the base term is the greater of the then fair market value of the tanks or 20% of their original cost. (Maxus Exhs. 2 and 3, section 8, captioned "End of Base Term") The option price at the end of the extended term is the then fair market value of the tanks. ( Id.).
Schedule Nos. 36 and 37 contain similar language under the section captioned "End of Base Term Options": That section provides in parts:
Each Schedule provides in pertinent part that Debtor shall have the option at the end of the initial Base Term to purchase all the equipment for a purchase price equal to the greater of (1) the then fair market value of the equipment or (2) 20% of the original cost of the equipment. If the Debtor does not exercise such purchase option, the Base Term shall automatically be extended for a period of 12 months. Debtor shall have the option at the end of the Extension Term to renew the agreement as to all of the equipment at a rental equal to the then fair rental value of the equipment. If Debtor does not exercise such renewal option, Debtor shall further have the option at the end of the Extension Term to purchase all of the equipment for a purchase price equal to the then fair market value of the equipment. "Fair market value" is defined to be a price ". . . obtained in an arms length transaction between a willing buyer and a willing seller, neither under a compulsion to buy or sell. . . ."
Under each of the Lease Schedules, the option price at the end of the base term is the greater of the then fair market value of the tanks or 20% of their original cost. (Maxus Exhs. 2 and 3, section 8, captioned "End of Base Term") The option price at the end of the extended term is the then fair market value of the tanks. ( Id). It is important to consider the testimony adduced at the evidentiary hearing held on December 11-12, 2002 to make a determination in the instant proceeding. Maxus' president, Chris Di Lillo, testified that at the time the lease agreements were executed, he anticipated that the fair market value of the 500 gallon tanks that comprise a majority of the tanks in question would have a value of $600-$800 per tank at the expiration of the lease term. (DiLillo, Direct).
Schedule Nos. 36 and 37 contain similar language under the section captioned "End of Base Term Options": That section provides in parts:
Each Schedule provides in pertinent part that Debtor shall have the option at the end of the initial Base Term to purchase all the equipment for a purchase price equal to the greater of (1) the then fair market value of the equipment or (2) 20% of the original cost of the equipment. If the Debtor does not exercise such purchase option, the Base Term shall automatically be extended for a period of 12 months. Debtor shall have the option at the end of the Extension Term to renew the agreement as to all of the equipment at a rental equal to the then fair rental value of the equipment. If Debtor does not exercise such renewal option, Debtor shall further have the option at the end of the Extension Term to purchase all of the equipment for a purchase price equal to the then fair market value of the equipment. "Fair market value" is defined to be a price ". . . obtained in an arm's length transaction between a willing buyer and a willing seller, neither under a compulsion to buy or sell. . . ."
Dwain Willingham of Propane Resources, Inc., testified that, in his opinion, six-year old used propane tanks of the type covered by the Lease Schedules had a fair market value of approximately 90% of the cost of a new tank. (Willingham, Direct). He further testified that the reason a six year old used propane tank maintains a value in close proximity to the cost of a new tank was that such tanks are made of steel and have useful lives of approximately 50 years. Such tanks simply do not depreciate in value. ( Id). Accordingly, he concluded that the fair market value of a six year old used 500 gallon propane tank sitting on the Debtor's lot was between $525 and $575. ( Id). The same tank, installed at a customer's premises, would have a fair market value, according to Willingham, of between $650 and $850. ( Id).
John Verbos, Level Propane's chief operating officer, testified that he agreed with Mr. Willingham that the fair market value of a used 500 gallon propane tank sitting on the Debtor's lot was between $525 and $575. (Verbos, Direct). He also testified that over the last three years that the Debtor has sold used 500 gallon tanks to customers for prices as high as $1,100, with the average price range being $560 to $575 per tank. ( Id.). The Debtor offered no other evidence regarding the fair market value of the tanks at issue in this proceeding or what the expectation of the parties was at the time the Lease Schedules were executed. However, each of the lease schedules provides that for purposes of the agreement the term "fair market value" shall be determined by Maxus. Maxus Exh. 2 and 3, section 8, captioned "End of Base Term").
Evidence was adduced that twenty percent (20%) of the original cost of the equipment was equal to $199,764.00 for Schedule 36 and $211,141.00 for Schedule 37. (DiLillo, Cross; Debtor's Exhs. 9 and 9.2). Notwithstanding, the Court must still determine whether or not the option price is greater than the lessee's reasonably predictable costs of performing under the lease if the option is not exercised under the second test of UCC § 1-201 (37)(x). Several courts continue to use common law tests to determine whether an option price is nominal. One test used under the UCC, both now and prior to the amendment, is a comparison of the option price to the original purchase or list price of the property. Pursuant to this test, option prices of less than 25% of the original cost have been found to be nominal. Similarly, courts have compared the option price to the total rentals to be paid under the agreement. Generally, option prices of 25% or less of total rentals have likewise been found to be nominal.
The record evinces a finding that twenty percent (20%) of the original cost of the equipment was equal to $199,764.00 for Schedule 36 and $211,141.00 for Schedule 37. Notwithstanding, the Court must still determine whether or not the option price is greater than the lessee's reasonably predictable costs of performing under the lease if the option is not exercised under the second test of UCC § 1-201 (37)(x). Several courts continue to use common law tests to determine whether an option price is nominal. One test used under the UCC, both now and prior to the amendment, is a comparison of the option price to the original purchase or list price of the property. Pursuant to this test, option prices of less than 25% of the original cost have been found to be nominal. Similarly, courts have compared the option price to the total rentals to be paid under the agreement. Generally, option prices of 25% or less of total rentals have likewise been found to be nominal.
These guidelines are also similar to those that have been set forth by the Internal Revenue Service ("IRS") and the FASB for purposes of a lessor's tax and accounting treatment of the leased property. The IRS has considered 20% of the original cost of the equipment as representing a valid residual useful life, while FASB has required that the leased item have an estimated residual life of more than 25%. Although the IRS and accounting standards for determining nominal value are all intended to distinguish between a true lease and a secured transaction, they are not controlling over the UCC standards embodied in § 1-201 (37). Nevertheless, these additional standards serve effectively to reflect the type of evidence which is typically considered.
Economic Realities Test
Generally, under the economic realities test, the option price is not nominal if it is greater than the lessee's reasonably predictable costs of performing under the lease in the event the option is not exercised. To make this determination, a court compares the option price to the anticipated costs the lessee will incur in the event the lessee chooses not to exercise the option. In re Charles, 278 B.R. 216,223 (Bankr. D. Kan. 2002); Taylor, 209 B.R. at 486.
The so-called "economic realities" test has also been dubbed the "no lessee in its right mind" or "no sensible alternative" test. This test provides that if at the end of the lease term, the only economically sensible course for the lessee to take is to exercise the option to purchase the property, then the lease is a security agreement. The "economic realities" test has been applied to demonstrate evidence of "nominal" consideration with respect to certain of the tests discussed above, including those where the option price is less than the reasonably predictable cost of performance, as well as those where the application of return or removal provisions would offset the value of an option to purchase or renew.
In the present case, the Master Lease provides that if the Debtor elects not to purchase the tanks at the end of the lease term, the Debtor is obligated, at its expense, to: de-install, pack and return the Equipment to Lessor at such location within the continental United States as shall be designated by Lessor in the same operating order, repair, condition and appearance as of the Installation Date, reasonable wear and tear excepted. (Maxus Exh. 1., Section 7(d)).
From the pleadings, it must be determined whether the Debtor is "economically compelled" to purchase the subject tanks at the end of the base term. In this regard, courts consider whether the terms of a purported lease agreement are such that only "a sensible course of action" would be for the lessee to exercise the option in determining whether the Debtor is "economically compelled" to exercise a purchase option.
The Debtor argued that 20% was the contemplated option price at the end of the base term. As noted above, the Master Lease provides that if the Debtor elects not to purchase the tanks at the end of the lease term, the Debtor is obligated, at its expense, to: de-install, pack and return the Equipment to Lessor at such location within the continental United States as shall be designated by Lessor in the same operating order, repair, condition and appearance as of the Installation Date, reasonable wear and tear excepted.
Based upon the above findings, it is evident that U.C.C. § 1-201(37)(d) is satisfied to indicate that the subject transactions are disguised security interests, as opposed to true leases. To summarize, firstly, the Master Lease, in Paragraphs One and Two, clearly reveal that the Debtor (Lessee) is obligated to make full payments under the lease without abatement and the obligation is unconditional. Secondly, the option price is 20% of the original cost of the equipment. That percentage constitutes a nominal purchase price. Thirdly, applying the economic realities test, the Debtor was economically compelled to purchase the equipment at the end of the base term.
In this regard, the cost and extraordinary effort in having to relocate the 2,980 tanks and deinstalling, packing and returning the Equipment to Maxus at such location within the continental United States as shall be designated by Maxus in the same operating condition and appearance as of the Installation Date, less reasonable wear, is sufficient to conclude that the Master Lease and Schedules No. 036 and 037 are disguised security interests, as that term is defined under the UCC.
Further, the retail customers who executed retail service contracts with the Debtor for propane service, did so at varying times, as opposed to a uniform date. Thusly, it is highly impractical and inconceivable to believe that each of the 2,980 tanks could be uniformly presented for inspection and recovery by the lessor upon lease termination, as addressed in the Master Lease. This, too, evinces a disguised security interest.
SUMMARY JUDGMENT
Summary judgment is proper if there is no genuine issue of material fact, and the moving party is entitled to judgment as a matter of law. Fed.R.Civ.P. 56(c); Celotex Corp. v. Catrett, 477 U.S. 317, 322-323 (1986). A fact is material if it would affect the determination of the underlying action. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986); Tennessee Dep't of Mental Health Retardation v. Paul B., 88 F.3d 1466, 1472 (6th Cir. 1996). An issue of material fact is genuine where a rational fact-finder could find in favor of either party on the issue. Anderson, supra, at 248-249; Structurlite Plastics Corp. v. Griffith (In re Griffith), 224 B.R. 27 (B.A.P. 6th Cir. 1998).
In a motion for summary judgment, the initial burden is on the movant to establish an absence of evidence to support the nonmoving party's case. Celotex, supra, at 322; Gibson v. Gibson (In re Gibson), 219 B.R. 195, 198 (B.A.P. 6th Cir. 1998). The burden then shifts to the nonmoving party to demonstrate the existence of a genuine dispute. Lujan v. Defenders of Wildlife, 504 U.S. 555, 590 (1992). An adverse party may not rest upon the mere allegations or denials of the adverse party's pleading, but instead, the nonmoving party must go beyond the pleadings and by her own affidavits, or by the depositions answers to interrogatories, and admissions on file, designate specific acts showing that there is a genuine issue for trial. Celotex, at 324. Although all inferences must be drawn in favor of the nonmoving party, it must present significant and probative evidence in support of its complaint. Hall v. Tollett, 128 F.3d 418, 421 (6th Cir. 1997). To preclude summary judgment, the non-moving party is required to present some significant probative evidence which makes it necessary to resolve the parties' differing versions of the dispute at trial. Gaines v. Runyon, 107 F.3d 1171, 1174-5 (6th Cir. 1997).
Based on the Court's determination that the leases at issue here are a disguised security interests under the standards enunciated under U.C.C. § 1-201 (37), there are no genuine issues of material fact in dispute, and partial judgment is warranted in favor of the Debtor.
Conclusion
Accordingly, the subject transactions are hereby determined to be disguised security interests, as opposed to true leases. Debtors' motion for partial summary judgment is granted as to the Master Lease Agreement and two (2) schedules in question: Schedule Nos. 1097-036, and 1097-037. Maxus' objection to the Debtor's motion for partial summary judgment is overruled. Maxus' cross motion for partial summary is hereby denied. The objection filed by the Debtor to Maxus' cross motion for partial summary judgment is sustained. Each party is to bear its respective costs.
IT IS SO ORDERED.
JUDGMENT
At Cleveland, in said District, on this 17th day of April, 2003.
A Memorandum of Opinion And Order having been rendered by the Court in this proceeding,
IT IS THEREFORE ORDERED, ADJUDGED AND DECREED that the subject transactions are hereby determined to be disguised security interests, as opposed to true leases. Debtors' motion for partial summary judgment is granted as to the Master Lease Agreement and two (2) schedules in question: Schedule Nos. 1097-036, and 1097-037. Maxus' objection to the Debtor's motion for partial summary judgment is overruled. Maxus' cross motion for partial summary is hereby denied. The objection filed by the Debtor to Maxus' cross motion for partial summary judgment is sustained. Each party is to bear its respective costs.