Summary
explaining that exercising an option to renew for nominal consideration would allow the equipment to be utilized to the extent of its useful life, which "may have no resemblance to the term of depreciation for taxation purposes"
Summary of this case from Prospect ECHN, Inc. v. Winthrop Res. Corp.Opinion
No. 89-08219-PR.
Decided November 29, 1990.
Anthony J. Celebrezze, Jr., Attorney General, and Nancy J. Miller, Assistant Attorney General, for plaintiffs.
Carlile, Patchen Murphy, Denis J. Murphy, Hakim B. Adjoua and Dennis J. Concilla, for defendant.
This cause originates from a series of agreements purporting to be leases entered into between plaintiff Auditor of the state of Ohio and defendant Tele — Communications, Inc. ("TCI"). These agreements were executed on May 11, 1987, and provided that TCI would install a computer-aided telephone system in all of the offices of the Auditor. These phone systems were installed and payments were being made under the agreement. Additional installations also occurred.
Following a series of newspaper articles, plaintiff Attorney General apparently advised the Auditor that the agreements were, in substance, purchases and that they had been entered into without the required competitive bidding or approval of the Controlling Board. The Auditor thereafter stopped all payments to TCI.
On April 28, 1989, plaintiffs commenced the present action with the filing of a five-count complaint in the Common Pleas Court of Franklin County. Defendant's answer included a multifaceted counterclaim that was followed by a petition for removal to this court. In essence, plaintiffs seek to void the agreement through any of several theories, i.e., that the transaction was a disguised conditional sale, that it was subject to competitive bidding and Controlling Board approval, that it violated the Ohio Constitution's ban on commitments beyond the two-year period, and that it was illegal for any of several other reasons which are discussed below.
TCI's counterclaim asserts that the agreements are leases and were validly entered into, which facts, it is contended, the state is now estopped from denying. As its basis for recovery, defendant asserts that the Auditor is in breach of the agreement, entitling it to various contractual remedies, and, in the event the court holds for plaintiffs upon their assertions, that defendant has been the victim of fraud, conversion, breach of warranty, etc.
The trial commenced on May 7, 1990. Thereafter, the case was re-opened on plaintiffs' motion to receive transcripts of testimony from certain federal criminal proceedings. The case was closed and submitted on September 20, 1990. This cause is now determined upon all the evidence submitted by the parties.
A determination of this case shall begin by a resolution of the central point of contention throughout the proceedings, that is, whether the agreements were true leases or disguised conditional sales. Although there were three agreements actually executed, the language used in each is identical and so they shall be hereinafter referred to in the singular. At the time of this transaction, the applicability of laws regulating the acquisition of products and services by public agencies turned upon whether the acquisition was a "purchase." Once the agreement is properly classified, it is evaluated pursuant to the applicable law. Finally, the counterclaims are considered.
THE AGREEMENT I
The determination in this case hinges greatly upon whether the agreement entered into by plaintiff Auditor of State and TCI constituted a true lease or was merely a disguised conditional sale. Plaintiffs repeatedly contended that a court must look to the substance of the agreement and to the intent of the parties, and not merely to the form of the agreement, in order to determine whether the parties created a lease or a conditional sale. Plaintiffs would have the court determine the intent of the parties by a review of their actions, statements, expectations and the asserted economic realities of the transaction, citing Bill Swad Leasing Co. v. Stikes (C.A.5, 1978), 571 F.2d 1361; State ex rel. Kitchen v. Christman (1972), 31 Ohio St.2d 64, 60 O.O.2d 42, 285 N.E.2d 362; Columbus Motor Car Co. v. Textile-Tech, Inc. (1981), 68 Ohio Misc. 25, 22 O.O.3d 354, 428 N.E.2d 882. A review of such extrinsic factors, it is contended, would convince the court that the agreement was not a true lease, but was a conditional sale, subject to all of the requirements of a purchase.
Plaintiffs actually seek to support two different legal conclusions by the suggested review of the transaction. On the one hand, they have asserted that the agreement was actually a conditional sale despite the appearance of the agreement, and therefore was an ultra vires transaction. On the other hand, they contend that such evidence proves that they have actually purchased the property at issue.
On these same issues, TCI asserts that the court is required to confine its analysis to the four corners of the document. It has pointed to the fact that the agreement refers to the parties as "lessor" and "lessee" throughout the writing, to payments as "rental payments," and that the agreement is, in form, a lease.
Insofar as determining the rights and obligations of the parties to an agreement, the law as enunciated in the parol evidence rule and the Statute of Frauds, excludes extrinsic evidence of the parties' intentions and "the writing alone shall be the sole repository of the terms of the agreement." Marion Production Credit Assn. v. Cochran (1988), 40 Ohio St.3d 265, 533 N.E.2d 325, paragraph four of the syllabus; Ameritrust Co. v. Murray (1984), 20 Ohio App.3d 333, 20 OBR 436, 486 N.E.2d 180; see, also, the plethora of cases set forth in 43 Ohio Jurisprudence 3d (1983), Evidence and Witnesses, Section 541, fn. 54.
The terms of the agreement speak for themselves as invocations of particular law; and plaintiffs cannot, in the guise of challenging the character of the agreement, seek, by way of mere parol evidence, to vary those terms to which the parties have agreed. See Cochran, supra, at Part III; Bowman v. Tax Comm. (1939), 135 Ohio St. 295, 14 O.O. 189, 20 N.E.2d 916. The question of ownership of the property at issue, as well as the other rights and obligations of the parties, can only be determined, absent fraud or illegality, by the document they have signed.
A different question is presented where the issue is the overall character of the document and whether an agreement, taken as a whole, is to be subject to a particular body of the law. Where the focus is not upon the rights and obligations of the parties as defined by the terms of the agreement but is instead upon the effect that inclusion of particular terms has upon the overall character of an agreement, then the parol evidence rule does not bind so securely. For example, evidence of the statements and conduct of the parties is often introduced to prove whether, under Uniform Commercial Code Section 1-201(37), an agreement was intended as security. (See the analysis which follows in Part III.) Thus, evidence of the existence of an oral purchase option would, regardless of the legal effectiveness of such option, indicate that the agreement was to provide a security interest. In this circumstance, the rights and obligations under the lease are secondary to the document's character as a security device, subject to the filing requirements of UCC Article 9.
In the present case, the concern is not whether a security interest has been created. Instead, the court must focus upon the overall character of the agreement. Whether the agreement is determined to be a lease or a disguised installment sale resolves several closely related and dependent issues. To this end, the court will consider all relevant factors bearing upon the character of the agreement, beginning with the agreement's own terms, then expanding into other indicators of the parties' intentions.
II
Both the conditional sale and the lease are ancient kinds of transactions and the legal distinction between the two has afforded substantially different remedies to the parties. See Leary, The Procrustean Bed of Finance Leasing (1981), 56 N.Y.U.L.Rev. 1061, 1065-1066, fn. 19, quoting III Gaius, Institutes of Roman Law (Whittuck Ed. 1904), Section 146. In the modern age, leasing, like the installment sale, has become a widespread method of obtaining the use of various kinds of personal property.
The problems attendant to distinguishing a lease from certain installment sales are not new ones and the issue has been the subject of litigation in American courts for some time. See, e.g., Hervey v. Rhode Island Locomotive Works (1876), 93 U.S. 664, 23 L.Ed. 1003; Williston, The Law Governing Sales of Goods at Common Law and Under the Uniform Sales Act (1 Ed. 1909), Sections 336, 338; Jones, The Law of Chattel Mortgages and Conditional Sales (5 Ed. Bowers Ed. 1933), Sections 934-968.
A perusal of the literature indicates that this issue has arisen in a number of specialized legal contexts. Whether a transaction is a sale or a lease has affected the rights of the parties under the laws of taxation, secured transactions, bankruptcy, and the Truth In Lending Act. See, e.g., Claxton, Lease or Security Interest: A Classic Problem of Commercial Law (1977), 28 Mercer L.Rev. 599; Note, The Applicability of the Federal Truth In Lending Act To Rental Purchase Contracts (1980), 66 Cornell L.Rev. 118; Coogan, Is There a Difference Between A Long Term Lease And An Installment Sale of Personal Property? (1981), 56 N.Y.U.L.Rev. 1036; Hiller, Security Aspects of Chattel Leases in Bankruptcy (1966), 34 Fordham L.Rev. 439; Baskes, Tax Planning For Lease Transactions, 1972 U.Ill.L.F. 482. Also, accountants are required to notice the proper classification of a transaction, which may have an impact upon financial statements. See Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 13 — Accounting For Leases (Nov. 1976 and subsequent amendments).
The cumulative learning and skill of those who practice in these fields have resulted in agreements of great sophistication and detail, sometimes written for the express purpose of obscuring the character of the agreement. While a document may be denominated a "lease," and refer to the parties as "lessor" and "lessee," it may nevertheless be written to accomplish a purpose unrelated to bailment or rental. Consequently, courts and commentators have been required to formulate modes of analyses to uncover the precise nature of the agreement.
Under the Uniform Commercial Code ("UCC"), sellers of goods must give notice to all the world, through the code's filing requirements, of their interest in goods actually possessed by another, such as the typical installment sale. One who leases goods to another, on the other hand, is not required to give such notice and a true lease will ordinarily be "effective and enforceable according to its terms between the parties, against purchasers of the goods and against creditors of the parties." UCC 2A-301 (1987) (not yet adopted in Ohio). Thus, UCC 1-201(37) (R.C. 1301.01[KK]) provides in pertinent part as follows:
"Whether a lease * * * is intended as security is to be determined by the facts of each case; however, (a) the inclusion of an option to purchase does not of itself make the lease one intended for security, and (b) an agreement that, upon compliance with the terms of the lease the lessee shall become or has the option to become the owner of the property for no additional consideration or for a nominal consideration does make the lease one intended for security." (Emphasis added.)
This section has been the subject of considerable litigation, especially by creditors and trustees in bankruptcy who have asserted that a particular lease was actually a disguised conditional sale, requiring the owner to perfect his security interest pursuant to UCC Article 9. See, e.g., cases and comments in Coogan, Leases of Equipment And Some Other Unconventional Security Devices: An Analysis of UCC Section 1-201(37) and Article 9, 1973 Duke L.J. 909; Peden, The Treatment of Equipment Leases As Security Agreements Under The Uniform Commercial Code (1971), 13 Wm. Mary L.Rev. 110.
The critical issue for purposes of the UCC is whether the lease was intended to secure a sale, i.e., whether the parties sought to erect a mere lien upon the chattels until a time when the title could pass. While allowing for that exceptional document, the UCC provision above creates an initial presumption that where title to the goods is to pass to the lessee, then the agreement was a device for securing title in the lessor until the occurrence of that condition which passes title.
That the law has customarily looked to the existence of a device for transferring title as a distinguishment of leases from sales is also demonstrated by the former Uniform Conditional Sales Act ("UCSA"). The UCSA was promulgated in 1922 by the National Conference of Commissioners on Uniform State Laws, one of the sponsors of the UCC, and withdrawn after the publication of the UCC in 1943. Under Section 1, Definition of Terms, the UCSA provided that:
"In this act `Conditional Sale' means (1) any contract for the sale of goods under which possession is delivered to the buyer and the property in the goods is to vest in the buyer at a subsequent time upon payment of part or all of the price, or upon the performance of any other condition or the happening of any contingency; or (2) any contract for the bailment or leasing of goods by which the bailee or lessee contracts to pay as compensation a sum substantially equivalent to the value of the goods, and by which it is agreed that the bailee or lessee is bound to become or has the option of becoming the owner of such goods upon full compliance with the terms of the contract." (Emphasis added.)
Both the UCC and UCSA are accurate codifications of long-established distinctions between a conditional sale and a true lease. See, e.g., Coogan, Leases of Equipment, supra, at 933, fn. 60.
More recently, the Truth In Lending Act, Section 1602, Title 15, U.S. Code (1976) defines a "credit sale" at Section 103(g) to include:
"[A]ny contract in the form of a bailment or lease if * * * it is agreed that the bailee or lessee will become, or for no other or a nominal consideration has the option to become, the owner of the property upon full compliance with his obligations under the contract."
The reasoning behind the above statutes is self-evident, i.e., that if there is to be no transfer of ownership then obviously no sale has been contemplated. Such transfer may be by an outright declaration in the agreement that title will automatically pass upon a number of successive renewals, at the end of the lease term or upon the happening of any conceivable variety of events.
Consequently, the proposition that a lease is a disguised conditional sale is very difficult to maintain unless the agreement provides, at the very least, some sort of option creating a possibility of ownership. The absence of an option to purchase is considered by most to be strong evidence that the agreement was not intended as security but is a true lease. In re Peacock (N.D.Tex. 1980), 6 B.R. 922; Indus. Leasing Corp. v. Sabetta (D.Conn. 1974), 16 UCC Rep.Serv. 195; In re Telemax Corp. (S.D.N.Y. 1973), 12 UCC Rep. Serv. 742; In re Wheatland Elec. Prod. Co. (W.D.Pa. 1964), 237 F. Supp. 820.
Inclusion of an option to purchase, especially at a nominal price, will usually tip the balance of analysis toward a conclusion that the document is an installment sale. Sight Sound of Ohio, Inc. v. Wright (S.D.Ohio 1983), 36 B.R. 885; Ryen v. Cottrone Dev. Co. (W.D.N.Y. 1981), 9 B.R. 26; In re Butcher Boy Meat Market, Inc. (E.D.Pa. 1980), 29 UCC Rep.Serv. 649; Jones v. Watson (N.D.Ga. 1980), 29 UCC Rep.Serv. 984; CIT Financial Services, Inc. v. Gott (1980), 5 Kan. App. 2d 224, 615 P.2d 774; Courtright Cattle Co. v. Dolsen Co. (1980), 94 Wn.2d 645, 619 P.2d 344; Fed. Sign Signal Corp. v. Berry (Tex.Civ.App. 1980), 601 S.W.2d 137; Laurel Bank Trust Co. v. Mark Ford, Inc. (Conn. 1980), 30 UCC Rep.Serv. 1423; Knickerbocker Russell Co. v. Mountain Valley Constr. Co. (W.D.Pa. 1980), 3 B.R. 433; see, also, Claxton, Lease or Security Interest: A Classic Problem of Commercial Law (1977), 28 Mercer L.Rev. 599, 604.
A very common method of lease-purchase is to include an option to purchase that can be exercised at some point during or after the term of the agreement. These options typically give the "lessee" the right to purchase the property "leased" for some nominal sum, such as $1. Ryen v. Cottrone Dev. Co. supra; CIT Financial Serv., Inc. v. Gott, supra. Or, the option may allow a deduction for a pro rata percentage of the rentals paid. Gen. Elec. Credit Corp. v. Bankers Commercial Corp. (1968), 244 Ark. 984, 429 S.W.2d 60; United Rental Equip. Co. v. Potts Callahan Contracting Co. (1963), 231 Md. 552, 191 A.2d 570; In re Royer's Bakery, Inc. (E.D.Pa. 1963), 1 UCC Rep.Serv. 342.
This is not to say that the inclusion of an option to purchase invariably creates a conditional sale. There are true leases which offer an option to purchase at the end of the lease term. Chopin v. Northwestern Pacific Indemn. Co. (1980), 49 Or. App. 139, 619 P.2d 300; Brokers Leasing Corp. v. Standard Pipeline Coating Co. (Tex.Civ.App. 1980), 602 S.W.2d 278; Commerce Union Bank v. John Deere Indus. Equip. Co. (Ala. 1980), 387 So.2d 787; Southwest Park Outpatient Surgery, Ltd. v. Chander Leasing Div. (Tex.Civ.App. 1978), 572 S.W.2d 53. A purchase option may be included because resale or deinstallation of the property is attendant with great expense.
Certainly an option to purchase for the market value of the property would indicate that a true lease exists, especially when the remaining value after the term of the lease is very high. Jahn v. M.W. Kellogg Co. (C.A.6, 1987), 822 F.2d 16, 18; In re Alpha Creamery Co. (W.D.Mich. 1967), 4 UCC Rep.Serv. 794. There are also cases where the option to purchase was considered not dispositive or of secondary importance because other evidence showed that the "lessee" was acquiring an equity interest in the property. Columbus Motor Car Co. v. Textile-Tech, Inc., supra; Bill Swad Leasing, supra; In re Wheatland Elec. Products Co. (W.D.Pa. 1964), 237 F. Supp. 820; Indus. Leasing Corp. v. Sabetta (D.Conn. 1974), 16 UCC Rep.Serv. 195.
Turning now to the agreement at issue, it provides no direct transfer of ownership either during or after the term of the agreement. Furthermore, no option to purchase is included within the agreement. More specifically, the agreement, at the eighth clause, expressly declares as follows: " Title. Lessor or its assignees will retain title to the Equipment during the Rental Term." Since there is no transfer of ownership or possibility thereof set forth in the agreement, it would be most difficult to conclude from the terms of the agreement that an actual conditional sale occurred. See In re Atlanta Times, Inc. (N.D.Ga. 1966), 259 F. Supp. 820, 825.
III
Plaintiffs set forth the additional argument that mere titular ownership is not dispositive of the intent of the parties. However, a thorough review of the agreement provides additional indicators that the parties intended a lease and not an installment sale.
It is a nearly universal view that where an agreement creates an optional power in the possessor of the goods to terminate the agreement without penalty, then the agreement can only be construed as a lease. This is because a sale must include, at the very least, an agreement to pay a sum which is substantially equal to the value of the property possessed. Where the possessor retains a reserved power to terminate, then that possessor need not pay a certain sum. Moreover, power to cancel the transaction for any reason or for no reason indicates that the transaction is not truly binding upon the holder of the power, which is a condition totally at variance with the obligational requirements of a conditional sale. See, e.g., Da Rocha v. Macomber (1953), 330 Mass. 611, 116 N.E.2d 139; Coogan, Leases of Equipment, supra, at fn. 19 and 62, and discussion at 933-934.
The agreement at issue provides under the Nonappropriation of Funds clause that: "In the event no funds or insufficient funds are appropriated and budgeted * * * this Agreement shall terminate * * * without penalty or expense to Lessee of any kind whatsoever * * *." Although not perfectly so, this nonappropriation clause appears to constitute a power of termination in the possessor. It allows the General Assembly, at its sole option, to refuse an allocation of funds for payment under this agreement, and allows no penalty "whatsoever" to attach on account of such decision. While it does not allow an instantaneous termination, the clause is nevertheless fully inconsistent with the notion that a binding debt has been created. As set forth in 2 Williston, The Law Governing Sales of Goods at Common Law and Under The Uniform Sales Act (Rev.Ed. 1948), Section 336, at 528, "a lease which provides for a certain rent in installments is not a conditional sale if the lessee can terminate * * * even though the lease also provides that if rent is paid for a certain period, the lessee shall thereupon become the owner of the property." (Emphasis added.) The inclusion of a nonappropriation clause within the document constitutes evidence that a true lease was intended.
A standard provision of installment sales contracts, however disguised, is the acceleration clause, or an equivalent device. Such clause would require that, upon default, all payments become then due and payable. Without its inclusion in the agreement, the installment seller could not obtain a judgment for future payments, but only for those that are then past due. See Farnsworth, Contracts (1982), Section 8.18. No such mechanism is included in the agreement at issue.
Ordinarily, the allocations of various risks and benefits are not useful indicators of the character of an agreement. This is because the parties to both kinds of agreements may arguably negotiate these allocations regardless of which transaction is contemplated. Usually, however, a conditional sale will consist of a one-sided distribution of various risks of loss in exchange for the single obligation to make payments. This is so often the case that one commentator was forced to remark that:
"In any analysis, contract terms allocating to the possessor the costs and duties of protecting the value of the property interests of the nonpossessor should not alter the classification of a transaction as security, lease, or bailment nor can they justify the application of an inappropriate substantive law to the finance leasing situation." Leary, The Procrustean Bed of Finance Leasing, supra, at 1076.
In contradistinction to the usual practice for conditional sales disguised as leases, the agreement at issue requires that the nonpossessor shall insure the property. Under the insurance clause, the agreement states: "Lessor will, at its own expense maintain at all times during the Rental Term, fire and extended coverage, and property damage insurance with respect to the Equipment." This clause places a burden upon the lessor that is inconsistent with an intent to accomplish a conditional sale. Furthermore, such an allocation of a burden exemplifies the sort of responsibility for the value of the equipment that a true lessor would contemplate.
The agreement also provides that the lessor is to have a prior security interest in the equipment and that the agreement would suffice as a financing statement for UCC Article 9 filing purposes. It might be argued that inclusion of such provision leads one to the conclusion that the agreement is a conditional sale, subject to UCC Article 9. This would be a hasty conclusion for several reasons. First, several courts have found that an agreement was intended to create a security interest regardless of the fact that the document was a true lease. When that occurs, the lessor is required to perfect his security interest if, upon the lessee's insolvency, he is to prevail over the trustee in bankruptcy. See, e.g., In re Transcontinental Industries, Inc. (N.D.Ga. 1965), 3 UCC Rep.Serv. 235. Such legal conclusions are the rare exception, however, and not the general rule.
Filing pursuant to UCC Article 9, while not required, is a prudent business practice for lessors of chattels. Filing protects the lessor's title against all third parties who might somehow obtain the equipment, including good faith purchasers from the lessee. See UCC Sections 2-403(2) and (3), and Leary, supra, at 1087 ("The cautious lessor, of course, would file the proper notice under [the UCC] as a sort of insurance."). Thus, rather than an indication that the document is a sale, a filing provision is really a protection from future litigation over the issue of title to the equipment. Such litigation has occurred often when the filing has been omitted.
One reason why the transaction would be foreseeably subject to the UCC is that both parties have certain rights of assignment. When one assigns his rights to a stream of payments, which payments are based upon rights created in chattels possessed by the debtor, then the document, whether a lease or a sale, constitutes chattel paper and/or the sale of an account. For either of these, the UCC requires the conclusion that such transactions create a security interest. For all of these reasons, the filing provision remains undispositive of the issue under consideration.
IV
Upon a review of the written terms of the agreement and their ordinary import, the court might easily end the analysis and conclude that only a lease was intended in the agreement. However, there are additional factual considerations that render this conclusion more certain.
The principal evidence upon this issue was the testimony presented, not only by the president of TCI, but by the plaintiff Auditor. The Auditor stated that his advisors had explained the transaction to him as a lease, and that the difference between a lease and a purchase was the transfer of ownership. More particularly, he stated that he personally authorized his staff to proceed with the transaction as a lease.
The Auditor, as well as several key employees, stated that they relied upon a memorandum from the Controlling Board's president, which was addressed to all departments and issued on December 9, 1985. This memorandum was "intended to clarify policy regarding the necessity of Controlling Board approval for telecommunications transactions." At the third provision, it states, "Leases or rentals with no option to purchase do not require Controlling Board approval." (Emphasis sic.)
While reserving for the moment any pronouncement upon the legal effectiveness of the memorandum, it is nevertheless significant evidence of the state of mind and intent of one party to the agreement. The fact that the Auditor and members of his staff relied upon the document in formulating the agreement provides an objective indicator of their intent at the time.
Also, the circumstances existing at the time of the transaction provide additional evidence that the Auditor intended a lease and not a conditional sale. Testimony was to the effect that the Auditor and his staff sought to avoid involvement from the Ohio Department of Administrative Services ("DAS") in their acquisition of a new telephone system. A memorandum from the Auditor's telecommunications coordinator to the Deputy Auditor of Administration states that: "Department of Administrative Services has legal authority over state agencies' telecommunications, * * * therefore they can be expected to oppose any system which decreases their revenues. Their vested interest causes me problems because I believe we are paying for incompetence and waste."
Apparently, as indicated by the testimony, the Auditor's staff concluded that DAS had a vested interest in maintaining its revenues from the internal communications network called "Centrex." The Auditor's employees were under the impression that DAS would not approve any transaction submitted to it and would oppose any submitted to the Controlling Board. It was to avoid such a confrontation that a lease transaction was proposed by the parties and discussed among them prior to the agreement.
Plaintiffs repeatedly brought out that TCI failed to provide the Auditor's office with a price breakdown of the equipment acquired. This assertion was evidently intended to prove bad faith on the part of TCI during the negotiations and culmination of the transaction. Instead, such is evidence of the conduct of the parties, indicating that a lease was contemplated and not a sale. TCI never supplied, and more significantly, no one from the Auditor's Office ever requested, a breakdown of the costs of equipment. This is probative of the fact that neither party was concerned with a purchase of equipment, which would normally require specific pricing, and supports TCI's assertions that a lease was contemplated.
At trial, much was also made of the fact that the Auditor, on or about the time the transaction was entered into, made a lump sum payment to TCI of $70,000. The evidence indicates that, just prior to executing that transaction, the Auditor's Office recognized that it would have a budget surplusage in the amount of $70,000. Rather than allow this amount to revert to the General Fund as an unexpended part of the Auditor's budget, with a possibility that such amount would be deducted from succeeding appropriations, the decision was made to expend the entire sum for the telecommunications agreement.
The conduct during this aspect of the transaction is convincing evidence that the parties did not intend a purchase of the equipment. As brought out several times by plaintiff, TCI "failed" to make any "interest" reduction because of this prepayment of the principal "cost" of the equipment and likewise did not refigure the monthly payment schedule or amounts to reflect the lower principal balance owed. Whether the underlying assertion was that TCI should have voluntarily made such an adjustment or that the Auditor should have insisted upon it is not at all clear. What does become evident, however, is that the parties to the agreement did not contemplate the need for an adjustment, making it more probative that no interest amount was charged, no purchase amount was surreptitiously financed, and the parties did not view the transaction as a credit purchase upon installments. In that context, admitting the questionable propriety of prepaying $70,000 worth of monthly rentals without some credit, the actions of the parties are considerably more consistent with a rental arrangement than with a purchase.
Additionally, there was testimony that the $70,000 payment and all subsequent payments under the agreement were made from the Auditor's operating account. The testimony of the Auditor was that if the phones had been a purchase, or if the Auditor's Office had expected to take ownership of the phones, all of the expenditures would have been taken from an account utilized for purchases.
Furthermore, the evidence submitted by plaintiff indicates that TCI was well aware of the distinctions between pure installment sales, installment sales denominated as leases and the true lease. Typically, TCI's proposals provided two options to potential purchasers, described as "Purchase Terms and Conditions." Option I described TCI's expectations for a cash sale, which was usually consummated in its "Equipment Sales Contract" forms. Option II, however, described the "Lease Option." This option allocates the investment tax credit under existing tax laws and, most revealingly, provided for a "$1.00 of Cash Price buy out option." Such "lease" arrangement was usually between a third-party financier, such as NEC/Chase Commercial Corporation, and the purchaser. The "Master Lease" between them allowed that "Lessor hereby grants to Lessee an irrevocable option to purchase said equipment for the sum of $ one dollar * * * at the end of the lease term." It also contained a non-cancellation clause and tied the monthly payment amounts to the interest rates given for treasury notes. Under all but the most broad definitions, e.g., that utilized in the Internal Revenue Code, such agreements constitute conditional sales.
The agreement at issue is most dissimilar, as previously explained, to these types of "leases" and, thus, from those kinds of agreements customarily offered to customers of TCI. The fact that different agreements were used in different circumstances indicates both that TCI was able to differentiate between them and that it intended a different legal characterization, that of a true lease, by its use of the latter agreement.
Testimony to the effect that TCI employed a "sales" staff that was paid a percentage commission on "sales" of telephone equipment installations for the state is not indicative of an actual sale, since a commission would be paid for a lease as well as a sale, the object being to compensate the acquirer of the business.
Plaintiffs asserted standards from the accounting profession and commentaries upon the UCC to the effect that, in order to show the existence of a conditional sale, one need only prove that an agreement calls for the payment of an equivalent of the full purchase price and that it provides for the possessor to consume the full useful life of the property. Plaintiffs' calculations indicate that the parties have agreed to an amount that is more than the cost of the equipment to TCI. Plaintiffs also point out that the agreement at issue grants to the Auditor a right to renew the lease for the nominal sum of $1. Thus, both conditions would be fulfilled under this analysis.
Plaintiffs misapprehend the nature and purpose of those standards relied on. They are not given to define a lease agreement as a matter of law but to augment particular policies within specialized practices. For example, the thrust of the UCC and Article 9 is to provide for public notice of ownership interests of nonpossessors of property. Arguably, one might conclude that an agreement was intended as security where the rights of creditors are at issue, yet conclude that the document is a true lease where the rights of the parties are concerned. This inconsistency has created confusion and ambiguity in some jurisdictions and spurred calls from commentators to require inclusion of leases of chattels within the ambit of Article 9 regardless of their terms. However, the greater weight of authority yet insists that "[t]he interests of a `true lessor' of personalty such as equipment is not an Article Nine security interest." White Summers, supra. In fact, the better rule is set forth in White Summers, supra, which section is relied on by plaintiff. Therein, the better rule is said to be exemplified by the case In re Alpha Creamery, Inc., supra, in which the following four factors are set forth:
The character of a transaction as a true lease is indicated by:
(a) Provision specifying purchase option price which is approximately the market value at the time of the exercise of the option.
(b) Rental charges indicating an intention to compensate lessor for loss of value over the term of the lease due to aging, wear and obsolescence.
(c) Rentals which are not excessive and option purchase price which is not too low.
(d) Facts showing that the lessee is acquiring no equity in the leased article during the term of the lease.
Most of these factors have been commented upon and found to indicate the existence of a true lease.
There was some evidence that for accounting purposes, the agreement might be termed a capital lease, as distinguished from an operating lease. A capital lease refers to an installment purchase in lease garb and it is to be given balance-sheet treatment, i.e., it is reported as a current indebtedness in the amount of the entire asset's value and the equipment is listed in the asset account as owned. The operating lease, on the other hand, requires only that the currently due payments be listed as current expenses.
Because of the capacity to disguise corporate indebtedness as mere current expenses, the accounting profession has gradually broadened the category of capital leases to require the broadest possible disclosure of financial obligations which would affect a financial statement. See Financial Accounting Standards Board, Statement of Financial Accounting Standards No. 13 — Accounting For Leases; Wyatt, Accounting for Leases, 1972 U.Ill.L.F. 497, 504. This emphasis has not occurred without criticism from legal commentators, who have concluded that such standards are no longer compatible with objective inquiries into the character of the agreement. See, e.g., Leary, The Procrustean Bed of Finance Leasing, supra, at 1095-1096 and fn. 149 ("The reasons why accountants characterize leases as `capital' or `operating' may not correspond to the policy reasons why transactions are characterized as leases or secured transactions for the benefits of creditors."); Boss, Leases and Sales: Ne'er or Where Shall the Twain Meet?, 1983 Ariz.St.L.J. 357, 361, at fn. 24 ("The guidelines given in FASB 13 have not been successful, however, and have been attacked as an arbitrary compromise between capitalizing all leases and capitalizing only those where title passes." [Emphasis added.])
The renewal for nominal consideration presents a different problem; for, by its exercise, the equipment could be utilized to the extent of its useful life, which, incidentally, may have no resemblance to the term of depreciation for taxation purposes. A nominal renewal has been interpreted by some to be an admission by the parties that the remaining value of the equipment is inconsequential and, because of the economic near certainty of renewal, that it constitutes an abandonment of the property such that actual title ownership is irrelevant. Thus, plaintiffs conclude, the substance of the transaction ought to be construed as a sale rather than its mere form as lease.
This kind of exultation of "substance" over "form" appears rather utopian when contrasted with the stark realities of long-term commercial undertakings such as the one now considered. A closer review of the facts here indicates that retention of actual title to the property leased was of crucial importance to TCI. The testimony at trial indicated that TCI had very substantial reasons for retaining title to its equipment, even well beyond a projected useful life thereof. TCI, like many others in such technical industries, earns a considerable profit from the service and repair of the leased equipment. Likewise, TCI profits from the training of new employees in the uses of such equipment. By retaining title to the equipment in perpetuity, TCI retains a valuable link with the lessee, that, properly handled, would allow it to obtain considerable additional business opportunities from the lessee.
Thus, rather than constituting an admission that the property was without value and worthy to be abandoned, the nominal renewal was of inestimable economic value to TCI. When, therefore, a lessor has consciously determined to retain title to its equipment, evidencing such in the written agreement, and with ample business reasons for doing so, no argument based upon economic factors viewed in isolation from business practice will suffice to convert the agreement into a conditional sale. The document at issue is a lease and title to all of the equipment leased presently resides in TCI.
Unconscionability of Price
Throughout the present litigation, plaintiffs have complained of the amounts paid to TCI pursuant to this transaction. In fact, the Auditor testified that his sole interest in becoming a plaintiff in the present action was his fear, based upon published reports, that he had paid "too much" for the lease of the phone systems. He also stated that he had been told by the Attorney General's Office that the agreement was a purchase and not a lease. More particularly, it is asserted that the price paid for the equipment was utterly unconscionable and, impliedly, that the agreement between them is therefore void as against public policy. Alternatively, it is contended that since the payments made by the Auditor total more than the fair market purchase price of the equipment, then the Auditor is now entitled to retain the equipment.
Such a proposition would, if approved, stand the law of contracts upon its head. Ownership of the property at issue is governed by the agreement between the parties, which is a lease, and no legal or equitable interest has passed thereby to the Auditor. Also, as a legal matter, there is no cause of action for the mere act of charging even a very high price, regardless of whether, at a later time, the alleged profit margin is characterized as "excessive" or "unconscionable." After-the-fact inquiries into the adequacy of one party's consideration, or excessiveness, will not lie whether the agreement is a sale of goods or, as here, a lease of equipment.
Furthermore, as a factual matter, the preponderance of the evidence compels the conclusion that the price was arrived at through negotiations and, in the context of the time at which the lease was entered into, was fair to both parties. Previous to reaching agreement with TCI, the Auditor leased telephone lines from the Ohio Bell Telephone Company, telephone equipment from AT T, and an interoffice communications system from DAS. TCI provided a much more sophisticated system with a number of functional advantages over the previous one, and, more importantly, for less money. The Auditor and all of the Auditor's staff were, at the time, thoroughly satisfied with the system acquired from TCI and considered it to be a vast improvement. Therefore, the agreement cannot be voided upon a purported unconscionability, whether of price or otherwise.
Usurious Interest
Plaintiffs would have the court declare the agreement void because an allegedly usurious interest rate was charged in the transaction. "Usury" is the charging of an interest rate above a statutorily established maximum percent. Here, the rate of ten percent is alleged to constitute the maximum amount allowed. The court will assume without deciding, for purposes of argument, that ten percent is the actual maximum allowed interest rate, although plaintiff has cited only meager legal authority for this proposition. At trial, plaintiffs' expert explained that a reasonable market price of the equipment could be determined and also that the rate of interest over and above what the likely "true cost" of the property could then be implied backward from the totals of all payments to be made under the contracts. He concluded that interest rates upon the contracts of 59.93 percent, 25.21 percent, and 93.51 percent were charged
The law is clear that there can be no usury unless interest is charged. Under the circumstances of this case, there could be no interest charges without a financed sale of the equipment. As has been already explained, the transaction at issue was a true lease and not a financed sale; therefore, no rate of interest was charged. As the law has been for centuries, a leasehold for a term of years is not subject to the laws pertaining to usury.
Unconstitutionality
The leases at issue allow that the state may make payments under them for more than two years. Plaintiffs contend that this violates the Ohio Constitution, Section 22, Article II, which states: "No money shall be drawn from the treasury, except in pursuance of a specific appropriation, made by law; and no appropriation shall be made for a longer period than two years." Additionally, R.C. 131.33 provides that: "No state agency shall incur an obligation which exceeds the agency's current appropriation authority." These clauses have been interpreted to limit the creation of any debt that will last longer than the then-existing General Assembly. See State v. Medbery (1857), 7 Ohio St. 522; State ex rel. Ross v. Donahey (1916), 93 Ohio St. 414, 113 N.E. 263; State ex rel. Preston v. Ferguson (1960), 170 Ohio St. 450, 11 O.O.2d 204, 166 N.E.2d 365; State ex rel. Lynch v. Rhode (1965), 2 Ohio St.2d 259, 31 O.O.2d 545, 208 N.E.2d 906; State ex rel. Shkurti v. Withrow (1987), 32 Ohio St.3d 424, 428, 513 N.E.2d 1332, 1336; Sorrentino v. Ohio Natl. Guard (1990), 53 Ohio St.3d 214, 560 N.E.2d 186. There is no doubt that the leases do allow for payments and use of the equipment well beyond two years.
The above debt limitations, in conjunction with other provisions, restrict the state government to a pay-as-you-go approach to financing. The Ohio approach is common to most of the other states.
In recent years, a practice that has become common for the acquisition of equipment at both the state and federal levels is that of leasing and lease-purchasing. At the state level, any attempt to bind the state beyond the term of the currently existing legislature would run head-on into the debt restrictions of the state Constitution. Accordingly, it has become commonplace to include a nonappropriation mechanism within all long-term agreements of whatever type. This mechanism typically reserves in the state government a penalty-free power to cancel the agreement by the simple expedient of refusing to appropriate sufficient funds to pay the obligation. There being no recourse to the seller/lessor, such an arrangement appears to place a high risk upon those who conduct long-term business with a state, yet a risk that has not deterred the considerable number of those who rent and sell to state governments.
Turning now to the present inquiry, the question narrows to whether the nonappropriation clauses common to each of the leases under consideration is of sufficient efficacy to preserve the validity of such leases against the plaintiffs' allegations of unconstitutionality. The nonappropriation clause here states as follows:
" Nonappropriation of Funds. In the event no funds or insufficient funds are appropriated and budgeted or are otherwise available in any fiscal period for Rental Payments due under this Agreement, then * * * this agreement shall terminate on the last day of the fiscal period for which appropriations were received without penalty or expense to Lessee of any kind whatsoever * * *." (Emphasis added.)
As previously mentioned, the practice of including a nonappropriation clause in agreements is widespread at both the state and federal levels. While the matter has not been directly litigated in Ohio's courts, the legality and precise effect of the inclusion of such a clause has been litigated in a number of other jurisdictions. Most of these courts have upheld the validity of nonappropriation clauses and have found that those agreements containing them do not violate constitutional restrictions upon public debt. See, e.g., Cochran v. Mayor of Middleton (1924), 14 Del. Ch. 295, 125 A. 459; Texas Natl. Guard Armory Bd. v. McCraw (1939), 132 Tex. 613, 126 S.W.2d 627; Loomis v. Keehn (1948), 400 Ill. 337, 80 N.E.2d 368; State ex rel. Fatzer v. Armory Bd. (1953), 174 Kan. 369, 256 P.2d 143; State ex rel. Thomson v. Geissel (1955), 271 Wis. 15, 72 N.W.2d 577; McFarland v. Barron (1969), 83 S.D. 639, 164 N.W.2d 607; Edgerly v. Honeywell Information Sys., Inc. (Me. 1977), 377 A.2d 104; Ruge v. State (1978), 201 Neb. 391, 267 N.W.2d 748; Glennon Hts., Inc. v. Central Bank Trust (Colo. 1983), 658 P.2d 872.
The validity of the agreement turns upon two questions: Does the lease create an obligation upon the General Assembly that is characterized as a present indebtedness for a future period wherein no funds have been appropriated? Does the agreement purport to bind a future General Assembly to make appropriations? An analysis of Ohio authorities indicates that both questions must be answered in the negative.
In State ex rel. Ross v. Donahey (1916), 93 Ohio St. 414, 113 N.E. 263, the Ohio Supreme Court considered whether a lease for a term of years constituted the creation of a debt either as a present indebtedness extending into the next session of the General Assembly or as a debt violating certain other constitutional limitations upon the types and amounts of debt. The court's answer to both questions was in the negative. Concerning the other constitutional limitations, the court concluded, at paragraph two of the syllabus:
"The necessary and current expense growing out of the rental of suitable and necessary quarters for the transaction of the state's business * * * is not a debt or liability within the inhibition of the provisions of the constitution." (Emphasis added.)
The court also explained that a lease, by definition, does not violate the constitutional ban against incurring a present indebtedness to pay money at a future time, without appropriations and revenue provided. This is because, as the court explained, a lease does not give rise to a present debt. It stated as follows:
"A long line of authorities hold[s] the true doctrine to be that the occupation of premises under a lease for a period of years, payable monthly or quarterly, does not fix a debt or liability for the whole amount that may become due and payable under the lease, but, upon the other hand, that such debt or liability arises only from month to month, or quarter to quarter, and becomes a debt or liability only when the use and occupation of the premises are actually furnished agreeable to the lease." Id. at 421, 113 N.E. at 265.
A lease therefore does not give rise to obligations beyond the current month and nothing of the agreement itself makes the state liable for amounts that have not yet come due. The lease at issue constitutes a mere current expense, and no debt was actually created. See, also, State ex rel Preston v. Ferguson (1960), 170 Ohio St. 450, 459, 11 O.O.2d 204, 209, 166 N.E.2d 365, 372.
Guidance for the resolution of the second question is also contained within the Ross case. The lease at issue in that case contained a clause that made it subject to future appropriations of the General Assembly and any cancellations caused thereby were to be without penalty to the lessee. The court found that where the express terms of a lease are "subject to the appropriation by the state legislature," then it does not constitute a present obligation to pay money at a future time, without appropriations and revenue provided. State ex rel. Ross, supra, 93 Ohio St. at 418, 113 N.E. at 264; State ex rel. Preston, supra, 170 Ohio St. at 455, 11 O.O.2d at 206, 166 N.E.2d at 369; State v. Medbery (1857), 7 Ohio St. 522.
The Preston case contains a number of factors and analyses that shed no light on the question of whether nonappropriation clauses, such as the one now considered, are valid. Nevertheless, one factor emerges as useful to the present evaluation. The court found considerable significance in the contractual provisions establishing that "subsequent General Assemblies are in no way bound by this agreement or the renewals thereof." Id., 170 Ohio St. at 461, 11 O.O.2d at 210, 166 N.E.2d at 373. This is the very essence of the nonappropriation clause in the lease here.
The case of State ex rel. Ohio Funds Mgt. Bd. v. Walker (1990), 55 Ohio St.3d 1, 561 N.E.2d 927, is not fully applicable. Therein, a statutory scheme authorized the issuance of notes, i.e., the borrowing of money. Furthermore, these notes gave the noteholder "a perfected security interest in the tax revenues deposited and to be deposited in the Note Service Fund." Id. at 8, 561 N.E.2d at 933. In contrast, the transactions here at issue did not constitute the borrowing of money and no interest in the General Revenue Fund was created. Instead, the Auditor covenanted to pay for services and the use of equipment during that time such as provided, so long as sufficient funds are appropriated to that office.
Finally, the previous opinions of the Attorney General are of interest upon the above issues. Those presented conclude uniformly that the state may enter leases for periods in excess of two years, especially when a nonappropriation clause has been included in the lease. See Attorney General Opinion No. 79-103 (Dec. 20, 1979) (thirty-five-year lease); No. 3098 (Oct. 17, 1938) (five-year lease).
In conclusion upon this issue, the court notes that where the providers of goods or services are willing to risk loss and bind themselves to the policies of fiscal responsibility that underlie the constitutional ban against the creation of unjustifiable debt, then another public policy must support the agreements they utilize to do so. The development and proliferation of the nonappropriation clause make possible a myriad of transactions by which a state agency and a vendor create a mutually beneficial and often crucial long-term relationship, yet subject to the command that the expenses of government must not exceed the revenues. For all of these reasons, the court finds that the lease at issue complies with the Ohio Constitution, Section 22, Article II, and R.C. 131.33.
Competitive Bidding
Plaintiffs assert that the leases are void as illegal on the grounds that they were required to be competitively bid. Plaintiffs point out that R.C. 125.07 requires "competitive bidding" of all purchases, which term is defined in R.C. 125.01(F) to include any "purchase, installment purchase, rent, lease, lease purchase" or other acquisition of equipment. A closer review of the law in this area, as well as the specific practices within these departments, indicates that plaintiffs' allegations are unfounded.
Initially, it must be pointed out that the parties have submitted only meager evidence upon the usual practices within the agencies and especially missing is the description of factors that would explain the differences in jurisdiction (for want of a better word) between the Controlling Board and DAS relative to the supervision and approval of purchases, leases and other kinds of acquisitions. The greater weight of the evidence at trial was that the parties to the transaction considered the matter to be within the ambit of the Controlling Board's discretion. The issue then becomes whether they were legally correct in their assumptions.
Plain upon its face, R.C. 125.01 et seq. applies to DAS as the supervisory executive branch agency that oversees the acquisition of products and services for other agencies. R.C. 125.041, however, limits the authority of DAS over the departments of other separately elected officials. It states:
" Nothing in sections 125.02 or 125.04 to 125.08 of the Revised Code shall be construed as limiting the attorney general, auditor of state, secretary of state, or treasurer of state in any of the following:
"(A) The purchase or lease of equipment, materials, supplies, or services for less than ten thousand dollars;
"(B) The purchase or lease of equipment, materials, supplies or services for ten thousand dollars or more with the approval of the controlling board." (Emphasis added.)
Thus, by its own terms, the statute exempts acquisitions of the Auditor, and DAS would not ordinarily be involved where the transaction is subject to Controlling Board approval alone. Once it is determined that the issue is one for the Controlling Board, the determinative law must be sought within R.C. Chapter 127, the enabling legislation for the Controlling Board.
Plaintiffs contend that Controlling Board approval is essential for the validity of a transaction that is not competitively bid and, it is pointed out, plaintiff Auditor never submitted this transaction to the Controlling Board for approval. The answer to this contention lies in the statutory provisions and certain pronouncements of the Controlling Board.
R.C. 127.16(B)(1) requires that a state agency may not make a purchase amounting to $10,000 or more "unless the purchase is competitively bid or approved by the controlling board." However, at the time the leases at issue were executed, this section also provided that: "(D) Nothing in division (B) of this section shall be construed as: * * * (7) Applying to leases." Consequently, the General Assembly had, at that time, expressly exempted leases from the ambit of this statute and the Auditor was entirely free, as a matter of law, to enter the transaction without competitive bidding or Controlling Board approval.
Further supporting this conclusion, the president of the Controlling Board had issued a "Memorandum" that, as explained by the plaintiff Auditor, was reviewed and relied upon by him in authorizing his staff to sign the leases. The document was dated December 9, 1985, and addressed to "[a]ll Departments, Offices, Institutions, Boards, Commissions, and Agencies." The subject of the memorandum was stated as the "[c]larification on the Need for Controlling Board Approval for Telecommunications Transactions." In pertinent part, the document stated as follows:
"This memorandum is intended to clarify policy regarding the necessity of Controlling Board approval for telecommunications transactions. * * * The need for approval depends on the form of the transaction and the manner in which procurement occurred.
" Form
"(1) If purchases exceed the applicable dollar limits and requirements established in Section 127.16 of the Revised Code, such purchases are required to go to Controlling Board unless they are competitively bid through State Purchasing or acquired under a DAS term contract or a GSA contract.
"(2) If leases with a fair market value of $10,000 or more contain options to purchase, Controlling Board approval is required unless they are competitively bid through State Purchasing or acquired under a DAS term contract or a GSA contract. (See Controlling Board Procedures, Article III.A.)
"(3) Leases or Rentals with no option to purchase do not require Controlling Board Approval.
"* * *
"(7) Assuming that the transactions were solely leases or rentals with no options to purchase, * * * Controlling Board approval is not required." (Emphasis sic.)
Plaintiffs contend that such memorandum is not an "action" of the Controlling Board, since it was not expressly approved by the board's members. Also, plaintiffs insist that this memorandum expressly waives submission to, and approval of, the Controlling Board for transactions involving true leases. Plaintiffs further argue that the memorandum does not comply with the requirements of rulemaking under Ohio's Administrative Procedure Act, R.C. Chapter 119. Consequently, it is asserted, the memorandum is without legal effect and provided no basis for the Auditor to avoid express submission of the matter to the Controlling Board for its approval. Finally, the memorandum is alleged to contradict the statute that, it is argued, expressly requires submission to the Controlling Board of any kind of acquisition.
If the language is to be given its usual import, it must be concluded that the memorandum of the Controlling Board's president tracks the language of R.C. 127.16 with remarkable accuracy and nowhere contradicts the statute. As the statute exempts leases from its purview, so too does the memorandum. The memorandum however does interpret the statute somewhat by its requirement that not every document denominated as a "lease," but only those containing no option to purchase, could qualify for such exempt treatment.
The more precise question of the legal impact of a memorandum of the president of the Controlling Board is not so easily answered. This is largely a result of a lack of evidence rather than any specific assertion by the plaintiff. Obviously, this memorandum is not a rule promulgated through the notice and hearing process of R.C. Chapter 119. Likewise, it does not constitute the formal action of the board on a particular submission. These arguments are largely straw men and avoid a substantive description of the place such memoranda occupy in the interactions between the agencies of the state government.
The Ohio Administrative Code contains only one regulation that has been officially promulgated by the Controlling Board, and it has no relationship to R.C. Chapter 127. A similar dearth of regulations exists for DAS and R.C. Chapter 125. A review of official documents of the agencies indicates that DAS annually publishes a compilation of "Directives." This is sent to all governmental bodies and provides instructions to the agencies covering many statutory subjects. Similarly, the memorandum at issue was not an isolated correspondence, but was part of a regular, ongoing publication of instructions for complying with the policies and objectives of the Controlling Board. And, it is not this sole memorandum that is called into question, but whether the administrative chief executive officer may customarily render such instructions or pronouncements to other affected state agencies.
The law is to the effect that an agency need not engage in the official promulgation of a rule when it issues directives, orders, policies, guidelines and interpretations that are intended for the direction of the personnel within the agency. These are matters that might change from time to time and from administration to administration. Where, as here, an agency or board is charged with the supervision of a particular range of activities of other state agencies, the issuance of directives to govern conduct and activities is fully binding upon the statutorily subject agency so long as the directive does not purport to regulate the rights of private parties. See, e.g., Lloyd v. Indus. Comm. (1964), 119 Ohio App. 467, 28 O.O.2d 80, 200 N.E.2d 705. The Administrative Procedure Act is not concerned with the internal administration and management of agencies.
Similarly, the administrative officer of a board may ordinarily publish statements of the board's policies, these being invaluable guides to those affected. The presumption established by this memorandum is that it reflected the board's policy and, more particularly, that the entire board was waiving the requirement of submission for the described leases. Plaintiffs' challenge, while cloaked as an attack upon the form of the policy pronouncement, is actually an attack upon its substance. Upon this point, plaintiffs have done little more than assert that the pronouncements of the president are not those of the entire Controlling Board, and no evidence was presented indicating that the other board members disagreed with such policy. Since the memorandum virtually tracked the statutory provision on the issue, its content cannot be labeled ultra vires by a mere implication upon its form. Consequently, plaintiffs have failed to prove that the memorandum was not the official policy of the Controlling Board, both legally and factually.
Further, the leases at issue were not entered into in violation of the applicable statutes, which, incidentally, have since been thoroughly restructured to require either competitive bidding or Controlling Board approval for leases and purchases of all types. Moreover, the memorandum from the Controlling Board's chief executive officer was binding upon the parties to the transaction and set forth the policy of the Controlling Board relative to leases and purchases of telecommunications equipment. The law never requires a vain act, and both the statutory exclusion of leases as well as the express Controlling Board waiver of submission operated individually and jointly to allow the Auditor to enter into the leases at issue.
Illegal Procurement
Plaintiffs have adduced evidence that the activities of a professional lobbyist were employed to initiate the transactions at issue. It was suggested that since both the lobbyist and several of his agents, including a DAS employee who approved the leases here, have pled guilty to various federal crimes growing out of lobbying activities, then the present transaction is tainted thereby and, accordingly, was illegal.
Plaintiffs have not shown the court any evidence that the leases here were the result of illegal action by the parties thereto. In fact, the major aspects of these transactions appear to be untainted and free of any aroma of perfidy. While, admittedly, the introductions were occasioned by efforts of a certain well-connected lobbyist, the evaluations that followed were conducted by members of the Auditor's own staff, including persons known to and customarily relied upon by him. The testimony at trial indicated that their decisions were based upon their personal best efforts and followed a review of other available systems.
Plaintiffs' colorful allegations of "conspiracies of silence, etc." are, before the law, insubstantial and do not constitute actual proof. At the trial on this issue, plaintiffs were unable to prove that any illegal act occurred in connection with this transaction. Allegations that an employee of the Ohio Lottery Commission and another employee of DAS were bribed by the lobbyist to expedite the transaction at issue remain unproven. Had plaintiffs been able to prove such, the leases may yet have been enforceable since, perhaps most crucially, there was no evidence of any kind to suggest that TCI had participated or even known of the purported activities of the lobbyist. The good faith negotiation and execution of these transactions by both the Auditor's staff and TCI would have vitiated any extrinsic activities by those not a party to the agreement.
Estoppel
By its counterclaim, TCI asserts separate yet related claims of estoppel against the state and breach of an express warranty contained within the agreement. These claims are now considered in the alternative to the conclusions set forth above. Before we continue, we should note that this court is familiar with the provisions of R.C. 109.02.
The basis of both claims is that, pursuant to the requirement of the leases, the Auditor's chief legal counsel issued a written legal opinion to TCI that provided as follows;
"As counsel for the State Auditor's Office, hereinafter referred to as Lessee, I have examined the duly executed originals of the Agreement (Lease/Rental Agreement) * * * between Lessee and Tele-Communications, Inc. and the proceedings taken by the State Auditor's Office to authorize and execute said Agreement. Based upon such examination and upon such other examination as I have deemed necessary or appropriate, I am of the opinion that:
"1. The agreement has been duly authorized, executed and delivered * * *.
"* * *
"3. The Agreement is a legal, valid and binding obligation of State Auditor's Office enforceable in accordance with its terms."
Also, the lease between the parties contains a clause entitled " Authority and Authorization," by which:
"Lessee represents, covenants and warrants, and as requested by Lessor, will deliver an opinion of counsel to the effect that: * * *
"(i) the execution, delivery and performance by the Lessee of this Agreement have been duly authorized by all necessary action on the part of the Lessee; * * * Lessee agrees that * * * (ii) it has complied with all bidding requirements where necessary and by due notification has presented this agreement for approval and adoption as a valid obligation on its part * * *."
Setting aside for the moment the question of whether estoppel may lie against a state agency, it must be commented that the above warranties and representations by the Auditor's chief legal counsel and by all of those authorized to execute the leases on behalf of the Auditor's Office constitute an express declaration that all necessary procedures, whether of competitive bidding, Controlling Board approval or any other legal requirement, had been met and that the Auditor was legally free to enter into these leases. And the testimony indicates that those involved so understood them. These clauses were not mere boilerplate that might be overlooked, but required specific affirmative action on the part of the Auditor, i.e., to investigate the matter and provide the opinion of his own legal counsel.
Testimony of the Auditor's chief legal counsel was to the effect that he merely copied a form of such opinion onto the Auditor's letterhead before signing it and did not truly perform the necessary investigation. Furthermore, he claimed that he personally informed the Auditor's deputy of his belief that the agreements were purchases, impliedly subject to competitive bidding requirements, but that he was told to provide the opinion of counsel since the agreements had already been authorized.
Certainly, his testimony was contradicted by other testimony. More indicatively, however, the preponderant evidence indicates that, at the time of the transaction, he made specific demands for alterations, by way of additions to the leases well in advance of their execution. This would indicate that the attorney made a significant evaluation of the agreements at that time. If his actions were otherwise, then he would not have fulfilled his oath and responsibility as an attorney at law, and the affixing of his signature to a representation of his personal, professional opinion is not an act that can be lawfully authorized by any other person.
Plaintiffs object to any consideration of the estoppel argument because it was not specifically pled by defendant as an affirmative defense. A review of the pleadings indicates that all of the facts necessary to such defense were alleged. Likewise, the matter was expressly litigated at trial by both of the parties. Thus, pursuant to Civ.R. 15(B), and upon the sua sponte motion of the court, the pleadings are hereby amended to reflect the inclusion of the affirmative defense of estoppel.
As to whether estoppel will lie against the state, the court concludes that it does for several reasons. Foremost among them is that the state is here suing a private vendor upon a contract (lease) for the supply of goods. The law has always been to the effect that when the state "appears as a suitor in her courts, to enforce her rights of property, she comes shorn of her attributes of sovereignty, and as a body politic, capable of contracting, suing, and holding property, is subject to those rules of, justice and right, which, in her sovereign character, she has prescribed for the government of her people." (Emphasis added.) State v. Exr. of Buttles (1854), 3 Ohio St. 309, 319. As a matter of justice, every other litigant in an action upon a contract is able to assert the affirmative defense that the other party is estopped by its own actions to deny the reasonable implications thereof. The state as a defendant might, under particular circumstances, be immune from the consequences of its own actions. However, when the state brings an action to nullify an agreement that it has freely entered into, then the defense of estoppel is not only available to the defendant, it will often be the crucial focus of analysis in determining the rights of the parties.
Another reason why the defense of estoppel is applicable against the state is its interconnection and dependence upon the sovereign attributes of the state that have been particularly abolished. As will be more fully explained below, the determination of whether estoppel could be applied as a defense against the state depended upon whether the state had acted in either a governmental or proprietary capacity. A private litigant could not assert estoppel when the state agency acted in a governmental capacity, but could when the actions were of a proprietary character. See, e.g., Cleveland Terminal Valley RR. Co. v. State (1912), 85 Ohio St. 251, 295, 97 N.E. 967, 973. These were the precise boundaries that previously defined the sovereignty defense. See, e.g., Wooster v. Arbenz (1927), 116 Ohio St. 281, 156 N.E. 210; Eversole v. Columbus (1959), 169 Ohio St. 205, 8 O.O.2d 167, 158 N.E.2d 515. In fact, the refusal to allow the ordinary application of the estoppel defense is observably similar to the "king can do no wrong" doctrine. By R.C. 2743.02, the state has formally renounced the mere fact of sovereignty as a defense and has consented to be sued and have its liability determined "in accordance with the same rules of law applicable to suits between private parties." The affirmative defense of estoppel is a well-known rule of law that is often utilized in suits between private parties and nowhere in the Court of Claims Act has the General Assembly excepted the state from its operation.
Whether the state's conduct was such as to estop it from denying the validity of the contract at issue can be determined from the applicable standards. The cases are legion which define the nuances of estoppel under every conceivable set of circumstances. It is generally expressed as arising when one induces another to act or rely to his detriment, and he does so rely. The law will not allow the first to later set up a claim based upon facts or matters that are inconsistent with the inducement. See cases and comments collected in 42 Ohio Jurisprudence 3d (1983), Estoppel and Waiver, Sections 24 through 30.
The case here presents a classic circumstance of induced reliance. TCI inquired diligently of the Auditor's Office regarding the Auditor's requirements for entering the leases and specifically whether it had complied with the pertinent requirements of the Controlling Board. Not only did the Auditor's authorized representatives set forth, by their signatures on the leases, that all governmental prerequisites for the transaction had been met, but the Auditor's own chief legal counsel separately certified that the transaction was a proper one that did not violate any Controlling Board or other legal requirement. Furthermore, as previously mentioned, these were the kinds of requirements that, along with the general statutory guidelines, depended greatly upon the policies and directives of the Controlling Board and DAS, which policies are not necessarily communicated to private vendors. Having represented that these leases were properly entered into and that all requirements of competitive bidding and Controlling Board approval had been satisfied, the state is now estopped from asserting that such conditions were not met.
Plaintiffs have asserted that the application of an estoppel doctrine will negate the state's competitive bidding laws and make it impossible to police improperly entered agreements. The answer to this difficulty was provided by the General Assembly in then-effective R.C. 127.16(C), which states: "Any person who authorizes a purchase in violation of division (B) of this section shall be liable to the state for any state funds spent on the purchase, and the attorney general shall collect the amount from the person." As in the present case, state agencies are often in sole possession of the information that formulates the policy preconditions for a particular transaction. To estop the private vendor from denying what he could not ascertain from a reading of the statutes on the subject is by far the more harsh and unjust principle.
Additional Installations
As part of its amended counterclaim, TCI requests that it be compensated for the delivery and installation of equipment that was not part of the original agreement. The evidence at trial was to the effect that such equipment was in fact delivered and installed in the offices of the Auditor at the request of the Auditor's authorized representative. The preponderance of the evidence indicates that the parties understood at the time that this equipment was additional and not provided for in the previously executed documents. Also, it was understood that the payment rate would be the same as that previously agreed upon for similar equipment that was covered under the leases. In other words, all of the ingredients for a contract were present.
Plaintiff now contends that the Statute of Frauds as set forth in R.C. 1335.05 would bar enforcement of any understanding, regardless of delivery to, acceptance and present possession of, the equipment by plaintiff Auditor, because the agreement was not reduced to writing and signed by, viz., the Auditor's representatives. Of course, the above terms were reduced to writing and sent to the Auditor's Office for signature; but because the present litigation was under way, the writing was not signed and returned to TCI.
The court is of the opinion that the actions of the parties including the partial performance of the oral agreement by TCI constitute significant evidence of the terms and conditions of the agreement, and that, but for the initiation of the present litigation, a writing would have been fully executed between the parties. Accordingly, the bar of the Statute of Frauds is ameliorated and the terms of the agreement as set forth in the lease agreement and schedule of payments sent to the Auditor's Office are found to be, by a preponderance of the evidence, those actually contemplated and agreed upon by the parties. See, e.g., Farnsworth, Contracts, supra, Section 6.9, Satisfaction [of the Statute of Frauds] by Part Performance; Collett v. DeHaven (1970), 24 Ohio App.2d 4, 53 O.O.2d 28, 263 N.E.2d 252; Babey v. Lowman (1966), 7 Ohio App.2d 38, 36 O.O.2d 94, 218 N.E.2d 626; Williams v. Terebinski (1970), 24 Ohio Misc. 53, 52 O.O.2d 114, 261 N.E.2d 920.
Furthermore, for those reasons expressed in the previous section on the issue of estoppel, the defense of promissory estoppel is as fully available against the state in a contract action as against any private party so involved. The Restatement of the Law 2d, Contracts (1981), at Section 139(1), provides that:
"A promise which the promisor should reasonably expect to induce action or forbearance on the part of the promisee or a third person and which does induce the action or forbearance is enforceable notwithstanding the Statute of Frauds * * *." See, also, Gathagan v. Fireston Tire Rubber Co. (1985), 23 Ohio App.3d 16, 23 OBR 49, 490 N.E.2d 923.
This provides an alternative basis for enforcing what the parties obviously agreed to, the performance of which was interrupted by the initiation of the present litigation.
Attorney Fees
Defendant has also sought an award of reasonable attorney fees. Ordinarily, an Ohio court would not contemplate a claim for such fees since, pursuant to the American Rule, Ohio courts are not empowered to grant attorney fees to the prevailing party. See, e.g., Alyeska Pipeline Serv. Co. v. Wilderness Soc. (1985), 421 U.S. 240, 95 S.Ct. 1612, 44 L.Ed.2d 141. Here, however, the lease agreement provides that the lessee shall be liable for "all legal fees and other costs and expenses, including court costs, incurred by Lessor with respect to the enforcement of any of the remedies listed above or any remedy available to Lessor." There is little doubt that the present action, regardless of whether the lessor or lessee initiated the litigation, concerns the enforceability of the lease, default thereunder, and applicable remedies. The issue then becomes whether a clause apportioning attorney fees is enforceable as between the parties.
The Ohio Supreme Court recently considered this very issue in Nottingdale Homeowners' Assn. v. Darby (1985), 33 Ohio St.3d 32, 514 N.E.2d 702. In that case, an agreement between a condominium owner and the condominium association allowed that the owner would be liable to the association for attorney fees in the event of legal action. The court held that the parties were free to make such concerns a subject of the contract between them and, so long as the contract was not one of adhesion, that such terms were to be enforced at law. See, also, Glaspell v. Ohio Edison Co. (1987), 29 Ohio St.3d 44, 46-47, 29 OBR 393, 394-395, 505 N.E.2d 264, 265-266.
A court faced with the task of awarding reasonable attorney fees may entertain post-trial briefs on the subject and, where necessary, conduct an additional hearing upon this issue alone. Darby, supra, 33 Ohio St.3d at 33, 514 N.E.2d at 703. The court concludes that defendant is entitled to an award of such attorney fees, costs and expenses as are "fair, just and reasonable." Id. at 37, 514 N.E.2d at 707. The parties are hereby instructed to file such post-trial briefs as they deem necessary upon this issue. Should either party so require, a hearing on the issue may be conducted.
Interest
There remains the issue of interest to be awarded. R.C. 2743.18(B) indicates that interest upon a judgment rendered is that provided in R.C. 1343.03, i.e., ten percent. Here, however, TCI has sought prejudgment interest and the provision for prejudgment interest as set forth in R.C. 2743.18(A) is not nearly as precise. That provision states merely that: "Prejudgment interest shall be allowed with respect to any civil action on which a judgment or determination is rendered against the state for the same period of time and at the same rate as allowed between private parties to a suit." This subsection is sufficiently broad as to allow an award of prejudgment interest based upon whatever rate the parties may have agreed to by contract or otherwise. Where, as here, interest was neither calculated nor charged, the court must determine the rate of interest that prevailed among "private parties to a suit."
R.C. 126.30(A) and (E) require that whenever an agency fails to make payments on its obligations, it shall be required to pay interest from the time of default as calculated pursuant to R.C. 5703.47. That provision states as follows:
"(B) On the fifteenth day of October of each year, the tax commissioner shall determine the federal short-term rate. For purposes of any section of the Revised Code requiring interest to be computed at the rate per annum required by this section, the rate determined by the commissioner under this section, rounded to the nearest whole number per cent, plus three per cent shall be the interest rate per annum used in making the computation for interest that accrues during the following calendar year."
The rates established by the Tax Commissioner on October 15 of each year, plus three percent, are as follows: 1986 — eight percent; 1987 — ten percent; 1988 — ten percent; 1989 — eleven percent; and 1990 — eleven percent. Therefore, the amount of prejudgment interest applicable in this case shall be calculated, and will be awarded pursuant to these rates for each period, beginning and ending on October 15.
Conclusion
The facts and law indicate that the agreements at issue are leases and, in the eyes of the law, they are valid and enforceable between the parties. Hence, the decision to stop payment, even if made upon the advice of the Attorney General's Office, constituted a breach of that contract. Accordingly, plaintiffs are liable to defendants for all payments owed up to the present date, plus interest at the above rate.
Additionally, the phones are and remain the property of TCI. Since plaintiffs breached the lease agreement, TCI may elect any of the contractual remedies, including the repossession of its property from every location wherever situated. Or, the parties may, if TCI agrees, continue under the terms of the leases, there having been considerable testimony that the Auditor's Office was completely satisfied with both the equipment and service up to the time of breach.
Having determined the above issues, it remains only to point out that the remaining allegations in defendant's counterclaim are moot and will not be resolved at this time.
Judgment will be rendered for the defendant and against the plaintiffs for all amounts yet unpaid pursuant to the above decision. A meeting of the parties shall be conducted at the court's earliest convenience, at which time the parties may prepare and submit their views upon the precise amounts by way of additional post-trial briefs.
Judgment accordingly.
RUSSELL LEACH, J., retired, of the Franklin County Municipal Court, sitting by assignment.