Iowa Court Finds Personal Property Lease was Disguised Security Agreement

In C & J Vantage Leasing Co. v. Wolfe — N.W.2d —-, 2011 WL 744633 (2011), the Iowa Supreme Court addressed whether a commercial personal property lease was a disguised security agreement. In finding that a triable issue of act existed as to whether the lease was a true lease, the Court explained:

First, we must decide whether the lease agreement entered into between the parties is properly considered a finance lease, as urged by Frontier, or a disguised sale with a security interest, as argued by Lake MacBride. . . .A lease is defined as a “transfer of the right to possession and use of goods for a term in return for consideration, but a sale … or retention or creation of a security interest is not a lease.” Iowa Code § 554.13103(1)(j ) (2003) (emphasis added). A finance lease is a lease that meets several additional statutory requirements. See id. § 554.13103(1)(g ). . .. A transaction must first qualify as a lease before it can qualify as a finance lease. U.C.C. § 2A-103, cmt. (g) (amended 2003), 1C U.L.A. 829 (2004); see also Iowa Code § 554.13103(1)(g ) (stating, “ ‘Finance lease ’ means a lease”); Outlook Farm Golf Club, LLC, 784 N.W.2d at 757. The definition of a lease specifically excludes a transaction that retains or creates a security interest. Iowa Code § 554.13103(1)(j ). Thus, to determine whether the lease agreement is properly considered a finance lease or a secured transaction, we must first consider whether the agreement retained or created a security interest. Outlook Farm Golf Club, LLC, 784 N.W.2d at 757. If so, the agreement cannot qualify as a lease or a finance lease because an agreement retaining or creating a security interest is specifically excluded from the definition of a lease. Iowa Code § 554.13103(1)(j ). . . .The facts of each transaction determine whether the transaction is a lease or a sale with a security interest. Id. § 554.1201(37)(b ). A security interest is defined as “an interest in personal property or fixtures which secures payment or performance of an obligation.” Id. § 554.1201(37)(a). Iowa Code section 554.1201(37)(b ) contains a bright-line test for determining whether an agreement creates a security interest. It provides that a transaction creates a security interest 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 not subject to termination by the lessee, and (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 additional consideration or nominal additional consideration upon compliance with the lease agreement, or (4) the lessee has an option to become the owner of the goods for no additional consideration or nominal additional consideration upon compliance with the lease agreement. Id. § 554.1201(37)(b ) (emphasis added). The first part of the bright-line test is found in the unnumbered paragraph of section 554.1201(37)(b ). The second part of the bright-line test contains the four criteria listed in sections 554.1201(37)(b)(1)(4). Each of the four criteria listed in the second part of the bright-line test are objectively based on economics, not the intent of the parties. U.C.C. § 1-201, cmt. 37 (amended 1999), 1 U.L.A. 168 (2004); PSINet, Inc. v. Cisco Sys. Capital Corp. (In re PSINet, Inc.), 271 B.R. 1, 44 (Bankr.S.D.N.Y.2001). . . . Applying the first part of the bright-line test, we find the lease agreement prohibited Lake MacBride from terminating its obligation to pay Frontier for the right to possess and use the beverage cart. . . . Applying the second part of the bright-line test, we note the lease agreement provides, “Lessee may purchase equipment at the end of the lease for $1.00 provided the terms of the lease are met.” If the only economically sensible decision is for the lessee to exercise the purchase option, the additional consideration is considered nominal. PSINet, Inc., 271 B.R. at 45. The law is well established that a purchase-option price of $1 amounts to nominal additional consideration, leaving no need to further analyze the economic sensibility of purchasing the equipment for that price. . . Therefore, we find the lease agreement provides Lake MacBride with the option to become the owner of the beverage cart for nominal additional consideration upon compliance with the lease agreement. Thus, the second part of the bright-line test under Iowa Code section 554.1201(37)(b )(4) has been satisfied. Accordingly, we hold the lease agreement is a sale with a security interest and not a lease or a finance lease.

The Court rejected the Lessor’s contention that the parties’ intent controls, explaining:

Frontier cites the UCC’s official comment to the definition of a finance lease, which provides, “[i]f a transaction does not qualify as a finance lease, the parties may achieve the same result by agreement; no negative implications are to be drawn if the transaction does not qualify.” . . . Frontier’s argument, however, fails to consider the full context of the official UCC comment from which it cites. The comment begins with the recognition that before a transaction can qualify as a finance lease, it must first qualify as a lease. Id. at 829. The comment then describes a typical finance lease and explains the requirements necessary for a lease to qualify as a finance lease. Id. at 829-30. Finally, the comment states that if the transaction does not meet the statutory requirements necessary for a lease to qualify as a finance lease, the parties may nevertheless agree to treat it as having qualified as a finance lease. Id. at 830. Thus, while Lake MacBride and Frontier could have agreed to treat a lease as a finance lease, they could not agree to treat a sale with a security interest as a lease. Before a transaction can qualify as a finance lease, it must qualify as a lease . . . Whether an agreement creates a security interest depends not on whether the parties intend that the law characterize the transaction as a security interest but rather on whether the transaction falls within the definition of “security interest” in Section 1-201 [Iowa Code section 554.1201(37)(b ) ]. Thus, an agreement that the parties characterize as a “lease” of goods may be a “security agreement,” notwithstanding the parties’ stated intention that the law treat the transaction as a lease and not as a secured transaction. U.C.C. § 9-102, cmt. 3(b), 3 U.L.A. 64-65 (2010). Accordingly, the fact the parties intended to treat the lease agreement as a lease or a finance lease is immaterial so long as the agreement substantively qualifies as a sale with a security interest under section 554.1201(37)(b ).