Different State Laws Make for Different Treatment of Lease vs. Security Agreement Issue

Posted by NCBRC - October 26, 2017

The substance of a lease for personal property mandated that it be treated as a security agreement rather than a true lease, and therefore, the debtors were entitled to bifurcate the debt into secured and unsecured portions for treatment in their chapter 13 plan. In re Price, No. 17-67 (Bankr. E.D. N.C. Sept. 14, 2017).

Co-debtor, Sidney Price, entered into several lease agreements for equipment with Peak Leasing. The agreements provided that, once he had made all payments under them, Mr. Price had the option to purchase the property for $1.00.

In their chapter 13 plan, the Prices sought to treat the lease agreements as a secured debts and bifurcate the claims into secured and unsecured portions under section 1322(b)(2). Peak Leasing countered that the agreements were true leases and sought relief from the automatic stay to allow it to take possession of the property in the event the debtors failed to make the contractual payments. The court entered an interim order permitting modification of the stay pending its determination of the issue of whether the agreements were leases or security agreements. Mr. Price, however, defaulted on his obligations under the order and it was therefore made permanent. The case was before the court on Mr. Price’s motion for reconsideration and relief from judgment.

The court began its analysis by delineating the significance in chapter 13 of the difference between a lease and a security interest. Under section 365, a lease may be assumed, rejected or assigned. If the lease is in default, the debtor, in order to exercise his right to assume it, must cure the default, recompense the lessor for any loss due to the default, and assure the lessor of future payments under the lease. Under a lease, the value of the property is irrelevant.

In the case of a security agreement, on the other hand, section 506(a) provides for valuation of property and section 1322(b) permits bifurcation into secured and unsecured portions for purposes of treated in a chapter 13 plan.

State law determines whether an agreement is to be treated as a security agreement or a true lease. North Carolina has adopted the Uniform Commercial Code’s Section 1-203, which provides that the nature of the agreement is determined by its operation under the facts of the case rather than its title. Under the UCC, there is a “bright-line” test which, if established, renders the agreement a security agreement as a matter of law. Under this test, if a lease agreement does not allow the lessee to terminate the agreement at will and one of four additional conditions is met, including the option to purchase the property at the end of the lease for no, or nominal, additional cost, a court will find that the lease is, in fact, a security agreement.

In this case, the agreement did not permit Mr. Price to terminate the lease at will and, therefore, the court found the first prong of the bright-line test was met. The option to purchase the property at the end of the lease period for $1.00 satisfied the second prong of the bright-line test. Thus, the court concluded that the agreements were security agreements rather than true leases.

Turning to the motion for relief from judgment of the order modifying the stay, the court found that Mr. Price had met the three conditions under Rule 60(b) in that the motion was timely, he had a meritorious argument, and reconsideration would not unfairly prejudice the non-moving party. Because the court determined that the agreements were, in fact, security agreements, Mr. Price had a meritorious defense to the relief from stay motion, and Peak Leasing, while losing on the ultimate issue, at least had the benefit of receiving adequate protection payments under the interim order and was therefore better off than it would have been had the court merely denied the motion for relief from stay at the outset.

The court found that there was cause to grant the Prices relief from judgment.

Price Bankr ED NC opinion Sept 2017

In contrast, the court in In re Jack, 2017 Bankr. LEXIS 2128, No, 16-8007 (Bankr. M.D. Fla. July 31, 2017), held that state law mandated treatment of an agreement substantially similar to the one in Price, as a true lease rather than a security agreement.

Jeremy and Theresa Jack entered into an agreement to lease furniture for their home from Acceptance Now. The agreement was for two-months with an automatic renewal option. The agreement provided that the Jacks could purchase the furniture at any time by either, 1) paying the purchase price in full, 2) paying the lease price for 37 months, or 3) exercising the “Early Purchase Option.”

When they filed for chapter 13 bankruptcy, the Jacks sought to treat the agreement as a security agreement and bifurcate the debt into secured and unsecured portions in their plan.

In this case, Florida law dictated a different outcome from that of Price. Under Florida Statutes, section 559.9232(1)(e), a “rental-purchase agreement” is an agreement for the use of personal property for an initial period of four months or less, that is automatically renewed with each rental payment following the initial period, and that permits lessee to acquire ownership of the property. Florida law specifically provides, under section 559.9232(2)(f), that a rental-purchase agreement is not construed to be a security interest.

Having found the agreement to be a true lease, the court ordered the Jacks to either assume or reject the lease as required by section 365(d)(2).

Jack Bankr MD Fla opinion July 2017

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