United Airlines Inc. v. Hsbc Bank Usa, N.A.

• Decision Date: 23 August 2005
• Docket Number: No. 04-4321.,No. 04-4315.,No. 04-4209.,04-4209.,04-4315.,04-4321.
• Citation: 416 F.3d 609
• Parties: UNITED AIRLINES, INC., Plaintiff-Appellant, v. HSBC BANK USA, N.A., as Trustee, and California Statewide Communities Development Authority, Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 609

416 F.3d 609

UNITED AIRLINES, INC., Plaintiff-Appellant, v. HSBC BANK USA, N.A., as Trustee, and California Statewide Communities Development Authority, Defendants-Appellees.

No. 04-4209.

No. 04-4315.

No. 04-4321.

United States Court of Appeals, Seventh Circuit.

Argued May 5, 2005.

Decided July 26, 2005.

Rehearing and Rehearing En Banc Denied August 23, 2005.^*

Harold L. Kaplan, Gary W. Garner and Mark F. Hebbeln, Gardner, Carton & Douglas, Chicago, IL, Kirk D. Dillman, James O. Johnston (argued), Hennigan, Bennett & Dorman, Los Angeles, CA, for Appellee HSBC Bank USA, N.A.

R. Dale Ginter, Jamie P. Dreher (argued), Downey Brand, Sacramento, CA, for Appellant.

James H.M. Sprayregen, Marc Kieselstein (argued), Kirkland & Ellis, Chicago, IL, for Debtor-Appellant.

William P. Smith, McDermott, Will & Emery, Chicago, IL, for Amicus Curiae, Bank of New York.

Douglas W. Jessop, Jessop & Co., Amicus Curiae, City of Denver.

Mark E. Abraham, Gould & Ratnet, Chicago, IL, for Amicus Curiae, U.S. Bank National Association.

David A. Golin, Gesas, Pilati, Gesas & Golin, Chicago, IL, for Amicus Curiae, Regional Airports Improvement Corp.

Charles P. Schulman, Sachnoff & Weaver, Chicago, IL, for Amicus Curiae, City of Los Angeles.

Before BAUER, EASTERBROOK, and MANION, Circuit Judges.

EASTERBROOK, Circuit Judge.

What is a "lease" in federal bankruptcy law? Businesses that do not pay up front for assets may acquire them via unsecured debt, secured debt, or lease; in each event the business pays over time. Similar economic function implies the ability to draft leases that work like security agreements, and secured loans that work like leases. Yet the Bankruptcy Code of 1978 distinguishes among these devices. A lessee must either assume the lease and fully perform all of its obligations, or surrender the property. 11 U.S.C. § 365. A borrower that has given security, by contrast, may retain the property without paying the full agreed price. The borrower must pay enough to give the lender the economic value of the security interest; if this is less than the balance due on the loan, the difference is an unsecured debt. See 11 U.S.C. § 506(a) and § 1129(b)(2)(A). There are other ways in which the Code treats leases differently from security interests, but they don't matter to today's dispute.

During the 1990s United Air Lines entered into complex transactions to obtain money to build or improve premises at four airports—San Francisco, Los Angeles, Denver, and John F. Kennedy in New York. For each airport, a public body issued bonds that, because of the issuer's status as a unit of state government, paid interest that is free of federal taxation. The public bodies turned this money over to United against its promise to retire the bonds and reimburse administrative costs. At each airport, United entered into a lease giving the body that had issued the bonds the right to evict United from operational facilities if it did not pay.

When United entered bankruptcy in 2002, however, it took the position that none of these transactions is a "lease" for purposes of § 365. United proposed to treat each transaction as a secured loan, so that it could continue using the airport facilities while paying only a fraction of the promised "rent." Chief Bankruptcy Judge Wedoff concluded that the word "lease" in § 365—a term not defined anywhere in the Bankruptcy Code—includes "true leases" but not transactions where the form of a lease is used but the substance is that of a security interest. Applying this approach as a matter of federal law, Judge Wedoff concluded that the Denver transaction is a true lease but that the other three are not. In re UAL Corp., 307 B.R. 618 (Bankr.N.D.Ill.2004). This meant that United had to cure the default and resume full payments on its Denver deal but could reduce its payments on the other transactions and treat the difference as unsecured debt.

Everyone appealed. The district judge issued four opinions, one for each airport, and held that all four transactions are "true leases." Two are published: United Air Lines, Inc. v. HSBC Bank USA, 322 B.R. 347 (N.D.Ill.2005) (Denver), and HSBC Bank USA v. United Air Lines, Inc., 317 B.R. 335 (N.D.Ill.2004) (San Francisco). Relying principally on Butner v. United States, 440 U.S. 48, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979), and In re Powers, 983 F.2d 88 (7th Cir.1993), Judge Darrah first concluded that state rather than federal law controls the distinction between security interests and leases. Then, applying California, Colorado, and New York law, he held that each transaction must be treated as a "lease." United has appealed in all of these adversary actions. The San Francisco dispute has been fully briefed; the other appeals are being held for the disposition of this one. Parties to the Los Angeles, Denver, and New York transactions have presented their views as amici curiae. We confine our attention in this opinion to the San Francisco transaction.

Since 1973 United has been the lessee of 128 acres, used for a maintenance base, at San Francisco International Airport. The lease will end in 2013 unless the parties negotiate an extension; rent depends on an independent party's estimate of the property's market value. In 1997 the California Statewide Communities Development Authority (CSCDA) issued $155 million in bonds for United's benefit. United received the proceeds for use in improving its facilities at the Airport—though not at the maintenance base. The transaction was accomplished through four documents.

• The sublease. United subleases 20 acres of the 128-acre maintenance base to the CSCDA for 36 years. This term matches the debt-repayment schedule rather than United's lease with the Airport. The total rent CSCDA pays is $1.

• The leaseback. The CSCDA leases the 20 acres back to United for a rent (paid to HBSC Bank as the Indenture Trustee) equal to interest on the bonds plus an administrative fee. The lease has a $155 million balloon payment in 2033 to retire the principal. United may postpone final payment until 2038; if it does, the sublease also is extended. United also is entitled to prepay; if it does, the sublease and leaseback terminate. If United does not pay as agreed, the CSCDA may evict it from the 20 acres. The leaseback includes a "hell or high water" clause: United must pay the promised rent even if its lease from the Airport ends before 2033, the property is submerged in an earthquake (the Airport abuts San Francisco Bay), or some other physical or legal event deprives United of the use or economic benefit of the maintenance base.

• The trust indenture. The CSCDA issues the bonds, turns the $155 million over to United against the promises made in the sublease, and arranges for the Trustee to receive United's payments for distribution to the bondholders. The bonds are without recourse against the CSCDA.

• The guaranty. United commits its corporate treasury to repayment of the bonds.

That the sublease and leaseback have the form of "leases" is unquestioned. But does § 365 use form, or substance, to distinguish "leases" from secured credit?

Although the statute does not answer that question in so many words, every appellate court that has considered the issue holds, and the parties agree, that substance controls and that only a "true lease" counts as a "lease" under § 365. See In re PCH Associates, 804 F.2d 193, 198-200 (2d Cir.1986); In re Pillowtex, Inc., 349 F.3d 711, 716 (3d Cir.2003); In re Moreggia & Sons, Inc., 852 F.2d 1179, 1182-84 (9th Cir.1988); In re Pacific Express, Inc., 780 F.2d 1482, 1486-87 (9th Cir.1986). See also, e.g., In re Continental Airlines, Inc., 932 F.2d 282 (3d Cir.1991) (same under 11 U.S.C. § 1110, another part of the Code dealing with leases). We'll return to what a "true lease" might be; that term is no more self-defining than the bare word "lease." Before fleshing out the definition, we explain why we agree with these decisions, because the reasons for preferring substance over form affect which substantive features of the transactions matter.

Whether the word "lease" in a federal statute has a formal or a substantive connotation is a question of federal law; it could not be otherwise. See Reves v. Ernst & Young, 494 U.S. 56, 71, 110 S.Ct. 945, 108 L.Ed.2d 47 (1990); Bryant v. Yellen, 447 U.S. 352, 370-71 & n. 22, 100 S.Ct. 2232, 65 L.Ed.2d 184 (1980). (Whether federal law incorporates state law to answer the questions that result from this choice is a different issue, to which we turn later. Cf. United States v. Kimbell Foods, Inc., 440 U.S. 715, 99 S.Ct. 1448, 59 L.Ed.2d 711 (1979).) The Bankruptcy Code specifies different consequences for leases and secured loans. If these were formally distinct—in the way that mergers and asset sales in corporate law are distinct—then the statutory reference might best be understood as adopting the established forms. But "lease" is a label rather than a form. A transaction by which A sells a widget to B in exchange for periodic payments, with B to own the asset after the last payment, could be structured as an installment sale, a loan secured by the asset, or a lease, with only a few changes in verbiage and none in substance. It is unlikely that the Code makes big economic effects turn on the parties' choice of language rather than the substance of their transaction; why bother to distinguish transactions if these distinctions can be obliterated at the drafters' will?

Many provisions in the Code, particularly those that deal with the treatment of secured credit, are designed to distinguish financial from economic distress. A firm that cannot meet its debts as they come due, but has a positive cash flow from current operations, is in financial but not economic distress. It is carrying too much debt, which can be written down in a reorganization. A firm with a negative cash flow, by contrast, is in economic distress, and liquidation may be the best option....