Pacific Exp., Inc., In re

• Decision Date: 22 January 1986
• Docket Number: Nos. 84-2803,84-2804,s. 84-2803
• Parties: , Bankr. L. Rep. P 70,954, 42 UCC Rep.Serv. 1414 In re PACIFIC EXPRESS, INC., a California corporation, Debtor. PACIFIC EXPRESS, INC., a California corporation, Plaintiff-Appellee, v. TEKNEKRON INFOSWITCH CORPORATION, a Nevada corporation, Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1482

780 F.2d 1482

14 Bankr.Ct.Dec. 69, Bankr. L. Rep. P 70,954,

42 UCC Rep.Serv. 1414

In re PACIFIC EXPRESS, INC., a California corporation, Debtor.

PACIFIC EXPRESS, INC., a California corporation, Plaintiff-Appellee, v. TEKNEKRON INFOSWITCH CORPORATION, a Nevada corporation,

Defendant-Appellant.

Nos. 84-2803, 84-2804.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Oct. 10, 1985.

Decided Jan. 22, 1986.

Julia P. Gibbs, Howard, Rice, Nemerovski, Canady, Robertson & Falk, San Francisco, Cal., for plaintiff-appellee.

M. Sean McMillian, Pamela M. Soderbeck, Loo, Merideth & McMillian, Los Angeles, Cal., for defendant-appellant.

Appeal from the United States District Court for the Eastern District of California.

Before MERRILL, TANG, and BOOCHEVER, Circuit Judges.

MERRILL, Circuit Judge:

Creditor Teknekron Infoswitch Corp. ("Teknekron") appeals the approval of the sale of certain telecommunications equipment by bankrupt debtor Pacific Express, Inc. ("Pacific"). The case requires us to resolve conflicting claims of title to two separate sets of equipment. We affirm as to one set, but reverse as to the other.

I. Facts and the Proceedings Below

On or around June 17, 1983, creditor Teknekron agreed to deliver to debtor Pacific certain telecommunications equipment (the "Original Equipment"). Teknekron is located in Texas; Pacific is in California. Later that year, on August 12, the parties executed a document denominated a "Lease Agreement." Under that "Lease Agreement," Pacific undertook to pay Teknekron $9,250 a month for the succeeding five years in exchange for the use of the Original Equipment. At the time of the execution of this document, the Original Equipment was worth in excess of $416,000. Teknekron has never filed a financing statement relating to the Original Equipment, now in Pacific's possession.

At approximately the same time, Pacific and Teknekron entered into a Maintenance Agreement in which Teknekron agreed to service the Original Equipment for a fee of $1,750 a month. As part of the Maintenance Agreement, Teknekron gave Pacific a non-exclusive license to use the software that was necessary to run the Original Equipment.

On October 7, 1983, in a separate and distinct transaction, Teknekron shipped to Pacific certain other telecommunications equipment (the "Additional Equipment"). Teknekron agreed to sell and Pacific agreed to buy this Additional Equipment for $112,060.

On February 2, 1984, before having paid any of the amounts owed to Teknekron, Pacific filed a petition as debtor-in-possession under Chapter 11 of the Bankruptcy Code. In the bankruptcy court, Teknekron applied for relief from the automatic stay triggered by the bankruptcy filing so that it could regain possession of both the Original Equipment and the Additional Equipment. In the alternative, it petitioned the court under Section 365 of the Bankruptcy Code, 11 U.S.C. Sec. 365, to order Pacific either to assume or reject what Teknekron claimed to be an executory contract comprised of the Original Equipment "Lease," the Maintenance Agreement, and the software license.

For its part, Pacific asserted that the "Lease" was intended as security. It therefore did not reserve title in Teknekron and created only a security interest. Under section 544(a)(1) of the Bankruptcy Code, 11 U.S.C. Sec. 544(a)(1), Pacific sought to avoid what it claimed to be Teknekron's unperfected security interest in the Original Equipment. ¹ Pacific also claimed that it owned the Additional Equipment free of any interest of Teknekron.

On cross-motions for summary judgment, the bankruptcy court ruled that the "lease" represented only a security interest avoidable under section 544(a)(1) and that Pacific, as debtor-in-possession, therefore owned the Original Equipment free of Teknekron's interest. It also ruled that Pacific held title to the Additional Equipment. Accordingly, it denied Teknekron's motions. The bankruptcy court subsequently authorized Pacific to sell all of the equipment in question. Upon Teknekron's tender of a deposit, that sale has been held in abeyance pending the resolution of this dispute.

Teknekron appealed the bankruptcy court's orders to the district court, which affirmed the bankruptcy court in all respects.

This court has jurisdiction pursuant to 28 U.S.C. Secs. 158(d) and 1291. As the case comes before us after a grant of summary judgment, we review the evidence de novo to determine whether the record, viewed in the light most favorable to the losing party, suggests the existence of any remaining issues of material fact. In re Cochise College Park, Inc., 703 F.2d 1339, 1346 (9th Cir.1983).

II. The Original Equipment

With regard to the Original Equipment, application of sections 544(a) and 365 depends on characterization of the "Lease Agreement." If the "Lease" only secures payments due under an installment sale, then Pacific owns the Original Equipment, and Teknekron's unperfected security interest is subject to avoidance under section 544(a)(1). If, however, the "Lease" is a true lease, then Teknekron retains a reversionary ownership interest and is entitled to the return of the Original Equipment. In re J.A. Thompson & Son, Inc., 665 F.2d 941, 945 (9th Cir.1982).

A. Security Lease vs. True Lease

Paragraph 15 of the Lease Agreement provides that Texas law shall govern the interpretation of the document. Like its Uniform Commercial Code equivalent, Tex.Bus. & Com.Code Ann. Sec. 1.201(37) (Vernon 1984) states that whether a lease is a true lease or a security agreement depends on the intention of the parties. The formal retention of title in a security lease serves to reserve only a security interest. The statute then continues:

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.

The statute mandates that we "must determine the parties' intent in the light of the facts and circumstances of each case," and that "the substance of the document rather than mere formality of wording must be examined to determine whether the transaction involved a lease, a conditional sale, or a security interest." Davis Brothers v. Misco Leasing, Inc., 508 S.W.2d 908, 912-13 (Tex.Civ.App.1974). Here, that factual examination discloses that the parties intended the purported lease to serve as security for Pacific's installment purchase of the Original Equipment from Teknekron.

As both parties have stipulated, the parties initially agreed on or around June 17, 1983, that Pacific would buy the Original Equipment from Teknekron. Only with the written formalization of that agreement on August 12 did the transaction take on the trappings of a lease. The "Equipment Order Schedule Detail" incorporated into the "Lease Agreement" lists the individual items of Original Equipment by "Purchase Price." The stipulated value of the equipment at that time, $416,000 or more, approximates the sum of those prices. Pacific was unconditionally obligated to pay $9,250 a month for five years. Its payments would have amounted to $555,000, which appears to represent the stipulated original value plus interest over five years. Thus, the economic substance of the transaction is that of an installment sale.

Moreover, the evidence suggests that Teknekron did not anticipate regaining the use of the Original Equipment. Teknekron's own evidence, consisting of an affidavit from one of its employees, Steven Gwilliam, showed that advances in technology would render the equipment obsolescent by the end of the five-year lease period. A lease term spanning the effective useful life of the equipment is a sign that the parties intended a sale. In re Marhoefer Packing Co., 674 F.2d 1139, 1145 (7th Cir.1982); In re Peacock, 6 B.R. 922, 926 (Bankr.N.D.Tex.1980); In re Teel, 9 B.R. 85, 88-89 (Bankr.N.D.Tex.1981).

Other provisions of the "lease" indicate that the parties intended to pass actual ownership to Pacific and to reserve only a security interest for Teknekron. Pacific had the right to purchase the Original Equipment for its fair market value, not to exceed $20,000, at the end of the five-year term. Pacific agreed to pay all sales, use and property taxes pertaining to the Original Equipment. It also agreed to insure the equipment in favor of the lessor. Pacific bore the risk of loss or damage of the equipment, and it agreed to post a substantial deposit. The "lease" gave Teknekron the rights of a secured party under the Uniform Commercial Code upon default by Pacific. In case of default, Teknekron would have the right to sell the equipment, with Pacific liable for any deficiency after application of the sales proceeds to the payments due.

These facts support a finding that the parties intended to create a security interest rather than a true lease. Davis Brothers, 508 S.W.2d at 913; In re Tulsa Port Warehouse Co., 690 F.2d 809, 811-12 (10th Cir.1982); American Standard Credit v National Cement Co., 643 F.2d 248, 265-66 (5th Cir.1981); United States v. Federal Insurance Co., 634 F.2d 1050, 1052-53 (10th Cir.1980); White and Summers, Handbook of the Law under the Uniform Commercial Code 882-83 (2d ed. 1980). Of course, any one of these facts alone might not suffice to justify that finding. In the aggregate, however, they point persuasively to the conclusion that the "lease" was actually a disguised security agreement. ²

Because the purported "lease" was not a true lease but a security arrangement, Pacific owned the Original Equipment on the date of bankruptcy, and Teknekron's rights were limited to the retention of a security interest. Teknekron...