In re Beker Industries Corp., Bankruptcy No. 85-B-11709-10

• Decision Date: 11 February 1987
• Docket Number: Bankruptcy No. 85-B-11709-10,Adv. No. 86-5458A.
• Parties: In re BEKER INDUSTRIES CORP., et al., Debtors. NYNEX BISC (formerly known as NYNEX Information Systems, Company), Plaintiff, v. BEKER INDUSTRIES CORP., as debtor in possession, Defendant.
• Court: United States Bankruptcy Courts. Second Circuit. U.S. Bankruptcy Court — Southern District of New York

69 B.R. 937 (1987)

In re BEKER INDUSTRIES CORP., et al., Debtors NYNEX BISC (formerly known as NYNEX Information Systems, Company), Plaintiff, v. BEKER INDUSTRIES CORP., as debtor in possession, Defendant.

Bankruptcy No. 85-B-11709-10, Adv. No. 86-5458A.

United States Bankruptcy Court, S.D. New York.

February 11, 1987.

Kronish, Lieb, Weiner & Hellman, New York City by William J. Rochelle, III, for debtors.

Michael Cook, New York City, for NYNEX BISC.

DECISION AND ORDER

HOWARD C. BUSCHMAN, III, Bankruptcy Judge.

Plaintiff, NYNEX Business Information Systems Company ("NYNEX"), seeks, in this adversary proceeding against the defendant debtor and debtor-in-possession, Beker Industries Corp., Inc. ("Beker" or the "Debtor"), to recover damages and immediate possession of telephone equipment which is the subject of an agreement between the plaintiff and the Debtor.¹ Plaintiff contends that the agreement is a true lease and therefore it is entitled to immediate possession or a judgment in the amount of rental payments due from the time of the Debtor's default, together with interest thereon, and requiring the Debtor to assume or reject the lease, cure prior defaults and provide adequate assurance of future performance. See 11 U.S.C. § 365(a), (b) (1984) (the "Code"). The Debtor claims that in substance and effect, the agreement is the functional equivalent of a sale coupled with a security agreement, pursuant to which plaintiff only retains a purported security interest in the equipment to secure Beker's obligations. It, therefore, asserts that the transaction is governed by Article 9 of the Uniform Commercial Code ("U.C.C."), as adopted in the State of Connecticut, Conn.Gen.Stat. §§ 42a-9-101 et seq.

It is undisputed that NYNEX did not file a U.C.C. financing statement to perfect its interest as would be required by U.C.C. § 9-302. Accordingly, if the transaction is found to have been a sale, the rights of NYNEX are "subordinate to the rights of ... a person who becomes a lien creditor before the security interest is perfected...." U.C.C. § 9-301(1)(b). Beker succeeded to such status upon filing its reorganization petition. See 11 U.S.C. §§ 544(a), 1107(a). It would consequently be entitled to avoid the security interest under 11 U.S.C. § 544 and § 550(a), if the transaction is deemed a sale rather than a lease, thereby leaving NYNEX with an unsecured claim for the amounts owed.

The principal issue to be decided in this case is whether there is a true lease or a lease intended as a security agreement. Trial was held on November 20, 1986 and post-trial briefs were submitted on December 19, 1986.

I.

The Debtor filed a voluntary petition for relief under Chapter 11 of the Code on October 21, 1985. This Court's jurisdiction is based on 28 U.S.C. § 157 and § 1334. Venue is based on the filing of a Chapter 11 petition by defendant, Beker, in the Southern District of New York.

Sometime in March of 1984, Barry Adams, an accounting manager for NYNEX, spoke with a Mrs. McGoldrick of Beker Industries "to review Beker's communication needs" (Tr. at 7). Adams subsequently met with McGoldrick and a Mr. Dennerly to discuss replacement of their old Centrex Telephone System (Tr. at 28). The Beker representatives were offered three various arrangements: (i) an outright sale of the equipment, (ii) a lease with a one dollar buy-out option at the end of the term, and (iii) a lease with a fair market value buyout option (Tr. at 9). The lease with the fair market value buy-out was selected (id. at 9-10). Pursuant to this selection an agreement, entitled the "Equipment Lease", was finalized on January 4, 1985 (the "Agreement").

On the face of the Agreement, NYNEX was to lease and Beker was to rent a certain telephone system comprised of three basic components: basic common equipment (commonly known as a switch), terminal equipment (better known as a receiver), and wiring (Tr. at 19-20). The payment terms consisted of a one-time administration fee of $6,457.80 plus monthly payments in the amount of $3,254.73, including sales tax of $244.10, for a period of forty-eight (48) months (Pl.Exh. 1). The system was installed and became operational in July of 1985 (Tr. at 35). Beker forwarded one payment on August 15, 1985, in the amount of $9,956.63, and has since been in default.

As a result of Beker's failure to meet its contractual obligations, NYNEX filed its complaint on May 5, 1986 seeking to enforce the default provisions of the Agreement, including its rights to repossession of the telephone equipment and money damages for unpaid rental fees.

II.

The basic guideline for determining whether a lease is a security agreement is set forth in U.C.C. § 1-201(37).² That section provides, in pertinent part:

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.

U.C.C. § 1-201(37) (emphasis added). Thus,

in determining when the lease is intended as security, consideration should be given to (a) the intention of the parties, (b) the consideration connected with the exercise of the purchase option, (c) "the percentage that option purchase price bears to list price, especially if it is less than 25%," (d) whether the terms of the lease and option are such that "the only sensible course for the lessee at the end of the lease term is to exercise the option and become the owner of the goods."

T. Quinn, Uniform Commercial Code Commentary and Law Digest ¶ 9-102A4b, at 9-8 (1978) (quoting In re Alpha Creamery Co., Inc., 4 U.C.C. Rep. 794 (W.D.Mich.1967)).

As to the intent of the parties at the time of contracting, an objective standard is employed. Michigan Carbonic Co. v. Anton's Lounge & Restaurant (In re Anton's Lounge & Restaurant), 40 B.R. 134 (Bankr.E.D.Mich.1984). "The parties' subjective intent `would not make a true lease of what economic realities might show to be a secured installment sale. To paraphrase Shakespeare's words, a secured transaction by any other name is still a secured transaction, and section 1-201(37) so recognizes.'" 40 B.R. at 136 (quoting Steele v. Gebetsberger (In re Fashion Optical Ltd.), 653 F.2d 1385, 1390 (10th Cir. 1981)).

Here, the undisputed testimony of Mr. Adams reveals that Beker rejected an outright sale and opted for an arrangement styled as a lease (Tr. at 9-10). This would tend to show that the parties intended a lease. On the other hand, Beker rejected the one dollar buy-out lease arrangement and chose the fair market value buy-out. On its surface, this election would also indicate that a lease was intended. But no evidence of the difference in the payment terms of the two leases was submitted. Had the dollar buy-out arrangement consisted of the same rental payments as the fair market value buy-out, one might infer that, in effect, the options were one and the same and that Beker chose the fair market value buy-out in the hope that the nature of the transaction would not be easily deciphered. See Liona Corporation, N.V. v. PCH Associates (In re PCH Associates), 804 F.2d 193, 200 (2d Cir.1986). Thus, the testimony as to the paper form of the transaction alone is an insufficient base upon which to determine whether the parties' objective intent was to enter into a lease or a sale.

Where such ambiguity exists, courts have considered an array of factors and tests to determine the objective intent or the economic reality of the situation. See In re Anton's Lounge, 40 B.R. at 136. Section 1-201(37) states that where the option price to become an owner is nominal, the "lease" is deemed a secured transaction as a matter of law. Steele v. Gebetsberger (In re Fashion Optical), 653 F.2d 1385, 1388 (10th Cir.1981). Four tests have been developed to determine whether an agreement is a true lease under the U.C.C.

The first test involves comparing the option price (purchase price) to the fair market value.

If the purchase price bears a resemblance to the fair market price of the property, then the rental payments were in fact designated to be in compensation for the use of the property and the option is a real one. On the other hand, where the price of the option to purchase is substantially less than the fair market value of the leased property, the lease will be construed as a mere cover for an agreement of conditional sale.

In re Oak Manufacturing, Inc., 6 U.C.C. Rep. 1273, 1276 (S.D.N.Y.1969) (citations omitted). The second test compares the option price to the total rental payments. "Where the option price is disproportionately small in comparison with the total rental, it has been held that the contract constitutes a conditional sale." Id. The percentages applied by the courts have varied from 25% to 10%. See, e.g., Percival Construction Co. v. Miller & Miller Auctioneers, Inc., 387 F.Supp. 882, 885 (W.D.Okla. 1973), aff'd, 532 F.2d 166 (10th Cir.1976) (less than 25% is nominal); Chandler Leasing Corp. v. Samoset Associates (In re Samoset Associates), 24 U.C.C.Rep. 510, 513 (Bankr.D.Me.1978) (10%); National Equipment Rental v. Priority Electronics Corp., 435 F.Supp. 236, 238-39 (E.D.N.Y. 1977) (4%). The third test involves a comparison of the rental payments to the selling price. Where the rental payments are equal to or greater than the selling price, the agreement has been held to be a conditional sales contract. In re Oak Manufacturing, 6 U.C.C.Rep. at 1277. The fourth test analyzes additional implications arising from the terms of the agreement itself. In re Tucker, 34 B.R. 257, 261 (Bankr.W.D. Okla.1983).

As to the first two tests, the Agreement provides that the option to buy is to be...