In re Sprecher Bros. Livestock & Grain, Ltd.

• Decision Date: 05 March 1986
• Docket Number: 484-00361 and 484-00362.,Bankruptcy No. 484-00181
• Citation: 58 BR 408
• Court: U.S. Bankruptcy Court — District of South Dakota
• Parties: In re SPRECHER BROTHERS LIVESTOCK & GRAIN, LTD., a South Dakota Corporation, Joel Kim Sprecher and Nancy Faye Sprecher, and Gene Alan Sprecher, Debtors.

58 B.R. 408 (1986)

In re SPRECHER BROTHERS LIVESTOCK & GRAIN, LTD., a South Dakota Corporation, Joel Kim Sprecher and Nancy Faye Sprecher, and Gene Alan Sprecher, Debtors.

Bankruptcy Nos. 484-00181, 484-00361 and 484-00362.

United States Bankruptcy Court, D. South Dakota.

March 5, 1986.

Brent A. Wilbur, May, Adam, Gerdes & Thompson, Pierre, S.D., for creditor/movant IFG Leasing Co.

Max A. Gors, Gors, Braun, Carlon, Smith and Zastrow, Pierre, S.D., for debtors/respondents Sprecher Bros. Livestock & Grain, Ltd., Joel Kim Sprecher, Nancy Faye Sprecher, and Gene Alan Sprecher.

MEMORANDUM DECISION

PEDER K. ECKER, Bankruptcy Judge.

Introduction

This matter is before the Court on a resistance to motion for determination of extent and validity of liens and motion to determine acceptance or rejection of executory contract filed on behalf of Sprecher Brothers Livestock & Grain, Ltd., Joel Kim Sprecher, Nancy Faye Sprecher, and Gene Alan Sprecher ("Debtors")¹ by Attorney Max A. Gors, Pierre, South Dakota, on April 26, 1985.² Debtors substantively allege that the two agreements which were entered into between IFG Leasing Company ("IFG") and the debtors are not true leases, but intended as security. Attorney Brent A. Wilbur represented IFG. Hearings on this were held on both May 29, 1985, and September 10, 1985, in Pierre, South Dakota. The Court subsequently requested additional information. In response, the parties filed a stipulation to certain facts on January 23, 1986.

Background

Two agreements, entitled "Lease," which were entered into between IFG and the debtors, are at issue. Other than payment and time of execution, the terms in the agreements are identical. One agreement involves a nursery-grower with an office which is 24' by 50' and a concrete pit which is 24' by 50' by 6' (herein "nursery-grower agreement"). The other involves two modified open front finishing buildings, one which is 36' by 60' and the other 36' by 30'. These buildings and concrete pit are used by the debtors in their hog raising operations. Construction was performed by TASCO, Inc., of Shell Rock, Iowa, who is both IFG's supplier and its agent.

The nursery-grower agreement was executed between the parties on April 24, 1980. According to agreement,³ the debtors were entitled to use the nursery-grower and concrete pit for a seven-year period conditioned on the following payment schedule:

There will be 7 rental payments made on an ANNUAL basis . . . The rental payments due under this Lease will be adjusted in accordance with the changes in the prime lending rate of Citibank, N.A. in arrears. The rental payments will be adjusted for each ¼ of 1% change in said prime lending rate at a factor of .115% of the cost of equipment, which for the purpose hereof is established at $62,600.00. On the commencement date of this Lease, the prime lending rate is 19½% and the initial rental payment is $15,646.24. In the event the prime lending rate is at or below 12% the rental payments will remain constant.

Under this schedule, the payout over the seven years is $62,600.00 plus applicable interest. On the execution date, the nursery-grower and concrete pit had a retail value of $62,600.00.

On January 5, 1983, the parties both extended the expiration date and modified the payment schedule as follows:⁴

"A total accounts receivable balance of $77,772.24 will be paid as follows:

Starting February 1, 1983, 84 monthly payments of $925.86 continueing (sic) until January 1, 1990."

On this date, the nursery-grower and concrete pit had an in-place value of $40,000.00 and liquidation value of $25,000.00.

The finishing buildings agreement was executed between the parties on September 26, 1980. According to the agreement, the debtors were entitled to use the two modified open front finishing buildings for a seven-year period conditioned on the following payment schedule:

There will be 7 rental payment(s) of $26,020.80 each. Rental payments shall be made annually. The first rental payment shall be due on September 26, 1980 with subsequent rental payments commencing September 25, 1981. The first one . . . being payable at the time of the signing of this lease in the total amount of $26,020.80 dollars.

Under this schedule, the payout over the seven-year period is $182,145.60. On the execution date, the retail value of the two finishing buildings was $119,949.13.

On January 5, 1983, the parties both extended the expiration date and modified the payment schedule as follows:⁵

"A total accounts receivable balance of $157,492.44 will be paid as follows:

Starting February 1, 1983, 84 monthly payments of $1,874.91 continueing (sic) until January 1, 1990."

On this date, the two buildings had an in-place value of $40,000.00 and liquidation value of $25,000.00.

According to the terms, both agreements provide that:

1) Debtors bear risk of loss;⁶

2) Debtors provide comprehensive insurance against loss, theft, damage, or destruction;⁷ 3) Debtors pay all charges, taxes,⁸ and maintenance;⁹

4) Debtors may earn equity in the buildings or concrete pit;¹⁰

5) IFG may, on default by the debtors, accelerate all payments;¹¹ and

6) All express or implied warranties of fitness and merchantability are excluded.¹²

Neither agreement included any purchase option or title transfer provision.¹³ Also, in the Fall of 1980, IFG filed two financing statements which covered the nursery-grower with office, the concrete pit, and the two finishing buildings in the Beadle County, South Dakota, recorder's office.

The debtors also contend that, because the buildings and concrete pit are "fixtures," this is indicative that both agreements were intended as security. The Court is unsure as to what the debtors intended by this argument. Nevertheless, there are only two reasonably possible meanings: 1) Whether, as a matter of law, a "lease" is intended as security when purportedly leased property has become a fixture prior to the expiration of the agreement; or 2) Whether, as a matter of fact, a "lease" agreement is intended as security when purportedly leased property has become a fixture prior to the expiration of the agreement.

In response, IFG insisted that it often removes these types of property and sells them by auction. In support of this, IFG provided numerous pictures showing both the removing and transporting of similar property.

Legal Issues

The fundamental issues raised are: 1) Whether the terms of the "lease" agreement create a security interest; and 2) If so, whether IFG had a perfected security interest in the nursery-grower, the concrete pit, or the two finishing buildings on the date which the debtors filed for relief under Chapter 11 of the Bankruptcy Code.

Law

A. First Issue

As to the first issue, the Court finds that, under South Dakota law, the terms of the "lease" agreements create a security interest, and the Court, therefore, holds that neither of the leases are true leases but are financing arrangements which are disguised as leases.

Because the first issue resolves this matter, the Court finds it unnecessary to address the debtors' "fixture" arguments. Prior to discussing the first issue, the Court, however, notes that:

1) No case was either offered or found as standing for the proposition that, as a matter of law, a lease is intended as security when the purportedly leased property has become a fixture prior to the expiration of the agreement; and

2) Although some courts have considered a property\'s "fixture" status as one of many factors considered in determining that a lease was intended as security, no case was either offered or found in which a court relied solely on "fixture" status. See WOCO v. Benjamin Franklin Corp., 20 U.C.C. 1015 (D.N.H.1976), aff\'d, 562 F.2d 1339 (1st Cir.1977); Meeker v. Fowler, 35 Ill.App.3d 313, 341 N.E.2d 412 (1976).

The Bankruptcy Code defines "security interest" as a lien created by agreement. 11 U.S.C. § 101(43). It does not define "lease." The legislative history states that state or local law should be applied in determining whether a lease constitutes a security interest under the Bankruptcy Code. H.R.Rep. No. 595, 95th Cong., 1st Sess. 313-314, reprinted in 1978 U.S.Code Cong. & Ad.News 5787.

The principal state law on this question is found in the South Dakota Uniform Commercial Code. Article 9 includes all transactions, regardless of their form, that are "intended to create a security interest in personal property or fixtures." S.D.C.L. § 57A-9-102(1)(a). To this end, Section 9-102(2) provides that Article 9 "applies to security interests created by contract including . . . leases . . . intended as security." This specific reference to leases makes it clear that Article 9 applies to transactions that, while disguised as leases, are, in effect, sales or conditional sales from the "lessor" to the "lessee." See American Standard Credit v. National Cement Co., 643 F.2d 248, 260 (5th Cir. 1981).

The South Dakota Code provides, in pertinent part, the following definition of "security interest":

"Security interest" means an interest in personal property or fixtures which secures payment or performance of an obligation. The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer (section 2-401) is limited in effect to a reservation of a "security interest." . . . Unless a lease . . . is intended as security, reservation of title thereunder is not a "security interest". . . . Whether a lease is intended as security is to be determined by the facts of each case; however, (1) the inclusion of an option to purchase does not of itself make the lease one intended for security, and (2) 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.

S.D.C.L. § 57A-1-201(37).

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