Article 9 of the Uniform Commercial Code governs any transaction, regardless of its form, which intends to and creates a security interest in personal property. On the other hand, Article 2A deals with any transaction, regardless of its form, that creates a lease of goods. This distinction can be very important in bankruptcy because sometimes a transaction may appear as a lease, but in reality it is a disguised sale with a security interest. If it really is a sale, this can be bad news for a creditor because he may not be fully secured and will only receive pennies on the dollar from the debtor in bankruptcy.
In theory at least it should not be difficult to tell the difference between these prototypical commercial transactions but many times it comes down to the facts of the case. The UCC defines a lease as a transfer of rights to possession and use of goods for a term in return for consideration, but a sale, or creation of a security interest is not a lease.
To determine if transaction is true lease or disguised sale, courts endorse the “economic realities test”. This test considers the likelihood at the time transaction entered into that the lessor will receive the goods back at a time when goods still have meaningful economic life.
Accordingly, the UCC has codified the economic realities test by providing a bright line test to distinguish the two transactions. Section 1-203 of the UCC states that a security interest is created if the transaction is not subject to termination (no termination clause) AND 1 of the following conditions apply:
- The original term of lease is equal to or greater than the remaining economic life of the goods
- The lessee is bound to renew the lease for the remaining economic life or bound to become owner
- The lessee has the option to renew for the remaining economic life for no additional or nominal consideration OR
- The lessee has the option to become owner for no additional or nominal consideration
Therefore, if the debtor cannot terminate the lease and it looks like the creditor will never again own the good, then it is a sale with a security interest. However, there are other signposts indicative of a sale such as if the debtor bears all cost of insurance, taxes, upkeep; there is a requirement of a down payment; or the goods are supplied by third party.
If you need help determining if a transaction is a true lease or a sale disguised a security interest, call Eric Lanigan and Roddy Lanigan in Winter Park, Florida. This distinction can be very important for both creditors and debtors and may affect how much you pay or receive in a bankruptcy case. The Lanigans will be able to discern the difference.