Title: The Continuing Debate regarding the Lease versus Disguised Security Interest Issue: Did the Edison Court Correctly Find a True Lease?
Abstract: I. INTRODUCTION Companies that engage in lease transactions need to be aware of how to structure their contracts to avoid risk of courts later finding their leases to be disguised security agreements. Since extensive revision of Uniform Commercial Code CI.C.C.) section 1-201(37) in 1987, companies now have list of criteria courts look to in determining whether transaction is true lease or disguised security agreement. Although revised section 1-201(37) was intended to clarify lease versus security interest issue, this issue continues to be one of most litigated issues under U.C.C.1 The consequences of whether court deems transaction to be lease or disguised security interest is critical in bankruptcy proceeding. Thus, some explanation of these consequences is helpful. The filing of bankruptcy petition triggers automatic stay, prohibiting both secured parties and lessors from taking action against debtor, debtor's property, and debtor's estate.2 In secured party's case, if collateral is worth less than debt and debtor's estate has no other use collateral, then secured party seek relief from automatic stay by filing a request relief from automatic stay under section 362.3 Section 362(d) provides two separate avenues of relief secured parties.4 The first avenue, under section 362(d)(2), allows secured party to get relief from stay if (A) debtor does not have an equity in such property; and (B) such property is not necessary to an effective reorganization.5 The second avenue, under section 362(d)(1), allows secured party to get relief from stay for cause, including lack of adequate protection.6 The secured party's process of seeking relief from stay under these two avenues be quite time consuming. The lessor has same options available to it as does secured party.7 However, lessor has another option not available to secured party.8 The lessor can use mechanism assumption or rejection of [unexpired leases] set forth in section 365.9 Under Bankruptcy Code, assets are not property of debtor and therefore do not enter bankruptcy estate, meaning that their value is not available distribution to creditors. lo Thus, bankrupt lessee must either lease (after curing any existing defaults), or reject lease and return assets to lessor.11 Assumption or rejection of lease must occur at any time before confirmation of plan but court, on request of any party to such . lease, may order trustee to determine within specified period of time whether to assume or reject such . . . lease.12 In other words, lessor has following two courses of action in bankruptcy proceeding: (1) to seek relief from automatic stay under section 362; or (2) to force assumption or rejection under section 365.13 Either way lessor is assured of receiving either assets or contract payments after lessee enters bankruptcy. 14 Another important consequence of characterizing transaction as either true lease or disguised security interest arises when value of leased property, or collateral if found to be disguised security interest, is less than parties' forecast.l5 In secured party's case, he will get preferential treatment only to extent of value of his security.16 The lessor, on other hand, has no such constraint.17 [I]t is rule of all or nothing: trustee must assume contract in toto, or reject it in toto.Is In reverse situation, if value of collateral is more than parties' forecast, then secured party is entitled to full amount of his claim.l9 One might think that lessor in this situation would be able to recapture leased property; however, the trustee has power to assume and assign lease. …
Publication Year: 1998
Publication Date: 1998-10-01
Language: en
Type: article
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