PR Bankruptcy Court Finds Debtor Waived Right to Re-Characterize Lease as a Secured Transaction

Clark's Secured Transactions Monthly

November 1, 2014
In a recent decision, In re Gutierrez, 2014 Bankr. LEXIS 3379 (Bankr. D.P.R. Aug. 8, 2014), the United States Bankruptcy Court for the District of Puerto Rico found that an agreement executed by the debtor prior to filing for bankruptcy was effective to waive the re-characterization of a “lease” transaction as a secured transaction in her chapter 13 bankruptcy case. As a result of her waiver, she lost her opportunity to wrest her car away from the lessor.
The re-characterization case. In November 2006, the debtor, Aleida Gutierrez leased a car from Popular Auto. The terms of the lease were that Ms. Gutierrez was to make 72 monthly payments of $385.44 per month. At the end of the lease Ms. Gutierrez had the option to purchase the car for “$0.00” plus payment of a charge of $150.00. The lease recited that the lessee agreed that the lease was a “Finance Lease” pursuant to the provision of Puerto Rico’s “Act to Regulate Personal Property Lease Contracts” and “not one intended . . . as a security interest for the purposes of . . . the Commercial Transactions Act”–Puerto Rico’s adoption of Article 9 of the UCC.
Ms. Gutierrez filed a chapter 13 petition on December 12, 2012 with $4,281.72 still due to Popular Auto, according to the proof of claim that Popular Auto filed in the case. Ms. Gutierrez then filed a complaint seeking a determination that the transaction was a disguised security agreement and that she was the owner of the car, even though it was subject to a lien. Popular Auto’s response was that the terms of the lease effectively waived the debtor’s argument that the lease should be treated as a secured transaction. The court held for the lessor and found that the debtor had waived her rights under the UCC. It also rejected the debtor’s argument that the Personal Property Leasing Act was repealed by the later enactment and revision of Article 9 of the UCC in Puerto Rico.
The Bankruptcy Court applied the standard in Puerto Rico law for the effectiveness of any waiver: “Rights granted by the laws may be renounced, provided that such renunciation may not be contrary to law, to public interest or public order, or prejudicial to the interest of a third person” and found that the waiver was enforceable.
Faulty judicial analysis. The court’s analysis was incorrect on several levels. First, the waiver was prejudicial to the interests of the debtor’s other creditors who would have had the benefit of the equity in the car if the transaction was recognized as a secured transaction. Second, by giving effect to the contractual language as the expression of the party’s intention that the lease not be treated as a lease intended for security, the court failed to give effect to the terms of the definition of a secured transaction in the UCC. Section 1-201(37) was amended in 1987 precisely to eliminate the “intent of the parties” as the test for a lease intended for security, and to substitute the objective criteria now present in UCC 1-203(37). Applying those criteria, since the lease contained a nominal purchase option, it was unquestionably a lease intended for security that must be treated as a disguised secured transaction.
Subjective intent has already been rejected by the U.C.C. As the Official Comment to UCC 1-203(37) notes, “reference to the intent of the parties to create a lease or security interest [in the prior formulation of the definition of a security interest] led to unfortunate results.” Accordingly, the UCC’s 1987 amendments to the section omitted any consideration of the parties’ intent. While the 1978 text was “whether a lease was intended as security,” the post-amendment language only seeks to determine “whether a transaction in the form of a lease creates a lease or security interest.” Thus, the U.C.C. concerns itself with the “economic reality” of an agreement, while disregarding what the respective parties may express as their intent. The section designates an agreement as a secured transaction per se where the lessee is bound to pay the lessor for the term of the lease and any of the following conditions are met: (1) the lease’s term is greater than or equal to the economic life of the goods; (2) the lessee must renew the lease for the economic life of the goods or become the owner; (3) the lessee has the option to renew the lease for the economic life of the goods for no (or nominal) consideration; or (4) as in Gutierrez, the lessee has the option to become the owner of the goods for no (or nominal) consideration. 1‑203(37)(b)(1)–(4). This section creates a bright-line test that conclusively establishes the existence of a secured transaction without inquiring as to what any party originally intended.
Cases from other jurisdictions squarely reject the Puerto Rico approach. In re Homeplace Stores, 228 B.R. 88 (Bankr. D. Del.1998), involved an agreement similar to that in In re Gutierrez. There the debtor, HomePlace Holdings (“HomePlace”), entered into an agreement whereby Maxus Leasing Company (“Maxus”) would lease furniture in return for scheduled payments.  This agreement recited that (1) the lease was a “finance lease and not a lease intended as a security as those terms are used in the [U.C.C.],” (2) that the lease was irrevocable, and (3) the lease was to be treated as a “Finance Lease as defined by Section 2A-103(g) of the [U.C.C.].” Id. at 90–91. The court, citing to the 1987 UCC. amendments, found that “the intent of the parties, no matter how clearly spelled out in the parties’ representations within the agreement, cannot control the issue of whether the agreement constitutes a true lease or a security agreement. . . . No matter how expressed or how often expressed, the parties cannot will away the application of UCC § 1-201(37).” Id. at 94–95.
Similarly, the court in In re ECCO Drilling Co., Ltd., 390 B.R. 221, 226 (Bankr. E.D. Tex. 2008), observed that “[T]he intention of the parties has been abandoned as a proper tool by which to distinguish a true lease from a disguised security interest and replaced by an evaluation of the economic structure of the particular transaction.” See also In re Triplex Marine Maint., Inc., 258 B.R. 659, 666, 45 UCC Rep. 2d 977 (Bankr. E.D. Tex. 2000), in which the court observed: “[T]he jurisprudence is clear that, in determining whether a document is a true lease or a disguised security agreement, this court is not bound by any ‘acknowledgment’ by the Debtor nor by any other language or designation of parties contained in the agreement.”
Bottom line.  As explained by the Third Circuit in In re Pillowtex, Inc., 349 F.3d 711, 722, 52 UCC Rep. 2d 18 (3d Cir. 2003), “[R]efusing to defer to the intent of contracting parties in resolving whether their agreement is a lease [or a secured transaction] is particularly appropriate in bankruptcy, as otherwise the costs of the agreement would be externalized to third-party creditors.” Even Gutierrez acknowledges that a waiver must not cause detriment to third-parties. Allowing the debtor’s waiver to stand violated both statutory definitions and common law contract principles on the enforcement of waivers.

James Gadsden is a partner and chair in the insolvency and creditors’ rights practice group at Carter Ledyard & Milburn LLP. Matthew B. James, an associate at Carter Ledyard, assisted in the preparation of this article.
Reprinted with permission from Clark’s Secured Transactions Monthly. © 2014 Matthew Bender & Company, Inc. a LexisNexis company. All rights reserved.

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