- Category: Judge Nugent
- Published: 21 September 2010
- Written by Judge Nugent
ROBERT E. NUGENT
UNITED STATES CHIEF BANKRUPTCY JUDGE
ROBERT E. NUGENT
UNITED STATES CHIEF BANKRUPTCY JUDGE
SIGNED this 03 day of September, 2010.
IN THE UNITED STATES BANKRUPTCY COURT
FOR THE DISTRICT OF KANSAS
IN RE: )
HP DISTRIBUTION, LLP., ) Case No. 09-12310
) Chapter 11
Debtor. ) Joint Administration
IN RE: )
HITCHIN POST STEAK CO., ) Case No. 09-12308
) Chapter 11
HITCHIN POST STEAK CO., )
vs. ) Adversary No. 09-5258
GENERAL ELECTRIC )
CAPITAL CORPORATION )
Case 09-05258 Doc# 58 Filed 09/03/10 Page 1 of 28
These cross-motions for summary judgment seek the Court’s determination whether certain
truck lease agreements between Hitchin Post Steak Co. (“HPS”) and General Electric Capital
Corporation (“GECC”) are true leases or disguised security agreements. These motions were argued
to the Court on July 13, 2010.1 At stake here is whether HPS must cure and assume these leases in
order to retain its tractors and trailers under 11 U.S.C. § 365 or whether it can cram down its
obligations to GECC to the current value of the tractors and trailers under 11 U.S.C. § 1129(b)(2).2
After careful review of the motions, memoranda, and arguments of the parties, the Court is prepared
Summary Judgment Standards4
The primary purpose of granting a summary judgment motion is to avoid an unnecessary trial
when there is no genuine issue of material fact in dispute. If there are no material facts in dispute,
the sole issue for the court is whether the moving party is entitled to judgment as a matter of law.5
1 HPS appeared by its attorney Mark Lazzo of Wichita, Kansas. GECC appeared by its
attorney Alexander Terras of Reed Smith, LLP, Chicago, Illinois.
2 Unless otherwise indicated, all statutory references are to the Bankruptcy Code, Title
11 U.S.C., as amended by BAPCPA (The Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005).
3 This is a core proceeding under 28 U.S.C. § 157(b)(O) and venue lies in the District of
4 The summary judgment rule, Fed. R. Civ. P. 56, is made applicable to adversary
proceedings by Fed. R. Bankr. P. 7056.
5 See E.E.O.C. v. Lady Baltimore Foods, Inc., 463 F. Supp. 406, 407 (D. Kan. 1986)
(Even if there are no genuine issues of material fact, the movant still has the burden to show that
those facts entitle movant to judgment as a matter of law.); Reed v. Bennett, 312 F.3d 1190, 1195
(10th Cir. 2002).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 2 of 28
Cross-motions for summary judgment do not require the Court to decide the case on the motions;
if neither moving party has met its burden of establishing that there are no genuine issues of material
fact and that, as a matter of law, it is entitled to judgment, the Court can deny both motions.6 The
interpretation of the Agreements at issue here are particularly well-suited for resolution by summary
judgment, where neither party asserts that the Agreements are ambiguous.7 As the party seeking
to characterize the lease Agreements as something “other than what they purport to be,” HPS bears
the ultimate burden of persuasion at trial and the summary judgment stage.8
Each motion included an extensive statement of uncontroverted facts. With one exception,
the only statements of fact controverted by either HPS or GECC related to the characterization given
by the parties of the transactions as either “purchases” or “leases.” Their legal character is the
ultimate legal issue in this case.9 There is no controversy as to the execution, delivery and content
6 Atlantic Richfield Co. v. Farm Credit Bank of Wichita, 226 F.3d 1138, 1148 (10th Cir.
2000) (Mere fact that cross motions are filed does not establish the absence of a material issue of
fact; cross motions for summary judgment are to be treated separately.). An issue is “genuine” if
sufficient evidence exists on each side “so that a rational trier of fact could resolve the issue
either way” and “[a]n issue is ‘material’ if under the substantive law it is essential to the proper
disposition of the claim. Adler v. Wal-Mart Stores, Inc., 144 F.3d 664, 670 (10th Cir. 1998).
7 In re Aramark Leisure Services, 523 F.3d 1169 (10th Cir. 2008) (The interpretation of
an unambiguous contract is a question of law to be determined by the court and may be decided
on summary judgment.); In re JII Liquidating, Inc., 341 B.R. 256, 264-65 (Bankr. N.D. Ill.
8 See WorldCom, Inc. v. Gen. Elec. Global Asset Mgmt. Serv. (In re WorldCom, Inc.),
339 B.R. 56, 62 (Bankr. S.D. N.Y. 2006) (chapter 11 debtor, as party seeking to characterize
purported lease agreement as disguised security arrangement, bore burden of proof at trial); In re
Brankle Brokerage & Leasing, Inc., 394 B.R. 906, 909 (Bankr. N.D. Ind. 2008) (truck-tractor
TRAC lease); In re Gateway Ethanol, L.L.C., 415 B.R. 486, 498 (Bankr. D. Kan. 2009); Celotex
Corp. v. Catrett, 477 U.S. 317, 325, 106 S. Ct. 2548, 91 L.Ed. 2d 265 (1986).
9 The characterization of a transaction is a question of law for the Court. Conclusory
characterizations without any concrete facts to support the characterizations are afforded no
Case 09-05258 Doc# 58 Filed 09/03/10 Page 3 of 28
of the transaction documents. The only other controverted fact is GECC’s assertion that, based upon
a summary appraisal (filed after the argument), the useful life of all of the property exceeds eight
years.10 HPS’s controverting statement contains no supporting citation to the record.11 At oral
argument, counsel for both sides agreed that the property had a useful life in excess of the terms of
the transactions.12 Whether the Court may consider the appraisal is considered below.
The facts controlling this adversary proceeding may be summarized as follows.
HPS filed this case on July 21, 2009. Beginning in 2006, HPS executed a series of
agreements titled “Truck Lease Agreement (TRAC)” (the “Agreements”) whereby GECC purported
to lease to HPS a line of tractors and refrigerated trailers for use in HPS meat delivery business. The
agreements are substantially similar in format and effect, except as set out below.
The First Agreement is dated June 30, 2006 and describes a 60-month lease of five sets of
new refrigerated trailers and refrigerator units (referred to herein as “reefers” and “reefer units”
respectively). The Second Agreement is dated September 1, 2006 and describes a 60-month lease
of ten new tractors. The Third Agreement is dated October 27, 2006 and describes a 60-month lease
of one new tractor. The Fourth Agreement is dated May 4, 2007 and describes a 60-month lease of
weight by the Court. See Murray v. City of Sapulpa, 45 F.3d 1417 (10th Cir. 1995); Patton v.
AFG Industries, Inc., 92 F. Supp. 2d 1200, 1202 n. 3 (D. Kan. 2000); Stephens v. City of Topeka,
Kan., 33 F. Supp. 2d 947, 959 (D. Kan. 1999); Rogers v. United States, 58 F. Supp. 2d 1235 (D.
10 Dkt. 17, ¶ 68.
11 Dkt. 27, p. 4 ¶ 68.
12 At oral argument, counsel for HPS conceded that the useful life was not disputed but
noted that this was not a material issue.
Case 09-05258 Doc# 58 Filed 09/03/10 Page 4 of 28
two new reefers and reefer units. The Fifth Agreement is dated October 27, 2006 and describes a
60-month lease of five new reefers (and no reefer units). The Sixth Agreement is dated May 20,
2007 and describes a 60-month lease of three new reefers and reefer units. The Seventh Agreement
is dated May 1, 2008 and describes a 48-month lease of six used reefers and six used reefer units.
Five of the six used units were model year 2006, thus at least two years old at the time of the
agreement. The sixth unit was a model year 2007, thus at least one year old at the time.13
GECC’s assertion that the useful life of these tractors, trailers and reefer units exceeds eight
years is supported by a summary appraisal that was referenced as an exhibit to its summary
judgment memorandum, but not attached.14 HPS’ rebuttal of this assertion is merely a general denial
that lacks any documentary support.15 At argument, however, both counsel agreed that this
equipment had a useful life in excess of the terms of the Agreements. After argument, the Court
noted the absence of the appraisal exhibit and the clerk advised the parties accordingly. GECC filed
this exhibit on July 21, 2010.16 The exhibit consists of the appraisal report under cover of a letter
dated February 16, 2010, from GECC’s counsel to debtor’s counsel stating that the attached
appraisal report is “our designation of expert and his report.” The appraisal report is not referenced
in GECC’s supporting affidavit submitted with its summary judgment papers as required by Fed.
13 There was no information in the papers concerning the “in-service” date of the used
14 Dkt. 17, p. 12, ¶ 68.
15 Dkt. 27, p. 4, ¶ 68.
16 Dkt 51.
Case 09-05258 Doc# 58 Filed 09/03/10 Page 5 of 28
R. Civ P. 56(e)(1) and this District’s local rule.17 Rule 56(c)(2) provides that summary judgment
may be rendered “if the pleadings, the discovery and disclosure materials on file, and any affidavits”
show the absence of a factual controversy and that the movant is entitled to judgment as a matter of
law. The Court concludes that the appraisal report is part of the “disclosure materials on file” and
finds that it may be relied upon by GECC in support of its motion. This finding is buttressed by the
parties’ stipulation that these tractors, trailers and reefer units have a useful life in excess of 60
months and HPS’s failure to properly controvert GECC’s paragraph 68 statement.18 The Court finds
that the useful life of the goods in question was equal to or exceeded 8 years at the times the
Agreements were executed.
While six of the seven Agreements are virtually identical, the First Agreement is different.
The Second through Seventh Agreements consist of the following components. The seminal
document is the “Truck Lease Agreement (TRAC).” Attached to this agreement are “Schedule A
Even Payments (TRAC)” and “Schedule B Final Adjustment Table.” The Agreement sets out the
relationship and duties of the parties while Schedule A contains what the parties agreed was the
value of the equipment at the inception date, the monthly rent, and the residual value at the end of
17 See D. Kan. LBR 7056(d); Thomas v. Wichita Coca-Cola Bottling Co., 968 F.2d 1022, 1024
(10th Cir. 1992) (noting that sufficient evidence pertaining to a material issue must be identified by
reference to affidavit, deposition transcript or specific exhibit incorporated therein), cert. denied, 506 U.S.
1013 (1992); Harris v. Beneficial Oklahoma, Inc. (In re Harris), 209 B.R. 990, 996 (10th Cir. BAP 1997)
(A document must be identified or authenticated by affidavit or sworn testimony.).
18 See Fed. R. Civ. P. 56(e)(2). Just as the summary judgment movant has a duty to
support its factual contention with a citation to the record, the non-movant has a like duty in
responding to the movant’s statements of uncontroverted fact. The non-movant cannot rely upon
mere denial of the statement as HPS did here. See D. Kan. LBR 7056(a) and (b). The
consequence of failing to properly controvert the movant’s statement is that the statement of fact
is deemed admitted. See D. Kan. LBR 7056(a).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 6 of 28
the term. Schedule B contains the “final adjustment,” the percentage by which the initial agreed
value of the equipment is multiplied to determine the extent to which the parties are indebted to each
other upon early termination of the lease.
The First Agreement is different in that it includes Schedule A, but does not include
Schedule B. Instead, the parties signed an “Amendment to Truck Lease Agreement (TRAC)” (the
“Amendment”) that modifies paragraph 9 of the form Agreement to reference a different formula
for determining the terminal adjustment, one that relies on the calculation of the net present value
of the agreed residual value.
All of the Agreements specify that Texas law will apply.19 The Court observes that Kansas
has also adopted the same UCC provisions at issue here.20 As a practical matter, the Court can
consider decisions from other jurisdictions that interpret these uniform provisions without affecting
There is no dispute that all of these agreements and supporting documents were properly
executed by authorized representatives of the parties and that they are enforceable. The only
remaining question here is a legal one, whether these Agreements should be enforced as leases to
19 It is well established that the determination of whether an agreement that appears to be
a lease on its face is in fact a lease or a security agreement is made by reference to state law. See
In re Gateway Ethanol, L.L.C., 415 B.R. 486, 498 (Bankr. D. Kan. 2009); In re Charles, 278
B.R. 216, 219-20 (Bankr. D. Kan. 2002); Butner v. United States, 440 U.S. 48, 54-55, 99 S. Ct.
914, 59 L.Ed. 2d 136 (1979).
20 KAN. STAT. ANN. § 84-1-203 (2009 Supp.) (Lease distinguished from security
interest); § 84-1-201(b)(35) (2009 Supp.) (“security interest” defined). Both of these statutory
provisions derive from the 1987 version of UCC § 1-201(37).
21 See In re Grubbs Const. Co., 319 B.R. 698, 712 (Bankr. M.D. Fla. 2005).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 7 of 28
be assumed or rejected under § 365 or allowed as secured claims to be crammed down to the
equipment’s value under §§ 506(a) and 1129(b)(2).
These motions require the Court to apply § 1-203 of the Uniform Commercial Code (UCC)
to determine the legal status of the Agreements as leases or security agreements. Texas has adopted
the UCC, but there are numerous cases that interpret this uniform section and its predecessor, the
1987 version of § 1-201(37).22 Before analyzing these Agreements by applying the statute, it is
important to note as have UCC treatise authors, James White and Robert Summers, that a true lease
in its purest form has two distinguishing attributes: the lessor retains an “entrepreneurial stake” in
the leased property and keeps a valuable “reversionary” interest:
The central feature of a true lease is the reservation of an economically meaningful
interest to the lessor at the end of the lease term. Ordinarily, this means two things:
(1) at the outset of the lease the parties expect the goods to retain some significant
residual value at the end of the lease term; and (2) the lessor retains some
entrepreneurial stake (either the possibility of gain or the risk of loss) in the value of
the goods at the end of the term.23
22 Texas adopted the UCC in 1965 and it became effective July 1, 1966. Texas has also
adopted the 2001 Revision of Article 1. See TEX. BUS. & COM. CODE ANN., Title 1, Refs &
Annos and § 1.101 (West 2009). The entire UCC as adopted in Texas can be found at TEX. BUS.
& COM. CODE ANN. §§ 1.101 - 11.108 (West 2009). Due to deletion and renumbering of the
definitional statute, the definition of “security interest” in former § 1-201(37) of the UCC is
found at § 1.201(b)(35) of the TEX. BUS. & COM. CODE ANN. See TEX. BUS. & COM. CODE ANN.
§ 1.201, UCC Comment (West 2009). Section 1.203 became effective September 1, 2003 with
an extensive amendment of Chapter 1 [UCC Article 1]. See TEX. BUS. & COM. CODE ANN., Title
1, Ch. 1, Refs and Annos (West 2009). See also, U.C.C. § 1-201(b)(35) and § 1-203 (2001),
Official Comments, 1 U.L.A. 16, 20, 23, 26 (West 2004) (discussing the 2001 revision to Article
23 J. White and R. Summers, UNIFORM COMMERCIAL CODE Vol 4 § 30-3 at p. 2 (2009),
citing Huddleson, Old Wine in New Bottles: UCC Article 2A Leases, 39 ALA. L. REV. 615,
Case 09-05258 Doc# 58 Filed 09/03/10 Page 8 of 28
On the other hand, a security interest involves a lender who lends money to a purchaser to acquire
property.24 The borrower grants a lien on the purchased goods to secure the loan’s repayment. The
lender has an interest in the collateral’s value not declining below the loan balance, but that is the
extent of the lender’s entrepreneurial interest in the property. Instead, it is the owner who retains
the stake. The Agreements before the Court today fall somewhere between these two extremes. The
Court applies § 1-203's provisions as “signposts” to determine whether these Agreements are true
leases as a matter of law.
Section 1-203(a) begins by stating that whether a particular transaction is a lease or a security
interest is determined by each case’s facts.25 Subsection (b)’s preface sets out the first signpost–
A transaction in the form of a lease creates a security interest if the consideration that
the lessee is to pay the lessor for the right to possession and use of the goods is an
obligation for the term of the lease and is not subject to termination by the lessee .
. . .26
If the transaction is subject to being terminated by the lessee, that points toward it being a lease
rather than a security interest. The second signpost is found in the four conditions enumerated in
subsection (b).27 If one of these is found in the transaction, and if the transaction cannot be
terminated by the lessee, the transaction is more likely a security interest. As these Agreements are
not renewable and there is no purchase option for the lessee upon termination, § 1-203(b)(1) is the
most relevant condition in this case. Is the original term of the lease equal to or greater than the
25 TEX. BUS. & COM. CODE ANN. § 1.203(a) (West 2009).
26 TEX. BUS. & COM. CODE ANN. § 1.203(b) (West 2009).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 9 of 28
remaining economic life of the goods? If it is, a security interest may be found to exist as the lessee
will have essentially retained the goods as long as or even after their usable life is exhausted, leaving
the lessor with no remaining value or use upon expiration of the agreement.
Subsection (c) of § 1-203 sets out a list of six conditions that are not sufficient by themselves
to render a transaction a security interest. They are:
A transaction in the form of a lease does not create a security interest merely
(1) the present value of the consideration the lessee is obligated to pay the lessor for
the right to possession and use of the goods is substantially equal to or is greater than
the fair market value of the goods at the time the lease is entered into;
(2) the lessee assumes risk of loss of the goods;
(3) the lessee agrees to pay, with respect to the goods, taxes, insurance, filing,
recording, or registration fees, or service or maintenance costs;
(4) the lessee has an option to renew the lease or to become the owner of the goods;
(5) the lessee has an option to renew the lease for a fixed rent that is equal to or
greater than the reasonably predictable fair market rent for the use of the goods for
the term of the renewal at the time the option is to be performed; or
(6) the lessee has an option to become the owner of the goods for a fixed price that
is equal to or greater than the reasonably predictable fair market value of the goods
at the time the option is to be performed.28
White and Summers suggest that “by these six conditions the drafters sought to overrule a series of
bad decisions under the pre-1987 version of section 1-201(37).”29 In short, these factors cannot, by
themselves, render a transaction in lease format a security interest per se as some cases under the
pre-1987 law found.
Subsection (e) of § 1-203 provides that the “remaining economic life of the goods” is to be
28 U.C.C. § 1-203(c) (2001), 1 U.L.A. 26 (West 2004); TEX. BUS. & COM. CODE ANN. §
1.203(c) (West 2009).
29 J. White and R. Summers, UNIFORM COMMERCIAL CODE Vol 4 § 30-3 at p. 7 (2009)
Case 09-05258 Doc# 58 Filed 09/03/10 Page 10 of 28
determined with reference to the facts and circumstances at the time the transaction is entered into.30
As White and Summers say, “[f]oresight not hindsight controls.”31
Finally, having determined whether the Agreements are terminable and whether one of the
four subsection (b) conditions exist, the Court must consider the economic realities to determine the
fundamental question: whether the lessor retains a “meaningful reversionary interest” in the
property. It is this determination that focuses the Court directly on the “terminal rent adjustment
clause” (TRAC) that has been the subject of many cases.
A supplemental consideration here is the fact that many states (including Texas and Kansas)
have enacted so-called TRAC-neutral statutes that provide, in essence, that the presence of a TRAC
clause does not render a transaction a security interest per se.32 Texas’ statute provides:
Notwithstanding any other law, an agreement for the lease of a motor vehicle does
not create a sale or security interest by merely providing that the rental price is
permitted or required to be adjusted under the agreement as determined by the
amount realized on the sale or other disposition of the vehicle.33
The Court views this legislation as adding a seventh condition to § 1-203(c). With this analytical
framework in mind, the Court turns to the Agreements themselves.
As noted above, the First Agreement contains a different TRAC clause than do the other six.
Other than that distinction, all of the Agreements share the same characteristics and terms. Each
30 See also TEX. BUS. & COM. CODE ANN. § 1.203(e) (West 2009).
31 J. White and R. Summers, UNIFORM COMMERCIAL CODE Vol 4 § 30-3 at p. 8 (2009)
32 See TEX. TRANSP. CODE ANN. § 501.112 (West 2009); KAN. STAT. ANN. § 84-2a
110(a) (2009 Supp.), enacted in 1998.
33 TEX. TRANSP. CODE ANN. § 501.112 (West 2009).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 11 of 28
provides at paragraph 3 that the lessee may terminate the lease as to any equipment on any
anniversary of the delivery date of the equipment by (1) giving notice to the lessor of its intent to
terminate; (2) returning the property to the lessor; and (3) paying the lessor any amounts owed under
paragraph 9 of the lease, the “final adjustment clause.” If the lessor consents, the lessee may
terminate the lease on a date other than an anniversary date by paying a fee of the greater of $500
per vehicle or 2 per cent of the agreed value of the vehicle on Schedule A as a termination fee, if the
termination occurs within the first twelve months of the Agreement’s term. If the termination occurs
after the first twelve months has elapsed, the lessee need only pay the greater of $500 or 1 per cent
of the agreed value. These termination fees are paid in addition to the “final adjustment.” HPS
alleges that this early termination clause is so onerous as to render it nugatory. GECC responds that
the cost of termination is sufficiently small to make lessee’s right to terminate substantial and
therefore these Agreements lie outside the conditions of § 1-203(b).
To address these arguments, the Court must also review and understand the operation of
paragraph 9, the “final adjustment” paragraph. Paragraph 8 provides that upon termination or
expiration of the Agreement’s term, the lessee is to return the property to the lessor after which the
lessor shall “cause the vehicle to be sold at public or private sale, at wholesale, for the highest cash
offer received and still open at the time of sale.” The “net proceeds of sale” include the sale
proceeds less any clean-up and other direct costs of sale. Paragraph 9 provides that, on final
adjustment, the lessor shall pay the lessee any amount by which “the sum of (a) the net sale
proceeds, and (b) surplus insurance recoveries, if any . . . , exceeds (c) a Final Adjustment Amount
. . . ” calculated as of the payment date immediately before the return of the property to the lessor.
The “final adjustment amount” is defined as the product of the Schedule A agreed value of the
Case 09-05258 Doc# 58 Filed 09/03/10 Page 12 of 28
vehicle multiplied by the “final adjustment percentage” on the respective calculation date as found
on the Final Adjustment Table on Schedule B. If the sum of the net sale proceeds and insurance
recoveries does not exceed the final adjustment amount, the lessee is required to pay the difference
to the lessor.
Applying this formula to the hypothetical return of one of the 2007 International Harvester
9400 Tractors covered by the Second Agreement, the Court assumed HPS cancelled the lease and
returned it in the 12th month of the lease term. The agreed value of the tractor on Schedule A is
$98,362.80. The Final Adjustment Percentage on Schedule B is 92.144 percent. Multiplying the
agreed value by the Final Adjustment Percentage yields $90,635.42. If the wholesale liquidation
of the tractor yielded more than that amount, GECC would owe the surplus to HPS. If it yielded less
than that amount, HPS would owe the shortfall to GECC. Absent a record, the Court cannot
speculate about what the sale of the tractor might have yielded 11 months after the inception of the
Agreement in September of 2006, but it can observe that the difference between what the sale of a
one year-old tractor might bring and $90,635 is not likely to be enough to deter a lessee from
terminating early. The Court distinguishes this hypothetical from the onerous requirement that a
lessee pay a significant portion of the remaining unpaid lease payments as the lessee was required
to do in In re Chance Industries, Inc., an unpublished opinion of this Court.34 There a debtor’s early
termination of a purported lease of computer equipment would have resulted in debtor being
34 Chance Industries, Inc. v. TCF Leasing, Inc. (In re Chance Industries, Inc.), 2002 WL
32653678 (Bankr. D. Kan. Mar. 29, 2002).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 13 of 28
required to pay over fifty per cent of the equipment cost, plus twelve months’ rental.35 The Court
concludes that the termination clauses in the Agreements before it today are meaningful and that the
Agreements are subject to termination by lessee HPS within the meaning of the preamble to § 1203(
The First Agreement’s final adjustment feature is different, but its effect is the same.
Appended to the First Agreement is an amendment that replaces paragraph 9 with a substitute that
changes the methodology for determining the final adjustment. As noted above, there is no
“Schedule B” that details a final adjustment percentage. Instead, the First Agreement’s final
adjustment process begins with the net proceeds of the post-termination or lease expiration sale of
the goods plus any insurance recoveries. From the net proceeds is subtracted the sum of any accrued
but unpaid rents plus the “termination value.” The termination value is defined as “an amount equal
to the then present worth of all unaccrued monthly rentals plus the then present worth of the
Residual Value. . . .” This is calculated by discounting the unaccrued rentals from their due dates
and discounting the residual value from the first date that rent is due under the Agreement using
monthly compounding intervals and the rate specified on Schedule A, 7.90 per cent. Summarizing,
if the net sales proceeds are greater than any accrued but unpaid rents plus the discounted value of
the future rents and the discounted value of the residual value, then HPS receives the surplus. If the
net sales proceeds are less, HPS pays GECC the shortfall.
The Court attempted to replicate these calculations for a hypothetical termination of one of
the First Agreement’s trailers. Consider a termination of the lease of the trailer acquired for $50,650
35 Id. at *5. In addition, the right to terminate was a limited one. The lessee was only
permitted to terminate in the twelfth month.
Case 09-05258 Doc# 58 Filed 09/03/10 Page 14 of 28
and rented at $868 per month. The agreed residual value is $10,130 and the Schedule A termination
value rate is 7.9 per cent. If HPS terminated the lease of one such trailer in the twelfth month of
the Agreement, the termination value would equal the present worth of the remaining 48 months of
unaccrued rents, discounted at 7.9 per cent per annum, plus the present worth of the residual value
of $10,130, discounted at a like percentage. The Court’s calculations suggest that the present value
of the 48 months’ rents at 7.9 per cent is approximately $35,623 and that the discounted value of the
$10,130 residual at the same rate is $7,393 for a total termination value of $43,016 or approximately
85 per cent of the initial value of the trailer. As with the other six Agreements, the Court believes
that the right to terminate early is a substantial one that might be exercised by a debtor and is very
different from the prohibitively expensive right to terminate that the Court addressed in Chance
Because HPS has a right of termination, the Agreements do not satisfy the first part of the
“bright line” test of § 1-203(b) to mandate a finding that the Agreements create a security interest.36
The Court next considers the four conditions comprising the second part of the bright line test of
§ 1-203(b), specifically subsection (b)(1) -- whether the original term of the lease is equal to or
greater than the remaining economic life of the goods. Six of the seven Agreements had 60 month
terms, and the seventh Agreement was to run 48 months. Counsel agreed that the useful life of these
tractors and reefers exceeded the terms of the Agreements. The summary appraisal suggested that
the tractors had a total useful life of 8 to 12 years and the trailers could last from 8 to 10 years. As
36 See Excel Auto and Truck Leasing, L.L.P. v. Alief Independent School Dist., 249 S.W.
3d 46 (Tex. App.-Houston 2007) (The agreement cannot be deemed a security interest if it is
terminable by the lessee); In re Grubbs Const. Co., 319 B.R. 698, 714 (Bankr. M.D. Fla. 2005)
(If the conditions of the bright line test are met, the agreement is per se a security agreement.).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 15 of 28
of February of 2010, the date of the appraisal, the tractors’ and trailers’ remaining useful lives
ranged from 3 to 8.5 years. The Court can conclude that the Agreements’ terms are less than or
equal to the remaining economic life of the equipment they cover.
As noted before, none of the remaining three conditions found in § 1-203(b) applies here.
Under paragraph 3, the term of each Agreement “shall extend for a period not in excess of the
Maximum Term noted in the Schedule A relating to such Vehicle.” Schedule A of the Agreements,
reflect a set lease term of 60 months, except for the Seventh Agreement which reflects a lease term
of 48 months. There is no right to renew or extend the maximum lease term of the Agreements
beyond those terms. Therefore, HPS was not bound to renew the lease for the remaining economic
life of the goods or to become their owner as stated in § 1-203(b)(2). Likewise, because the
Agreements’ terms are limited, there is no option for HPS “to renew the lease for the remaining
economic life of the goods” as set out in § 1-203(b)(3). Nor is there an option for HPS to become
the owner of these goods for no consideration or for nominal consideration as set out in § 1203(
Because the Agreements do not satisfy the bright line test of § 1-203(b), the Agreements do
not create a security interest per se. This does not end the Court’s inquiry however. The Court is
required to consider the economic realties of the Agreements and the § 1-203(c) terms to determine
whether the Agreements create a security interest.37
37 Excel Auto and Truck Leasing, L.L.P., supra at 51 (“If the bright-line test is not
satisfied, the finding of a security interest is not mandated, and the court may examine additional
facts, recognized by the statute, to determine whether the economic realities of a particular
transaction create a security interest.”); In re Gateway Ethanol, L.L.C., 415 B.R. 486, 498
(Bankr. D. Kan. 2009) (“[C]ourts and commentators agree, that even if the bright line test is not
satisfied, the courts must apply a second test, examination of the specific facts of the case to
Case 09-05258 Doc# 58 Filed 09/03/10 Page 16 of 28
The Agreements do contain several terms that are described in § 1-203(c)(1) through (c)(6),
factors that should not, standing alone, mandate the finding that a lease is, in fact, a security
agreement. There is no direct evidence suggesting that the present value of the lease rents is
substantially equal to or greater than the fair market value of the goods, and the Court observes that
each Agreement contemplates significant residual values being left at expiration.38 HPS assumed
certain risk of loss by virtue of the TRAC clause and paragraph 10 which provides that “loss or
damage to each vehicle and loss of use thereof, from whatsoever cause, are risks assumed by Lessee
. . . .”39 HPS agreed to pay taxes, insurance and other costs as Additional Rents.40 Thus the first
three subsections of § 1-203(c) apply here, but the rest of the subsections do not. None of these
conditions standing alone render these transactions security interests per se. As noted previously,
the Texas TRAC-neutral statute provides that the presence of an adjustment clause does not mandate
the finding of a security interest.
Having determined that these Agreements have no provisions that force a finding that they
are security interests under subsection (b) and finding only three of the six “merely because”
conditions listed in subsection (c), the Court turns to the economic realities of these Agreements.
This requires us to look beyond the form of the Agreements and examine the nature and extent of
determine whether the economics of the transaction support such a result [security interest].”); In
re Grubbs Const. Co., 319 B.R. 698, 714 (Bankr. M.D. Fla. 2005); WorldCom, Inc. v. Gen. Elec.
Global Asset Mgmt. Serv. (In re WorldCom, Inc.), 339 B.R. 56, 65 (Bankr. S.D. N.Y. 2006).
38 See § 1-203(c)(1). With one exception, the 2007 utility trailer (unit number 043804)
has a -0- residual value in the Seventh Agreement. This lone exception will be discussed below.
39 See § 1-203(c)(2).
40 See § 1-203(c)(3).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 17 of 28
the reversionary interests GECC retained in the tractors and trailers. Did GECC retain a meaningful
upside or downside in these goods?
In general, GECC and HPS agreed that all of the property would have some residual value,
in most cases about 20 or more per cent of its initial value. This alone suggests that GECC retained
some valuable interest in the property at expiration. The total residual value stated in the
Agreements is $651,500. The total fair market value of the equipment as of February of 2010 was
$973,250.41 GECC’s “stake” in the equipment at the end of the Agreements’ term is substantial.
HPS argues that the final adjustment process essentially protects GECC from downside risk
to its residual property interest by assuring that if the sale of the property brings less than the
residual value, HPS is required to pay the difference. GECC’s response to this proposition is that
it is only protected to the extent that HPS is credit-worthy and that the terminal adjustment process
merely shifts the risk of the equipment’s overuse to the user, HPS, rather than the owner, GECC.
Various commentators and courts have concluded that TRAC provisions merely operate to shift risk,
not to transfer ownership from the lessor to the lessee. One such decision is Sharer v. Creative
Leasing, Inc., where the Alabama Supreme Court found as much.42 In their treatise, John Minan and
William Lawrence refer to the Sharer case as “a step in the right direction.”43 They comment that
lessors know that some lessees will use goods harder than others and that a TRAC clause merely
allows the lessor to adjust the total lease payment to reflect the value of the lessee’s usage and more
41 See Dkt. 51.
42 612 So. 2d 1191 (Ala. 1993)
43 J. Minan and W. Lawrence, THE LAW OF PERSONAL PROPERTY LEASING, § 2:26, p. 2
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accurately compensate the lessor. “Most significantly, provided that the lease is not to the end of
the useful life of the goods, the lessor has retained a meaningful residual interest in the goods. By
its very nature, a TRAC lease provision shows that the lessor is concerned about the return of the
goods at the end of the lease term and the protection of its residual interest.”44
Two recent Kansas bankruptcy cases have considered the question of a “meaningful
reversionary interest.” Most recently, Judge Somers addressed it in In re Gateway Ethanol, L.L.C.,
a case dealing with the lease of a boiler system to an ethanol plant operator.45 After a careful
analysis of case law under the pre-1987 version of § 1-201(37), the court applied the bright line test
by applying the factors that appear in § 1-203(b) and determined that the purchase option’s
consideration was not nominal. Then the court focused on the “economic factors of the agreement”
to evaluate whether the lessor retained a residual interest in the boiler. In particular, he considered:
(1) The anticipated useful life of the TO/Boiler; (2) IPE's [lessor’s] ability to market
the TO/Boiler at the end of the lease term; (3) the amount of the lease payments in
relation to the value of the TO/Boiler; (4) whether the TO/Boiler is unique because
it was designed for installation in the Gateway plant; (5) whether at the time of the
Agreement, the long term operation of the ethanol plan required Gateway's continued
possession of the TO/Boiler; and (6) the economic benefit to Gateway and
Dougherty [lessee] from the transaction being structured as a lease rather than a
The bankruptcy court concluded that the boiler’s useful life was substantially longer than the lease
and that it would have value if returned to the lessor at expiration. The total lease payments did not
45 415 B.R. 486 (Bankr. D. Kan. 2009) (applying Illinois law due to presence of choice
of law provision in the agreement).
46 415 B.R. at 505.
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equal the initial full price of the boiler. Though the boiler was unique, it could be removed and
refitted to another application. In short, the boiler would have meaningful economic life left at the
end of the lease that made its lessor’s reversion meaningful. Under the facts and circumstances of
the case, the court found that a reversionary interest remained and the transaction was appropriately
denominated a lease.
This Court has considered a TRAC lease of tractors in In re Charles.47 That lease provided
that, at the end of the lease term, the debtor could either acquire the tractors for the residual value
plus a $500 fee or not acquire them. If the debtor chose the latter, the lessor was required to sell the
tractors at auction to the highest bidder or re-let them. Either the sale proceeds or the present value
of the re-letting rentals set the terminal value. If it was higher than the residual value, the debtor was
paid the surplus; if lower, then the debtor made up the difference. The debtor could also hold the
vehicles over and the lessor, at its option, could extend the lease on its terms for six additional
months. This Court applied the provisions of the post-1987 version of § 1-201(37) (now § 1-203)
to determine whether, under the terms of those agreements, the lessor retained some reversionary
interest. Because these agreements were not subject to termination and featured a purchase option,
the trustee alleged that they were disguised security agreements and sought to avoid the “liens” of
the lessor. The trustee relied on In re Zerkle Trucking Co.48 to contend that the rent adjustment
provision at the end made the lessee’s purchase price option essentially nominal, but the Court
concluded that Kansas’ enactment of the TRAC-neutral statute “hobbles the Trustee’s argument that
47 278 B.R. 216 (Bankr. D. Kan. 2002).
48 132 B.R. 316 (Bankr. S.D. W.Va. 1991).
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TRAC leases are . . . by definition sales or security transactions.”49 The TRAC provisions merely
adjust the value of the lease property at the end of the term. The lessee –
“pays” the Residual Value only in the sense that he returns the vehicle (and pays any
shortfall between the realized value of the vehicle and the Residual Value). Were this
the badge of a disguised sale, nearly every lease would be subject to the Trustee's
attack. Rather than creating an arrangement which effectively forces the lessee to
purchase, the TRAC provision instead provides valuable incentive to the lessee to
maintain the vehicle so that, upon its return to the lessor, he will not be obligated for
any Residual Value shortfall.50
In Charles, this Court declined to follow previous Tenth Circuit authority because it was based on
the prior version of § 1-201(37) and instead held that the lessor maintained a significant reversionary
interest in the vehicles while the debtor retained no equity in them.51
Some courts take the opposite view and hold that since a TRAC lessor is protected from risk
of loss by the adjustment clause, it retains no down-side risk and therefore has lost its
entrepreneurial interest. Others directly addressing TRAC features have held that because the lessor
sells the property at the end, it retains no meaningful reversionary interest in it. Two such cases are
Zerkle Trucking Co. and In re Grubbs Constr. Co.,52 both of which HPS relies upon extensively
In Zerkle,53 the debtor entered into a series of leases that contained a TRAC feature and
delegated to the debtor many of the burdens of ownership enumerated in § 1-203(c). The TRAC
49 Charles, 278 B.R. at 223.
51 Id. at 224 discussing In re Tulsa Port Warehouse, Inc., 690 F.2d 809 (10th Cir. 1982).
52 319 B.R. 698 (Bankr. M.D. Fla. 2005).
53 132 B.R. 316.
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provision provided that at term’s end, debtor would return the trucks to the lessor and either pay
additional rent if the sale of the trucks brought less than the previously-agreed 20 per cent residual
value or receive a rebate if the sales brought more. Zerkle was permitted, but not required, to
purchase the vehicles at the sales. The court analyzed these transactions under the pre-1987 version
of U.C.C. § 1-201(37) as well as the revised version that is identical to § 1-203. The bankruptcy
court concluded that, as a practical matter, Zerkle had the right to become the owner of the vehicles
for no more consideration than it was obligated to pay at the outset of the lease and, therefore, the
leases were intended for security as a matter of law. The court also held that sale of the vehicles to
a third party was “in the nature of a sale by Zerkle” because Zerkle was effectively required to
guarantee the outcome by paying any shortfall between the residual value and the sale proceeds.
Addressing the meaningful reversionary interest issue, the court commented that the fact that all risk
of loss as well as anticipated benefit emanating from market factors had the effect of Zerkle
obtaining an equity in the vehicle.54 Thus, Zerkle, not the lessor, retained the meaningful
reversionary interest, rendering the lease as one taken for security.
In Grubbs, the court considered an equipment lease with a TRAC clause somewhat different
from that before us today. There, the debtor agreed to repay the lessor what the bankruptcy court
characterized as a “balloon payment” equal to 20 per cent of the initial purchase price of the goods.
The source of this payment was the sale, by the lessor, of the property at auction and the application
of the net sale proceeds to the balloon. If the sale brought more than the balloon, the debtor received
the surplus, but if the sale proceeds were short, the debtor was required to pay the balance. Under
54 Id. at 321-22.
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this agreement, the debtor had the right, but not the obligation, to bid. The opinion is silent as to the
remaining economic life of the property. The judge compared this arrangement to a “typical
installment loan” with a balloon payment in lieu of a down payment. He noted that in a typical
installment arrangement, the borrower finances the acquisition of equipment with a loan that is
repaid over a set term. If there is a balloon payment, the borrower can sell the equipment to pay it.
The lender in such an arrangement has “no expectation or right to retain ownership of the ‘collateral’
at the conclusion of the loan period.”55 The court then concluded that in these circumstances a
“lessor” reserves no meaningful interest in the property as a matter of economic reality. The court
further determined that TRAC clauses recognize that the lessee retains an equity in the leased
property because the lessee, and not the lessor, bears any loss arising from the terminal sale of the
The only Tenth Circuit case directly addressing a TRAC clause is In re Tulsa Port
Warehouse, Inc.57 There, the debtor entered into four automobile leases that were assigned to
General Motors Acceptance Corporation. The parties agreed to residual values at the end of the
lease and deducted this amount from the vehicles’ initial value. The total monthly rentals were that
remainder, divided by the number of months in the lease to yield the monthly payment. Under one
form of the lease, the vehicle was to be returned to GMAC at the conclusion of the rental period and
sold. If the net sales proceeds exceeded the residual value, the lessee received the surplus; if not,
55 319 B.R. at 708.
56 319 B.R. at 718-19, citing In re Tillery, 571 F.2d 1361, 1365 (5th Cir. 1978).
57 690 F.2d 809, 811 (10th Cir. 1982).
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the lessee paid lessor the difference, a classic TRAC clause. Applying the former version of UCC
§ 1-201(37), the Tenth Circuit relied on earlier precedent to conclude that a lease without a purchase
option could still be intended as security “if the facts otherwise expose economic realities tending
to confirm that a secured transfer of ownership is afoot.”58 Then the court reviewed the same
laundry list of factors that is now found in § 1-203(c) with respect to the respective parties’ duties
to insure, pay sales tax, pay all other taxes, indemnification, or assumption of the risk of loss. Then,
agreeing with In re Tillery, the court concluded that “[t]he termination formula recognizes the equity
of the ‘Lessee,’ in the vehicle because he is required to bear the loss or receive the gain from its
wholesale disposition.”59 It is important to remember here that Tulsa Port Warehouse was decided
under the pre-1987 version of § 1-201(37) where intent of the parties, not economic realities, was
the focus. There was no TRAC-neutral statute like those enacted in both Texas and Kansas to color
the court’s analysis.60
This Court concludes that GECC retained a meaningful reversionary interest in the tractors
and trailers. The Court respectfully disagrees with Zerkle and Grubbs and holds that the lessee’s
duties to hold the lessor harmless from any depreciation in addition to the agreed residual price does
not make these transactions more like a loan than a lease. In particular, the Court questions those
courts’ assumptions that (1) the lessor’s sale is the “equivalent” of the debtor’s purchase of the
58 Id. at 811, quoting Steele v. Gebetsberger (In re Fashion Optical, Ltd.), 653 F.2d
1385, 1389 (10th Cir. 1981). Former § 1-201(37) read in part, “whether a lease is intended as
security is to be determined by the facts of each case.” (Emphasis added).
59 Id. at 811, quoting In re Tillery, 571 F.2d 1361, 1365 (5th Cir. 1978).
60 See TEX. TRANSP. CODE ANN. § 501.112 (West 2009); KAN. STAT. ANN. § 84-2a110(
a) (2009 Supp.) (enacted in 1998).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 24 of 28
property at a nominal price; and (2) that the lessor’s sale strips it of a reversionary interest in the
goods sold. First, while HPS might have the right to bid at GECC’s sale, it is likely that HPS would
have to bid the residual amount to acquire the goods. That amount is not “nominal.” Unless HPS
purchases these vehicles at the end of the lease term, it will retain no interest in them. Second,
while GECC may no longer have the property after the sale, it will retain the proceeds of the
property which is its economic equivalent. It is therefore difficult for this Court to see how GECC
“loses” its reversionary interest in the property when it keeps the proceeds. Further, while HPS is
bound to make up any shortfall between the sale proceeds and the residual value, GECC has the
credit risk that HPS may not be in a position to pay that shortfall at termination. HPS’ obligation
to make up the shortfall also creates an incentive for it to use and maintain the leased goods in a way
that protects it from paying the shortfall at the end. As Minan and Lawrence point out, a TRAC
provision “is simply a more sophisticated means to measure the true extent to which the lessee has
consumed the lessor’s interest in the goods.”61 Terminal rent adjustment effectively prices use over
and above that which the parties contemplate at the outset of the transaction. So long as the retained
reversionary interest is substantial, the presence of a TRAC clause does not change the economic
reality of the transaction. The economic reality here is that these Agreements are leases.
Comparing these Agreements to the agreement in Grubbs shows the fundamental difference
between GECC’s documents and a loan transaction. The presence of a balloon payment purchase
provision in the Grubbs case makes the loan analogy more apt there than it would be here. As the
Grubbs court pointed out, that payment is analogous to a down payment, except that it is paid at the
61 THE LAW OF PERSONAL PROPERTY LEASING, § 2:26, p. 4, citing In re Otasco, Inc., 196
B.R. 554 (N.D. Okla. 1991).
Case 09-05258 Doc# 58 Filed 09/03/10 Page 25 of 28
end of the relationship.62 In Grubbs, the presence of a purchase option suggests that both parties had
some expectation that the lessee would wind up with the goods in the end. In a loan transaction, the
lender primarily expects to receive repayment of its principal and interest The only expectation a
lender has concerning its collateral is secondary: the lender hopes that the collateral will be worth
the balance of the note in the event the borrower’s default requires the lender to foreclose and realize
the benefit of the collateral. In every other respect, the borrower retains every incident of ownership
as well as a duty to pay for that ownership. When the loan is paid, the borrower is entitled to a
release of the lender’s lien on property that he has owned all along. Only if the borrower defaults
will the lender have any possessory interest in the collateral. Contrast that model with a lessee being
obligated to pay for the use of property that, at lease’s end, has an agreed residual value. Even
where the lessor’s interest in the residual value is protected by a rent adjustment clause, the lessor
still retains a residual interest throughout the transaction’s term. Here, where there is no balloon
payment option, the Court may easily conclude that these Agreements are leases.
Texas law supports this view. As noted above, Texas has enacted a TRAC-neutral statute,
but that alone should not drive this analysis. In Excel Auto and Truck Leasing, L.L.P. v. Alief
Independent School Dist., the Texas Court of Appeals applied § 1-203 to hold that the inability of
the lessee to terminate before the end of the lease term is still an indispensable requirement to
finding the presence of a security interest.63 The agreements there contained provisions permitting
the lessee to terminate the agreements at any time. The Texas court then analyzed the TRAC
62 319 B.R. at 707-08.
63 249 S.W.3d 46 (Tex.App-Houston, 2007).
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provision as well as the other risk-shifting provisions contained in that lease by comparing them to
the § 1-203(c) conditions and concluded that the presence of some of those conditions was not
controlling and the agreements did not meet the two-part test for the existence of a security interest.64
The Court does not reach this conclusion without recognizing the significant effect it will
have on this reorganization. A substantial portion of the HPS fleet is leased under these Agreements
and this Court’s determination that they are true leases will compel HPS either to cure and assume
these leases or to reject them under § 365. HPS contends that TRAC leases and TRAC-neutral
statutes are designed solely to force debtors into § 365 and deprive them of substantial rights under
the cramdown provisions and that this result would be inequitable. Appeals to “equity” in the
context of this legal issue may be facially attractive, but they have no basis in the Bankruptcy Code.
While other sections of the Code specifically authorize the court to consider the equities of a
situation in making a decision, nothing in § 365 suggests an “equitable” approach to resolving the
lease/financing question.65 The Court cannot view these transactions in a bankruptcy-induced
vacuum when their essential legal nature must be determined by applicable state commercial law.
In the absence of any compelling similarity to secured transactions, these Agreements must be
declared to be the true leases that they are.
Accordingly, the Court concludes that GECC is entitled to judgment as a matter of law that
the Agreements are leases that are subject to treatment under § 365 and not to cram-down under §
64 249 S.W.3d at 53-54.
65 See, e.g., § 552(b)(1), allowing the court to sever a security interest in proceeds or
products of pre-petition collateral “based on the equities of the case.”
Case 09-05258 Doc# 58 Filed 09/03/10 Page 27 of 28
1129(b). GECC’s motion for summary judgment is granted; HPS motion for summary judgment
is denied. A Judgment on Decision will enter this day.
# # #
Case 09-05258 Doc# 58 Filed 09/03/10 Page 28 of 28
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