“True Lease” Versus “Disguised Security Interests”

"Whether a transaction in the form of a lease creates a lease or security interest is determined by the facts of each case. 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, and: (a) The original term of the lease is equal to or greater than the remaining economic life of the goods; (b) The lessee is bound to renew the lease for the remaining economic life of the goods or is bound to become the owner of the goods; (c) The lessee has an option to renew the lease for the remaining economic life of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement; or (d) The lessee has an option to become the owner of the goods for no additional consideration or for nominal additional consideration upon compliance with the lease agreement.

A transaction in the form of a lease does not create a security interest merely because: (a) 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; (b) The lessee assumes risk of loss of the goods; (c) The lessee agrees to pay, with respect to the goods, taxes, insurance, filing, recording, or registration fees, or service or maintenance costs; (d) The lessee has an option to renew the lease or to become the owner of the goods; (e) 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 (f) 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. (KRS § 355.1-203)"

The test embodied in KRS 355.1-203 does not focus on whether a lessee has a contractual right to terminate under the agreement in question. Rather, the test focuses on whether the consideration the lessee is to pay the lessor for the right to use and possess the goods is an obligation for the term of the lease not subject to termination by the lessee. If a lease agreement requires a lessee to pay upon termination the present value of precisely what the lessor would receive if the debtor made all required monthly payments for the full contract term and then exercised the purchase option, there is no true lease (In re Consol. Energy, Inc., 2007 Bankr. LEXIS 3470 (E.D. Ky 2007)). Thus, in Kentucky, a lease is not created where the agreement calls for payment of both the payment stream and the residual value where that amount equals the amount the lessor would have received in exchange for giving the lessee the right to use and possess the goods for the term and then purchase the same upon conclusion of the term