True Lease v. Sales Device

"Section 1.203 of Texas Uniform Commercial Code (hereinafter the “U.C.C.”) entitled “Lease Distinguished from Security Interest” controls the determination of whether a transaction in the form of a lease, creates a lease or a security interest in Texas. See Excel Auto and Truck Leasing LLP v. Alief Independent School District, 249 S.W.3d 46, 63 (Tex. App.-Houston [1st Dist.] 2007, pet. denied) (denying defense of non-ownership and finding leases were true leases and taxes due by lessor). Section 1.203(a) of the U.C.C. states that each transaction is determined by the facts of each case. Section 1.203(b) of the U.C.C. sets forth a two-part test to determine whether the transaction creates a lease or security interest.

The first part of the test requires that the rental payments the lessee must pay cannot be terminable by the lessee during the term of the lease. This requires the existence of a “hell or high water” clause. In re Triplex Marine Maint., Inc. 258 B.R. 659, 669 (Bankr. E.D. Tex. 2000). The second part of the test requires the existence of one of four possible factors, one of which must also exist for the lease to be deemed a security interest. The four factors are: (1) the original term of the lease is equal to or greater than the remaining economic life of the equipment; (2) the lessee is bound or obligated to renew the lease for the remaining economic life of the equipment or is obligated to become the owner of the equipment; (3) the lessee has the option to renew the lease for the remaining economic life for no additional consideration or nominal consideration upon compliance with the lease agreement; or (4) the lessee has the option to become the owner of the equipment for no additional consideration or nominal consideration upon compliance with the lease agreement. Tex. Bus. & Comm. Code Ann § 1.203(b) 1-4.

Section 1.203 (c) of the U.C.C. also sets out factors that do not create a security interest just because they exist. These factors are: (1) the present value of the lessee’s consideration is substantially equal to or greater than the FMV of the equipment at the time the lease is entered into; (2) the risk of loss is assumed by lessee; (3) lessee agrees to pay taxes, insurance, filing and recording fees or maintenance costs on the equipment; (4) lessee has an option to purchase or renew the lease; (5) lessee has an option to renew the lease for a fixed rental equal to or greater than the reasonably predictable fair market rent; or (6) lessee has an option to become owner of the equipment for a fixed price equal to or greater than the reasonably predictable FMV of the goods. In addition to being addressed by Section 1.203(c) of the U.C.C., the fact that a lessee pays certain costs and fees has also been held to be typical of true leases, not secured transactions because it is a recognition by courts of the relative bargaining power between the parties and the fact that a lessor will include those costs within the rental charge or agree to lower the rental payment. See Excel Auto and Truck Leasing LLP v. Alief Independent School District, 249 S.W.3d 46, 63 (Tex. App.-Houston [1st Dist.] 2007, pet. denied), citing, Rainier Nat’l Bank v. Inland Mach. Co., 29 Wash. App. 725, 631 P.2d 389, 395 (1981).

For leases which satisfy the two-part test under Section 1.203(b), the inquiry comes to an end-such leases constitute security interests as a matter of law. See In re Triplex Marine Maint. Inc., 258 B.R. at 668-669. If the two-part bright-line test is not satisfied, a court may examine additional facts, recognized by statute, to determine whether the economic realities of the transaction create a security interest. Id. One of those factors is whether the lessee has any equity interest in the equipment. Courts have held that if a lessee does not have an equity interest in the equipment, the lease may be a true lease and not a security interest. See Excel Auto and Truck Leasing LLP v. Alief Independent School District, 249 S.W.3d 46, 63 (Tex. App.-Houston [1st Dist.] 2007, pet. denied), citing, Touch of Class Leasing v. Mercedes-Benz Credit of Canada, Inc., 248 N.J.Super. 426, 591 A.2d 661, 656-66 (1991)."