Builders and Contractors Exchange
Weekly Bulletin: 15 Nov 2005
Is Your Equipment Lease Really A Lease?
By: Stephanie Himel-Nelson
Construction contractors and suppliers engaged in leasing equipment often assume that their contracts create a lease arrangement. But a lease may not always be a true lease. If your contract provides for monthly payments followed by an option to buy the equipment for nominal or no additional consideration at the end of the lease, it may actually create a security agreement in the leased property. Security agreements are subject to the Uniform Commercial Code and remedies for default may be very different from those under a traditional lease.
In C.F. Garcia Enterprises, Inc. v. Enterprise Ford Tractor, Inc., 253 Va. 104, 480 S.E.2d 497 (1997), the parties entered into an agreement where the plaintiff, C.F. Garcia, would use a backhoe belonging to Enterprise Ford in exchange for monthly payments. The contract provided that at the end of the lease, Garcia retained an option to purchase the backhoe for $1. Garcia was frequently late in make its payments and made its final payment two months late, but Enterprise failed to demand the entire lease balance or return of the backhoe. Instead, Enterprise cashed the final check after it had repossessed the backhoe. Enterprise then sold the backhoe without notifying Garcia. Garcia filed suit, alleging breach of contract, conversion, and violations of the Virginia Uniform Commercial Code. The trial court granted summary judgment for Enterprise, noting that Garcia failed to make timely rental payments, to give notice of its intent to purchase the backhoe, or to tender the $1 to Ford.
On appeal, Garcia argued that the contract provision permitting it to purchase the backhoe for $1 made the contract a security agreement rather than a lease. Enterprise was, therefore, not entitled to repossess the backhoe based on late payments, but was limited to pursuing a secured party's remedies under the UCC. The Supreme Court of Virginia agreed, holding that the contract was indeed a security agreement under the UCC. The court noted that where a contract permits the lessee to become the owner of leased property for nominal or no additional consideration, that contract creates a security interest in the leased property under Virginia Code § 8.01-201. Because the contract between Garcia and Enterprise was a security agreement, Enterprise was required to comply with Article 9 of the UCC in taking possession and selling the backhoe. Enterprise should have conducted a commercially reasonable sale of the equipment, with prior notice to Garcia, and given Garcia any surplus funds remaining after satisfaction of Garcia's debt and subtraction of reasonable attorney's fees and expenses. Because Enterprise failed to do so, Garcia was entitled to damages for Enterprise's wrongful seizure and sale of the backhoe.
All businesses involved in leasing equipment should be aware that a lease may not always be a true lease. If you suspect that your "lease" may actually create a security interest in the leased property, you may want to consult your attorney before pursuing remedies for default.
Questions?
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This article is meant to bring awareness to this topic and is not intended to be used as legal advice.