Section 365(d)(10)¹ of the Bankruptcy Code was added under the Bankruptcy Reform Act of 1994 to grant personal property lessors additional protections,² similar to the protections afforded to real property lessors.³ It requires the trustee or debtor-in-possession (DIP)to perform under the lease (paying to the lessor the contractual lease payment) until a determination is made to assume or reject the lease.⁴

Section 365(d)(10) provides for a post-petition abeyance period⁵ in which the debtor has 60 days after the Order for Relief to decide whether to assume or reject a personal property lease. Following that period, if the decision has not been made, the trustee or DIP is required to honor the lease obligations.⁶ The purpose behind §365(d) (10) is to grant the debtor a "breathing period" to make an informed decision, while assuring the lessor that after 60 days it will receive its lease payments without having to demonstrate an actual benefit to the estate.⁷

What Is the Difference Between a Lease and a Security Agreement?

A lease is defined in §2A-103(1)(j) of the Uniform Commercial Code as a "transfer of the right to possession and use of goods for a term in return for consideration, but a sale, including a sale on approval or a sale or return, or retention or creation of a security interest is not a lease."⁸ The definition of "lease" shifts the focus to the term "security interest." Although courts have applied various factors to determine if a transaction is a "true lease,"⁹ most jurisdictions have been guided by §1-201(37) of the Uniform Commercial Code. Section 1-201(37) defines the term "security interest" and sets forth a statutory test for determining if a transaction is a secured transaction.¹⁰ A transaction will be declared a secured transaction if (1) the obligation to pay rent extends for the entire term of the lease and cannot be subject to termination by the lessee, and (2) the transaction meets any one of the four independent standards enumerated in §1-201(37).¹¹ The essence of §1-201(37) is, "do the terms of the lease create an irresistible economic impulse on the lessee to become the owner, thereby suggesting that the lessor has no meaningful residual interest?"¹²

The distinction between a lease and a security interest is crucial to the application of Bankruptcy Code §365(d)(10).¹³ If the lease is not deemed a "true lease" then §365(d)(10) is not applicable and the debtor is not obligated to perform under the "lease."¹⁴ This article, however, will not focus on how courts make the distinction between a lease and a security interest,¹⁵ but rather how courts apply §365(d)(10) when a debtor alleges that §365(d)(10) is inapplicable because the transaction is not a "true lease." Two courts have addressed the issue of whether a debtor may avoid the obligation under §365(d)(10) while awaiting a court determination of whether the transaction in question is a lease or security interest. The opposite conclusions have created a new dysfunction for equipment lessors caught in a bankruptcy case. This article will examine the courts' rationales and offer an approach to reconciling the split of authority.

The Split of Authority: In re The Elder-Beerman Stores Corp.

In 1996, the U.S. Bankruptcy Court for the Southern District of Ohio held that the Elder-Beerman Stores Corp. Inc. had to perform all obligations under §365(d)(10) until given leave by the court to do otherwise.¹⁶ The debtors entered into a series of transactions, beginning Dec. 28, 1990, with Star Bank (the lessor) providing for payments in return for the use of personal property.¹⁷ The transactions were embodied in a written agreement that was titled "Master Equipment Lease" or "Acceptance Supplement (True Lease)."¹⁸ On Oct. 17, 1995, the debtors filed for chapter 11 protection and did not make payments after that date.¹⁹

The issue before the court was whether the debtors could avoid their obligations under §365(d)(10) during the pendency of a challenge to the nature of the underlying transactions.²⁰ Based on legislative history, the court found that §365(d)(10) was created to give a debtor limited "breathing room." To allow a debtor to extend the period provided by §365(d)(10) by claiming that the transaction was not a "true lease" was beyond Congress's intentions.²¹ The court held that in circumstances "[w]here an agreement at issue appears on its face to be a commercial personal property lease, the debtor is charged by §365(d)(10) to timely perform all duties of the agreement that arise [60] days after the...petition, until such time as the debtor is relieved of the obligation."²² The debtors were directed to make the payments to an escrow account at a separate institution, which would protect the lessor if the estate became insolvent, and the debtors were protected in the event the agreements were found to be secured transactions.²³

In re Circuit-Wise

On the contrary, in In re Circuit-Wise, the U.S. Bankruptcy Court for the District of Connecticut held that Wells Fargo was not entitled to the protections of §365(d)(10) until and unless the court determined that the lease was a "true lease."²⁴ Circuit-Wise entered into a lease on May 16, 1996, with Celtic Leasing Corp., which eventually became Wells Fargo.²⁵ On March 28, 2001, Circuit-Wise filed for chapter 11 protection, and no payments were made after the petition date.²⁶ Circuit-Wise argued that the lease was not a "true lease" but a security agreement, and therefore Wells Fargo was not entitled to the protections of §365(d) (10).²⁷ Wells Fargo, however, asserted that, regardless of the ambiguity of the document, it should still be entitled to protection under §365(d)(10) until the court found the lease to be a security agreement.²⁸

The court held that Wells Fargo was not entitled to the protection of §365(d)(10) until it determined that the transaction was in fact a "true lease."²⁹ The court reasoned that the plain meaning of the statute was dispositive because the person or entity trying to obtain the protection must be a lessor and not the holder of a security interest.³⁰ Furthermore, the court provided in dictum additional rationale that would defeat Wells Fargo's claim (if the plain meaning interpretation had not been dispositive).³¹ According to the court, Wells Fargo misinterpreted the term "lease" by construing it to mean "putative." It stated that the interpretation of "lease" was not intended to mean "putative" or "presumptive" because of the interpretation of the term within other Bankruptcy Code sections³² and Congress's knowledge of the then-existing precedents when the section was added.³³ Moreover, the court acknowledged the concern that debtors would raise this claim merely to postpone payment of lease obligations but found that "appropriate protections" could be structured to prevent this abuse.³⁴

Can the Cases Be Reconciled?

The court in Elder-Beerman focused on two specific aspects when it held that the debtor was obligated to make lease payments under §365(d)(10)...(1) the legislative history and (2) the limitations of its decision. The court in Circuit-Wise relied on the plain meaning of the statute to render its decision. The fact that the courts applied different rationales to reach opposing holdings provides some hope that the cases can be reconciled.

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[S]tatutory interpretation was not the issue before the court in Elder-Beerman.

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Circuit-Wise was decided six years after Elder-Beerman, and the U.S. Bankruptcy Court for the District of Connecticut chose not to adopt the reasoning in the prior case.³⁵ The Circuit-Wise court did not specifically address the issues raised in Elder-Beerman, but instead made a decision based solely on the "plain meaning" of the statute. It is true that, in a statutory construction case, the court will begin with the language of the statute.³⁶ The U.S. Supreme Court has stated "[t]he inquiry ceases if the statutory language is unambiguous and the statutory scheme is coherent and consistent."³⁷ Therefore, the reasoning of the Circuit-Wise case appears consistent with Supreme Court precedent.

However, statutory interpretation was not the issue before the court in Elder-Beerman. The court in Elder-Beerman did not dispute the statutory construction of Bankruptcy Code §365(d)(10). It did not find that the term "lease" had a different meaning. Essentially, the court in Elder-Beerman said that "on its face" the agreement entered into by the two parties was a lease, a "true lease," and §365(d)(10) was applicable until a factual finding was made that the transaction was not a "true lease." The court reached this holding by examining the legislative history of §365(d)(10). With the addition of Bankruptcy Code §365(d)(10), the burden of proof was shifted to the debtor. After the 60-day abeyance period, the lessor is automatically entitled to rent. When debtors refuse to comply with §365(d)(10), they are violating Congress's intent behind Bankruptcy Code §365(d)(10). Although the court in Circuit-Wise touched on this issue, it considered it only in the context of remedies, and not in connection with an analysis of the legislative history.

At its core, the Elder-Beerman court limited its holding to cases where the presence of a "true lease" was clear: "in limited circumstances extant in this case, that is where the debtor is faced with agreements unambiguously titled as 'leases,' the debtor may not circumvent the requirements of §365(d)(10) while challenging the nature of the agreements."³⁸ This holding should survive an attack under the rationale expressed in Circuit-Wise because if the document is not clearly a "true lease," then §365(d)(10) will not apply.

Conclusion

The holdings in Elder-Beerman and Circuit-Wise can be reconciled, although in a strained way and admittedly with deference given to the Elder-Beerman decision. If, on its face, the transaction appears to involve a "true lease," then the debtor must begin making payments after the 60-day abeyance period and is not permitted to delay its clear obligations to make such payments by waiting for the court to characterize the transaction. If, on its face, it is unclear whether the transaction is a "true lease," the debtor should file an action for court determination within the 60-day abeyance period and pay into escrow the lease payments after the 60-day abeyance period in order to protect the lessor in the event the transaction is characterized as a "true lease." This approach balances the interests of the lessor and the debtor, provides some reconciliation to the holdings in Elder-Beerman and Circuit-Wise, and is consistent with the legislative history of §365(d)(10) and the plain language approach to statutory construction.

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Footnotes

¹ Section 365(d)(10) states:

The trustee shall timely perform all of the obligations of the debtor, except those specified in §365(b)(2), first arising from or after 60 days after the order for relief in a case under chapter 11 of this title under an unexpired lease of personal property (other than personal property leased to an individual primarily for personal, family or household purposes), until such lease is assumed or rejected notwithstanding §503(b)(1) of this title, unless the court, after notice and a hearing and based on the equities of the case, orders otherwise with respect to the obligations or timely performance thereof. This subsection shall not be deemed to affect the trustee's obligations under the provisions of subsection (b) or (f). Acceptance of any such performance does not constitute waiver or relinquishment of the lessor's rights under such lease or under this title.

11 U.S.C. §365(d)(10). Return to article

² Crocker, Randall D. and Mathison, Erin N., "Property Leases, Adequate Protection Payments and the Debtor's Statutory Duty to Perform Lease Obligations," Am. Bankr. Inst. J., Feb. 2002, On the Edge. Prior to 1994, "it was first necessary for a lessor seeking administrative expense payments for post-petition, pre-rejection or assumption rent to establish that the lessor had conferred some benefit to the estate." In re The Elder-Beerman Stores Corp., 201 B.R. 759, 762 (Bankr. S.D. Ohio 1996). It should also be noted that Congress did not just amend §365(d)(3) to add commercial personal property leases but added a similar, yet not identical, section (§365(d)(10)). Id. Return to article

³ In re Ernst Home Ctr. Inc., 209 B.R. 955, 965 (Bankr. W.D. Wash. 1997). Section 365(d)(3) is similar to §365(d)(10), but §365(d)(10) applies only in chapter 11 cases, whereas §365(d)(3) applies to all bankruptcy filings. 3 Resnick, Alan, et al., Collier on Bankruptcy 365-44 (15th ed. rev. 2002). Return to article

⁴ Crocker & Mathison, supra note 2. Return to article

⁵ "In re The Elder-Beerman Stores Corp....characterized the [60]-day period set out in §365(d)(10) as an "abeyance period." In re Russell Cave Co., 247 B.R. 656, 659 (E.D. Ky. 2000). Return to article

⁶ Crocker & Mathison, supra note 2. Return to article

⁷ Id. Prior to 1994, the burden was on the lessor to establish that a benefit had been conferred upon the debtor in order to support an administrative expense. Id. The new amendment shifts the burden of proof from the lessor to the debtor. Id. Return to article

⁸ U.C.C. §2A-103(1)(j). Return to article

⁹ See In re PCH Assocs., 804 F.2d 193, 201 (2d Cir. 1986). Return to article

¹⁰ Clark, Barkley, The Law of Secured Transactions Under the Uniform Commercial Code, 1-73 (1999). Return to article

¹¹ Id. Section 1-201(37) of the Uniform Commercial Code focuses on the economic reality of the transaction. Essentially the four factors ask: "Will the lessee enjoy possession and use of the goods for their entire economic life (1) under a lease whose term exceeds the useful economic life of the goods, (2) by reason of a mandatory 'put,' (3) by reason of a nominal purchase or renewal option or (4) for some other reason?" Id. The factors are commonly referred to as the "residual value factors." PSINet Inc. v. Cisco Sys. Capital Corp., 271 B.R. 1, 45 (Bankr. S.D.N.Y. 2001). Return to article

¹² Clark, supra note 10 at 1-74. Return to article

¹³ Pantaleo, Peter V. and Winter, Robert E., "Unexpired Real and Personal Property Leases in Bankruptcy," Commercial Law and Practice Course Handbook Series, Practising Law Institute, Oct. 25, 2001, citing In re Homeplace Stores Inc., 228 B.R. 88, 90 (Bankr. D. Del. 1998). Return to article

¹⁴ Id. Return to article

¹⁵ For a discussion of the distinction between a lease and security agreement, see Coleman, Kenneth P., "How to Tell if a Transaction Is a True Lease or a Disguised Secured Transaction," 114 Banking L.J. 953 (1997). See, also, In re Edison Bros. Stores Inc., 207 B.R. 801 (1997) (applying §1-207(37) of the New York Uniform Commercial Code to find that the transaction was a "true lease"). Return to article

¹⁶ In re The Elder-Beerman Stores Corp., 201 B.R. 759, 765 (S.D. Ohio 1996). Return to article

¹⁷ Id. at 761. Return to article

¹⁸ Id. Return to article

¹⁹ Id. Return to article

²⁰ Id. at 764. Return to article

²¹ Id. Return to article

²² Id. The court found that the debtor may be relieved of the obligation by rejecting the lease under §365(a), by leave of the court due to equities of the matter, or if the court determines that the transactions are not "true" leases. Id. Return to article

²³ Id. See, also, In re Kyle Trucking Inc., 239 B.R. 198 (Bankr. N.D. Ind. 1999) (stating that...although the decision in the case was based on different issues...the motion for relief resulted in an agreed order that provided for partial payment of the rent otherwise due the lessor, with the balance being placed in escrow pending the court's ruling concerning the nature of the agreement between them). Return to article

²⁴ In re Circuit-Wise Inc., 277 B.R. 460, 464 (Bankr. D. Conn. 2002). Return to article

²⁵ Id. at 461. Return to article

²⁶ Id. Return to article

²⁷ Id. The debtor alleged that the transaction was within §101(50) of the Bankruptcy Code (the definition of "security agreement"). Id. Return to article

²⁸ Id. Return to article

²⁹ Id. at 462. Return to article

³⁰ Id. Return to article

³¹ See Id. at 462-64. Return to article

³² 11 U.S.C. §365(d)(3) (2002). Return to article

³³ Circuit-Wise, 277 B.R. at 463. Return to article

³⁴ Id. at 463. The court provided an example of "appropriate protections" and stated that a putative lessor's request for a reasonably expedited trial schedule for the "true" lease issue would be liberally granted. Id. Return to article

³⁵ "To the extent that In re The Elder-Beerman Stores Corp, 201 B.R. 759, is inconsistent with the ruling, this court respectfully declines to follow Elder-Beerman Stores." Id. Return to article

³⁶ Barnhart v. Sigmon Coal Co. Inc., 534 U.S. 438, 440 (2002) (citations omitted). Return to article

³⁷ Id. Return to article

³⁸ In re The Elder-Beerman Stores Corp., 201 B.R. 759, 764 (S.D. Ohio 1996). Return to article