Lease Distinguished from a Security Interest in Texas

The issue of whether a lease is a true lease or merely a disguised security instrument comes up frequently in connection with bankruptcy filings by a lessee or as a defense to lease enforcement actions filed in state court. State law determines whether an agreement is characterized as a lease or a security agreement. While the revisions to the Uniform Commercial Code have eliminated reference to the intent of the parties as being determinative, the focus now is the underlying economics of the transaction.[i] The important point to keep in mind is that for it to be a lease, the transaction should grant the right of the lessee to use the equipment for a period shorter than its economic life and obligate the lessee to return the equipment while there is still remaining economic life in the equipment. Section 1.203[ii] 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.[iii] 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.[iv] A “hell or high water” clause means that the lessee is obligated to pay regardless of whether the leased equipment works and regardless of the conduct of the lessor.[v] 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.[vi] These four factors are commonly referred to as the “residual value factors.”[vii]

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.[viii]

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.[ix]  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.[x]  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.[xi]

Courts (and lawyers) continue to struggle with the issue of whether a transaction creates a lease or a security instrument in Texas. Hopefully, the information provided in this blog entry will be useful in your next appearance. The opinions are those of the author and not those of the Bickerstaff Heath Law firm. Comments, replies and suggestions can be sent to me at JJONES@bickerstaff.com. Happy New Year from my family to you and yours!

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[i]   4 ECKLICN 16:21, citing, Nimmer, “U.C.C. Article 2A: The New Face of Leasing?, 3 DePaul Bus. & Com. L.J. 559, 565 (2005).

[ii]   By enacting Section 1.203, Texas adopted the official version of Uniform Commercial Code Section 1-201(37) and therefore, Texas courts will look to other jurisdictions to interpret the uniform statute. Excel Auto and Truck Leasing LLP v. Alief Independent School District, 249 S.W.3d 46, 63 (Tex. App.-Houston [1^st Dist.] 2007, pet. denied), citing, Franklin Nat’l Bank v. Boser, 972 S.W.2d 98, 103 (Tex. App.-Texarkana 1998, pet. denied).

[iii]  Excel Auto and Truck Leasing LLP v. Alief Independent School District, 249 S.W.3d 46, 63 (Tex. App.-Houston [1^st Dist.] 2007, pet. denied) (denying defense of non-ownership and finding leases were true leases and taxes due by lessor).

[iv]  In re Triplex Marine Maint., Inc. 258 B.R. 659, 669 (Bankr. E.D. Tex. 2000).

[v]   Id. at n. 20.

[vi]  Tex. Bus. & Comm. Code Ann § 1.203(b) 1-4.

[vii]  4 ECKLICN § 16:21 (2012)

[viii]  Excel Auto and Truck Leasing LLP v. Alief Independent School District, 249 S.W.3d 46, 63 (Tex. App.-Houston [1^st Dist.] 2007, pet. denied), citing, Rainier Nat’l Bank v. Inland Mach. Co., 29 Wash. App. 725, 631 P.2d 389, 395 (1981).

[ix]  In re Triplex Marine Maint. Inc., 258 B.R. at 668-669.

[x]   Id.

[xi]  Excel Auto and Truck Leasing LLP v. Alief Independent School District, 249 S.W.3d 46, 63 (Tex. App.-Houston [1^st 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).

Enforcement of Foreign Judgments in Texas

One of the goals of this blog is to provide a starting point for trial lawyers and general counsel on various trial and equipment leasing issues that they may face in Texas. While my writing will never be called Shakespearean, I am hopeful that it will provide a starting point or basic understanding of a topic. I have provided citations when possible.  This week’s blog is on a topic that is, based on my experience, misunderstood. The responses I see to foreign judgments I file for clients indicate a lack of practical experience or understanding that upon filing, a foreign judgment becomes a final Texas Judgment. Responses I see treat the foreign judgment like it is the start of a lawsuit when the correct view should be that a judgment has just been entered against your client as if it had been tried in a Texas court.

Texas, like other states, has adopted the Uniform Enforcement of Foreign Judgments Act (the “Act”) and it can be found in Chapter 35 of the Texas Civil Practice and Remedies Code. The Act is based on the full faith and credit clause of the United States Constitution and “foreign judgment” means a judgment, decree, or order of a court of the United States or of any other court that is entitled to full faith and credit in this state.

Article 4, §1 of the United States Constitution known as the “full faith and credit” clause requires a state to give the same force and effect to a judgment of a sister state that it would give to its own judgments.  See Cash Register Sales and Services of Houston, Inc. v. Capelco Capital, Inc., 62 S.W.3d 278, 280 (Tex. App.—Houston [1^st Dist.] 2001, no writ), citing, U.S. Const. art IV, §1.  When a judgment creditor files an authenticated copy of a foreign judgment, a prima facie case for enforcement of the judgment is presented and it is a final Texas Judgment subject to normal post-trial motions.  See Minuteman Press Int’l., Inc. v. Sparks, 782 S.W.2d 339, 340 (Tex. App.—Fort Worth 1989, no writ).  Once the foreign judgment is filed, the burden then shifts to the judgment debtor to prove why the sister state’s judgment should not be given full faith and credit.  Minuteman, 782 S.W.2d 339, 340-41 (Tex. App.—Fort Worth 1989, no writ).  The presumption of validity can only be overcome by clear and convincing evidence to the contrary.  Escalona v. Combs, 712 S.W.2d 822, 824 (Tex. App.—Houston [1^st Dist.] 1986, no writ).

Section 35.003(c) of the Texas Civil Practice and Remedies Code states as follows:

“A filed foreign judgment has the same effect and is subject to the same procedures, defenses, and proceedings for reopening, vacating, staying, enforcing, or satisfying a judgment as a judgment of the court in which it is filed.”

A defense interposed in a Texas Court against the enforcement of a foreign judgment is a collateral attack.  See Cash Register Sales and Service, 62 S.W.3d 278, 281 (Tex. App.—Houston [1^st Dist.] 2001, no writ), citing, Corporate Leasing Int’l., Inc. v. Bridgewell, 896 S.W.2d 419, 422 (Tex. App.—Waco 1995, orig. proceeding).  In a collateral attack on a sister state’s judgment, no defense may be set up that goes to the merits of the original controversy.  See Strick Lease, Inc. v. Cutler, 759 S.W.2d 776, 777 (Tex. App.—El Paso 1988, no writ). Texas law is clear.  A defendant may challenge the jurisdiction of a sister state to render a foreign judgment on only two grounds:

(1)     Defendant may try to demonstrate service of process was inadequate under the service of process rules of the sister state, or 

(2)     Defendant may assert that the sister state’s exercise of due process offends due process because it does not have minimum contacts with the sister state.

Karsetter v. Voss, 184 S.W.3d 396, 401-402 (Tex. App.—Dallas 2006, no pet.); see also Studebaker Worthington Leasing Corp. v. Texas Shutters Corp. and Jesus Figueroa, 243 S.W.3d 737 (Tex. App.—Houston [14^th Dist.] 2007, no writ).  Examples that illustrate the mechanics of the Act and the limited ability to challenge a foreign judgment are set out in three cases which I recommend to you for further information on this topic. See Mayhew v. Caprito, 794 S.W.2d 1, 2 (Tex. 1990); Bahr v. Kohr, 928 S.W.2d 98 (Tex. App.—San Antonio 1996, writ denied); and Walnut Equipment Leasing Co., Inc. v. Wu, 920 S.W.2d 285 (Tex. 1996).

The opinions in this blog are solely the author’s and not those of Bickerstaff Heath Delgado Acosta LLP. Comments, replies and suggestions can be sent to John Jones at jjones@bickerstaff.com.

Disclaimers of Agency in Lease Contracts in Texas

A disclaimer denying the existence of any agency relationship between the leasing company and the equipment vendor and vendor’s salespeople is an important contractual tool in the toolbox of leasing and finance companies in Texas. In a typical lease transaction, the lessor does not have much contact with the lessee until after the transaction has been approved and funded. When the issue comes up at trial and lessee’s attorney raises the issue that my client, the leasing company, should be more involved, I have by analogy compared the lease transaction with the indirect purchase of a car from a dealership in Texas. When a car is purchased, the buyer picks the car he wants, meets with the dealership’s finance department and the dealership shops to find the buyer an acceptable loan with a lender it has a dealership agreement with and once approved by the buyer and lender, the documents are prepared and the sale of the vehicle completed.  The dealership then assigns the retail installment note to the indirect lender who funds the transaction. Unlike indirect lenders under a retail installment contract who have the protection of the Federal Trade Commission’s “Holder Rule” in a vehicle purchase and sale to protect indirect lenders from unlimited liability for a bad dealer, lessors are forced to rely on well drafted disclaimer clauses, among other things, for protection.

Texas Courts have come down on both sides of the fence on whether disclaimers of agency clauses are effective in lease cases.  In Stewart v. United States Leasing Corporation, 702 S.W.2d 288, 290 (Tex. App.—Houston [1^st Dist.] 1985, no writ), the Houston Court of Appeals without much discussion upheld the disclaimer of agency clause in the lease when it affirmed the summary judgment in favor of United States Leasing. See also Southwest Park Out-patient Surgery, Ltd. v. Chandler Leasing Division, 572 S.W.2d 53 (Tex. Civ. App.-Houston [1^st Dist.] 1978, no writ) (upholding summary judgment for lessor and holding lessee liable for the stipulated rental payments).  However, in Tri-Continental Leasing Corp. v. Law Office of Richard W. Burns, 710 S.W.2d 604, 607 (Tex. App.—Houston [1^st Dist.] 1986, no writ), the same Court of Appeals distinguished its own opinion in Chandler because the trial court found the lease to be unconscionable, the equipment failed to perform its intended function, and found the equipment defective from the very beginning. The trial court held that in determining whether a lease term is unconscionable, courts can look at the “entire atmosphere in which agreement was made, the alternatives, if any, available to the parties at the time of making the contract; and the non-bargaining ability of one party” and also referenced the definition of unconscionable conduct used in §17.45(5) of the Texas Deceptive Trade Practices-Consumer Protection Act. See Tri-Continental Leasing Corp. v. Law Office of Richard W. Burns, 710 S.W.2d 604, 607 (Tex. App.—Houston [1^st Dist.] 1986, no writ), citing, Wade v. Austin, 524 S.W.2d 79, 86 (Tex. Civ. App.-Texarkana 1975, no writ).  Moreover, the Houston Court of Appeals upheld the trial court’s judgment despite the execution of a delivery and acceptance receipt that acknowledged “full inspection” of the equipment and that it was in “good working condition.”  Relying on Texas Uniform Commercial Code §2.606(a)(1), the Court held the principal of acceptance of goods in the sale of goods under the UCC was also applicable to cases involving the leasing of equipment and, therefore, acceptance occurred after the lessee had a reasonable opportunity to inspect the equipment. Id. at 608.

Since these opinions were issued, Texas has adopted and amended various versions of Article 2A entitled “Uniform Commercial Code-Leases.” See Tex. Bus. & Com. Code Ann. §2A.101 (Vernon’s 2009).  § 2A.108 entitled “Unconscionability” codifies that a court may overturn a lease contract or any clause of a lease contract if it was unconscionable at the time it was made.  As a result when drafting a lease for use in Texas, lease disclaimers should be conspicuous, specific as to the issue or right disclaimed or waived, in at least 12 point font and set off so as to draw attention to lessee. Other important sections to review when enforcing or drafting the lease are §§2A.214 (Exclusion or Modification of Warranties), 2A.208 (Modification, Rescission and Waiver) and 2A.202 (Final Written Expression; Parol or Extrinsic Evidence).

The opinions in this blog are mine and not those of Bickerstaff Heath Delgado Acosta LLP.  Comments, replies and suggestions can be sent to me at jjones@bickerstaff.com.

 

Right to Jury, Jury Waivers and John Adams

I am a big fan of President John Adams and his life and achievements. Being sandwiched between Presidents George Washington and Thomas Jefferson, John Adams is not remembered for all his many achievements including the fact that he was a gifted trial lawyer and defended the eight British soldiers accused of murder during a riot in Boston known as the Boston Massacre on March 5, 1770. President Adams was also dedicated to the right to a jury trial by your peers without qualification or limit. While I am an strong advocate for protection of the jury trial because I believe most jurors get it right, I understand that the added cost and uncertainty a jury trial causes is an important business reason to insert a conspicuous jury waiver clause in lease, loan and employment documents in Texas.

The right of trial by jury is recognized in Article 1, Section 15 of the Texas Constitution. Section 15 states in part that “The right of trial by jury shall remain inviolate. The Legislature shall pass such laws as may be needed to regulate the same, and to maintain its purity and efficiency.” Despite the favored status the jury trial has enjoyed in America and Texas, it is not against public policy to waive the right to jury trial in Texas.

Any review to determine whether a particular jury waiver is enforceable in Texas must begin with the Supreme Court of Texas’ opinion in the Prudential Insurance Company of America case. In re Prudential Insurance Co. of America, 148 S.W.3d 124 (Tex. 2004). In an opinion authored by Justice Nathan Hecht, who is the longest serving member of the current Supreme Court of Texas, the Supreme Court found that a tenant’s pre-suit waiver of trial by jury was knowingly done, conspicuous, voluntary and enforceable even though the wavier was in the fifty-third paragraph of a sixty-seven paragraph document, seven pages before the signature page in a paragraph entitled “jury trial” not jury waiver. Moreover, the Supreme Court held that while a jury waiver obtained by coercion would not be enforced, it held that a jury trial waiver was enforceable, even if it was part of an agreement that was fraudulently induced. Id. The In re Prudential Insurance Co. case is also noteworthy because the opinion addressed the constitutional right to a jury trial in Texas, the provision for jury trials in the Texas Rules of Civil Procedure and various other arguments against enforcement and held that there is no adequate remedy at law when the jury waiver is not enforced so as to allow appellate review based on an abuse of discretion because the trial court refused enforcement of the jury wavier. The Court also reaffirmed the rule that parties have a right to contract as they see fit so long as the agreement does not violate law or public policy. Id. The issues remaining after In re Prudential Insurance Co. were what constitutes coercion and is there a presumption against waiver that places the burden of proof on the lender or lessor (or employer) to prove that the waiver was executed knowingly and voluntarily?

The Supreme Court of Texas answered the question of the presumption against waiver and burden of proof in 2009. In re Bank of America, N.A., 278 S.W.3d 342 (Tex. 2009).  In the Bank of America case, the Supreme Court of Texas held that Prudential did not impose a presumption against the vendor to prove that the waiver contained in a real estate purchase contract was knowingly and voluntarily entered into by the purchasers.  Guidance on the issue of coercion was also recently provided by the Supreme Court of Texas in the In re Frank Kent Motor Company case when a trial court and court of appeals refused to enforce a jury waiver in an age discrimination case.  In re Frank Kent Motor Company, 361 S.W.3d 628 (Tex. 2012).  In the Frank Kent Motor Company case, the Supreme Court of Texas held that the employer’s threat to exercise its right to terminate an at-will employee unless he signed a jury waiver did not constitute coercion so as to invalidate the jury waiver. The Supreme Court of Texas also reaffirmed that mandamus relief is available to correct a clear abuse of discretion by the trial court when it fails to enforce a valid jury trial waiver.

The opinions in this blog are the author’s and not those of Bickerstaff Heath Delgado Acosta LLP. Comments, suggestions and replies may be sent to me (John Jones) at John@jrjoneslaw.com.