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Addison v. Burnett
41 Cal.App.4th 1288 (Cal. Ct. App. 1996)
In this action for breach of an automobile lease and
related causes of action, defendant Brian Burnett moved for nonsuit, claiming the lease
was actually a security agreement as a matter of law. The trial court denied the motion,
and at the conclusion of a jury trial, Burnett was found liable under the lease.
Burnett appeals, contending the court erred in ruling that the disputed
document was a true lease rather than a disguised security agreement. He also appeals,
without argument, from the postjudgment order awarding attorney fees, solely to preserve
his challenge in the event that the underlying judgment is reversed. We find no basis for
reversal, however, and accordingly affirm both the judgment and the attorney fee order.
BACKGROUND
Burnett is an automobile dealer, co-owner (with his wife) of RBB, Inc.,
doing business as Ferrari of Los Gatos. Addison, the owner of an automobile leasing
company, regularly did business with Burnett personally as well as with Ferrari of Los
Gatos. He would purchase a vehicle from the dealership for Burnett or for Burnett's
customer and then lease it back to that person.
In May of 1989 Burnett asked Addison to purchase a 1967 Ferrari 330 GTC
Roadster and lease it back to him. The car was worth $240,000, and Addison did not have
sufficient resources to make this purchase. Addison contacted Executive Car Leasing
Company (Executive) on Burnett's behalf. Executive consented to the transaction on the
condition that Addison guarantee Burnett's obligation under the lease. As an accommodation
to Burnett, Addison agreed to sign a separate guaranty. On July 17, 1989, Burnett signed a
lease agreement with Executive for the car.
The lease provided that the "original value" of the Ferrari
330 GTC Roadster was $244,800. Burnett was to pay a total of $4,213.23 per month for 36
months. At the expiration of the term or surrender upon Burnett's default, Executive had
the option of selling the vehicle or having it appraised at its wholesale value. In either
case, Executive was obligated to credit Burnett with the excess of the sale proceeds or
"appraised value" over its depreciated value. If instead the depreciated value
exceeded its appraised value or the sale proceeds, Burnett would owe the difference to
Executive "as additional rental." n1 The
lease further provided that the vehicle was "the sole property of Lessor, and Lessee
shall have no right, title or interest therein as to the ownership thereof and shall have
no right or option whatsoever to purchase said vehicle at any time, and this instrument is
a lease and not a contract of sale." Just above his signature, Burnett acknowledged
that he understood that he would not be treated as the owner of the vehicle for federal
income tax purposes. He further acknowledged that he had read and fully understood all of
the provisions of the lease.
On December 1, 1990, Burnett breached the lease by
failing to make the monthly payment due. Addison attempted to help bring the payments
current by making a series of payments totaling $16,852.95. On January 10, 1991, Executive
notified Burnett of his default and advised him of the alternatives available under the
lease. He could pay the final balance of $113,921.72, thereby completing his lease
obligation; he could pay the past due amount of $13,347.30 and continue the lease; or he
could purchase the vehicle for $255,809.78.
On March 15, 1991, the Ferrari was sold at an auction for $93,500. The
sale left a deficiency of $142,935.35, representing the final balance plus attorney's
fees. Addison paid that amount to Executive pursuant to the guaranty, and Executive
assigned its rights under the lease to Addison. Addison then brought this action against
Burnett to recover both the deficiency amount and the installment payments he had made on
Burnett's behalf.
At trial, after Addison rested, Burnett moved for nonsuit on the ground
that the purported lease was in fact a disguised security agreement. All
"open-ended" leases such as this one were security agreements, according to
Burnett. Because Executive had not complied with the notice provisions of California
Uniform Commercial Code section 9-504 [9-611 in Revised Article 9], Burnett argued, it had
waived its rights to the deficiency when it sold the vehicle, and Addison, as the assignee
of Executive's interest in the lease, likewise was barred from relief.
After a hearing outside the presence of the jury, the trial court
denied the motion. Relying on Triple C. Leasing v. All-American Mobile Wash (1976) 64
Cal.App.3d 244 [134 Cal.Rptr. 328], the court found that the objective intent of Burnett
and Executive was to create a lease rather than a security interest. At the conclusion of
the evidence, the jury found in favor of Addison, and the court entered judgment for
$159,788.30, plus prejudgment interest and attorney fees.
DISCUSSION
Burnett contends that the trial court erred in construing the contract
between Executive and him as a true lease rather than a secured sale. Addison maintains
that the terms of the contract unequivocally describe a lease.
Our analysis is directed by the California Uniform Commercial Code
provisions governing the identification of leases as distinguished from secured
transactions. If the contract at issue gave Executive a secured interest in the Ferrari,
then division 9 was applicable and Executive was required to give notice of the sale
pursuant to section 9504, subdivision (3).
California Uniform Commercial Code section 9102 states that a secured
interest may be created by a lease "intended as security." [9-109(a)(1) in
Revised Article 9 uses different language to reflect the same rule.] The distinction
between a lease and a secured transaction is addressed in section 1201, subdivision
(37)(b) (hereafter, section 1201(37)(b)). Before its amendment in 1988, this section
provided: "Whether a lease is intended as security is to be determined by the facts
of each case; however, (a) the inclusion of an option to purchase does not of itself make
the lease one intended for security, and (b) an agreement that upon compliance with the
terms of the lease the lessee shall become or has the option to become the owner of the
property for no additional consideration or for a nominal consideration does make the
lease one intended for security." (Stats. 1963, ch. 819, @ 1, p. 1854.)
This statutory reference to the intent of the contracting parties
generated a proliferation of decisions in which courts attempted to refine the distinction
between leases and security agreements. Many courts relied on a list of several factors
that presumably indicated that a particular transaction was intended to be a secured sale
rather than a true lease. These indicia included the following: (1) the lessee was granted
an option to purchase the product for a nominal price rather than its fair market value;
(2) the lessee acquired equity in the property such that the only economically sensible
course was to exercise the purchase option; (3) the lessee was to pay for insurance,
licensing fees, sales tax and other taxes, maintenance, and repairs; (4) the lessee
assumed the risk of loss or damage; (5) the agreement permitted acceleration of payments
or resale upon default; (6) the agreement contained a disclaimer of normal warranties; and
(7) the lessor lacked facilities to store or retake the goods. [Citations omitted.]
According to the official comments accompanying the 1988 amendment, the
emphasis of the statute on intent "has led to unfortunate results." The numerous
factors believed to define secured sales proved unworkable, producing inconsistency and
unpredictability among courts characterizing similar transactions. (Carlson v. Giacchetti
(1993) 35 Mass.App. 57 [616 N.E.2d 810, 812].) As the official comments point out,
"[m]ost of these criteria ... are as applicable to true leases as to security
interests." Consequently, all but the first two factors were discarded when section
1201(37) was revised. Indeed, paragraph (c) of revised section 1201(37) specifically
discourages judicial reliance on these factors. n3
The Legislature adopted the Uniform Commercial Code
revisions to section 1201(37) in 1988. The amendment was made effective January 1, 1990.
Although the contract between Executive and Burnett was executed in 1989, before the 1988
amendment took effect, our analysis should be consistent with the current statute, not the
pre-1988 version. One of the reasons for the amendment, according to the official
comments, was to clarify the confusion engendered by the "vague and outmoded"
references to "leases intended as security," thereby "sharpening the line
between true leases and security interests." In our view, the amendment was intended
to clarify the process of determining the nature of these contracts, not to change the
substance of the law. [Citations omitted.] The discussion that follows will therefore
conform to the analysis prescribed by section 1201(37) as amended in 1988.
Section 1201(37)(b) now reads: "Whether a transaction creates a
lease or security interest is determined by the facts of each case; however, a transaction
creates a security interest if the consideration 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 not
subject to termination by the lessee, and [P] (i) The original term of the lease is equal
to or greater than the remaining economic life of the goods, [P] (ii) 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, [P] (iii) The lessee has an option to renew the lease for the
remaining economic life of the goods for no additional considera-tion or nominal
additional consideration upon compliance with the lease agreement, or [P] (iv) The lessee
has an option to become the owner of the goods for no additional consideration or nominal
additional consideration upon compliance with the lease agreement."
Revised section 1201(37)(b) initially instructs us, as before, to
examine the facts of each case in characterizing a transaction. Yet this instruction is
immediately qualified by the delineation of circumstances that create a security interest
as a matter of law.
These circumstances are captured in a two-part test. First, if the
lessee does not have the right to cancel the purported lease prior to the expiration of
its term, the parties will be considered to have entered into a security agreement. If, on
the other hand, the relationship is terminable by the lessee at any time, the instrument
is a true lease.
Second, at least one of the four enumerated conditions must be present.
If the lease term extends or may be renewed for the duration of the useful life of the
product, or if the lessee may acquire the product for little or no additional
consideration, then the lessor is said to have agreed to forgo an economic interest in the
goods at the end of the lease term. In such a case, the purported lease will be deemed to
be a security agreement. "[A]bsent a concern for the value or expectant return of the
goods upon the conclusion of the lease term the lessor, at the inception of the lease, had
really formulated no further anticipation of an investment return from the leased goods,
an anticipation more historically associated with an intent to transfer a title interest
in the goods .... Hence, the need for some form of security." (In re Zaleha, supra,
159 Bankr. at p. 585.)
If, on the other hand, none of the enumerated conditions is present, a
security interest will not conclusively be found to exist. In such a case, the court must
then resort to an examination of the facts of the case to determine whether the lessor has
retained a "meaningful residual interest" in the goods. [Citations omitted.] If
so, a lease will be found. [Citations omitted.] As one court explained, "If the
lessor retains a meaningful residual interest in the leased property at the end of the
lease term, the lease is a true lease. If, however, the lessor cannot reasonably expect to
receive back anything of value at the end of the lease, then the lease creates a security
interest." (Kimco Leasing, v. State Bd. of Tax Com'rs, supra, 656 N.E.2d at p. 1218.)
In this case, the first prong of the test of a security interest is
easily met. Burnett did not have the option of terminating the lease until he had
completed 36 months of rental payments. The statute then directs us to the four conditions
comprising the second step of the test. None of these conditions is satisfied here. First,
there is no dispute that the Ferrari retained some useful life beyond the mandatory three
years of the lease. Second, Burnett was under no obligation either to renew the lease for
the remaining economic life of the car or to purchase it. Third, the contract contained no
option either to renew the lease or to purchase the car for nominal additional
consideration. Because no security interest could be conclusively presumed according to
these factors, we must look to the facts of the case to determine whether Executive, the
lessor, relinquished its reversionary interest in the Ferrari under the terms of the
agreement.
Two features of a lease must be examined in this light: (1) any option
to purchase and (2) any provision for the lessee's acquisition of equity in the goods. As
one court explained, "If a lease contains an option to purchase for no or nominal
consideration ... it suggests that the lessor does not care, in an economic sense, whether
or not the option is exercised. If the lessee develops equity in the leased property such
that the only sensible decision economically for the lessee is to exercise the option ...
it suggests the lessor did not expect the return of the leased goods." (In re Zaleha,
supra, 159 Bankr. at p. 585; accord, In re Bumgardner, supra, 183 Bankr. at p. 228.)
In this case, as noted earlier, the lease did not contain a purchase option
at the end of its term. After repossessing the vehicle, Executive did offer Burnett an
opportunity to purchase the vehicle, but as the trial court observed, the option price of
$255,809.78 was not nominal. Burnett does not contest this finding. Instead, he focuses on
the second component of the analysis, contending that the lease gave him equity in the
Ferrari by requiring him to bear the risk of gain or loss in value upon the termination of
the lease. According to Burnett, "Every court that has ever ruled on this
subject" has considered such a provision to denote a security agreement.
Burnett relies on two federal decisions, Matter of Tillery, supra, 571
F.2d 1361, and In re Tulsa Port Warehouse Co., Inc. (10th Cir. 1982) 690 F.2d 809, where
the leases in question imposed on the lessee the risk of loss in value upon the mandatory
resale of the vehicle. In Tillery, the lessee was entitled to terminate the lease after
six months, " 'provided that Lessee shall bear any loss or receive any gain which
results from final disposition of a vehicle.' " (571 F.2d at p. 1362.) Similarly, in
Tulsa, the lessee was obligated to return the vehicle to the lessor at the end of the
lease term, at which time the lessor was required to sell it. If the price received
exceeded the depreciated value, the lessee received the surplus; conversely, if the sale
yielded an amount lower than the depreciated value, the lessee was liable for the
difference. (690 F.2d at p. 811.)
In both cases, the court found that a secured transaction had taken
place. The termination formula, the Tillery court reasoned, "recognizes the equity of
the [lessee] in the vehicle because he is required to bear the loss or receive the gain
from its wholesale disposition." (In re Tillery, supra, 571 F.2d at p. 1365; accord,
In re Tulsa Port Warehouse Co., Inc., supra, 690 F.2d at p. 811.)
Burnett exaggerates the extent to which this view is shared by other
courts. In Sharer v. Creative Leasing, Inc., supra, 612 So.2d 1191, for example, the
Alabama Supreme Court expressly disagreed with the Tillery court's assumption that
termination clauses requiring the lessee to assume the risk of gain or loss in value
confer an ownership interest on the lessee. "Viewed as to its economic function, such
a termination clause does not represent an equity in the vehicle, but a shifting of the
risk that the actual value of the leased vehicle at the time the lease is terminated ....
We do not agree that the resulting loss or gain to the lessee necessarily represents an
'equity' in the property." (Id. at p. 1195.) Thus, the Sharer court concluded,
"... it cannot be said that such a shifting of the risk of loss in value of the item
alone is sufficient to hold that any lease agreement containing such a clause necessarily
was intended to create a security interest." (Id. at p. 1196.)
We need not express an opinion as to the correctness of either the
result in Tillery and Tulsa or the opposing view expressed in Sharer, because, contrary to
Burnett's representation, the lease in this case does not contain "identical
provisions." In both Tillery and Tulsa, the lessor was required to sell the vehicle. n4 The lessor thus could legitimately be said to have
surrendered any residual interest in the goods, and the lessee could be deemed to have
acquired an equitable ownership interest. As one court observed, "from the moment the
agreement was signed [in Tulsa], lessor ... lost any reversionary interest in the property
itself, any expectancy that some day he might 'do as he pleases with' it." (In re
Breece (Bankr.N.D.Okla. 1986) 58 Bankr. 379, 385 [as in Tulsa, lease obligated lessor to
sell vehicle].) In this case, however, the lessor retained the "sole and exclusive
option" to appraise or dispose of the Ferrari. Executive was under no obligation to
sell the car; it could "in its sole discretion" appraise the vehicle, sell it,
or do neither.
In Keeling v. Ford Motor Credit (1988) 314 Md. 311 [550
A.2d 932], the appellate court drew a similar distinction. The lease in Keeling permitted
the lessor to sell the vehicle if the lessee defaulted; but since the lease did not
provide for permanent transfer of ownership to the lessee, it was not a secured sale. The
court thus distinguished the facts before it from those of Tillery and Tulsa, where
"the vehicle did not revert to the permanent possession of the lessor" and the
lessee therefore acquired equitable ownership. [Citations omitted.]
Burnett maintains that "all open ended [sic] lease [sic] are in
fact security agreements." He mistakenly assumes, however, that the contract at issue
is an open-end lease. An open-end lease calls for "reciprocal obligations to continue
after expiration of the fixed term.... After termination, lessee would return the vehicle
to lessor; lessor [would] then [be] required to sell it, to apply the proceeds against the
amount of lessee's remaining liability, and to account to lessee for any difference
between the sale proceeds and the amount of lessee's remaining liability." n5 (In re Breece, supra, 58 B.R. at pp. 384-385.) Here,
although the agreement is denominated an "open-end lease," the lessor
nonetheless retains a reversionary interest. If Executive were to elect to dispose of the
vehicle, some accounting would have to be made between the parties to settle the
difference between its appraised value or sale price and its depreciated value; n6 but by granting Executive that choice, the contract
preserved Executive's right to do whatever it wished with the car upon its return. This
was not an open-end lease.
The remaining terms of this document support its
construction as a true lease. Paragraph 13 expressly states that the vehicle is "the
sole property of Lessor, and Lessee shall have no right, title or interest therein as to
the ownership thereof ... and this instrument is a lease and not a contract of sale."
Moreover, at trial Burnett testified that he understood that he was signing a lease. He
also acknowledged that he was bound by its terms even though he signed without reading it.
We would reach the same result by examining the instrument under former
section 1201(37), as did the trial court. The intent expressed in this agreement is
clearly to enter into a lessor-lessee relationship, not a secured sale. Executive did not
grant Burnett an option to purchase the Ferrari for no or nominal additional
consideration, the only statutory criterion defining a security interest as a matter of
law. Nor is there any implicit provision for transfer of ownership in the agreement. Any
question as to Burnett's subjective intent in executing the contract was immaterial, since
a proper analysis is based not on the parties' private motives but on their objective
intent as expressed in the language of the instrument. (See Carlson v. Giacchetti, supra,
616 N.E.2d at p. 812; LMV Leasing, Inc. v. Conlin, supra, 805 P.2d 189, 192.) The
remaining factors Burnett cites to support a characterization as a security agreement--his
payment of sales tax, insurance, licensing and registration fees as well as his assumption
of the risk of loss or damage--are no longer considered controlling. (@ 1201(37)(c); In re
Bumgardner, supra, 183 Bankr. at pp. 228-229; Kimco Leasing v. State Bd. of Tax Com'rs,
supra, 656 N.E.2d at p. 1218, fn. 15.)
In summary, on the facts before us we can only conclude that the
parties entered into a lease rather than a security agreement. The provisions of division
9 of the California Uniform Commercial Code therefore did not apply to this transaction,
and the trial court properly denied Burnett's motion for nonsuit.
DISPOSITION
The judgment and postjudgment order awarding attorney fees are
affirmed.
Premo, Acting P. J., and Mihara, J., concurred.