High court questions whether transactions are leases or security interest sales

Examining whether a transaction between two businesses is a lease or a sale subject to security interest, the Indiana Supreme Court has adopted an approach used in Colorado. The court held that various factors, such as the economy, must be considered in each situation to decide that question.

As a result, the state justices have adopted a bright-line rule with multiple parts. Essentially, they leave it up to trial courts and attorneys to determine how each transaction might be interpreted.

The ruling came Tuesday in Gibraltar Financial Corp. v. Prestige Equipment Corporation, et. al , No. 20S03-1010-CV-618, an Elkhart Superior case that involves a contract dispute over a punch press at a now-defunct manufacturing business in northern Indiana.

Vitco Industries was a porcelain manufacturer in Napanee that paid $243,000 for a punch press in early 2004. Later that year, Vitco sold the punch press to Key Equipment Finance for the same amount. Key Finance and Vitco entered into a six-year master lease agreement contract where Vitco would make monthly payments to use the punch press. The contract was governed by Colorado law.  Vitco was no longer in business by 2007 and defaulted on the lease agreement.

But independent of its dealings with Key Finance in that lease agreement, Vitco had also entered into several loan agreements with Gibraltar Financial Corp. and granted Gibraltar a security interest in almost all tangible and intangible property. A separate lawsuit in 2007 resulted in Gibraltar receiving possession of all collateral it had perfected security interest in. Gibraltar sold all of the equipment and credited Vitco with the sale proceeds, but in the meantime Key Finance had repossessed the punch press and sold it in an unrelated business venture with Prestige Equipment Corp.

In May 2008, Gibraltar sued Prestige Equipment, attempting to recover the value of the press on allegations that Prestige had acquired the equipment subject to Gibraltar’s security interest. A line of third-party suits and disputes arose. In the end, the current suit came down to whether the initial transaction between Vitco and Key Financial was a true lease or rather a sale subject to security interest.

Elkhart Superior Judge Charles Wicks granted summary judgment in favor of the defendants after concluding the transaction was a true lease, and the Court of Appeals affirmed that finding last year.

Unable to reach a final decision on whether the agreement was in fact a lease, the Supreme Court remanded for further proceedings but outlined some general rationale in making that decision on these situations in the future.

The justices relied on the Uniform Commercial Code adopted in some form in all 50 states, and they specifically looked at how Colorado has adopted a provision in §1-203 that addresses how to distinguish whether a transaction is a lease or one that creates or retains a security interest. That state has a bright line test involving two-prongs that must be met, and in this case it appears that both prongs have been satisfied to prove the transaction was a security interest, the Indiana justices found.

But other aspects of the contract – such as the early buyout option and fair market value, and any residual interest in the property – must also be examined, and factors such as the economic climate at the time can help determine whether the transaction was a lease or security interest.

“To review, we have applied the objective bright-line test of (Colorado) §1-203(b) and concluded that the Lease did not create a security interest per se,” Justice Frank Sullivan wrote, noting that material facts about the economic issues weren’t provided in the record.

“We see no way of resolving this case without this evidence (about trial-specific facts such as intent between the parties). Because such evidence was not presented, summary judgment was not appropriate.”

The trial court’s judgment is reversed and the case is remanded for further proceedings to determine whether this specific transaction constituted a lease or security interest.