Summary:   The United States Bankruptcy Court for the District of Connecticut recently held that a lessor is not entitled to the benefits of 11 U.S.C. § 365(d)(10) unless and until a court first determines that a lease is a “true” lease and not a “security agreement”.  In re Circuit-Wise, Inc., 277 B.R. 460 (Bankr. D. Conn. 2002).  This case is significant because it erodes lessor protections specifically provided for under Section 365(d)(10) by delaying the date on which a debtor must begin making post-petition payments (and any other obligations required under a lease).

On May 16, 1996, Circuit-Wise, Inc. entered into a Master Lease with Celtic Leasing Corp., predecessor in interest to plaintiff Wells Fargo Equipment Finance, Inc.  Circuit-Wise filed a voluntary Chapter 11 petition on March 28, 2001.  Nearly a year later, Circuit-Wise had not made any payments under the Lease since its filing date.  Wells Fargo filed a motion seeking payment of all amounts due or to become due under the Lease pursuant to Section 365(d)(10).  In response, Circuit-Wise argued that the Lease was not a “true” lease but was a lease intended as security under Section 1-201(37) of the Uniform Commercial Code.  Therefore it argued Well Fargo was not entitled to the protections of Section 365(d)(10).  Wells Fargo claimed that the Lease was at least a “presumptive” or “putative” lease entitled to Section 365(d)(10) protections until the court ruled otherwise.  Circuit-Wise countered that the Lease was not entitled to the protections of Section 365(d)(10) until the Court determined that it was a “true” lease.  The Court agreed with Circuit-Wise denying Wells Fargo’s request for post-petition payments and set the matter for further proceedings regarding resolution of the “true” lease issue.

The Court found that Wells Fargo was not entitled to Section 365(d)(10) protections unless and until the Court first determined that the Lease was a “true” lease.  The Court stated that its ruling was based primarily on a “plain meaning” analysis, noting that the language of Section 365(d)(10) explicitly applies only to leases and not to “security interests” as defined in Section 101(50).  The Court found particular relevance in this distinction because of the different rights and remedies accorded to lessors and holders of security interests under the Bankruptcy Code.  The language of Section 365(d)(10), the Court stated, “leaves no room for judicial construction.”  Moreover, the Court reasoned, the term “lease” has been construed by courts to mean a “true” lease, and not a “security agreement”, in the context of the Bankruptcy Code.

The Court rejected Wells Fargo’s argument that the term “lease,” as used in Section 365(d)(10), referred to a “presumptive” or “putative” lease and that the analysis of whether the Lease was a “true” lease was essentially an “equities of the case” analysis.  Even if the plain meaning was not clear, the Court reasoned, Wells Fargo’s interpretation would be contrary to the established rule of statutory construction that a word used throughout a statute has a uniform meaning.  Moreover, in a footnote, the Court stated that it had found no legislative history that was “dispositive” on the issue.  The Court  then reiterated that courts have applied “true” lease meanings in the context of Section 365(d)(3) and (4), adding that Section 365(d)(3) was “in some sense” the model for Section 365(d)(10).  Ultimately, the Court found that Congress’s deliberate exclusion of words like “putative” and “presumptive” in Section 365(d)(10) to be determinative of the issue.  The Court stated that Congress was surely aware of caselaw interpreting the term “lease” to mean a “true” lease in the context of Section 365(d)(3) and (4).  If Congress had wanted to extend the protections under Section 365(d)(10) to “putative” or “presumptive” leases, it surely would have used such qualifiers in drafting the subsection.

Finally, the Court stated that it was aware that its decision might pave the way for debtors to routinely raise the “true” lease issue as a way of delaying their timely performance obligations.  Nevertheless, the Court suggested that there are currently available measures that are sufficient to protect putative lessors without having to resort to a “strained construction” of Section 365(d)(10).  For example, a court can liberally grant a lessor’s request for an expedited trial, can require the debtor to post a security, or can award attorneys’ fees for raising the “true” lease issue for an improper purpose under Bankruptcy Rule 9011(b)(1).   

The Circuit-Wise decision amounts to an unjustified judicial validation of a debtor strategy that attempts  to shift the burden to the lessor to prove that its transaction is a “true” lease transaction, unnecessarily delaying the debtor’s time to perform under a lease even though the debtor may enjoy the continued use of the lessor’s equipment in the debtor’s post-petition operations.  In so doing, the decision gives unwarranted leverage to the debtor and seriously erodes intended lessors’ rights under Section 365(d)(10).  This holding is contrary to both the legislative intent behind Section 365(d)(10) and relevant caselaw, most specifically the case of In re Elder-Beerman Stores Corp., 201 B.R. 759 (Bankr. S.D. Ohio 1996), which states that that a lease is a lease transaction unless proven otherwise.  In light of this holding, a lessor should plan to file a motion to compel Section 365(d)(10) payments on or about the 60th day of the debtor’s bankruptcy.  By being the first to file a motion to compel, the lessor may convince the court that it should enforce Section 365(d)(10) as written or have the initial opportunity to frame the lease/security issue in the most favorable light.  If this strategy proves unsuccessful,  the lessor should request that the debtor at least be required to make a prima facie showing that there is a real dispute as to whether a lease is a “true” lease or a security agreement before denying the lessor’s Section 365(d)(10) payments.  Short of this, the lessor may have to settle for post-petition lease payments (commencing on the 61st day) being made into a separate blocked account while it attempts to prevail on the lease/security litigation.

If you have any questions, please do not hesitate to contact one of Cooper, White & Cooper LLP’s Bankruptcy/Creditors’ Rights attorneys.

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