Friday, May 25, 2012

Is it a sale or lease?

A common mistake that businesspersons who deal in goods may make is to characterize a transaction improperly. At first glance, it would seem that it is easy to delineate what constitutes a sale from what constitutes a lease. If it is a sale, Article 2 will apply. If it is a lease, Article 2A will apply. The line between sales and leases becomes fuzzy when security interests are involved. A sale intended for security occurs when goods are purchased on credit but the seller retains the right to foreclose on the goods if the buyer stops making payments. In such a case, Article 9 also applies.

The "Economic Realities" test offers salient guidance. It posits that a purported lease is actually a sale when the lessor/seller is scheduled to receive the goods back with little or no economically useful life remaining. The UCC goes beyond merely asking whether the putative lessor would receive the goods back with any economically useful life. The UCC does not follow the Economic Realities test, even though the test is subsumed in it.

Article 1 of the UCC distinguishes a lease from a security interest. It defers to the facts of each case. If the lessee/buyer cannot terminate the lease and is obligated to pay for the entire term of it, there is a security interest if: (a) there is no remaining economic life to the goods after the lease expires; (b) the lessee/buyer must renew the lease; or (c) the lessee/buyer has an option to renew the lease for little to no additional payment.

If you lease goods in your business, you should take care to ensure that your leases are not disguised sales. If they are disguised sales and a security interest is created, you would be remiss to not take advantage of Article 9 by perfecting your security interest. Generally, to perfect, it is necessary for the security interest to "attach" and to file a financing statement with the Secretary of State. Generally, a security interest attaches only when it becomes enforceable against the buyer. Perfecting your security interest helps establish priority over other creditors. A perfected security interest has priority over later-in-time perfected security interests. A perfected security interest has priority over unperfected security interests, even those that attached before perfection.

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