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When is a lease not a lease?

Many individuals and small businesses in Vancouver use various forms of financing to acquire or rent personal property, such as automobiles, construction equipment, or over-the-road trailers. If the payments are made on time and if other terms of the agreements are satisfied, the characterization of the agreement as a lease or financing agreement usually makes little difference. If, however, the lessee decides to file a bankruptcy petition, the substance of these agreements can become all-important.

If the document is a true lease, the lessor can seek relief from the automatic stay to recover its property. If the document is deemed to be a financing agreement, the property belongs to the debtor, subject only to a lien in favor of the party providing the financing. A case recently decided by the United States Bankruptcy Court for the Eastern District of North Caroline demonstrates the importance of these distinctions.

The debtor used over-the-road trailers owned by another party. The parties executed a separate "lease" for each trailer, and the documents used the terms "lessor" and "lessee" throughout. When the so-called "lessee" defaulted, the owner of the trailers sought relief from the automatic stay and attempted to repossess the trailers. The court analyzed the documents to determine whether they constituted a true lease or merely a disguised financing arrangement. The consequence of the difference is straightforward: if the transaction is a true lease, the leasing party owns the property, and it has a claim against the debtor for unpaid rent. If the transaction is a disguised financing agreement, the bankrupt estate owns the property, and the claim for unpaid rent becomes an unsecured debt. In the former case, the lessor will recover a far greater percentage of its claim than if the transaction was merely disguised financing.

The court found that the agreements were disguised financing and that the so-called lessor could not recovery possession of the trailers and that the lessor's claim for the balance due on the contract was merely an unsecured debt. Determining whether an agreement is a true lease or disguised financing must be done before the agreement is executed. An experienced bankruptcy lawyer can help draft the documents to ensure that they meet the parties' intention to be either a true lease or disguised financing.

Source: National Law Review, "In Bankruptcy, a Lease Isn't Always a Lease,"Lance Martin, Nov. 20, 2017