Rainier National Bank v. Inland MacHinery Co.

Munson, J.

Inland Machinery Co. appeals from a summary judgment holding that Rainier National Bank's previously perfected security interest, which included after-acquired property, had priority over the subsequent purchase money security interest of Inland Machinery Co. (Inland) because of Inland's failure timely to file pursuant to RCW 62A.9-312(4). Inland and Rainier National Bank (Rainier) are secured creditors of Tonasket Timber Co. (Tonasket).

In October 1978, Tonasket executed a security agreement in favor of Rainier covering all of its equipment, including after-acquired property. Rainier filed an appropriate financing statement. In November of 1978, Tonasket executed two documents, a machine rental agreement and an option to purchase, and took possession of a Caterpillar front loader. The machine rental agreement was for the period November 13, 1978, to April 13, 1979, at $6,000 per month, plus taxes of $306 per month. The customer was to provide insurance. Handwritten into this agreement, in a section labeled "Comments" was the following:

Rental to convert to contract at end of 4 months. Credit of $4,000 for 966A S/N33A668 and $2,000 for 966A S/N33A1009 (not running now—all components to be sent in) to apply to down payment.

Below that "Comment" was a printed section of the form containing a holdover provision which read:

D) Any holdover beyond the term of this Rental as set forth above shall extend the term of the Rental on the same terms and conditions as set forth herein except that during any holdover period, Owner May Repossess the equipment and terminate the Rental, with or without cause, on 24 Hours Notice. On termination of this Rental during any holdover period, the rent for the entire period shall be recomputed on the lowest basis provided above and adjusted with User accordingly.

Attached to the rental agreement and executed at the same, time and incorporated as part thereof is an option to purchase extended to Inland at or before the expiration of the rental term, which states that the purchase price of the equipment is $121,304 plus applicable taxes; and that credit shall be given for all monies paid by Tonasket to Inland except 1 percent of the purchase price will be credited to Inland each month for allowing the option to remain in force. It further states that notice of the exercise of the option must be made in writing not less that 30 days prior to the expiration of the rental term and states in capital letters on the printed form:

It is agreed and understood that this is an option to PURCHASE ONLY AND IS NOT TO BE CONSTRUED AS OR UNDERSTOOD TO BE A CONDITIONAL SALES CONTRACT.

Tonasket took possession of the equipment in November 1978, and sometime before February 5, 1979, indicated to Inland it wished to exercise its option. On February 5, Inland signed and mailed a conditional sales contract and security agreement dated February 15, 1979, to Tonasket's president at his office in the state of Michigan. Tonasket's president signed and mailed the documents back to Inland on February 26, 1979. On March 5, less than 10 days after Tonasket signed the documents, Inland filed a financing statement on the equipment.

Subsequently, Rainier began an action on Tonasket's promissory note and sought to foreclose an existing mortgage to declare the priority of security interests and for damages. Several defendants were named, including Tonasket and Inland. Tonasket had failed to keep current its obligations to Inland; therefore, as between Inland and Rainier the only issue was the priority of their relative security agreements. Both parties moved for summary judgment on that issue; the trial court found in favor of Rainier National Bank.

The issues presented are whether the original instruments, the rental agreement and option to purchase, were a true lease with an option or a security agreement, which creditor had the priority interest and the amount of that interest.

RCW 62A.1-201(37)¹ states in part:

Unless a lease ... is intended as security, reservation of title thereunder is not a "security interest" . . . 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.

The trial court held as a matter of law that the option to purchase was a disguised security transaction; that Inland had failed to file the necessary financing statement within 10 days of Tonasket's taking possession of the equipment; and pursuant to RCW 62A.9-312(4),² Rainier's after-acquired property security interest had priority for the full value of the equipment and not merely Tonasket's equity therein.

Our review of summary judgment is limited to determining whether there is any genuine issue of material fact existing between the parties and whether Rainier was entitled to judgment as a matter of law. Nance v. Metropolitan Transit Corp., 3 Wn. App. 99, 473 P.2d 207 (1970).

I

Construction of the Lease Documents

Our initial inquiry is to the documents themselves. Leasing Serv. Corp. v. American Nat'l Bank & Trust Co., 19 U.C.C. Rep. Serv. 252 (D.N.J. 1976). The statute, RCW 62A.1-201(37) states: "Whether a lease is intended as security is to be determined by the facts of each case; . . ."If the lease is unambiguous, if it purports to be a lease, and if it gives to the lessee no rights of determination thereof, its meaning shall be deduced from the language of the instrument itself. However, if the language is ambiguous, it is the "duty of the court to search out the intent of the parties by viewing the contract as a whole and considering all the circumstances surrounding the transaction, including the subject matter and the subsequent acts of the parties.” Fancher Cattle Co. v. Cascade Packing, Inc., 26 Wn. App. 407, 409, 613 P.2d 178 (1980). Whether a written, instrument is ambiguous is a question of law for the court. Fancher Cattle Co. v. Cascade Packing, Inc., supra; R.A. Hanson Co. v. Aetna Ins. Co., 26 Wn. App. 290, 295, 612 P.2d 456 (1980). Ambiguous means "'Capable of being understood in either of two or more possible senses."' Ladum v. Utility Cartage, Inc., 68 Wn.2d 109, 116, 411 P.2d 868 (1966). Further, parol evidence may be used to explain ambiguities in written instruments and to ascertain the true intent of the parties. In re Tillery, 571 F.2d 1361 (5th Cir. 1978); Levy v. North Am. Co. for Life & Health Ins., 90 Wn.2d 846, 852, 586 P.2d 845 (1978); Green River Valley Foundation, Inc. v. Foster, 78 Wn.2d 245, 473 P.2d 844 (1970).

Here, ambiguity is intrinsic in the documents themselves which provide for a 5-month period in one portion of the rental agreement, while a handwritten portion sets a 4-month rented "to convert to contract." While the court did find that the 4-month period for the conversion to a conditional sales contract was intended to be a security agreement, it made no specific finding as to the parties' intent, and whether the 5-month period retained validity. There is an affidavit from the sales representative of Inland that this writing was inserted to assure Tonasket that the rental payments, less the 1 percent, would be applied toward the purchase price. While that affidavit was belatedly filed, it was considered by the trial judge prior to entry of the summary judgment order.³ The insertion of two different time periods within the same instrument created an ambiguity as to the intent of the parties; accepting as true the affidavit, the language merely supports the option to purchase which is attached to the agreement. On summary judgment, all evidence must be viewed in a light most favorable to the nonmoving party. The credibility of the affiant was an issue, as was the purpose of the insertion and the parties' intent reflected thereby. In short, the matter should not have been decided on summary judgment: whether the handwritten 4-month period should control is a question of fact. Because of the ambiguity inherent in the document, the court must entertain parol evidence to determine whether the original 5-month provisions or the handwritten insertion regarding 4 months will control; and if the latter, whether automatic conversion to contract was intended.

Clearly, if the handwritten "Comments" control, the court was correct in finding that this was a security agreement. Such a lease is in fact a tax avoidance device, in which the credit of the lessor is used by the lessee to finance the purchase of the equipment. This is the type of agreement article 9 of the Uniform Commercial Code was designed to cover. Wo Co. v. Benjamin Franklin Corp., 562 F.2d 1339 (1st Cir. 1977); Leasing Serv. Corp. v. American Nat'l Bank & Trust Co., supra; In re Transcontinental Indus., Inc., 3 U.C.C. Rep. Serv. 235 (N.D. Ga. 1965).

II

Lease or Security Agreement

If the court gives credence to the 5-month rental, it must then determine whether the rental agreement was intended as a true lease or as a disguised security agreement. In Courtright Cattle Co. v. Dolsen Co., 94 Wn.2d 645, 656, 619 P.2d 344 (1980), the court, quoting from All-States Leasing Co. v. Ochs, 42 Ore. App. 319, 324-25, 600 P.2d 899 (1979), adopted several relevant considerations (set forth at the margin for clarity) typical of those considered in other jurisdictions:

[T]he presence of certain factors can be indicative, including, but not limited to:

(1) whether the lessee is given an option to purchase the equipment, and, if so, whether the option price is nominal. . .

(2) whether the lessee acquires any equity in the equipment;

(3) whether the lessee is required to bear the entire risk of loss; or

(4) pay all charges and taxes imposed on ownership;

(5) whether there is a provision for acceleration of rent payments, and

(6) whether the property was purchased specifically for lease to this lessee.

A

Examining Those Factors Seriatim

We find, first, that RCW 62A.1-201(37) recognizes that there may be a true lease which includes an option to purchase, where it was not the intent of the parties that the lease be for security. When a lease, with or without an option, entitles a lessee to become the owner of property for no or only nominal consideration, by statute, the lease is one intended for security.⁴ This was the case in Courtright Cattle Co. v. Dolsen Co., supra. For the most part, decisions from other jurisdictions where the amount of the purchase price at the time of option was less them 25 percent of the fair-market value have been held to be for nominal amounts. See National Equip. Rental, Ltd. v. Priority Elecs. Corp., 435 F. Supp. 236 (E.D.N.Y. 1977), citing cases in which the option price was 2.7 to 4 percent of the total rental value. See also Annot., 76 A.L.R.3d 11 (1977). Likewise, security agreements have been found in other cases where economic reality would as a practical matter obligate the lessee to pay an amount substantially equal to the fair-market value of the equipment, or where the rental price exceeded the market value of the equipment plus what a reasonable interest would be for purchasing the equipment on installment contract. Rushton v. Shea, 419 F. Supp. 1349 (D. Del. 1976); In re Gehrke Enterprises, Inc., 28 U.C.C. Rep. Serv. 794 (Bankr. Ct. W.D. Wis. 1979); In re Lakeshore Transit-Kenosha, Inc., 7 U.C.C. Rep. Serv. 607 (E.D. Wis. 1969); In re Alpha Creamery Co., 4 U.C.C. Rep. Serv. 794, 798 (W.D. Mich. 1967); In re Washington Processing Co., 3 U.C.C. Rep. Serv. 475 (S.D. Cal. 1966); Eimco Corp. v. Sims, 100 Idaho 390, 598 P.2d 538 (1979); see also Cougan, Leases of Equipment and Other Unconventional Security Devices: An Analysis of UCC § 1-201(37) and Article 9, 73 Duke L.J. 909 (1973); 1 U.C.C. Serv. § 4A.07[1] (Bender 1980).⁵

The second factor in Courtright was whether the lessee acquired equity in the equipment. In re Royer's Bakery, Inc., 1 U.C.C. Rep. Serv. 342, 345 (E.D. Pa. 1963), the court defined equity as follows:

By crediting earlier payments of rent to the purchase price, the lessee is accorded an equity or pecuniary interest in the subject matter of the lease which he may recover at his option.

Thus, an equity arises where the lessee acquires an enforceable ownership interest in the collateral. See In re Joe Necessary & Son, Inc., 27 U.C.C. Rep. Serv. 551 (W.D. Va. 1979); Hawkland, The Impact of the Uniform Commercial Code on Equipment Leasing, 72 U. Ill. L.F. 446, 450 (1972).

Requirements that the lessee bear the entire loss, pay all charges and taxes imposed on ownership, or make accelerated rental payments are three factors mentioned in Court-right which have been considered in other jurisdictions. See In re Tillery, supra; In re Joe Necessary & Son, Inc., supra; Leasing Service Corp. v. American Nat'l Bank & Trust Co., supra; In re Transcontinental Indus., Inc., supra; U C Leasing, Inc. v. Laughlin, 96 Nev. 157, 606 P.2d 167 (1980).

While these are three factors which should be considered, it must be remembered these costs, insurance, taxes, and the like, are going to be borne by one party or the other. The lessor is either going to include those costs within the rental charge or agree to a lower rent if the lessee takes responsibility for them. The provision for acceleration of rental payments may be relevant, depending upon other provisions of the lease. See Computer Sciences Corp. v. Sci-Tek, Inc., 367 A.2d 658 (Del. Super. Ct. 1976).

The sixth factor set forth in Courtright is whether the property was purchased specifically for lease to this lessee. This is of particular interest in a financial transaction or installment sale when the lessor is not the real provider of the equipment. In re Transcontinental Indus., Inc., supra. Here, this factor may not be as relevant since the lessor is the actual supplier of the equipment.⁶

B

Additional Factors From Other Jurisdictions

Other factors which have been considered include whether the lessor disclaims all warranties as to the equipment and the lessee agrees to hold the lessor harmless from all liability associated with the equipment, U C Leasing, Inc. v. Laughlin, supra; whether a security interest has been extended to other equipment of the lessees, Computer Sciences Corp. v. Sci-Tek, Inc., supra; and lastly, whether the lessee treats the lease as a lease for tax purposes, In re Shell, 390 F. Supp. 273 (E.D. Ark. 1975); In re Transcontinental Indus., Inc., supra; In re Royer's Bakery, Inc., supra; Accounting Principles Board Opinion No. 5, cited in Coogan, Leases of Equipment and Some Other Unconventional Security Devices: An Analysis of UCC Section 1-201(37) and Article 9, 1973 Duke L.J. 909, 968.

The characteristics of a true lease are designated in In re Alpha Creamery Co., supra at page 798 as:

(a) Provision specifying purchase option price which is approximately the market value at the time of the exercise of the option.

(b) Rental charges indicating an intention to compensate lessor for loss of value over the term of the lease due to aging, wear and obsolescence.

(c) Rentals which are not excessive and option purchase price which is not too low.

(d) Facts showing that the lessee is acquiring no equity in leased article during the term of lease.

The court in In re Alpha Creamery Co., supra at page 798, found the

option price was more than nominal, the lessee acquired no equity during the lease term, the option purchase price at the termination of the lease term was approximately an additional 32% of the list price indicating that the parties did not intend that the lease with option to purchase created a security interest. . .

and held the instrument was a true lease, thus negating the requirement that a financing statement be filed.

Where there is a de facto commitment by the iessee to pay substantially the economic value of the lease equipment, a security agreement is easy to find. 1 U.C.C. Serv. § 4A.07(1) (Bender 1980). As to closer cases, the court must decide on balance whether the bargain struck by the parties must be treated as a lease or security.⁷

Because the trial court did not comment on the rental agreement as to the 5-month period, we have set forth some of the factors which the court should consider if in fact it does not find that the handwritten portion relating to the 4-month rental period with a conversion to a conditional sale contract incorporated the intent of the parties. If the trial court finds that the rental agreement, regardless of the rental period, was intended to be a security transaction, the balance of this opinion becomes superfluous. However, if the court finds it is a true lease, then we must discuss the other assignments of error.

Ill

Timely Filing of Financing Statement

The next issue is whether there was a timely filing of the financing statement. The contract of sale was mailed February 5, dated February 15, but not returned signed until after February 26, and filed oh March 5. The trial court held in the alternative: (a) that the rental agreement was not a true lease, inasmuch as it did contain the 4-month provision with conversion to conditional sales contract, and that the financing statement had not been filed within 10 days of the execution thereof; or (b) if it was not considered a security agreement, Inland was still delinquent in filing its financing statement because Tonasket as a "debtor," had taken possession of the "collateral" more than 10 days prior to the filing. RCW 62A.9-312(4) requires filing within 10 days of the debtor taking possession of the collateral. When such a filing is made, the later-perfected purchase money security agreement takes priority over previously perfected security interests with after-acquired property clauses.

As to the first position of the trial court, if on remand it finds that the lease/option agreement was not a true lease, the ruling is correct because that transaction occurred in November, and the filing occurred the following March. However, as to the second conclusion, that in these circumstances the seller must file within 10 days after the debtor takes possession of the equipment, we disagree.

The statute is subject to two interpretations: (1) "Security interest" as defined in RCW 62A.1-201(37) is very broad—sufficiently broad to include any lease as an "interest in personal property . . . which secures payment or performance of an obligation." The lessee is in possession; he has at least a lessee's interest; and the lease secures payment or performance of his financial obligation; or (2) A true lease with an option to purchase, which places possession in the lessee, does not create a security interest until the parties create one by completing the purchase agreement. In this instance, the equipment does not acquire the status of "collateral" until the agreement is signed; then the 10-day period of RCW 62A.9-312(4) begins to run and filing must occur within that period.

As to (1), arguably, this broad definition should apply except where specifically limited. Thus, where a lease is not intended as security, it might nevertheless be a "security interest" for the purpose of other definitional sections— such as RCW 62A.9-105(l)(c) defining "collateral." Under this analysis, Inland was required to file within 10 days of delivering the equipment under the lease. Such an analysis is desirable in that it promotes the policy of requiring filings, thus putting all persons on notice. It may meet a current business practice of routinely filing all lease options, thus eliminating any contention as to priorities and may have a practical application of avoiding lawsuits. Apparently it has no adverse effect upon taxes. However, it has one disadvantage: that interpretation overlooks another provision of RCW 62A.1-201(37), which specifically states:

Unless a lease ... is intended as security, reservation of title thereunder is not a "security interest" ... (a) that inclusion of an option to purchase does not of itself make the lease one intended for security,. . .

RCW 62A.2-401(1) and RCW 62A.9-113, cited by the dissent, make U.C.C. article 2 security interests subject to the provisions of U.C.C. article 9.⁸ Furthermore, RCW 62A.1-201(37) applies to all sections of the code. This very specific exclusion section exempts true leases from the category of "security interests" and could not be clearer. Property subject to a true lease is not subject to a security interest, be it under article 2 or article 9. It is equally clear that "collateral" under RCW 62A.9-105(l)(c) is "property subject to a security interest". Therefore, property subject to a true lease cannot be collateral. Only when some additional triggering event occurs to change the status of the lease to a security interest, can the property become collateral. Only then may the debtor be deemed in possession of that collateral, the event necessary to begin the running of the 10-day period under RCW 62A.9-312(4).

We believe that a proper reading of the statute required that no security interest arose until this purchase agreement was signed by the debtor.⁹ See also- RCW 62A.2-201(1) and RCW 62A.9-203(1). Here, while the lessee-debtor was in possession, there was no collateral until the purchase agreement was executed; then a security interest was created. The equipment in Tonasket's possession did not become collateral until February 26, when Tonasket signed the purchase agreement; the 10-day period began to run from that date.¹⁰ A financing statement was filed within that time period; if the trial court finds that the lease was a true lease; there was compliance with RCW 62A.9-312(4).

IV

Limitation of Recovery to Debtor's Equity

Lastly, Inland contends the court erred in not limiting Rainier's recovery to Tonasket's equity in the collateral. That is a position held in International Harvester Credit Corp. v. American Nat'l Bank, 296 So. 2d 32, 85 A.L.R.3d 1015 (Fla. 1974), but rejected in General Elec. Credit Corp. v. Tidwell Indus., Inc., 115 Ariz. 362, 565 P.2d 868 (1978); and Whitworth v. Krueger, 98 Idaho 65, 558 P.2d 1026 (1976). The code does not provide for limiting security interests in after-acquired property to the debtor's equity. The filing provisions of the purchase money security interests are to protect both the previous creditor and the purchase money creditor. As noted in RCW 62A.1-102, one of the underlying purposes and policies of the entire title is to simplify, clarify and modernize the law governing commercial transactions while permitting the continued expansion of commercial practices through custom, usage and agreement of the parties, and to make uniform the law among the various jurisdictions. One who has a purchase money security interest is by statute bound to file that within 10 days or he loses his priority. If he desires his priority, it is incumbent upon him to file his financing statement.

Judgment is reversed and the matter remanded for disposition in accordance with this opinion.

Roe, J., concurs.

1 RCW 62A.1-20H37):

"'Security interest1 means an interest in personal property or fixtures which secures payment or performance of an obligation. The retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer (RCW 62A.2-401) is limited in effect to a reservation of a 'security interest'. The term also includes any interest of a buyer of accounts, chattel paper, or contract rights which is subject to Article 9. The special property interest of a buyer of goods on identification of such goods to a contract for sale under RCW 62A.2-401 is not a 'security interest', but a buyer may also acquire a 'security interest' by complying with Article 9. Unless a lease or consignment is intended as security, reservation of title thereunder is not a 'security interest' but a consignment is in any event subject to the provisions on consignment sales (RCW 62A.2-326). 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."

2 RCW 62A.9-312(4):

"(4) A purchase money security interest in collateral other than inventory has priority over a conflicting security interest in the same collateral if the purchase money security interest is perfected at the time the debtor receives possession of the collateral or within ten days thereafter."

3 Rainier attacks the court's consideration of this affidavit, but the court may accept affidavits any time prior to issuing its final order. Felsman v. Kessler, 2 Wn. App. 493, 468 P.2d 691 (1970). Rainier also attacks the affidavit because it does not recite that it is based on personal knowledge. CR 56(e), relating to summary judgments, only requires the content of an affidavit be based on personal knowledge, not that it recite that it is based on personal knowledge. We find no error in the court's considering this documentation.

4 Consideration may be "nominal" either in the absolute sense—e.g., $1—or relative to the value of the machine. For example, consideration of $1,000 for a machine worth $10,000 would be nominal.

5 The Internal Revenue Service has its own means for determining the distinctions between leases and sales for tax purposes; see Rev. Rul. 55-540, 1955-2 C.B. 39; Rev. Rul. 68-590, 1968-2 C.B. 66; see also Rev. Proc. 75-21 1975-1 C.B. 752 modified, Rev. Proc. 76-30 1976-2 C.B. 647.

6 Although the lease recites that the equipment was procured for the lessee, again parol evidence is admissible to determine whether this was true. This is because the factors considered here must necessarily go beyond the face of the document; the parol evidence exclusion goes only to interpreting the agreement as between the parties to that agreement. We are interested in the actual facts surrounding the transaction.

7 What makes this case unusual is the extremely short period of the lease. Our research discloses no case where a 5-month lease was considered, much less held, a security. But the question here is merely made closer, not foreclosed by, the short lease term. If the trial court were to find the parties intended a 5-month lease only, with no requirement of purchase after that date, and that the purchase-option price was substantially equivalent to the fair-market value of the equipment, a strong case could be made for the lease being, in fact, a true lease. The other factors, of course, must be considered. Rainier urges that the holdover provisions contemplate an indefinite lease period with eventual conversion to sale for nominal consideration. This, too, is an issue of fact for the trial court— whether the documents may be construed to give an option for only the rental term, or for the holdover term as well, abides the court's determination of the intent of the parties.

8 Article 2 security interests terminate when the debtor is in' possession of the "goods" (not "collateral") under RCW 62A.9-113. J. White & R. Summers, Uniform Commercial Code 898 (2d ed. 1980).

9 The dissent argues conversion from lease to purchase occurred when Tonasket orally informed Inland it wished to exercise the option. But the option by its own terms required a writing. And to be enforceable, the exercise of a purchase option requires compliance with RCW 62A.2-201(1) (Formal requirements-statute of frauds) which demands a writing signed by the party to be charged. Before Tonasket signed the conditional sales contract, it was not bound to buy.

10 Inland's security interest could not be perfected until after the lease was converted to a security interest. However, it would have been permissible for Inland to have filed in this matter when the lease began; perfection then would have occurred when the last step necessary for attachment—here Tonasket's signature—occurred. RCW 62A.9-303(1); Empire Mach. Co. v. Union Rock & Materials Corp., 119 Ariz. 145, 579 P.2d 1115, 1118 (Ct. App. 1978). Such filing would have avoided all need for this complex and expensive litigation, since Inland's priority would have been undisputed.