The New Dysfunction in Post-petition Lease Obligations Elder-Beerman v. Circuit-Wise

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Feb 2003

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Section 365(d)(10)<a href="#1" name="1a">1</a> of the Bankruptcy Code was added under the Bankruptcy Reform Act of 1994 to grant
personal property lessors additional protections,<a href="#2" name="2a">2</a> similar to the protections afforded to real property
lessors.<a href="#3" name="3a">3</a> It requires the trustee or debtor-in-possession (DIP)to perform under the lease (paying to the lessor
the contractual lease payment) until a determination is made to assume or reject the lease.<a href="#4" name="4a">4</a>

Section 365(d)(10) provides for a post-petition abeyance period<a href="#5" name="5a">5</a> in which the debtor has 60 days after the
Order for Relief to decide whether to assume or reject a personal property lease. Following that period, if
the decision has not been made, the trustee or DIP is required to honor the lease obligations.<a href="#6" name="6a">6</a> The purpose
behind §365(d) (10) is to grant the debtor a "breathing period" to make an informed decision, while
assuring the lessor that after 60 days it will receive its lease payments without having to demonstrate an
actual benefit to the estate.<a href="#7" name="7a">7</a>

<h3>What Is the Difference Between a Lease and a Security Agreement?</h3>

A lease is defined in §2A-103(1)(j) of the Uniform Commercial Code as a "transfer of the right to
possession and use of goods for a term in return for consideration, but a sale, including a sale on approval
or a sale or return, or retention or creation of a security interest is not a lease."<a href="#8" name="8a">8</a> The definition of "lease"
shifts the focus to the term "security interest." Although courts have applied various factors to determine if
a transaction is a "true lease,"<a href="#9" name="9a">9</a> most jurisdictions have been guided by §1-201(37) of the Uniform
Commercial Code. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U… 1-201(37)</a> defines the term "security interest" and sets forth a statutory test for
determining if a transaction is a secured transaction.<a href="#10" name="10a">10</a> A transaction will be declared a secured transaction
if (1) the obligation to pay rent extends for the entire term of the lease and cannot be subject to termination
by the lessee, and (2) the transaction meets any one of the four independent standards enumerated in
§1-201(37).<a href="#11" name="11a">11</a> The essence of §1-201(37) is, "do the terms of the lease create an irresistible economic
impulse on the lessee to become the owner, thereby suggesting that the lessor has no meaningful residual
interest?"<a href="#12" name="12a">12</a>

The distinction between a lease and a security interest is crucial to the application of Bankruptcy Code
§365(d)(10).<a href="#13" name="13a">13</a> If the lease is not deemed a "true lease" then §365(d)(10) is not applicable and the debtor is
not obligated to perform under the "lease."<a href="#14" name="14a">14</a> This article, however, will not focus on how courts make the
distinction between a lease and a security interest,<a href="#15" name="15a">15</a> but rather how courts apply §365(d)(10) when a debtor
alleges that §365(d)(10) is inapplicable because the transaction is not a "true lease." Two courts have
addressed the issue of whether a debtor may avoid the obligation under §365(d)(10) while awaiting a court
determination of whether the transaction in question is a lease or security interest. The opposite
conclusions have created a new dysfunction for equipment lessors caught in a bankruptcy case. This article
will examine the courts' rationales and offer an approach to reconciling the split of authority.

<h3>The Split of Authority: In re The Elder-Beerman Stores Corp.</h3>

In 1996, the U.S. Bankruptcy Court for the Southern District of Ohio held that the Elder-Beerman Stores
Corp. Inc. had to perform all obligations under §365(d)(10) until given leave by the court to do
otherwise.<a href="#16" name="16a">16</a> The debtors entered into a series of transactions, beginning Dec. 28, 1990, with Star Bank
(the lessor) providing for payments in return for the use of personal property.<a href="#17" name="17a">17</a> The transactions were
embodied in a written agreement that was titled "Master Equipment Lease" or "Acceptance Supplement
(True Lease)."<a href="#18" name="18a">18</a> On Oct. 17, 1995, the debtors filed for chapter 11 protection and did not make payments
after that date.<a href="#19" name="19a">19</a>

The issue before the court was whether the debtors could avoid their obligations under §365(d)(10) during
the pendency of a challenge to the nature of the underlying transactions.<a href="#20" name="20a">20</a> Based on legislative history, the
court found that §365(d)(10) was created to give a debtor limited "breathing room." To allow a debtor to
extend the period provided by §365(d)(10) by claiming that the transaction was not a "true lease" was
beyond Congress's intentions.<a href="#21" name="21a">21</a> The court held that in circumstances "[w]here an agreement at issue
appears on its face to be a commercial personal property lease, the debtor is charged by §365(d)(10) to
timely perform all duties of the agreement that arise [60] days after the...petition, until such time as the
debtor is relieved of the obligation."<a href="#22" name="22a">22</a> The debtors were directed to make the payments to an escrow
account at a separate institution, which would protect the lessor if the estate became insolvent, and the
debtors were protected in the event the agreements were found to be secured transactions.<a href="#23" name="23a">23</a>

<h3>In re Circuit-Wise</h3>

On the contrary, in In re Circuit-Wise, the U.S. Bankruptcy Court for the District of Connecticut held that
Wells Fargo was not entitled to the protections of §365(d)(10) until and unless the court determined that
the lease was a "true lease."<a href="#24" name="24a">24</a> Circuit-Wise entered into a lease on May 16, 1996, with Celtic Leasing
Corp., which eventually became Wells Fargo.<a href="#25" name="25a">25</a> On March 28, 2001, Circuit-Wise filed for chapter 11
protection, and no payments were made after the petition date.<a href="#26" name="26a">26</a> Circuit-Wise argued that the lease was not
a "true lease" but a security agreement, and therefore Wells Fargo was not entitled to the protections of
§365(d) (10).<a href="#27" name="27a">27</a> Wells Fargo, however, asserted that, regardless of the ambiguity of the document, it
should still be entitled to protection under §365(d)(10) until the court found the lease to be a security
agreement.<a href="#28" name="28a">28</a>

The court held that Wells Fargo was not entitled to the protection of §365(d)(10) until it determined that
the transaction was in fact a "true lease."<a href="#29" name="29a">29</a> The court reasoned that the plain meaning of the statute was
dispositive because the person or entity trying to obtain the protection must be a lessor and not the holder
of a security interest.<a href="#30" name="30a">30</a> Furthermore, the court provided in dictum additional rationale that would defeat
Wells Fargo's claim (if the plain meaning interpretation had not been dispositive).<a href="#31" name="31a">31</a> According to the
court, Wells Fargo misinterpreted the term "lease" by construing it to mean "putative." It stated that the
interpretation of "lease" was not intended to mean "putative" or "presumptive" because of the interpretation
of the term within other Bankruptcy Code sections<a href="#32" name="32a">32</a> and Congress's knowledge of the then-existing
precedents when the section was added.<a href="#33" name="33a">33</a> Moreover, the court acknowledged the concern that debtors
would raise this claim merely to postpone payment of lease obligations but found that "appropriate
protections" could be structured to prevent this abuse.<a href="#34" name="34a">34</a>

<h3>Can the Cases Be Reconciled?</h3>

The court in Elder-Beerman focused on two specific aspects when it held that the debtor was obligated to
make lease payments under §365(d)(10)...(1) the legislative history and (2) the limitations of its decision.
The court in Circuit-Wise relied on the plain meaning of the statute to render its decision. The fact that the
courts applied different rationales to reach opposing holdings provides some hope that the cases can be
reconciled.

<blockquote><blockquote>
<hr>
<big><center>
[S]tatutory interpretation was not the issue before the court in Elder-Beerman.

</center></big>
<hr>
</blockquote></blockquote>

Circuit-Wise was decided six years after Elder-Beerman, and the U.S. Bankruptcy Court for the District of
Connecticut chose not to adopt the reasoning in the prior case.<a href="#35" name="35a">35</a> The Circuit-Wise court did not
specifically address the issues raised in Elder-Beerman, but instead made a decision based solely on the
"plain meaning" of the statute. It is true that, in a statutory construction case, the court will begin with the
language of the statute.<a href="#36" name="36a">36</a> The U.S. Supreme Court has stated "[t]he inquiry ceases if the statutory
language is unambiguous and the statutory scheme is coherent and consistent."<a href="#37" name="37a">37</a> Therefore, the reasoning
of the Circuit-Wise case appears consistent with Supreme Court precedent.

However, statutory interpretation was not the issue before the court in Elder-Beerman. The court in
Elder-Beerman did not dispute the statutory construction of Bankruptcy Code §365(d)(10). It did not find
that the term "lease" had a different meaning. Essentially, the court in Elder-Beerman said that "on its face"
the agreement entered into by the two parties was a lease, a "true lease," and §365(d)(10) was applicable
until a factual finding was made that the transaction was not a "true lease." The court reached this holding
by examining the legislative history of §365(d)(10). With the addition of Bankruptcy Code §365(d)(10),
the burden of proof was shifted to the debtor. After the 60-day abeyance period, the lessor is automatically
entitled to rent. When debtors refuse to comply with §365(d)(10), they are violating Congress's intent
behind Bankruptcy Code §365(d)(10). Although the court in Circuit-Wise touched on this issue, it
considered it only in the context of remedies, and not in connection with an analysis of the legislative
history.

At its core, the Elder-Beerman court limited its holding to cases where the presence of a "true lease" was
clear: "in limited circumstances extant in this case, that is where the debtor is faced with agreements
unambiguously titled as 'leases,' the debtor may not circumvent the requirements of §365(d)(10) while
challenging the nature of the agreements."<a href="#38" name="38a">38</a> This holding should survive an attack under the rationale
expressed in Circuit-Wise because if the document is not clearly a "true lease," then §365(d)(10) will not
apply.

<h3>Conclusion</h3>

The holdings in Elder-Beerman and Circuit-Wise can be reconciled, although in a strained way and
admittedly with deference given to the Elder-Beerman decision. If, on its face, the transaction appears to
involve a "true lease," then the debtor must begin making payments after the 60-day abeyance period and is
not permitted to delay its clear obligations to make such payments by waiting for the court to characterize
the transaction. If, on its face, it is unclear whether the transaction is a "true lease," the debtor should file
an action for court determination within the 60-day abeyance period and pay into escrow the lease payments
after the 60-day abeyance period in order to protect the lessor in the event the transaction is characterized as
a "true lease." This approach balances the interests of the lessor and the debtor, provides some
reconciliation to the holdings in Elder-Beerman and Circuit-Wise, and is consistent with the legislative
history of §365(d)(10) and the plain language approach to statutory construction.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> Section 365(d)(10) states:
<blockquote>
The trustee shall timely perform all of the obligations of the debtor, except those specified in
§365(b)(2), first arising from or after 60 days after the order for relief in a case under chapter 11 of
this title under an unexpired lease of personal property (other than personal property leased to an
individual primarily for personal, family or household purposes), until such lease is assumed or
rejected notwithstanding §503(b)(1) of this title, unless the court, after notice and a hearing and
based on the equities of the case, orders otherwise with respect to the obligations or timely
performance thereof. This subsection shall not be deemed to affect the trustee's obligations under
the provisions of subsection (b) or (f). Acceptance of any such performance does not constitute
waiver or relinquishment of the lessor's rights under such lease or under this title.
</blockquote>
<a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §365(d)(10)</a>. <a href="#1a">Return to article</a>

<a name="2">2</a> Crocker, Randall D. and Mathison, Erin N., "Property Leases, Adequate Protection Payments and the
Debtor's Statutory Duty to Perform Lease Obligations," Am. Bankr. Inst. J., Feb. 2002, On the Edge.
Prior to 1994, "it was first necessary for a lessor seeking administrative expense payments for post-petition,
pre-rejection or assumption rent to establish that the lessor had conferred some benefit to the estate." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re
The Elder-Beerman Stores Corp., 201 B.R. 759, 762 (Bankr. S.D. Ohio 1996)</a>. It should also be noted that
Congress did not just amend §365(d)(3) to add commercial personal property leases but added a similar, yet
not identical, section (§365(d)(10)). <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#2a">Return to article</a>

<a name="3">3</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Ernst Home Ctr. Inc., 209 B.R. 955, 965 (Bankr. W.D. Wash. 1997)</a>. Section 365(d)(3) is similar to
§365(d)(10), but §365(d)(10) applies only in chapter 11 cases, whereas §365(d)(3) applies to all bankruptcy
filings. 3 Resnick, Alan, et al., Collier on Bankruptcy 365-44 (15th ed. rev. 2002). <a href="#3a">Return to article</a>

<a name="4">4</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… & Mathison, supra note 2</a>. <a href="#4a">Return to article</a>

<a name="5">5</a> "In re The Elder-Beerman Stores Corp....characterized the [60]-day period set out in §365(d)(10) as an
"abeyance period." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Russell Cave Co., 247 B.R. 656, 659 (E.D. Ky. 2000)</a>. <a href="#5a">Return to article</a>

<a name="6">6</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… & Mathison, supra note 2</a>. <a href="#6a">Return to article</a>

<a name="7">7</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; Prior to 1994, the burden was on the lessor to establish that a benefit had been conferred upon the
debtor in order to support an administrative expense. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; The new amendment shifts the burden of proof
from the lessor to the debtor. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#7a">Return to article</a>

<a name="8">8</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…. §2A-103(1)(j)</a>. <a href="#8a">Return to article</a>

<a name="9">9</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=8… re PCH Assocs., 804 F.2d 193, 201 (2d Cir. 1986)</a>. <a href="#9a">Return to article</a>

<a name="10">10</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…, Barkley, The Law of Secured Transactions Under the Uniform Commercial Code, 1-73 (1999)</a>. <a href="#10a">Return to article</a>

<a name="11">11</a> Id. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U… 1-201(37) of the Uniform Commercial Code</a> focuses on the economic reality of the
transaction. Essentially the four factors ask: "Will the lessee enjoy possession and use of the goods for their
entire economic life (1) under a lease whose term exceeds the useful economic life of the goods, (2) by
reason of a mandatory 'put,' (3) by reason of a nominal purchase or renewal option or (4) for some other
reason?" <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…; The factors are commonly referred to as the "residual value factors." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… Inc. v. Cisco Sys.
Capital Corp., 271 B.R. 1, 45 (Bankr. S.D.N.Y. 2001)</a>. <a href="#11a">Return to article</a>

<a name="12">12</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=U…, supra note 10 at 1-74</a>. <a href="#12a">Return to article</a>

<a name="13">13</a> Pantaleo, Peter V. and Winter, Robert E., "Unexpired Real and Personal Property Leases in
Bankruptcy," Commercial Law and Practice Course Handbook Series, Practising Law Institute, Oct. 25,
2001, citing <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Homeplace Stores Inc., 228 B.R. 88, 90 (Bankr. D. Del. 1998)</a>. <a href="#13a">Return to article</a>

<a name="14">14</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#14a">Return to article</a>

<a name="15">15</a> For a discussion of the distinction between a lease and security agreement, see Coleman, Kenneth P.,
"How to Tell if a Transaction Is a True Lease or a Disguised Secured Transaction," <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… Banking L.J. 953
(1997)</a>. See, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Edison Bros. Stores Inc., 207 B.R. 801 (1997)</a> (applying §1-207(37) of the New York
Uniform Commercial Code to find that the transaction was a "true lease"). <a href="#15a">Return to article</a>

<a name="16">16</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re The Elder-Beerman Stores Corp., 201 B.R. 759, 765 (S.D. Ohio 1996)</a>. <a href="#16a">Return to article</a>

<a name="17">17</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 761</a>. <a href="#17a">Return to article</a>

<a name="18">18</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#18a">Return to article</a>

<a name="19">19</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#19a">Return to article</a>

<a name="20">20</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 764</a>. <a href="#20a">Return to article</a>

<a name="21">21</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#21a">Return to article</a>

<a name="22">22</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; The court found that the debtor may be relieved of the obligation by rejecting the lease under
§365(a), by leave of the court due to equities of the matter, or if the court determines that the transactions
are not "true" leases. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#22a">Return to article</a>

<a name="23">23</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; See, also, <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Kyle Trucking Inc., 239 B.R. 198 (Bankr. N.D. Ind. 1999)</a> (stating that...although the
decision in the case was based on different issues...the motion for relief resulted in an agreed order that
provided for partial payment of the rent otherwise due the lessor, with the balance being placed in escrow
pending the court's ruling concerning the nature of the agreement between them). <a href="#23a">Return to article</a>

<a name="24">24</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re Circuit-Wise Inc., 277 B.R. 460, 464 (Bankr. D. Conn. 2002)</a>. <a href="#24a">Return to article</a>

<a name="25">25</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 461</a>. <a href="#25a">Return to article</a>

<a name="26">26</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#26a">Return to article</a>

<a name="27">27</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; The debtor alleged that the transaction was within §101(50) of the Bankruptcy Code (the definition
of "security agreement"). <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#27a">Return to article</a>

<a name="28">28</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#28a">Return to article</a>

<a name="29">29</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 462</a>. <a href="#29a">Return to article</a>

<a name="30">30</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#30a">Return to article</a>

<a name="31">31</a> See <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 462-64</a>. <a href="#31a">Return to article</a>

<a name="32">32</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=1… U.S.C. §365(d)(3) (2002)</a>. <a href="#32a">Return to article</a>

<a name="33">33</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; 277 B.R. at 463</a>. <a href="#33a">Return to article</a>

<a name="34">34</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; at 463</a>. The court provided an example of "appropriate protections" and stated that a putative lessor's
request for a reasonably expedited trial schedule for the "true" lease issue would be liberally granted. <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#34a">Return to article</a>

<a name="35">35</a> "To the extent that <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re The Elder-Beerman Stores Corp, 201 B.R. 759</a>, is inconsistent with the ruling,
this court respectfully declines to follow Elder-Beerman Stores." <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2…; <a href="#35a">Return to article</a>

<a name="36">36</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=5… v. Sigmon Coal Co. Inc., 534 U.S. 438, 440 (2002)</a> (citations omitted). <a href="#36a">Return to article</a>

<a name="37">37</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=5…; <a href="#37a">Return to article</a>

<a name="38">38</a> <a href="http://www.westlaw.com/find/default.wl?rs=CLWD3.0&vr=2.0&cite=2… re The Elder-Beerman Stores Corp., 201 B.R. 759, 764 (S.D. Ohio 1996)</a>. <a href="#38a">Return to article</a>

Journal Authors

Melissa Piccioni

Pete Clarke

Journal Date

Saturday, February 1, 2003 - 12:00

Bankruptcy Rule

2003