As in most areas of the law, the rules and practices of the United States relating to financial leasing of equipment are more complex than those of any other country. Notable points are that commercial
and tax law emphasize the substance of a transaction, but do so differently; that bankruptcy law appears to emphasize the substance but may be controlled instead by the expressed intent of the parties; that the rules of financial accounting emphasize literal compliance, rather than substance; that there are special rules, often very complex and different from one another, for leasing of aircraft, ships, and rolling stock; that most modern international conventions dealing with these and related areas set forth rules largely consistent with those of the United States, but that the United States nevertheless rarely ratifies them; and that when the United States adds new requirements, such as those of an international convention, its lawyers usually treat those requirements as additions, rather than replacements, to its existing rules.
Leasing is an ancient device, which came to America after thousands of years, but financial leasing arose almost entirely in the last half-century and the way was led by the United States. Almost any topic in U.S. law is more complex than the same topic elsewhere, but the U.S. law of financial leasing is particularly so.1 The modern U.S. practice of equipment leasing has been shaped primarily by lawyers responding to:
tax law, as developed mainly by the Internal Revenue Service (IRS) and the courts,
financial accounting rules,
* A.B. Shimer College; J.D. and M.Comp.L., University of Chicago; S.J.D., University of Michigan; M.B.A., Rensselaer Polytechnic Institute; MSc, School of Oriental and African Studies; D.H.L. (hon.), Shimer College. Attorney, New York City and Connecticut.
† DOI 10.5131/ajcl.2009.0039.
1. In response to the length limit, the audience for this Article is assumed to be
non-U.S. lawyers familiar with the subject generally and with the international instruments:
the more unusual the U.S. position, the more space it receives.
specialized administrative systems for particular industries, especially transportation by air, sea, and rail, and
more recently, bankruptcy law, as developed by Congress and the courts, including special rules for aircraft, ships, and railway rolling stock.
The Uniform Commercial Code (U.C.C.) and international treaties have played highly visible, but less substantial roles. As a first approximation, it appears that commercial law turns, more than the others, on the business and economic substance of a transaction; that tax law is a close second in this respect; that bankruptcy law appears to turn on the business and economic substance but may be controlled instead by the expressed intent of the parties; and that the financial accounting rules turn primarily on literal compliance, which may be far removed from business and economic substance.
I. BACKGROUND
At a basic level, leasing (or comparable devices, such as conditional sales) often greatly increased the resources available to a business that would otherwise have had to depend on equity investment and borrowing: the lessor was protected by its ownership of the property and therefore did not require payment of the purchase price, a business owner’s personal guaranty, a mortgage on the business’s real property or some comparable arrangement. In addition, however, some businesses that were not able to use depreciation deductions to reduce their taxes, perhaps because they were young and not yet profitable, were able to receive the benefit of depreciation in the form of a reduced interest rate implicit in the rentals they paid for equipment, because their lessors, as owners, could depreciate the equipment.2 From time to time, other tax benefits were made available for lease transactions; the most important of these to the growth of equipment leasing were tax incentives, notably investment-tax credits (generalized from 1962 to 1986 and thereafter focused to encourage particular kinds of investment, such as solar energy) and accelerated depreciation.
In 1963, first national banks, then state-chartered banks were authorized to own and to lease equipment3. In 1975, the IRS published the guidelines it would follow in ruling on whether a
2. The lease structure allows the lessee to benefit from the lessor’s tax deductions for depreciation even if the lessee is in a loss position and therefore unable to use its own tax deductions for the rental payments.
3. For national banks, see Comptroller of the Currency, Rule 3400, 12 C.F.R. § 7.3400 (repealed). For discussion of the current leasing authority of national banks, see Gordon D. Alter & Francis Zou, Legal Authority for Leasing, in 1 IAN SHRANK & ARNOLD G. GOUGH, JR., EQUIPMENT LEASING–LEVERAGED LEASING § 13:2 (4th ed. 1999, updated to July 2009) (hereinafter SHRANK & GOUGH). The same chapter covers bank holding companies (§ 13:3), federal savings and loan associations and federal
transaction qualified as a true lease for tax purposes,4 thereby bringing much greater certainty to the leasing business. A year later, the Financial Accounting Standards Board issued its first detailed statement of the rules to be applied in accounting for leases.5.6. Under the Bankruptcy Reform Act of 1978, lessors are expressly distinguished from, and preferred to, secured creditors.
A. Beginnings in Law
References to leasing of agricultural tools have been found in clay tablets from Ur, there are rules on leasing in the Code of Hammurabi, and so forth;7 in eighteenth and early nineteenth century England and the United States, there were bailments for hire;8 one of the most successful of Justice Story’s many treatises was on bailments;9, and arrangements for financing of railroad rolling stock that might be called financial leases were accepted under the law of Pennsylvania and New York by the late 19th century.10 For all of that,
savings banks (§ 13:4), state banks and savings associations (§ 13:5) and insurance companies (§ 13:6).
4. See infra note 102 and accompanying text.
5. See infra note 111 and accompanying text.
6. There was also a brief but extraordinary bubble of tax-motivated “safe harbor” leasing based on § 168(f)(8) of the Economic Recovery Tax Act of 1981, Pub. L. No. 9734, 95 Stat. 172 (1981), which amounted to authorizing a market in asset-related tax benefits. See Note, “Safe Harbor” as Tax Reform: Taxpayer Election of Lease Treatment, 95 HARV.L. REV.
1648 (1982). Most of this was repealed a year later by the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, 96 Stat. 324 (1982).
7. Rather than belabor this, I will just cite Gaius, who describes a sophisticated system that could deal with conditional sales of gladiators that were merely leases if it turned out the gladiators were not killed or wounded: Item si gladiatores ea lege tibi tradiderim, ut in singulos, qui integri exierint, pro sudore denarii XX mihi darentur, in eos uero singulos, qui occisi aut debilitati fuerint, denarii mille, quaeritur, utrum emptio et uenditio an locatio et conductio contrahatur. et magis placuit eorum, qui integri exierint, locationem et conductionem contractam uideri, at eorum, qui occisi aut debilitati sunt, emptionem et uenditionem esse; idque ex accidentibus apparet, tamquam sub condicione facta cuiusque uenditione aut locatione. iam enim non dubitatur, quin sub condicione res uenire aut locari possint.
G. INST. 3, 146.
8. See 2 WILLIAM BLACKSTONE, COMMENTARIES ON THE LAW OF ENGLAND 453 (1765); WILLIAM JONES, AN ESSAY ON THE LAW OF BAILMENTS (1781). These books on English law were used regularly by lawyers and judges in America. The locatio conductio rerum of Roman law had become a bailment for hire, recognized in English law at least as early as Coggs v. Bernard, 2 Ld. Raym. 909, 92 E.R.107 (K.B. 1703): “[T]here are six sorts of bailments . . . . The third sort is, when goods are left with the bailee to be used by him for hire; this is called locatio et conductio, and the lender is called locator, and the borrower conductor.”
9. JOSEPH STORY, COMMENTARIES ON THE LAW OF BAILMENTS (1832). There were nine editions of this book, the last in 1880. (Story, the most important American legal writer of his time and perhaps of any time, was simultaneously a Justice of the U.S. Supreme Court and a professor of law at Harvard.).
10. See James A. Montgomery, Jr., The Pennsylvania Bailment Lease, 79 U. PA. L. REV. 920 (1931); KENNETH DUNCAN, EQUIPMENT OBLIGATIONS (1924); Lehigh Coal & Nav. Co. v. Field, 8 Watts & Serg. 232 (Pa. 1844) (Philadelphia plan trust); Fosdick v.
true leases even of rolling stock developed only in the 1940s and equipment leasing of any kind became a major source of business finance in the United States only in the 1960s and 1970s.
B. The Law and Modern Leasing
Commercial law, however, was not ready for equipment leasing until the late 1980s. Before then, U.S. courts borrowed variously from the law of real estate leasing, sales, and secured transactions, with unpredictable and often unsatisfactory results. The 1978 version of the U.C.C. inserted an unhelpful rule, declaring that whether a (purported) lease was intended as a (disguised) security interest was to be determined from the facts of each case.11 Nine years later, the U.C.C.’s drafters acknowledged their error:
Reference to the intent of the parties to create a lease or se-curity interest led to unfortunate results. In discoveringintent, courts relied upon factors that were thought to be more consistent with sales or loans than leases. Most of these criteria, however, were as applicable to true leases as to security interests. Examples included the typical net lease provisions, a purported lessor’s lack of storage facilities or its character as a financing party rather than a dealer in goods. Accordingly, this section contains no reference to the parties’ intent.12
United States commercial, tax, bankruptcy, and aircraft-registration law have all come to focus, for most purposes, on whether a transaction is economically and in business substance a “true lease.” That said, they apply significantly different standards and do not always agree on the conclusion, particularly because the parties often
Schall, 99 U.S. 339 (1879) (New York conditional sale). It is important to note that neither the Philadelphia plan equipment trust nor the New York conditional sale was a “true lease,” because in both arrangements the railroad company became the owner of the goods when it made the last payment.
11. Former § 1-201(37), no longer in force in any state.
12. U.C.C., 1987 Amendments, Official Comment to revised § 1-201(37), which was replaced in 2001 by § 1-203. The 1987 version of this section is still in effect in about 11 states, but this probably makes no difference, because revised § 1-201 (37) and new § 1-203 are almost identical (except that the definition of “present value” was moved to § 1-201(28)). “[U]nder revised [New York] § 1-201(37) applicable to this dispute, the intention of the parties has been abandoned as a proper tool by which to distinguish a true lease from a disguised security interest and replaced by an evaluation of the economic structure of the particular transaction.” In re Ecco Drilling Co., 390 B.R. 221, 226 (E.D. Tex. 2008).
13. Whether a leased aircraft must be registered in the name of the lessee as owner is not determined by statute or regulation, but under an opinion of the FAA’s Chief Counsel (the “Leiter Letter”), which in substance says that a full payout lease makes the lessee the owner. Treatment of Leases with an Option to Purchase for Aircraft Registration, 55 Fed. Reg. 40502 (1990); see Dean N. Gerber, Aircraft Financing, in 2 SHRANK & GOUGH, supra note 3, chap. 17, § 17:4.6[B] (hereinafter Gerber).
work very hard to arrange their transactions so as to be leases for one purpose but not for another. The accounting rules, on the other hand, have followed a very different path, relying heavily on multiplication and literal reading of complex, ad hoc provisions.14 At this writing, the difference between the accounting rules and everyone else’s rules seems about to widen further.16
Terms such as lease, finance lease, and financial lease may be used broadly or narrowly. If we use them narrowly, under a “true lease,” the lessor has a reasonable expectation of some meaningful residual value in the goods, or, in a tax case, the lessor has the “benefits and burdens” of ownership or there is “economic substance” or profit potential in the transaction.17 A “finance lease,” when that is a term of art in U.S. law, is a true lease in which the lessor and the supplier are separate—a three-party transaction—and only the supplier, not the lessor, has responsibility to the lessee for the quality and performance of the goods.1918 “Financial lease,” which is not a term of art in U.S. commercial law, is broader and may include financing of the entire economic value of the goods.20
In the vast majority of cases, leases, like most contracts, are performed by the parties and never tested, approved or disapproved by any court or governmental agency. Nevertheless, usually they are tested by lawyers and accountants who are not employees of the parties, in the absence of whose favorable opinions the transactions will not go forward. For example, a major leasing transaction involving an aircraft, a ship, or rolling stock normally requires a legal opinion
14. In particular, a “synthetic lease” is in substance a loan secured by the financed goods; however, it is documented as an operating lease—and therefore “offbalance-sheet”—for accounting purposes but a loan for tax purposes. Changes in the relevant accounting standards and the disclosure rules of the Securities and Exchange Commission have made synthetic leases less attractive, but they continue to be used and recognized. See generally W. Kirk Grimm, Michael G. Robinson & Arnold G. Gough, Jr., Synthetic Leasing, in 2 SHRANK & GOUGH, supra note 3, chap. 23. See also infra note 97.
15. See text infra, following note 110.
16. See text infra at notes 117-121.
17. For a more detailed definition, see U.C.C. § 1-203.
18. For a more detailed discussion, see infra notes 101-106 and accompanying text.
19. See U.C.C. § 2A-103(1)(g).
20. Some of the legislative history of the Bankruptcy Reform Act of 1978 suggests that a “financing lease” is a disguised security interest, as opposed to a true lease. See In re Winston Mills, Inc., 6 B.R. 587, 594 (S.D.N.Y. 1980). This may account for some of the erroneous explanations of “finance lease” in law-review articles and elsewhere. The better practice, when discussing U.S. law, is to avoid the term “financing lease” entirely (although it cannot be avoided when discussing U.S. accounting rules).
21. The lease, whether of real or personal property, has traditionally been understood as a conveyance of a property right, but in modern U.S. commercial law a lease of personal property is understood primarily as a contract. An interesting discussion of the corresponding development in the law of real estate leases is John V. Orth, Leases: Like Any Other Contract?, 12 GREEN BAG 2d 53 (2008),
No comments:
Post a Comment