Equipment Financing Risks in Bankruptcy: Implications of Lease vs. Secured Transaction

Description

Seemingly simple equipment financing transactions may not be as straightforward for the lender/lessor when a borrower/lessee files for bankruptcy. The rights of the parties are wholly dependent on whether the transaction is a true lease or a secured transaction.

If the transaction is deemed a secured financing or a sale, rather than a true lease, then assuming the lender perfected a security interest in the collateral under Article 9 of the UCC, the lender is afforded important protections under the Bankruptcy Code and the UCC. If the transaction is a true lease, then the rights of both parties are governed by Section 365(d)(5) of the Bankruptcy Code and, as an executory contract, the debtor/lessee has the right to assume or reject the contract. The lessor is also afforded certain protections for its lease payments.

If the transaction is couched as a lease, however, the debtor may challenge the transaction arguing that the lease should be recharacterized as a financing transaction. If the lease is recharacterized and the lessor has not perfected its interest in the equipment, it will be an unsecured creditor.

Even if the lessor perfected a security interest, its secured interest may be limited to the actual value of the equipment, which may be less than what the lease payments were. The issue of what constitutes a true lease vs. a sale has been vigorously litigated in recent years. There are many factors that courts will consider in examining the transaction, generally focusing on the economic substance of the deal.

Listen as our authoritative panel of bankruptcy practitioners analyzes risks faced by equipment lenders or lessors in the event of the borrower/lessee’s bankruptcy. The panel will review a secured lender’s rights in bankruptcy under the UCC as well as how the Bankruptcy Code treats equipment leases as an executory contract. The panel will then discuss the risks facing an equipment lessor if the lease is challenged by the debtor and recharacterized as a sale, including factors courts consider in determining whether the transaction is a sale vs. a lease.