The U.S. Bankruptcy Appellate Panel of the Ninth Circuit recently ruled in the case, In re Commercial Money Center, Inc., 2006 WL 2505205, that it is possible for an originator to strip off and sell the right to receive payments under any equipment lease, that this “payment intangible” is separate and distinct from an assignment of the lease itself, and that the purchaser of the rent payment stream is immediately perfected without the necessity of taking an interest in the underlying lease. This means that the assignee of a lease can perfect its interests and still, in some circumstances, find itself without a right to receive rental payments.

Background
Commercial Money Center, Inc. (CMC) originated equipment lease transactions and assigned the payment streams to NetBank. As part of the transaction, CMC also granted NetBank a security interest in the leases. NetBank failed to take possession of the original counterparts of the leases, which were chattel paper, or to file a Uniform Commercial Code (UCC) financing statement against CMC, which covered the payment streams, the leases or the underlying equipment. When CMC filed for bankruptcy protection, the bankruptcy trustee sought to avoid NetBank’s interest as an unperfected security interest.

Because NetBank failed to perfect by taking possession of the leases or filing a financing statement, its only chance of beating the bankruptcy trustee was to succeed on an argument that the assignment of the rent stream by CMC to NetBank constituted an outright sale of a “payment intangible.” Such a holding would protect NetBank if it purchased the rent streams outright since §9-309(3) of the UCC provides that a purchaser’s interest in payment intangibles is automatically perfected and that no UCC-1 filing or possession of the lease is required when buying a payment intangible.

The trustee successfully argued at trial that the rent payment stream was merely part of the chattel paper (the lease) and that NetBank could not perfect its rights without taking possession of the original counterpart of the lease or filing a UCC financing statement against CMC.

The appeals court, however, overruled the trial court and held that the rent payment stream could be stripped from the lease itself and that, once it was detached from the lease, the payment stream constituted a payment intangible. This holding did not save NetBank, however, because the appellate court also held that the transaction between NetBank and CMC constituted a loan and not an outright sale of the rent stream. As such, the automatic perfection provided by §9-309 (which operates only for the benefit of outright sales) did not apply. The case has been remanded for further determinations of fact since there is some possibility that NetBank actually took possession of the chattel paper through an agency arrangement.

Although the NetBank/CMC case only involves a battle between a secured party and a bankruptcy trustee, the appellate court holding raises several issues regarding whether a purchaser, who is automatically perfected upon the purchase of a payment intangible, takes priority over a subsequent assignee that later perfects an interest in the chattel paper (lease).

It should be noted that the appellate court left open some possibility that the super-priority-possession rules of §9-330 may grant an assignee whom perfects an interest in the chattel paper by possession priority over a purchaser who is automatically perfected upon the purchase of a payment intangible (emphasis added). However, significant issues of statutory interpretation need to be resolved before a court could make such a holding. Since this particular case only involves a battle with the bankruptcy trustee, the issue is merely one of whether Netbank is perfected or not. As such, the appellate court will not end up addressing priority issues in this case and we will have to wait for another case or legislative action to know for certain who “wins” when an outright purchaser of only the rent stream battles a funder who takes possession of the sole original of the lease.

In any event, it is safe to say that the appeal court’s ruling has left the lease syndication/funding market in something of a state of disarray.

What All This Means
While other courts outside the Ninth Circuit (which includes only California, Oregon, Washington, Arizona, Montana, Nevada, Alaska, Hawaii and certain U.S. possessions) are not bound to follow the CMC ruling, the Ninth Circuit is highly respected and the logic behind its ruling is, technically, supportable. As such, cautious funders may want to proceed on the assumption that other courts will follow that court decision. If they do, funders should assume the following:

Recommendations to Consider
There will undoubtedly be much written about this case, and there will be both legislative and judicial response. The UCC Committee of the Business Law Section of the State Bar of California has written to the Permanent Editorial Board for the UCC to ask for clarification. Unfortunately, this clarification will probably require legislative action in each of the states and may take months or years.

For the present, funders should consider the following precautions (many of which were good practice prior to the CMC holding):

Kenneth P. Weinberg is a founding partner of Marks & Weinberg, PC. He and co-founder, Barry Marks, have significant experience in dealing with virtually every type of equipment and facility lease financing, have participated in leasing financings for more than a billion dollars of equipment and are recognized throughout the industry. Weinberg has written Dispatches From the Trenches since 2002, routinely writes articles in a variety of equipment leasing and financing journals, and has participated in numerous seminars on equipment leasing issues. If you would like more cases or articles on leasing, or have any questions or comments about this column, please visit www.leaselawyer.com or contact Weinberg at 205-251-8307.