Which types of equipment can be considered fixtures? Ken Weinberg says there are many ways to answer that question and discusses the importance of establishing intention about the fixture status of a piece of equipment in a lease or finance agreement.
A classic proverb states that the road to a bad, bad place is paved with good intentions. When it comes to a particular type of goods, known as fixtures, an expression of intent can be very valuable.
Strong equipment leasing and finance forms generally include a provision evidencing the parties’ intention that none of the leased or financed equipment constitutes a fixture under the laws of the state where it is located. Stronger language often provides the equipment is severable/removable from the premises where it is located, is not a permanent part of such premises and is not essential to the operation or use of the premises.
This edition of Dispatches from the Trenches provides a refresher explaining why lessors or lenders leasing or financing equipment generally prefer not to deem equipment a fixture. It also provides insight into the value of a non-fixture provision.
What Are Fixtures and Why Are They Problematic?
The term, fixtures, is defined in articles 2A and 9 of the Uniform Commercial Code as “goods that become so related to particular real estate that an interest in them arises under real estate law.”1 The official comments to UCC §9-334 focus on the types of fixtures that concern most equipment leasing and finance companies, providing:
[T]his section recognizes three categories of goods: (1) [t]hose that retain their chattel character entirely and are not part of the real property; (2) ordinary building materials that have become an integral part of the real property and cannot retain their chattel character for purposes of finance; and (3) an intermediate class that has become real property for certain purposes, but as to which chattel financing may be preserved.
The third category sometimes applies when the equipment being leased or financed is large and integrated into real property. Because an interest may arise in such equipment under real property law, the UCC requires recordations in the real property records in order for the equipment lessor/lender to have priority over an encumbrancer or owner of the real property other than the lessee/debtor (real estate claimant).2 This recordation, often called a fixture filing, is more labor intensive than the standard central-level filings with the secretary of state or similar entities that equipment leasing and finance companies generally make for nonfixtures. This filing must provide a description of the applicable real property to be indexed in the real property records (something which can vary by state) and the name of the record owner if that person is someone other than the lessee/borrower.3 A fixture filing is not necessary to take priority over creditors that are not real estate claimants, and the regular priority rules applicable to central level filings continue to apply to such other parties, including a trustee in bankruptcy.4
Leased or financed property classified as fixtures can raise a variety of other issues too, including which state and local taxes, and tax rates, apply. The key takeaway is members of our industry are equipment leasing and finance companies — rather than fixture leasing and finance companies — and would prefer if applicable state law did not categorize the leased or financed property as a fixture.
Effectiveness of Express of Intent Regarding Fixtures
When faced with a non-fixture provision, the curious reader may wonder about its usefulness. Is it too self-serving to be effective? In particular, it seems reasonable to assume such a provision would be effective against the lessee or borrower, or its successors or assignees, which step into its shoes under lease or loan documents. However, what is the effect of such a provision against third parties who had no input into the language and never even saw it? Would a real estate claimant really be bound by such a provision? How about a taxing authority?
Our industry is so familiar with Article 9 of the UCC and its fundamental principles of putting third parties on notice that it may be surprising to hear a non-fixture provision can sometimes bind third parties with respect to whether or not the leased/financed property constitutes fixtures.
For example, in Magnavox Consumer Electronics v. King, the Tennessee Supreme Court, when analyzing whether certain local taxes applied to a large tank secured to real property, stated:
In Tennessee, only those chattels are fixtures which are so attached to the freehold that, from the intention of the parties and the uses to which they are put, they are presumed to be permanently annexed, or a removal thereof would cause serious injury to the freehold. [Citations omitted.] The usual test is said to be the intention with which a chattel is connected with realty. If it is intended to be removable at the pleasure of the owner, it is not a fixture.5
Although factors like the type of structure and mode of attachment may be considered, the intent of the parties is the most important factor. When it comes to binding third parties, like a taxing authority, there may be a closer look, but intent still plays a very prominent role. As one court noted when determining whether large pipes buried on land were fixtures:
There can be no doubt, as we have said, that the intent of the parties is the single dispositive factor in determining whether an item of personal property is a fixture, and thus will be deemed to be a part of the realty upon which it is attached. To belabor the point, the parties’ intent is the dominant theme in practically all of the cases addressing the law of fixtures. But not even this single statement is capable of application in all situations owing to the difficulty encountered in attempting to discover intent, particularly in cases where, as here, the issue is raised by the taxing authority in purported reliance upon a statute.
As between [the parties to the applicable contract] there can be no doubt that the pipelines are personal property. It was clearly never intended by either party that the pipes — obviously personal property before being rolled into the trench — would not lose that status simply by being covered over to enable the landowner to resume the surface use of his land. Otherwise, the pipeline became the property of the landowner subject only to the provisions of the easement, an obviously unintended result. The statutory definition of real property — with respect to the taxing power — is not essentially different from the common law definition; “affixed to the realty” is the operative statutory phrase, which implicates intent.6
Even as protective as the law often is of bona fide purchasers, a non-fixture provision can even bind them. In Koch Foods of Alabama v. General Electric Capital,7 GE Capital leased a chicken deboning line and spiral freezer to lessee Silvest Farms. When the lessee went into bankruptcy, Koch Foods of Alabama purchased the lessee’s assets at a bankruptcy sale, including the plant in which the equipment was located, without knowledge of the lessor’s interest in the equipment.
The Alabama Court of Appeals analyzed the extent of Koch’s rights by noting that the lease contained a non-fixture provision and stated, “[t]he chattel character of a fixture may be retained by an agreement between [two parties] even against third persons purchasing or taking a mortgage upon the land upon which the fixture stands, bone fide and without notice of such agreement.”8
It is worth noting, however, that the court in the Koch case failed to mention the case on which its holding is based included a potential limitation to the above quoted rule, noting its application “depends upon their essential character, and the mode in which they are annexed, e.g., whether they can be removed without serious damage to the freehold, or substantially destroying their own qualities or value …”9
At the end of the day, a non-fixture provision can be helpful. It is not, however, a panacea given that laws in various states differ and additional analysis of the nature of the leased or financed equipment, and the manner in which it is affixed to real property, can still come into play. In any event, prudent equipment lessors and financiers should include such provisions in their documents.
November 7, 2018
In the final installment of a two-part series, David Wiener reports on the ELFA Convention. Keynote speaker Dr. Larry J. Sabato, professor of politics at the University of Virginia, is a leader in the field of political predictions. Did he accurately predict the results of the mid-term elections?
DLL’s John Sparta explains how the shift from fee-for-service to value-based payments in healthcare mirrors a broader trend affecting multiple industries — paying for results instead of paying for assets — and how usage-based agreements allow healthcare providers to take part in this trend.