A recent federal court decision from Pennsylvania advances existing law to a level that approaches a presumption of enforceability against typical challenges to a lease contract. Judicial focus on the public policy advanced by statutory recognition of finance leases under UCC Article 2A and reinforced by statutory and standard contractual hell or high water protection for the lessor directly undermines defenses commonly raised by lessees attempting to fend off collection.

In late July 2011, the U.S. District Court for the Eastern District of Pennsylvania published a 37-page long decision granting summary judgment for an equipment lessor on various defenses and counterclaims raised by three business lessees of telephone equipment. De Lage Landen Fin. Services, Inc. v. Rasa Floors, LP, 792 F. Supp. 2d 812 (E.D. Pa. 2011). In the course of the opinion, the court reviewed the established law on finance leases under UCC Article 2A, noting that finance leases are statutorily sanctioned, well-recognized in case law, have standard lease provisions integral to their existence (including the hell or high water clause), and draw special protections for lessors under Article 2A, because they provide an important alternative method for businesses to acquire needed equipment. The court’s emphasis on these affirmative elements of the law and policy concerning finance leases undergirds its rejection of the lessees’ defenses.

Election of Finance Lease Treatment Binding Conveys Hell or High Water Protection

The De Lage court began the UCC analysis with the important recognition that UCC Article 2A gives parties the right to make a binding stipulation that a lease is a finance lease governed by the Article, even when the lease would not meet the test for such classification found in UCC §2A-103(g). The court noted that the official comment to §2A-103(g) describes the finance lease by its three-party structure (supplier/vendor, lessor and lessee) and added that, in such an arrangement, “[d]ue to the limited function usually performed by the lessor, the lessee looks almost entirely to the supplier for representations, covenants and warranties.” De Lage, 792 F.Supp.2d at 828 (quoting 13 Pa.C.S.A. §2A103(g), cmt.). As quoted in De Lage, id., the same UCC comment allows parties to expressly elect finance lease treatment in the contract: “even ‘[i]f a transaction does not qualify as a finance lease, the parties may achieve the same result by agreement.'”

In fact, the comment opens with the recommendation that lessors use an express election to remove any doubt: “Unless the lessor is comfortable that the transaction will qualify as a finance lease, the lease agreement should include provisions giving the lessor the benefits created by the subset of rules applicable to the transaction that qualifies as a finance lease under this Article.” UCC §2A-103, cmt.g (2001).

As De Lage noted, courts have recognized the binding effect of such a contract term, especially when the parties are reasonably sophisticated businesses. De Lage, id., citing De Lage Landen Fin. Servs., Inc. v. M.B. Mgmt. Co., Inc., 888 A.2d 895, 901 (Pa.Super.Ct.2005) and GE Capital Corp. v. Nat’l Tractor Trailer Sch., Inc., 175 Misc.2d 20, 667 N.Y.S.2d 614 (N.Y.Sup.Ct. 1997). This right of parties to contractually elect Article 2A finance lease treatment is particularly important because doing so locks in the lessor’s unconditional right to receive the lease payments, by triggering statutory hell or high water clause protection:

As parties to valid finance lease transactions, [lessees’] payment obligations “under the lease contract [became] irrevocable and independent upon [their] acceptance of the goods,” pursuant to [UCC §2A-407(a) and (b)], which extends “the classic ‘hell or high water’ clause to a finance lease that is not a consumer lease.” [UCC §2A-407(a) and (b)],cmt. 1; see also C & J Vantage Leasing Co. v. Wolfe, 795 N.W.2d 65, 77 (Iowa 2011) (“If an agreement qualifies as a finance lease under the UCC, an express hell or high water clause is unnecessary because such a provision automatically attaches to a finance lease by statute.”) (citing UCC §2A–407). De Lage, 792 F. Supp. 2d at 828.

Thus, for the many equipment leases that already contain hell or high water clauses (as was the case in De Lage), their additional express election of finance lease treatment (as was also the case in De Lage) ensures belt-and-suspenders protection. Rather than de-emphasizing the hell or high water clause as superfluous or redundant when Article 2A finance lease treatment is expressly invoked, the court in De Lage found it to be further evidence of the parties’ intent to make a finance lease: provisions “which make payment obligatory and unconditional, disclaim any warranties, and transfer to the lessee any warranties made by the manufacturer, confirm that the Agreements are structured to function as finance leases.” De Lage, 792 F. Supp. 2d at 828 (emphasis added).

The failure of the business lessees’ defenses (substantive unconscionability, procedural unconscionability and breach of contract) becomes a foregone conclusion once the court enforces the parties’ explicit and implicit election of Article 2A finance lease treatment, because the underlying public policy promoted by the governing UCC provisions, bolstered by hell or high water protection for the lessor, sweeps away the rationales for these defenses.

Finance Leases Are Not Generally Unconscionable Because They Expand Choices for Business Acquiring Needed Equipment

A substantive unconscionability defense requires that the party challenging contractual terms show that it is unreasonably or grossly favorable to one side and that the disfavored party does not assent to them. De Lage, 792 F. Supp. 2d at 829-30 (quoting Harris v. Green Tree Fin. Corp., 183 F.3d 173, 181 (3rd Cir. 1999). Three-way finance lease arrangements, which would not exist without the lessor protections challenged by the lessees here, do not meet this test, because they expand the range of options for businesses in need of equipment.

UCC Article 2A evinces a public policy favoring such expanded opportunity by giving legislative sanction to the market-created finance lease arrangement and by expressly protecting the unique and limited role the lessor plays in that relationship. Accordingly, “finance lease transactions are not one-sided transactions, but, rather, assist lessors in securing funding for equipment which ‘would not otherwise be available.'” De Lage, 792 F. Supp. 2d at 830 (quoting Colorado Interstate Corp. v. CIT Group/Equip. Fin., Inc., 993 F.2d 743, 749 (10th Cir. 1993).

Hell or high water clauses (both contractual ones and the statutory one supplied by UCC §2A-407) protecting the right of lessors to receive payment play an integral role by bringing lessors into the equipment leasing market, since “[t]he party merely financing the transaction has no control over its manufacture, is not involved in the selection of the product nor in any way makes a representation as to its quality or soundness.” De Lage, 792 F. Supp. 2d at 830, quoting De Lage Landen Fin. Servs., Inc. v. Rozentsvit, 939 A.2d 915, 919 (Pa.Super.Ct. 2007) and Nath v. Nat’l Equip. Leasing Corp., 497 Pa. 126, 439 A.2d 633, 636 (1981).

The defense of procedural unconscionability likewise fails under the court’s recognition of the Article 2A policy of protecting finance leases as a means of expanding choice for businesses in need of equipment. Procedural unconscionability exists where “there is no meaningful choice on the part of the other party regarding acceptance of the [challenged] provisions,” i.e., “unfair surprise.” De Lage, 792 F. Supp. 2d at 829 (quoting Green Tree, 183 F.3d at 181).

But experienced businesses that enter into finance leases cannot credibly claim they lack a meaningful choice as to whether to enter into such leases, the terms of which recognized by courts to be typical, consistent with Article 2A, enforceable and necessary to the existence of finance leasing in general. De Lage, id.

The court noted that hell or high water clauses in particular allow the finance leasing industry to exist, making financing accessible for potential lessors, and promoting the use of leasing in situations where lessees would otherwise be tempted to terminate early once the equipment started to become obsolete. Id. (citing Colorado Interstate, 993 F.2d at 749). See also id. at 836 “The standard form nature of the finance lease does not support a finding of procedural unconscionability,” because the lessees “did not lack meaningful choice in entering into their respective contracts.”

Unconditional Duty to Pay Lessor, Inherent to Finance Leases, Defeats Equipment-Related Breach of Contract Claims

The De Lage court further found that the leases’ hell or high water clauses easily neutralize the lessees’ breach of contract arguments arising from problems with the equipment. These clauses are a standard feature of commercial finance leases precisely because the lessor’s only obligation is to provide money to the vendor. Reasonably sophisticated business lessees are charged with knowledge that by entering into these agreements they are undertaking the unconditional duty to pay the lessor, especially upon written acknowledgement of delivery and acceptance of the equipment. See De Lage, 792 F. Supp. 2d at 831, citing with discussion Info. Leasing Corp. v. Chambers, 152 Ohio App.3d 715, 789 N.E.2d 1155, 1163 (2003); Wells Fargo Bank, N.A. v. Brook s America Mortg. Corp., 419 F.3d 107, 110 (2d Cir. 2005); Harte–Hanks Direct Marketing/Baltimore, Inc. v. Varilease Tech. Fin. Group, Inc., 299 F.Supp.2d 505, 522 (D.Md. 2004); Rozentsvit, supra, 939 A.2d at 921; and Lyon Financial Services Inc. v. Woodlake Imaging, LLC, No. Civ. A. 04–CV–334, 2005 WL 331695 at *4–5 (E.D.Pa. Feb. 9, 2005).

Agency-Based Defense Theories Fundamentally Inconsistent With Finance Lease Arrangement

The De Lage defendants asserted several counterclaims (fraudulent misrepresentation, deceptive trade practices and RICO) against the lessor founded wholly or partly on the imputation to the lessor of alleged misconduct by the vendor. De Lage, 792 F. Supp. 2d at 839, 845, and 849. The court rejected all of the lessees’ proffered agency theories for such imputation (actual agency, apparent agency, agency by estoppel), and granted the lessor summary judgment on these counterclaims. See De Lage, 792 F. Supp. 2d at 839-849, generally.

In doing so, the court essentially held that the public policy favoring finance leases by recognizing their inherent three-party structure and enforcing common contractual protections for lessors creates what amounts to a presumption against finding any agency relationship between a vendor and a lessor. The De Lage court stated that the lessees’ agency arguments are an attempt to circumvent the standard language of finance lease contracts, and have been rejected by courts in other jurisdictions for that very reason as invalid in the Article 2A finance lease context. De Lage, 792 F. Supp. 2d at 842-43, citing Lyon Financial Svcs., Inc. v. Oxford Maxillofacial Surgery, Civ. No. 08–5498, 2009 WL 2170999 (D.Minn. 2009) and Unistar Leasing, Div. of United Computer Capital Corp. v. Lipkin, 12 A.D.3d 1166, 784 N.Y.S.2d 423, 424 (N.Y.App.Div. 2004).

The court in De Lage acknowledged that the Iowa Supreme Court recently allowed a lessee to pursue a vendor-lessor agency claim where several factors gave rise to a genuine issue. De Lage, 792 F. Supp. 2d at 843, citing C & J Vantage Leasing Co. v. Outlook Farm Golf Club, LLC, 784 N.W.2d 753 (Iowa 2010), said the genuine issue of material fact as to agency where the lessor allowed the vendor to place a logo on a lease agreement, in addition to other factors. Nevertheless, the court reiterated that the existence of finance leases hinges on a healthy respect for the statutory and contractual devices that clearly indicate to lessees choosing to enter into such relationships that vendors and lessors are arms-length participants, even though they may have regular relationships in the leasing market. “[F]inance leases and explicit contractual waivers… would be superfluous unless they rendered relationships between the lender and the manufacturer of equipment irrelevant.” De Lage, 792 F. Supp. 2d at 843 (quoting with approval Citicorp Leasing, Inc. v. Kusher Family Ltd. Partnership, No. 05 Civ. 9163 CM MDF, 2006 WL 1982757 at *6 (S.D.N.Y. 2006) ((McMahon, J.).

In the end, the De Lage court found that the lessees are attempting unsuccessfully to draw a mere inference of agency from the manner in which lessors and vendors normally interact. The absence of any actual evidence of an agency relationship, together with the statutory hell or high water protection afforded the lessor by UCC §2A-407, the contractual hell or high water protection expressly granted the lessor by the lessees, and the express disclaimers of any agency relationship between the lessor and the vendor, all combine to require summary judgment for the lessor. De Lage, 792 F. Supp. 2d at 843.

Conclusion: Lessor’s Collection Toolkit

In these and other respects, De Lage Landen Fin. Services, Inc. v. Rasa Floors is well worth study and application by lessors and their counsel involved in leasing litigation. It stands as a thorough and recent analysis of the maturing law on the general enforceability of finance leases, as promoted by UCC Article 2A, recognized by the courts, and reinforced by standard protections for the unique and limited role of lessors (such as hell or high water clauses and waiver of defense clauses). Though beyond the scope of this article, the opinion also contains succinct but insightful discussions of other common attacks on finance leases, in the course of rejecting defense theories such as fraudulent inducement, illegality, mutual mistake, violation of consumer protection and unfair trade practices statutes and RICO violations. Kudos go to lessor’s counsel, James W. Hennessey, Matthew P. Faranda-Diedrich, Patrick M. Northen and C. Lawrence Holmes of Dilworth Paxson LLP in Philadelphia for briefing these issues so well on summary judgment and prompting the court to hand down such a solid and useful precedent.

John G. Sinodis has served as managing partner at Jennings, Haug & Cunningham, LLP since 1999 and is the chairman of the firm’s Executive Committee. His practice emphasizes the representation of equipment lessors and funding sources in all aspects of equipment leasing including litigation, documentation, insolvency and transactional matters. Besides representing equipment lessors and funding sources, Sinodis represents financial institutions and asset-based lenders in the areas of commercial litigation, secured transactions, asset recovery, loan restructure and business litigation. He is an active member of the Equipment Leasing and Finance Association and the National Equipment Finance Association. Sinodis has earned the AV Rating with Martindale Hubbell. Prior to joining the firm, he served as the president of General Leasing Co. and is presently a member of its board of directors. Sinodis began his law practice with the firm of McCormick, Barstow, Sheppard, Wayte & Carruth, LLP. He joined the firm in 1993 and became a partner in 1995. He is a graduate of Arizona State University (B.S. 1982 and J.D. 1985).

Christopher R. Stovall practices in the areas of construction law, surety & fidelity, commercial business litigation, bankruptcy and liability & insurance defense at Jennings, Haug & Cunningham. Stovall joined in March 2009. He is a graduate of Emory University (B.A. in psychology and political science, 1992) and the University of Georgia School of Law (J.D. 1995).