Minnesota Court Applies Article 9 Commercial Reasonableness Standard to Article 2A Equipment Lease

by Andrew K. Alper June 2010
Andrew Alper returns to discuss a recent case in which the Minnesota court drew from Article 9 commercial reasonable standards to justify its ruling in an Article 2A lease transaction when such requirements do not exist in Article 2A … not good news for lessors that don’t comply with Article 9 disposition agreements.

Article 2A of the Uniform Commercial Code (UCC) or Article 10 in California governs personal property lease transactions. Article 9 of the UCC governs secured transactions in personal property. When a secured party decides to dispose of its collateral after default, the secured party must comply with the Article 9 disposition rules set forth in UCC §9610 through §9614. A secured party can also accept its personal property collateral in full or partial satisfaction of its obligations and must comply with UCC §9620 through §9622 if it proceeds in that fashion. In the event that a secured party is not, or does not, proceed in accordance with Article 9 of the UCC, a court may order or restrain collection, enforcement or disposition of collateral on appropriate terms and conditions. The secured party will be liable for damages in the amount of any loss to the debtor or other person caused by the failure to comply with Article 9 of the UCC. In addition to any damages recoverable, the debtor, any consumer obligor or person named as a debtor in a filed record may also recover statutory penalty damages of up to $500 (see UCC §9625).

In contrast to Article 9 of the UCC, in an Article 2A personal property lease transaction (lease) when there is a default by a lessee after the lease is entered into and the goods delivered and accepted, the lessor may dispose of the goods and recover damages or retain the goods and recover damages, or in a proper case, recover rent for the terms of the lease discounted to present value. In addition, the lessor can exercise any other rights or pursue any other remedies provided in the lease contract including incidental damages and recovery for loss of, or damage to, its residual interest in the leased goods (see UCC §2A-527 through §2A-532). Article 2A of the UCC does not have the same requirements for notice, disposition and damages contained in Article 9 of the UCC. Therefore, there is no strict statutory requirement to give a lessee or guarantor notice of the disposition of the goods.

To determine whether a transaction is an Article 2A or Article 9 transaction, courts look to UCC §1203, which discusses leases and the factors that indicate whether a security interest has been created along with the definitions set forth in UCC §1201 and §2A-103. If the transaction is a true lease, its rights and remedies are determined largely by Article 2A and if a transaction is a “lease intended as security” or simply a disguised loan transaction in the form of a lease, then it is subject to the provisions of Article 9 of the UCC.

With that short summary of the law, this brings us to the recent case of Lyon Financial Services, Inc. (d/b/a US Bancorp Business Equipment Finance Group), v. Oxford Maxillofacial Surgery, Inc. and Dr. Scott D. Whitaker, [United States District Court for the District of Minnesota 2009 U.S. Dist. LEXIS 61347; 69 U.C.C. Rep. Serv. 2d (Callaghan)], 553 decided on July 17, 2009. Lyon Financial Services, Inc. leased to Oxford Maxillofacial Surgery, Inc. a Cutera Laser (laser) pursuant to a finance lease. Whittaker executed a Personal Guaranty of the lease. Oxford accepted delivery of the laser and Whittaker signed a Certificate of Acceptance on its behalf. The court went through the proper Article 2A analysis finding that the lease was a finance lease as defined in 2A-103(a)(7), that there was a statutory “hell or high water” clause making payment obligations irrevocable and unconditional once the leased goods are accepted and that courts generally enforce such clauses in non-consumer finance leases (2A-407).

The court then discussed the two defenses of Oxford and Whittaker to enforcement of the lease and guaranty. One defense was “estoppel” where Oxford and Whittaker contended that the equipment vendor or supplier made representations as to the amount of income that the laser would produce, which turned out to be untrue. Therefore, it was contended that because of the fraud of the equipment vendor or supplier they should have no liability. Oxford and Whittaker further contended that the equipment vendor’s representatives were Lyon’s agents. However, the court dismissed the agency contention because there was no evidence demonstrating Lyon’s right to control the equipment vendor and the fact that the equipment vendor simply assisted Whittaker in obtaining financing did not establish agency. Further, the court stated that even though the vendor’s representative was paid a commission for obtaining the lease by Lyon this was not evidence that there was an agency relationship as it depended on the degree of control by the lessor. The court said that there was no evidence of such agency relationship because Lyon had no control over the vendor’s representative and dismissed this argument.

However, the court did not grant summary judgment on the complaint for Lyon because questions existed as to whether Lyon reasonably attempted to mitigate its damages. The laser was sold for $12,000, which was 6% of the original purchase price of $195,000. Oxford and Whittaker directed the court to two websites offering the Cutera Laser for sale prices of $75,000 and $130,000. According to Minnesota law, the injured party upon a breach of contract has the duty to use reasonable diligence in mitigating its damages. However, what constitutes reasonable diligence will depend on the facts of the particular case. The court then went on to state that: “While the Uniform Commercial Code’s concept of ‘commercial reasonableness’ in a secured transaction is not directly applicable in this case, Minnesota Courts find it helpful in determining mitigation of damages issues when leased property is repossessed and resold. Accordingly, for the resale of the laser to constitute a reasonably diligent mitigation effort, ‘every aspect of the disposition, … including the method, manner, time, place and other terms,’ must be commercially reasonable. Minn. Stat. §336.9-610. Generally, commercial reasonableness is a question of fact… The burden is on the non-breaching party to demonstrate the reasonable mitigation of damages.”

Lyon argued that it did not have a duty to mitigate damages because this was a lease transaction under Article 2A. Notwithstanding the foregoing, Lyon did obtain bids and wrote a letter to Oxford stating that the laser would be sold by private sale and that if Oxford was aware of another business that may be interested in the laser or had any suggestions that might help Lyon in obtaining a maximum sale price, such information should be communicated to Lyon. Oxford did not respond to the letter. Lyon therefore contended that even under Article 9 concepts of “commercial reasonableness,” it provided the court with sufficient evidence to establish its commercial reasonableness as a matter of law. Unfortunately for Lyon, because the laser was sold for 6% of its original value when similar Cutera Lasers had been offered for sale at significantly higher prices, the court stated that the low price suggests that a court should scrutinize carefully all aspects of the disposition to ensure that each aspect was commercially reasonable thereby denying the motion for summary judgment for damages and the issue for trial would be the amount of damages since liability was proven.

In reviewing this case, there was no first step analysis as to whether the transaction was a “true lease” or a “lease intended as security” to determine whether UCC Article 2A or Article 9 applied to this transaction. Without that analysis it is impossible to know whether Article 2A or Article 9 governs the transaction. If Article 9 applies, then the court could have simply stated that no proper notice of disposition of the collateral was given and decided that the lessee was entitled to its rights under UCC §9625. The court instead went to Article 2A to discuss the case.

What is more disturbing about this case is that the court, under the guise of mitigation of damages arguments, then drew from Article 9 commercial reasonableness standards to justify its ruling in an Article 2A lease transaction when such requirements do not exist in Article 2A. This is not good news for lessors that may not comply with Article 9 disposition requirements. Although it is always suggested that notice of disposition be given to all persons entitled to notice by law and that the repossessed equipment always be marketed for the highest price commercially obtainable, lessors do not always comply with Article 9 of the UCC both with respect to the sending of a Notice of Disposition, obtaining the timely UCC search, and also going through the hoops in making certain that the time, manner, method, price and other elements are proper. Although the price the lessor or secured party receives on the disposition of the equipment should not be determinative (see UCC §9627), interestingly, it always seems to be. Given the fact that Article 9 concepts have been inserted into an Article 2A lease transaction, the recommendation is to always follow the procedures set forth in Article 9 to demonstrate the lessor’s commercial reasonableness with respect to the disposition of leased equipment to avoid potential liability and/or the bar or reduction of a judgment in accordance with UCC §9625.

Andrew K. AlperAndrew K. Alper is a partner with the law firm of Frandzel Robins Bloom & Csato, LC in Los Angeles. Alper has been representing equipment lessors, funding sources and other financial institutions since 1978. Alper obtained his B.A. in Political Science, magna cum laude, from the University of California at Santa Barbara, and received his J.D. from Loyola Marymount University School of Law. Alper’s practice emphasizes the representation of equipment lessors and funding sources in all aspects of equipment leasing. Alper also represents banks and financial institutions in commercial litigation, insolvency, secured transactions, banking law, real estate and business litigation.

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