When parties enter into a true lease, the lease is governed by Article 2A of the Commercial Code (Article 10 in California). When the lease is not a true lease, but is a lease intended as security, it should be governed by Article 9 of the Commercial Code since it is no more than a secured transaction in personal property unlike Article 2A.

Pursuant to Commercial Code, §9102 (a)(11) “chattel paper” means a record or records that evidence both a monetary obligation and a security interest in specific goods, a security interest in specific goods and software used in the goods, a security interest in specific goods and a license of software used in the goods. When an equipment lease is assigned to an assignee, the assignee takes the lease as chattel paper.

With the foregoing as background, the recent California case of Wells Fargo Bank Minnesota, N.A. v. B.C.B.U. 143 Cal. App. 4th 493 (September 2006), demonstrates how a court will deal with conflicting Article 9 and Article 2A remedies in deciding a dispute between an assignee of an equipment lease and a lessee. (Any references in the B.C.B.U. case discussed below to Article 10 would be referenced to Article 2A in other states.)

In the B.C.B.U. case, B.C.B.U. (lessee) sought financing from Crocker Capital, Inc., (lessor) to acquire computer equipment for use in its nursing home business. While the parties were still negotiating, the lessor sent lease documents to the lessee to execute orally, assuring the lessee that it was common practice in the industry to execute the lease documents, but not date them, and that the lessor would hold the documents in escrow until a deal was reached.

In reliance on that statement, the lessee executed the lease, an Acknowledgment and Acceptance of Equipment (Acceptance Certificate), an Equipment Schedule and the principal of the lessee executed a guaranty. The lease stated that it was entered into on November 22, 2000, and was signed by the lessor on December 4, 2000. The lease also stated that it is a statutory “finance lease,” that it could be assigned by the lessor, that the lessee waives any and all defenses counterclaims or offsets against any such assignee, and that the lease was governed under California law. The Acceptance Certificate stated that it should not be executed until all equipment is received in good condition and until all equipment has been accepted.

On December 4, 2000, the lessor assigned the lease and guaranty to a third party for payment of $99,000. The lease documents were dated by the lessor without the knowledge or permission of the lessee. This lease was included in a pool with other leases and used in a securitization transaction, meaning that the pool of leases secured negotiable notes with the leases being assigned to a third-party trustee for the benefit of the holder of the notes. The lease was part of the securitization pool and assigned to Wells Fargo Bank as the trustee.

In the meantime, lessor and lessee were unable to come to terms, and on January 30, 2001, lessor and lessee rescinded the lease with lessor returning to lessee its first and last months advance payments paid at the time the lease was signed. No equipment was ever delivered or accepted by the lessee. The lessor never bothered to tell Wells Fargo Bank that the lease was rescinded nor did the lessor attempt to replace it. Two years later, Wells Fargo Bank brought suit for breach of the lease and for declaratory relief establishing the enforceability of the lease and the guaranty. In an Answer to the Complaint, the lessee had many affirmative defenses, which centered around the fact that the lease was rescinded and the lessee never received anything of value. Therefore it was contended that the lease was void for lack of consideration.

With this example, we have the collision between Article 9 and Article 2A of the Commercial Code as the assignee and the lessee both relied on different sections of the Commercial Code to support their positions. Wells Fargo Bank, as assignee of the lease, contended that because it was a good faith assignee of the lease (the chattel paper), and the lease specifically provides that the lessee will not assert any defenses, offsets and counterclaims against any assignee, all such defenses cannot prevent the enforcement of the lease. On the other hand, the lessee contended that pursuant to Commercial Code, §10407 (2A-407 in other states), the lessee’s obligation under a lease only becomes irrevocable upon the lessee’s acceptance of the goods. Since no goods were ever received, the lessee never accepted the goods, and the lessee and lessor rescinded the lease, the lessee contended that the lease obligation was not enforceable.

The Court sided with the assignee. Pursuant to Commercial Code, §9403, an agreement between an account debtor and an assignor not to assert defenses or claims that an account debtor may have against the assignor is enforceable so long as the assignment is a.) taken for value, b.) taken in good faith, c.) taken without notice of a claim or a property or possessory right to the property assigned and d.) taken without notice of a defense or claim in recoupment of a type that may be asserted a person entitled to enforce a negotiable instrument under subdivision (a) of Commercial Code, §3305. These defenses are infancy, duress, lack of legal capacity or illegality of the transaction which, under other law nullifies the obligor of the obligor, fraud that induced the obligor to sign the instrument with neither knowledge nor reasonable opportunity to learn of its character or essential terms, or discharge of the obligor by insolvency.

This waiver of defenses section of the Commercial Code is designed to put the assignee in a position that is no better or worse than that of a holder in due course of a negotiable instrument under Article 3 of the Commercial Code. The reference to the term “account debtor” in the Commercial Code means a person who is obligated on an account, chattel paper or general intangible [see Commercial Code, §9102(a)(3)]. The definition of “account” in the Commercial Code, means a right to payment of a monetary obligation, whether or not earned by performance, for property that has been or is sold, leased, licensed, assigned or otherwise disposed of [see Commercial Code, §9102 (a)(2)].

The Court held that although at first glance §9403 and §10407 appeared to conflict since pursuant to §10407, acceptance of the equipment is a condition to the effectiveness of the lease. The Court reasoned that §9403 would govern this case even if another law would not permit an assignee to enforce a waiver of defense clause so long as the assignee met the four requirements to become a holder in due course to enforce the waiver of defense clause and, in essence, was a holder in due course. The Court also discussed the fact that securitization is the modern version of the historical practice of financing by factoring, in which a factor buys a creditor’s account by paying a percentage of the face value of the account and then receiving an assignment of that account.

The Court reasoned that enforcing a waiver of defense clause in a lease — except for those defenses that would be good against a holder in due course of a negotiable transaction — promotes the transfer of an accounts by allowing a purchaser to rely on the face of the documents. Thus the lessee bears the risk of putting into the stream of commerce documents that appear regular on their face but have underlying flaws. The Court also stated that because the dispute was not between the lessee and the lessor but instead involves a security transaction between an account debtor and an assignee of the chattel paper, Article 9 of the Commercial Code controls rather than Article 10 of the Commercial Code.

Although the Court dealt with other defenses to enforcement of the lease raised by the lessee ruling in favor of the assignee such as the lessee’s contentions that 1.) there was never any meeting of the minds so there was no contract in the first place, 2.) there was a material alteration of the lease, which voided the lease and 3.) the lease was canceled by the lessor and therefore unenforceable. Most significantly, the Court held that the lack of consideration defense and the other defenses, are not defenses which can defeat a holder in due course. Therefore as between the assignee and the lessee, the lease is enforceable.

Bad facts sometime make for bad law. In recent litigation against assignees of leases, this has clearly been the case. As with the series of cases in New York involving assignments of leases from Terminal Marketing to Wells Fargo Bank (see e.g., Wells Fargo Bank v. BrooksAmerica Mortgage Corp. (2d. Cir. 2005) 419 F. 3d. 107), it appears that when the Courts weigh the fact that the lessee signed an Acceptance Certificate stating it has received and accepted the equipment even though that is not true, the lessee will bear the brunt of the equities going against it and therefore will not prevail against an assignee.

Certainly, a more consumer-oriented Court could rule in favor of a lessee and against a lessor if it wanted to do so by stating that the assignee should do some modicum of due diligence such as making a telephone call to the lessee or getting an estoppel certificate before acquiring a lease and fashion its remedy accordingly. However, absent major scams such as Norvergence, where Courts can be influenced by political forces outside the normal legal system, assignees should be pleased with the direction Courts have been taking in enforcing assigned leases against leases who may have be the victim of an unscrupulous lessor.

Andrew 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 Bachelor of Arts degree in Political Science, Magna Cum Laude, from the University of California at Santa Barbara and received his Juris Doctor from Loyola Marymount University School of Law making the Dean’s List.