§ 102.8 — Fake Leases and Rental Agreements
Revised: June 7, 2004
With the possible exception of public housing leases in Philadelphia,1 if the contract or lease is a true lease, the debtor’s only choices are to assume, assign or reject consistent with § 365.2 If the contract is not a true lease and can be recharacterized as either a disguised or a failed security interest, then the debtor has many other tools for managing the claim. For example, if a lease of personal property is determined to be a disguised security agreement, the debtor can modify the terms under § 1322(b)(2) and provide for the claim under § 1325(a)(5) by paying the value of the collateral over the life of the plan, with the balance of the debt treated as an unsecured claim.3
Characterizing a contract as a security agreement rather than a lease is usually advantageous to the debtor because lease payments are more onerous than the payments required by § 1325(a)(5), and once the value is paid, the property does not revert to the (fake) lessor. Leases rarely are good value for the debtor: the total lease payments far exceed the value of the leased property, and the internal interest rates in most consumer leases are outrageous. If the contract is a security agreement, the debtor acquires ownership through reduced payments under the plan.
Debtor’s counsel should carefully examine leases and rental agreements to determine whether they are indeed true leases. The lucrative “rent-to-rent” industry feeds on the inability of financially disadvantaged families to get ordinary credit. The typical rent-to-rent contract offers the use of personal property for weekly or biweekly rental payments that grotesquely exceed the real value of the personal property involved. Penetrating the true character of a fake lease has Truth-in-Lending Act implications,4 can entitle the debtor to remedies under state consumer fraud statutes and permits the debtor to aggressively manage the claim through the plan. A Chapter 13 case can be an effective forum within which to test the true nature of a contract or lease.
In recent years, the legislatures of many states have amended their installment sales acts and uniform commercial codes to “clarify” that rent-to-rent contracts are leases and not installment purchase agreements.5 In the bills leading up to the Bankruptcy Reform Act of 1994, legislation was introduced to require that rent-to-rent contracts be treated as installment sales in bankruptcy cases. These provisions did not survive into the 1994 Act. After passage of the 1994 Act, Senator Metzenbaum chided the Senate for failing to address the problems with rent-to-rent contracts and observed that this failure “should not be interpreted as a Congressional determination with regard to the treatment of rent-to-own contracts in bankruptcy cases one way or another. The [failure to include a rent-to-own provision in the 1994 Act] will leave this determination in the hands of the court in a particular case, depending upon the facts and circumstances of that case.”6
1 See In re Day, 208 B.R. 358, 360–68 (Bankr. E.D. Pa. 1997) (“[W]e reject the CHA’s argument that the Debtors are obliged to assume their leases to retain their public housing tenancies, reaffirming our holdings in In re Sudler, 71 B.R. 780, 786–87 (Bankr.E.D.Pa.1987), that public housing tenants are protected by 11 U.S.C. § 525(a) and that a public housing tenant can generally retain a premises despite the failure of the case trustee to assume the lease or, except where a prior Chapter 7 discharge was obtained in a previous case instituted within six years of a refiling, paying dischargeable rent. . . . [A]n executory contract that is neither assumed nor rejected continues in place between the parties, passing through the bankruptcy to the reorganized debtor.”).
2 See Rent-A-Center, Inc. v. Mahoney (In re Mahoney), 153 B.R. 174 (E.D. Mich. 1992) (Rental purchase agreements between the debtor and Rent-A-Center, Inc., were true leases, not security agreements, and thus the debtor could retain possession and use the goods only by complying with § 365. Debtor was under no obligation to renew the agreements, the debtor could terminate at will, and the Michigan legislature amended the Michigan Retail Installment Act to clarify that rental purchase agreements were not retail installment contracts.); In re Rembert, 293 B.R. 664 (Bankr. M.D. Pa. 2003) (Agreement with Aaron’s Rentals was a lease, not a credit sale, for purposes of the Pennsylvania Rental Purchase Agreement Act.); In re Pittman, 289 B.R. 448, 451–52 (Bankr. M.D. Fla. 2003) (Because car lease was a true lease, purchase option could not be exercised in installments through Chapter 13 plan notwithstanding that the debtor filed a secured claim on behalf of the car lessor. “Debtor’s filing of a secured claim on behalf of GE does not unilaterally transform GE from a lessor into a secured claimant. Because GE is a lessor rather than a secured claimant, § 1322(b)(2) does not permit Debtor to modify GE’s rights, including the right to receive a lump sum payment for the vehicle’s purchase price upon Debtor’s exercise of the purchase option. . . . [Section] 1322(b)(2) applies only to secured creditors and therefore does not permit a Chapter 13 debtor to modify the rights of a lessor. . . . [Section] 1322(b)(7) does not permit a Chapter 13 debtor to finance the residual purchase price of a leased vehicle over the life of the Chapter 13 plan.”); In re Damron, 275 B.R. 266 (Bankr. E.D. Tenn. 2002) (Commercial transportation lease agreement for a 1997 freightliner truck was a true lease under Tennessee law; plan that treated lessor as a secured creditor failed the confirmation requirement in § 1325(a)(1) because it did not provide for assumption of the agreement as required by § 1322(b)(7).); In re Minton, 271 B.R. 335 (Bankr. W.D. Ark. 2001) (Contracts with Rent-A-Center are true leases, not disguised security agreements, under Arkansas Rental Purchase Act.); Ford Motor Credit Co. v. Hoskins (In re Hoskins), 266 B.R. 154 (Bankr. W.D. Mo. 2001) (Applying 1992 version of Missouri UCC, contract with Ford Motor Credit was a true lease; therefore, FMCC did not violate UCC when it disposed of the repossessed car.); In re Smith, 259 B.R. 561 (Bankr. D.S.C. 2000) (GMAC SmartLease was a true lease, not a security agreement; thus, debtor could not modify payments due under the contract.); In re Knowles, 253 B.R. 412 (Bankr. E.D. Ky. 2000) (Rental purchase agreements for furniture “are neither true leases nor security instruments, but . . . they are ‘sufficiently executory to fall within § 365.’ The debtors must therefore either assume or reject the leases in question.”); Lamar v. Mitsubishi Motors Credit of Am., Inc. (In re Lamar), 249 B.R. 822 (Bankr. S.D. Ga. 2000) (Car lease was a true lease under Georgia law, and the lease terminated before the petition when the car was repossessed and the lessor mailed notice of termination to the debtor.); In re Copeland, 238 B.R. 801 (Bankr. E.D. Ark. 1999) (Contract for lease of portable building was a true lease under Arkansas law; Chapter 13 debtor cannot treat seller as an undersecured creditor.); In re Stellman, 237 B.R. 759, 761–64 (Bankr. D. Idaho 1999) (Enactment of Idaho Lease-Purchase Agreement Act in 1993 overruled In re Goin, 141 B.R. 730 (Bankr. D. Idaho 1992). Rent-to-rent contract for consumer goods is an executory contract that can only be managed under § 1322(b)(7) and § 365. “Pursuant to the [Idaho Lease-Purchase Agreement] Act, the Idaho Legislature has decreed that a lease-purchase agreement is not governed by the laws relating to security interests. . . . [I]f the agreement is a ‘lease-purchase agreement,’ it need be nothing more or less. That creature of consumer financing is now recognized.”). In re Street, 214 B.R. 779, 781–82 (Bankr. W.D. Pa. 1997) (Week-to-week lease of personal property is a true lease subject to Pennsylvania Rental-Purchase Agreement Act, not a security interest; because debtor is not a signatory to the lease but has only a possessory interest, debtor cannot assume or reject lease and cannot treat the lease as a security agreement through plan. “[T]he agreements at issue fall squarely within the scope of the Rental-Purchase Agreement Act. They are for use of personalty by an individual for household purposes. The initial period was one week or month . . . . Renewal is automatic . . . and the renter may acquire ownership of the property. . . . When a rental-purchase agreement statute that classifies the collateral as subject to a lease applies, a security interest is not created.”); In re Rigg, 198 B.R. 681 (Bankr. N.D. Tex. 1996) (Apply Texas law, week-to-week rental of 31-inch color television, a 52-inch projection television and an 18-cubic-foot refrigerator are leases, not security agreements, because the debtor has the right to return the merchandise without further obligation. Grants RAC’s motion to compel the debtor to assume or reject the contracts.); In re Bowman, 194 B.R. 227, 229 (Bankr. D. Ariz. 1995) (Week-to-week rental of two stereo systems, a kitchen set, and a television set were true leases and not security interests under the 1992 amendments to the Arizona Uniform Commercial Code. “[T]he lessee’s obligation does not extend beyond one week and can be terminated and the property returned by the lessee with no further obligation. . . . [T]his term removes the present contracts from the realm of disguised sales.”); In re Murray, 191 B.R. 309, 314–16 (Bankr. E.D. Pa. 1996) (Car lease was not a security agreement under Pennsylvania law. “The judicial opinions construing U.C.C. § 1-201(37) . . . place the focus of the inquiry under the revised statute on the economics of the transaction rather than on the intent of the parties as had been the emphasis previously. . . . [T]he Lease contains a fixed price purchase option. . . . [T]he only evidence in the record concerning the reasonably predictable fair market value of the Vehicle at the time that the purchase option was to be performed is the Lease itself. . . . [T]he fact that the fixed option purchase price is equal to movant’s estimate of the residual value strongly supports the conclusion that the Lease is a true lease.”); In re Trusty, 189 B.R. 977, 980–81 (Bankr. N.D. Ala. 1995) (“Rent-to-rent” agreement under Alabama law is neither a true lease nor a security agreement but is a new kind of executory contract that can be assumed or rejected by a Chapter 13 debtor under § 365. “[T]his Court finds as a matter of fact and as a matter of law that the rent-to-own agreements in these three cases are neither ‘true leases’ nor ‘security agreements’ but are, under Alabama law, legislatively created commercial devices designated by the Alabama Legislature as ‘rent-to-own’ agreements, agreements which qualify under the Bankruptcy Code as executory contracts with all rights and requirements of assumption and cure guaranteed to like contracts. Rent-to-own agreements have some of the characteristics of leases but are not leases. . . . [I]n contrast to common leases, they transfer ownership to the debtor after the specified payments are made. . . . Rent-to-own agreements have some of the characteristics of sales contracts but are not sales contracts. . . . Rent-to-own agreements are contracts that allow for the payment of amounts in installments but they also allow for the termination of the contract before all installments are paid without detrimental consequences to the debtor. In rent-to-own contracts the property being purchased does not secure the debt. . . . A rent-to-own agreement is nothing less and nothing more than a hybrid commercial device created by the Alabama Legislature for a distinctive exchange of particular types of property. The clear intent . . . was to create a commercial device that would allow for the transfer of property from a creditor to a debtor with the eventuality of ownership but that would allow the quick and painless termination of the process at the behest of either. . . . [R]ent-to-own agreements do not create security agreements and are not sale contracts.”); In re Winston, 181 B.R. 589 (Bankr. N.D. Ala. 1995) (“Gold key lease agreement” was a true lease, not a disguised security agreement. The agreement was styled as a “lease agreement,” the contract did not require the debtor to renew at the end of the initial 48 months, and the $8,391.30 option to purchase was not nominal but was close to the value of the car at the end of the lease term. The debtor could not treat the lease as a secured claim through the plan.); In re Connelly, 168 B.R. 714 (Bankr. W.D. Wash. 1993) (Contracts between debtor and Rent-A-Center by which the debtor could acquire ownership of a sofa, chair, stereo system and three rings were lease-purchase agreements under Washington law and could not be characterized as disguised sales and security agreements for purposes of confirmation of the debtor’s Chapter 13 plan. Debtor’s only option was to assume or reject each of the lease-purchase agreements.); In re Frady, 141 B.R. 600 (Bankr. W.D.N.C. 1991) (Distinguishing In re Shelby, 127 B.R. 682 (Bankr. N.D. Ala. 1991), 69-week, $9.99-per-week rental agreement for VCR and 82-week, $18.99-per-week rental for washer were true leases under North Carolina law. Debtor could terminate the agreements without further obligation at any time and purchase option was at fair market value.); In re Wallace, 122 B.R. 222 (Bankr. D.N.J. 1990) (True lease can only be assumed, assigned or rejected consistent with § 1322(b)(7) and § 365.); In re Blevins, 119 B.R. 814 (Bankr. N.D. Okla. 1990) (Rental purchase agreements for color television, bedroom set, compact disc player, microwave oven and stereo speakers were true lease agreements and can only be dealt with through assumption or rejection.); In re Haigler, 119 B.R. 531 (Bankr. D.S.C. 1990); In re Harris, 102 B.R. 128 (Bankr. S.D. Ohio 1989); In re Farrell, 79 B.R. 300 (Bankr. S.D. Ohio 1987) (Agreement between debtor and GMAC was a true lease. Plan treating creditor as a secured claim holder consistent with § 1325(a)(5) fails to satisfy the assumption requirements in § 365(b)(1).); Shamrock Rental Co. v. Huffman, 63 B.R. 737 (Bankr. N.D. Ga. 1986) (Chapter 13 debtor’s contract for rental of an electric range was a true lease, not a disguised credit sale. Plan treating rental agreement as a credit sale is denied confirmation.).
3 See International Harvester Credit Corp. v. Rojas, 10 B.R. 353 (B.A.P. 9th Cir. 1981); South Carolina Rentals, Inc. v. Arthur (In re Arthur), 187 B.R. 502, 505 (D.S.C. 1995) (“Lease-Purchase Agreements” with Ace TV Rentals were disguised security interests that could be managed under § 1325(a)(5). Agreements covered a VCR, refrigerator, stove and television, with “overall terms” ranging from 61 to 91 weeks. Ownership transferred to the debtor after payment in full or the debtor could purchase the property at any time by paying 55% of the remaining scheduled payments. Applying Fourth Circuit law, “an ‘obligation to purchase may be found even where an agreement does not explicitly require the putative lessee to make sufficient payments to allow the exercise of a purchase option with no further consideration.’ . . . [E]ven if there is no express obligation under the terms of the agreement, those same terms could create a ‘significant economic compulsion’ for the putative lessee to continue making payments.”); In re Mandrell, 246 B.R. 528 (Bankr. D.S.C. 1999) (“Ace Loan Program” was a financing agreement, not a true lease, for essentially the same reasons that GMAC’s “Smart Buy” contract was not a true lease. In the alternative, the financing contract was not an executory contract but was a sales agreement subject to modification under § 1322.); In re Macklin, 236 B.R. 403, 407 (Bankr. E.D. Ark. 1999) (Transaction with respect to flat-bed trailer was a secured claim and not a true lease. “[T]he Arkansas Code compels the result that the transaction be construed as a sale and security interest as a matter of law because there was no agreement the Debtor could terminate the lease and the Debtor became the owner of the trailer at the end of the lease term for the sum of one dollar ($1.00).” Debtor can pay claim with interest in monthly installments through plan.); HPSC, Inc. v. Wakefield (In re Wakefield), 217 B.R. 967 (Bankr. M.D. Ga. 1998) (“Lease” of dental equipment was disguised security agreement and was properly treated as a secured claim in the confirmed plan. Applying Massachusetts UCC rules, debtor was obligated for entire term of agreement, option price at end of term was nominal, debtor had risk of loss or damage and debtor was obligated to insure and maintain the dental equipment.); In re Crummie, 194 B.R. 230, 237 (Bankr. N.D. Cal. 1996) (GMAC “SmartBuy” is an installment sale and security interest, not an executory contract. Of the three options given the buyer at the end of a SmartBuy contract—pay cash in a specified amount equivalent to a “balloon” payment; sell the car to GMAC for an amount specified; or finance the balloon payment with GMAC on terms that are not specified—none is “executory” in the sense required to trigger § 365 analysis. “This Court agrees with the reported decisions that the gravamen of the Contract is the sale of an automobile and, once the seller has delivered the automobile to the buyer, the seller has substantially performed. . . . [T]he Contract operates as a security agreement and creates a security interest, which type of agreement is generally considered not subject to § 365.”); In re Barnhill, 189 B.R. 611, 615–16 (Bankr. D.S.C. 1992) (Applying South Carolina law, 104-week “lease” of a home entertainment center and a stereo were security agreements. “There are several factors persuading this court that the agreements are security agreements: the debtor’s assumption of the risk of any loss or damage to the collateral; the debtor’s risk of any loss and her responsibility to provide insurance on the property; the total amounts of the payments under the agreements exceeding the value of the property; the property’s having a useful life in excess of the economic value to the lessor; the debtor’s equity acquired by her making payments under the security agreements; and, the debtor’s right to purchase the property for no additional consideration at the end of the agreements.”); In re Lewis, 185 B.R. 66 (Bankr. N.D. Cal. 1995) (GMAC “SmartBuy” contract is a retail installment sale and not an executory contract. Debtors can pay the remaining value of the vehicle over 60-month life of plan under § 1325(a)(5)(B)(ii).); In re Steffen, 181 B.R. 981, 987 (Bankr. W.D. Wash. 1995) (GMAC “SmartBuy” contract is a financed sale and not an executory contract. “In essence the SmartBuy contract is a secured installment sale with a low monthly payment and a balloon payment at the end. . . . Steffens need not assume the entire SmartBuy contract to keep the car.”); In re Shelby, 127 B.R. 682 (Bankr. N.D. Ala. 1991) (78-week, $18.99-per-week “rental” agreement for television was in reality a security device that could be crammed down as if it were a secured claim in a Chapter 13 case.); Ledford v. NRM, Inc. (In re Rose), 94 B.R. 103 (Bankr. S.D. Ohio 1988); In re Puckett, 60 B.R. 223 (Bankr. M.D. Tenn. 1986); In re Redifer, 53 B.R. 35 (Bankr. D. Or. 1985).
4 See also § 306.1 [ Truth-in-Lending and Other Consumer Protection Statutes ] § 138.5 Truth-in-Lending and Other Consumer Protection Statutes.
5 See, e.g., Rent-A-Center, Inc. v. Mahoney (In re Mahoney), 153 B.R. 174 (E.D. Mich. 1992) (Michigan legislature amended the Michigan Retail Installment Act to clarify that rental purchase agreements were not retail installment contracts.); In re Rembert, 293 B.R. 664 (Bankr. M.D. Pa. 2003) (Agreement with Aaron’s Rentals was a lease, not a credit sale, for purposes of the Pennsylvania Rental Purchase Agreement Act.); In re Minton, 271 B.R. 335 (Bankr. W.D. Ark. 2001) (Contracts with Rent-A-Center are true leases, not disguised security agreements, under Arkansas Rental Purchase Act.); In re Stellman, 237 B.R. 759, 761–64 (Bankr. D. Idaho 1999) (Enactment of Idaho Lease-Purchase Agreement Act in 1993 overruled In re Goin, 141 B.R. 730 (Bankr. D. Idaho 1992). Rent-to-rent contract for consumer goods is an executory contract that can only be managed under § 1322(b)(7) and § 365. “Pursuant to the [Idaho Lease-Purchase Agreement] Act, the Idaho Legislature has decreed that a lease-purchase agreement is not governed by the laws relating to security interests. . . . [I]f the agreement is a ‘lease-purchase agreement,’ it need be nothing more or less. That creature of consumer financing is now recognized.”); In re Osborne, 170 B.R. 367 (Bankr. M.D. Tenn. 1990) (Tennessee legislature amended its commercial code to ensure that “rent-to-rent” contracts were not treated as installment sales contracts.).
6 140 Cong. Rec. S14,598 (statement by Sen. Metzenbaum).