Sunshine Heifers, LLC v. Citizens First Bank (In re Purdy)

Summarized by Paul Hage , Taft, Stettinius & Hollister, LLP
11 years 6 months ago

Citation:

No. 13-6412 (6th Cir. Aug. 14, 2014)

Tag(s):

Ruling:

Reversing the bankruptcy court, the Sixth Circuit Court of Appeals held that dairy cow leases were true lease agreements, as opposed to disguised security agreements and, thus, lessor's reversionary interest in cows trumped the secured creditor's security interest. Summarizing the applicable law, the court noted that "a lease involves payment for the temporary possession, use and enjoyment of goods, with the expectation that the goods will be returned to the owner with some expected residual interest of value remaining at the end of the lease term." In contrast, the court found, a security agreement "involves an unconditional transfer of absolute title to goods ... with only an inchoate interest contingent on default and limited to the remaining secured debt." Looking to the Uniform Commercial Code, the court adopted a two-part, fact intensive analysis. First, courts employ a "bright-line test" which provides that "[a] transaction in the form of a lease creates a security interest if the consideration that the lessee is to pay the lessor for the right to possession and use of the goods is an obligation for the term of the lease and is not subject to termination by the lessee, and ... [t]he original term of the lease is equal to or greater than the remaining economic life of the goods." If the lease runs longer than the economic life of the goods, the court explained, the lease is a per se security agreement. If however the goods retain meaningful value after the lease expires, the court moves to the second step and looks "at the specific facts of the case to determine whether the economics of the transaction suggest" that the arrangement is a lease or a security interest. Applying this two-part test, the court first found that the bankruptcy court erred in its analysis of the cattle's economic life because it focused upon the economic life of the individual cows originally leased to the Debtor, instead of the life of the herd as required by the lease agreements themselves. Pursuant to those agreements, it made little difference whether Sunshine received the exact same cows that it originally leased to the Debtor, rather, what was important was that Sunshine receive a herd of the same size at the end of the lease term. Thus, the economic life of the goods at issue (the herd of cattle) exceeded the term of the lease. Having concluded that the lease agreements flunked the "bright-line test," the court turned to the "economics of the transaction test" which focuses on two particular factors: (i) whether the lease contains a purchase option price that is nominal, and (ii) whether the leasee develops equity in the property such that the only economically reasonable option for the lessee is to purchase the goods. In this case, the court found that Sunshine kept more than a meaningful reversionary interest in the herd because the lease agreements did not provide to the Debtor an option to purchase the herd at the end of the lease term at any price, let alone at a nominal one.

Procedural context:

The bankruptcy court ruled in favor of the secured creditor, Citizens First, finding that the dairy cow leases were really disguised security agreements. The court reasoned that the original term of the lease was for 50 months which, clearly, was longer than the economic life of the cows. As a result, the entire dairy herd would be culled before the end of the lease term. Because none of the individual cows would remain at the end of the term, the transaction could not be classified as a lease. The Sixth Circuit reversed and remanded for further proceedings.

Facts:

Between 2009 and 2012, Sunshine Heifers, LLC ("Sunshine") and Lee Purdy (the "Debtor"), a dairy farmer, entered into several "dairy cow leases" pursuant to which the debtor received a total of 435 cows to milk in exchange for a monthly rental payment to Sunshine. When Debtor's dairy business faltered, he petitioned for bankruptcy protection. Thereafter, Sunshine moved for relief from the automatic stay to retake possession of the leased cattle. The Debtor's secured creditor, Citizens First, who had a perfected purchase money security interest in the Debtor's assets, likewise sought relief from the automatic stay to foreclose on, among other collateral, the cows. Citizens First argued that: (I) the "leases" between Sunshine and the Debtor were disguised security agreements, (ii) the Debtor actually owned the cattle, and (iii) such livestock was covered by the bank's security interest. Relevant to the Sixth Circuit's ruling was the fact that, under the terms of the leases, the Debtor received a total of 435 cattle for 50 months. The agreements prohibited the Debtor from terminating the leases, and required the Debtor to replace any cows that were "culled" (i.e. the practice of replacing older and less productive cows with younger, healthier ones) during the term of the lease. The leases did not provide the Debtor with an option to purchase the cows at the end of the lease but, rather required that the Debtor return the herd at the end of the term.

Judge(s):

Circuit Judges Moore and Cole, and District Judge Drain

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