Court: United States Bankruptcy Court, E.D. North Carolina; September 14, 2017; Us Bankruptcy; United States Bankruptcy Court
The court issued an order regarding two motions: Peak Leasing, LLC's Motion for Relief from Automatic Stay, filed on January 30, 2017, and the Debtors’ Emergency Motion to Reconsider the Interim Order, filed on June 15, 2017. Interim hearings were held on March 23 and April 19, 2017, with a final hearing on June 26, 2017, during which evidence and arguments were presented by attorneys for both parties and the Chapter 13 trustee.
Key findings include:
1. The Debtors filed for Chapter 13 bankruptcy on January 5, 2017, with the Trustee appointed to oversee the estate under 11 U.S.C. 1302.
2. Prior to the bankruptcy filing, the male Debtor entered into four identical Lease Agreements with Peak Leasing for various trailers, specifying weekly rental amounts and lease terms ranging from 130 to 208 weeks.
3. The Lease Agreements included provisions for default, allowing Peak to take various actions if the Debtors failed to make payments, including taking possession of the equipment and selling it. Furthermore, the Debtors were required to return the equipment in good condition at the end of the lease, and the leases would automatically renew on a week-to-week basis unless terminated with prior notice.
The court ultimately granted relief from the interim order but denied the motion for relief from the automatic stay.
Each Lease Agreement includes a Purchase Option, executed by both the male Debtor and Peak, stipulating that if the Lessee maintains timely payments and settles all dues, they may purchase the Equipment at the end of the lease term. The options available include a Fixed Price Purchase Option of $1.00 or various Fair Market Value options, with the $1.00 option selected for each. Peak had not received post-petition payments when it filed a Stay Motion, seeking relief from the automatic stay under 11 U.S.C. § 362 to reclaim leased trailers. In response, the Debtors argued that the Lease Agreements should be classified as security agreements under N.C. Gen. Stat. § 25-1-208, positioning Peak as a secured creditor.
The Debtors filed a Chapter 13 Plan requiring monthly payments of $500 for two months, followed by $1,075 for fifty-seven months, proposing to surrender the 2008 Timpte Hopper Bottom Trailer and granting Peak a secured claim of $40,000, the asserted value of the remaining trailers, while any balance on the Lease Agreements would be treated as an unsecured claim. Peak subsequently filed a Proof of Claim for $132,026, including a $10,187 pre-petition arrearage.
Following an initial hearing on the Stay Motion, the court partially granted relief to Peak concerning the 2008 Timpte Hopper Bottom Trailer, allowing the Trustee to make an adequate protection payment of $1,384. However, the Trustee reported only $460 was disbursed due to insufficient funds. At the second hearing, both parties debated the classification of the Lease Agreements, with the Trustee agreeing with the Debtors that they function as security agreements. The court ruled that until a determination is made, the Debtors must continue making weekly payments of $692 for the trailers. An Interim Order was issued, continuing the hearing to June 22, 2017, and mandating that the Debtors make the required payments and maintain insurance on the trailers, stating that failure to comply would result in immediate modification of the automatic stay to enable Peak to reclaim the trailers.
In the Reconsideration Motion, the Debtors acknowledged they made timely payments under the Interim Order initially but were late on payments due May 31 and June 5, 2017. Peak accepted these late payments but subsequently demanded possession of the Trailers, claiming the Debtors' default had terminated the automatic stay. The Debtors argued that the Lease Agreements should be considered security agreements, stating that the adequate protection payments imposed significant financial strain.
The Debtors seek two forms of relief: first, reconsideration of the Interim Order provisions that modified the automatic stay, and second, reinstatement of the automatic stay until the resolution of the Stay Motion and classification of the Lease Agreements is determined.
The Stay Motion is deemed a core proceeding under 28 U.S.C. 157(b)(2)(G), granting the court authority to address both the Stay Motion and the Reconsideration Motion. The court has subject matter jurisdiction under 28 U.S.C. 157(a) and 1334, as well as the General Order of Reference from the Eastern District of North Carolina.
The court is also assessing whether the Lease Agreements are true leases or disguised security agreements, as this classification impacts the relief requested in the Reconsideration Motion. Proper classification is crucial because the Bankruptcy Code treats leases and secured transactions differently, affecting claim treatment for lessors versus secured creditors. In Chapter 13 cases, a debtor may assume, reject, or assign unexpired leases, but cannot assume an unexpired lease in default without curing defaults, compensating for losses, and assuring future performance.
A Chapter 13 debtor is permitted to cure pre-petition lease defaults through their repayment plan, but must make direct payments to the lessor for obligations arising post-order for relief, as specified by local rules (E.D.N.C. LBR 3070-l(c)(1)). Adequate protection payments outlined in the Interim Order meet these requirements. A true lessor's interest is not subject to the trustee’s strong arm power to avoid unperfected security interests for the estate's benefit, according to In re Grubbs Const. Co. The valuation of personal property under an assumed lease does not affect its treatment in Chapter 13; however, the value of collateral securing a creditor’s claim is crucial. An allowed claim secured by a lien is classified as secured to the extent of the collateral's value and unsecured for any excess, per 11 U.S.C. 506(a)(1). A Chapter 13 plan can modify the rights of secured claim holders, except for those secured only by the debtor’s principal residence. Debtors may bifurcate claims secured by personal property into secured and unsecured portions based on collateral value, as demonstrated in the proposed Plan which treats Lease Agreements as security agreements, valuing the Trailers at $40,000 and bifurcating Peak’s claim accordingly.
Determining whether an agreement is a lease or a security agreement requires examination of state law, specifically North Carolina's adoption of the UCC, with the court potentially referencing case law from other jurisdictions. The burden of proof lies with the Debtors to establish that the Lease Agreements are actually security agreements, as highlighted in In re Johnson.
In Johnson, the court examined the criteria for distinguishing a lease from a secured transaction. It established that a lease typically involves temporary possession of property, with the obligation to return it to the owner, whereas a sale transfers ownership without conditions. A security interest represents an incomplete claim dependent on default and tied to the remaining secured debt. Section 1-203 of the UCC outlines that whether a lease constitutes a true lease or a security interest hinges on the specific facts of each case, emphasizing that the document’s title is not decisive.
The analysis employs the UCC's Bright-Line Test, which categorizes a lease as a security interest if the lessee's payment obligation is non-terminable and meets one of four specified conditions regarding the lease's term and options for renewal or ownership. The court determined that the male Debtor's Lease Agreement did not permit him to terminate the lease before its initial term ended, as only the lessor, Peak, could terminate early. Additionally, the Debtor remained liable for rental payments even if Peak regained possession of the Trailers due to default. Thus, the court concluded that the male Debtor's obligation to pay was non-terminable, fulfilling the first criterion of the Bright-Line Test.
The court determines that the Lease Agreements may be classified as disguised security agreements under N.C. Gen. Stat. 25-1-203(b) if any of the four "Residual Value Factors" are present, which assess whether the lessor retains any residual interest in the leased property. The Debtors argue that a one-dollar purchase option at the lease's end qualifies as "nominal consideration," as defined by the UCC, since it is lower than the cost of continuing to perform under the lease. This assertion is supported by a North Carolina Court of Appeals decision, which recognized a similar agreement as a security interest rather than a true lease. Consequently, the court concludes that the Lease Agreements meet the criteria of N.C. Gen. Stat. 25-1-203(b)(4) and are, therefore, security agreements that finance the purchase of the Trailers.
If the Bright-Line Test were not satisfied, a contextual analysis would be necessary to differentiate between a security arrangement and a true lease based on the economic realities. However, since the Bright-Line Test is satisfied, such an analysis is unnecessary.
The court also contemplates the implications of its classification of the agreements on the automatic stay under 11 U.S.C. 362(a), which typically halts actions to recover claims against the debtor following a bankruptcy filing. The significance of the automatic stay in bankruptcy proceedings is emphasized, indicating that any modification of the stay would depend on whether relief from the stay is warranted, considering the reclassification of the Lease Agreements.
The Fourth Circuit's ruling in Grady emphasizes the significance of the automatic stay as a pivotal protection for debtors under bankruptcy law, providing relief from creditor actions and enabling debtors to pursue repayment or reorganization. The Plan proposes bifurcating Peak’s claim under Lease Agreements into a secured claim of $40,000, with the remainder classified as a general unsecured claim. Debtors are to make monthly payments of $500 for two months, then $1,075 for fifty-seven months, significantly lower than the previous weekly payments of $692. If the Debtors had adhered to the Interim Order's payment terms, the court would deny the Stay Motion and allow the Debtors to address their debt to Peak through the Plan; thus, the court will consider the Reconsideration Motion.
Under Rule 60(b) of the Federal Rules of Civil Procedure, which applies to bankruptcy proceedings via Rule 9024, a court can reconsider its orders for specified reasons, including mistake, newly discovered evidence, or fraud. The Interim Order, initially temporary, became final due to the Debtors' default on adequate protection payments, modifying the automatic stay. In this jurisdiction, a Rule 60(b) motion is evaluated in two stages. First, the movant must demonstrate the motion's timeliness, a meritorious defense, and that the opposing party would not suffer undue prejudice. Upon satisfying these conditions, the movant must then meet one of the six grounds for relief specified in Rule 60(b).
The court determined that the Debtors met all three threshold conditions for relief under Rule 60(b). Firstly, the Reconsideration Motion was filed within a reasonable time, occurring during the Stay Motion's pendency and shortly after the Debtors defaulted under the Interim Order. Secondly, the Debtors presented a potentially valid defense by arguing that the Lease Agreements were actually disguised security agreements, thus justifying their request to restructure the debt to Peak. The court found this allegation sufficient to satisfy the requirement for a meritorious defense. Thirdly, Peak failed to demonstrate any specific prejudice resulting from the granting of the Reconsideration Motion, noting that Peak benefited from receiving more adequate protection payments than it would have under the original characterization of the Lease Agreements.
The court then evaluated whether the Debtors established grounds for relief under Rule 60(b). While reasons (1) through (4) did not apply, the court found relief appropriate under reason (5) or reason (6). Rule 60(b)(5) allows for relief if the judgment or order's prospective application is no longer equitable, a principle supported by the Supreme Court’s interpretation allowing modifications due to significant changes in factual conditions or law that could harm the public interest. The court emphasized the equitable and prospective nature of Rule 60(b)(5), asserting that its modification power extends beyond injunctions to any judgment with prospective effects, aligning with the historical powers of equity courts.
The court determined that the Lease Agreements in question are actually security agreements, which relieves the male Debtor from making payments directly to Peak under these agreements, as per 11 U.S.C. 365 and E.D.N.C. LBR 3070-l(c)(1). This classification allows the Debtors to restructure their debt under their Plan according to 11 U.S.C. 506(a) and 1322(b)(2). While Peak was awarded adequate protection payments during the consideration of the Stay Motion, the 'drop dead' provision of the Interim Order was deemed inequitable, as it impedes the Debtors' ability to confirm their Plan. Consequently, the court modified this provision under Rule 60(b)(5), finding the provision detrimental to public interest.
Rule 60(b)(6) permits relief from a final order for any reason justifying relief in extraordinary circumstances. The court indicated that the reclassification of the Lease Agreements constitutes such extraordinary circumstances, providing grounds for relief from the Interim Order. Even if relief under Rule 60(b)(5) were not appropriate, the court granted relief under Rule 60(b)(6).
Additionally, the court clarified that a request for relief from an order modifying the automatic stay is effectively a request to reinstate the original automatic stay. Given that the court's granting of relief from the Interim Order implies the automatic stay remains in effect, the Debtors' request to reinstate the stay became moot. However, any request to reimpose the automatic stay must be made through an adversary proceeding under Rule 7001 of the Federal Rules of Bankruptcy Procedure, which includes requests for injunctive relief. Even if the court had denied the Rule 60(b) relief, it could not entertain the Debtors’ request for reinstatement of the automatic stay as it was not properly presented.
Under N.C. Gen. Stat. 25-1-203, the Lease Agreements in this case are classified as security agreements rather than true leases. Consequently, applying the Interim Order prospectively is deemed inequitable, leading the court to grant the Debtors relief from the Interim Order under Rule 60(b)(5) of the Federal Rules of Civil Procedure, which is applicable through Rule 9024 of the Federal Rules of Bankruptcy Procedure. Any objections from Peak regarding the Plan’s treatment of its claim, particularly concerning the valuation of the Trailers, should be addressed during the confirmation process. The court allows the Debtors an opportunity to perform under the Plan and denies relief from the automatic stay at this time.
The court orders that: 1) the Lease Agreements are recognized as security agreements for the Chapter 13 proceedings; 2) the Reconsideration Motion is granted, retroactively relieving the Debtors from the Interim Order’s requirement of timely adequate protection payments to Peak; and 3) the Stay Motion is denied without prejudice. Following the court’s ruling on June 26, 2017, the Debtors submitted an Amended Chapter 13 Plan on July 25, 2017.
The court notes that while 11 U.S.C. 365 allows the trustee to assume or reject an executory contract or unexpired lease, Chapter 13 debtors have this authority under 11 U.S.C. 1322(b)(7). The male Debtor can purchase the Trailers for one dollar at the end of the lease term, rendering the option to terminate a Lease Agreement after renewal essentially meaningless. This case relies on a prior UCC version, which states that a lease allowing the lessee to acquire ownership for nominal consideration is conclusively a security agreement. Although the current UCC's Bright-Line Test requires that the lease not be terminable by the lessee, previous interpretations of “nominal consideration” remain valid. The court has the authority to issue orders necessary to enact the provisions of this title under 11 U.S.C. 105(a). Furthermore, a Rule 60(b) motion to vacate an order lifting the automatic stay is considered a contested matter under Rule 9014 of the Federal Rules of Bankruptcy Procedure.
