Menu    1 ABR 243 

HERBERT A. ROSS
U.S. Bankruptcy Judge


UNITED STATES BANKRUPTCY COURT FOR THE DISTRICT OF ALASKA
605 West 4th Avenue, Anchorage, AK 99501-2296




_________________________________________x 
In re 
MARTINSON GRAVEL AND CRANE,INC., 
 Case No. A89-01142-HAR
 Chapter 11
Debtor(s).MEMORANDUM DENYING WILDER CONSTRUCTION'S MOTION FOR RELIEF FROM STAY
_________________________________________x 


IndexPage
1. PROCEDURE AND HOLDING 244
2. FACTUAL BACKGROUND 244
3. DISCUSSION 247
3.1. Integration of the Lease and Option247
3.2. Security Interest v. Lease 247
3.2.1.Was the Option Price "Nominal?" 247
3.2.2.Was a Security Interest Created Even if the Option Price Was Not Nominal?252
3.3. Debtor's Breach of Contract Does Not Affect the Character of the Transaction252
3.4. Fraudulent Conduct by Debtor 252
4. CONCLUSION 253
TOP    1 ABR 244 
APPENDIX "A" - LEASE AGREEMENT254
APPENDIX "B" - OPTION AGREEMENT256

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  Contents        1. PROCEDURE AND HOLDING located in Nome, Alaska in the possession of debtor, Martinson Gravel and Crane, Inc. The motion seeks relief under § 362(d)(1) of the Bankruptcy Code (11 USC § 362(d)(1)) on the grounds that Martinson Gravel cannot adequately protect Wilder.

      Wilder claims that Martinson Gravel holds the property under a true lease, subject to the provisions of § 365 of the Bankruptcy Code (11 USC § 365). Martinson Gravel claims that Wilder is not a lessor, but holds an unperfected security interest.

      After a final relief from stay hearing on October 25, 1990, the court holds that the arrangement was a "security interest" under the Alaska Uniform Commercial Code, as opposed to a true lease, and that, since Wilder has not perfected its security interest, Martinson Gravel will probably be able to avoid the Wilder lien under § 544(a) of the Bankruptcy Code (11 USC § 544(a)). Relief from stay is, therefore, denied.

  Contents        2. FACTUAL BACKGROUND - The D-9 dozer was purchased by Wilder from Windfall Mining in about September, 1989. The opportunity to buy it had been located by Martinson Gravel and, when Martinson Gravel could not make a deal to buy directly from Windfall Mining, Judy Martinson (Martinson Gravel's president) TOP    1 ABR 245  asked Harold Kerslake, a Wilder official, if Wilder would buy it. Apparently both Wilder and Martinson Gravel had reasons why Wilder should buy the D-9. They both wanted it to remain in Nome. Martinson Gravel wanted to own it. Martinson Gravel was a subcontractor to Wilder on an airport job in Nome and both Wilder and Martinson Gravel knew that the D-9 would be needed on the job since there was no comparable equipment available at a reasonable price.

      Kerslake said he knew that in September and October, 1989 Martinson Gravel was in a weak financial condition since he had been getting calls from Martinson Gravel's creditors who wanted to be paid from Martinson Gravel's earnings under its subcontract with Wilder. Judy Martinson tried to deal directly with Windfall Mining to lease-purchase the D-9, but the weight of the testimony is that Martinson Gravel was not strong enough financially.

      Wilder bought the D-9 from Windfall Mining for about $75,000 in September or early October, 1989. Wilder in turn entered a lease with Martinson Gravel in October, 1989 with monthly lease payments of $12,500 per month for six months with some idle or skip months interspersed. A copy of the lease is found in Appendix "A" to this memorandum. At the same time, Wilder and Martinson Gravel entered a separate option agreement to allow Martinson Gravel to purchase the D-9 for $3,850 at the end of the lease term if the lease payments were current. A copy of the option is found in Appendix "B". These documents were drafted by TOP    1 ABR 246  Harold Kerslake, Vice-President and Alaska Division Manager for Wilder, without the help of its lawyers.

      Prior to entering into the lease and option shown in the appendices, Judy Martinson proposed a form of contract to Kerslake under which Martinson Gravel would lease with an option to purchase for $100. The total payments were to be $78,255.55. This proposal was telecopied to Kerslake, but never executed by Wilder. Kerslake chose to draft his own forms.

      Had the lease-option deal shown in the appendices paid out according to the terms, Wilder would have received $75,000 in lease payment and $3,850 for the option. Kerslake said the $3,850 was to recover the "cost of capital" or interest on the $75,000 it had tied up in the D-9. The $3,850 closely approximates a 10-12% interest payable in the installments shown on Appendix "A".

      On November 3, 1989, less than a month after Wilder and Martinson Gravel entered into their deal on the D-9 dozer, Martinson Gravel filed a chapter 11 petition. Only one $12,500 lease payment has been made, although Martinson Gravel claims an offset for Wilder's use of its office and lab for about $10,000 more.

      The parties agree that the option exercise date was July 31, 1990. The option was not exercised, and Martinson Gravel was substantially in default in making lease payments at that time.

      Subsequent to July 31, 1990, Martinson Gravel invested about more than $50,000 to refurbish the D-9. Wilder offered TOP    1 ABR 247  testimony that a D-9 in a more worn condition might be worth only $40,000 or less on July 31, 1990. Martinson Gravel offered testimony that a D-9 in the condition it is presently in (with a new undercarriage and relatively new engine, and refurbished parts) is worth about $70,000 in Nome.

  Contents        3. DISCUSSION -

  Contents        3.1. Integration of the Lease and Option - Wilder argues that the lease and option are not an integrated agreement and only the lease (and not the option) should be considered. Judy Martinson testified that these were in separate documents because Martinson Gravel had an agreement with National Bank of Alaska restricting additional financing without the bank's approval. Kerslake acknowledged that he prepared the lease and the option together, sent them to Judy Martinson at the same time, and that she signed them at about the same time. The question of whether the contracts were integrated is one for the court. Alaska Diversified Contractors, Inc. v. Lower Kuskokwim School District, 778 P.2d 581, 585 (Alaska 1989). The court holds that the lease and the option form an integrated contract.

  Contents        3.2. Security Interest v. Lease -

  Contents        3.2.1. Was the Option Price "Nominal?" - A bankruptcy court generally looks to state law to determine property rights. In re Rega Properties, Ltd., 894 F.2d 1136, 1139 (9th Cir. 1990). Under Alaska law, the question of whether an agreement creates a security interest or a true lease has been the subject of TOP    1 ABR 248  several Alaska Supreme Court decisions. In Western Enterprises, Inc. v. Arctic Office Machines, Inc., 667 P.2d 1232 (Alaska 1983) the court interpreted Alaska's version of UCC § 1-201(37), AS 45.01.201(37). The Alaska Statute provides:

Sec. 45.01.201. General definitions.

      Subject to additional definitions contained in the subsequent articles of AS 45.01 -- AS 45.09 that are applicable to specific articles or sections, and unless the context otherwise requires, in AS 45.01 -- AS 45.09, • • •

      (37) "security interest" means an interest in personal property or fixtures which secures payment or performance of an obligation; the retention or reservation of title by a seller of goods notwithstanding shipment or delivery to the buyer (AS 45.02.401) is limited in effect to a reservation of a "security interest"; the term also includes an interest of a buyer of accounts or chattel paper which is subject to AS 45.09; the special property interest of a buyer of goods on identification of the goods to a contract for sale under AS 45.02.401 is not a "security interest," but a buyer may also acquire a "security interest" by complying with AS 45.09; unless a lease or consignment is intended as security, reservation of title under the lease or consignment is not a "security interest," but a consignment is in any event subject to the provisions on consignment sales (AS 45.02.326); whether a lease is intended as security is to be determined by the facts of each case; however, (A) the inclusion of an option to purchase does not of itself make the lease one intended for security, and (B) an agreement that upon compliance with the terms of the lease the lessee shall become or has the option to become the owner of the property for no additional consideration or for a nominal consideration does make the lease one intended for security; • • •

      Western Enterprises at 1235 overruled McGalliard v. Liberty Leasing Co., 534 P.2d 528, 532 (Alaska 1975) which used three tests to determine if an option price was "nominal" under the TOP    1 ABR 249  AS 45.01.201(37): (a) comparison of the option price with the value of the property at the time the option is to be exercised; (b) comparison of the option price with the value of the property at the time the transaction was entered into; and, (c) an "economic compulsion" test based on a determination that exercising the option was the only sensible economic choice for the option holder.

      Whether a transaction should be characterized as a lease or a security interest generally depends upon the intent of the parties. The mere designation of the transaction as a "lease" does not control. Western Enterprises at 1234 and Stanley v. Fabricators, Inc., 459 P.2d 467, 469 (Alaska 1969). The determination of whether an option price is "nominal" is a factual one. However, "a finding that the option price was nominal would conclusively establish that the transaction was a conditional sales agreement [security agreement]." Western Enterprises at 1235.

      The testimony varied about what was the appropriate value to use for the D-9 as of the option date (July 31, 1990). Wilder says it is $40,000 or less. Martinson Gravel says it is $65,000 to $70,000. Wilder seeks a lower figure, since, if the option date value is less, the $3,850 option price becomes a larger percentage or fraction of the value of the D-9 on the option date ($3,850/$40,000 is a larger fraction than $3,850/$70,000). When the fraction or percentage is high enough (e.g. 20% or 1/5th), some cases dealing with the interpretation of UCC § 1-201(37) find the option price to be greater than "nominal." Western Enterprises, TOP    1 ABR 250  for example, affirmed a ruling that an amount equal to 20% of the value of furniture at the date of exercise would not be "nominal."

      Wilder argues that Martinson Gravel could have returned the D-9 with the undercarriage damaged and in basically battered condition since that is "normal wear and tear" for which Martinson Gravel was not responsible under the lease. Wilder's argument is that the $57,000 in parts and labor which Judy Martinson testified it put into the D-9 in 1990 should not be counted toward its value on the option date and, in fact, about $50,000 of this was after July 31, 1990. The inference is that the value of the D-9 might have been as low as about $20,000 on July 31, 1990 ($70,000 per Hess's testimony for a D-9 in good shape, less the $50,000 cost to get it in such shape), raising the option price to over 20%.

      When analyzing a transaction to see if the option price is "nominal," Western Enterprises contemplated comparing the option price at the time the transaction is entered into compared to the expected value of the equipment at the future date when the option is exercised. In other words, the court should not use hindsight to determine what is "nominal". Use of hindsight might make one transaction "nominal" because minimal use of the equipment, and another virtually identical transaction "not nominal" because the equipment was abused. The correct test is "to compare the price specified in the option with the value of the property at the time the option is to be exercised" (connoting estimating on the date of the lease the probable value of the equipment on the option date). TOP    1 ABR 251  Western Enterprises at 1235 [emphasis supplied]. Thus, the fact that Martinson Gravel spent $57,000 repairing the D-9 during 1990 has little bearing on the determination of what is "nominal" within the purview of AS 45.01.201(37). The equipment was in good shape and worth $70,000 to $75,000 in October, 1989 when it was leased. Auctioneer James Hess testified that a D-9 in good condition in July, 1990 would have been worth about $65,000 to $70,000. Hess's estimate is the most reasonable one to use when applying AS 45.01.201(37) to determine if an option price is nominal since it reasonable to presume that it would be in the same general condition on the transaction date (October, 1989) as the option date (July 31, 1990).

      The $3,850 price to exercise the option is less than 6% of $65,000. It is only 9.6% of $40,000. In either event, $3,850 is "nominal" for the purposes of AS 45.01.201(37). By holding that the option price is "nominal," the relationship between Wilder and Martinson Gravel is "conclusively established" under Western Enterprises to be a security interest as opposed to a lease. Martinson Gravel cited a number of cases in its Opposition to Motion for Relief from Stay at page 7 (Docket No. 201, filed on October 5, 1990) concerning option prices ranging from 4% to 18% which were held to be nominal. See, also Annot., Equipment Leases as Security Interest Within Uniform Commercial Code § 1-201(37), 76 ALR3d 11, 81, § 18 (1977) ["Annot., Equipment Leases"].

TOP    1 ABR 252    Contents        3.2.2. Was a Security Interest Created Even if the Option Price Was Not Nominal? - Even if the option price is not "nominal," Kerslake's testimony leads me to conclude that, despite labeling the transacting as a lease, the parties contemplated a security interest. Cf. Western Enterprises at 1235-36. The $78,350 to be paid for the lease-purchase was Wilder's cost plus its interest. Wilder was accommodating a weak subcontractor. There is no real question that, had Martinson Gravel paid on time, it would have "purchased" the D-9 for Wilder's cost plus a reasonable carrying charge. Wilder merely financed the Windfall Mining purchase for Martinson Gravel.

  Contents        3.3. Debtor's Breach of Contract Does Not Affect the Character of the Transaction - Wilder argues that, even if this is a security interest, Martinson Gravel is not entitled to exercise the option because of its default in payment, and therefore the transaction is transmogrified back into a lease. A number of cases indicate that

for the purposes of determining under § 1-201(37) whether an option to purchase could be exercised for no additional or nominal consideration, the fact that the lessee may have defaulted under the lease and thus be unable to exercise the option does not affect the determination whether the lease is intended for security.

Annot., Equipment Leases at 44, § 7[b].

  Contents        3.4. Fraudulent Conduct by Debtor - The briefs filed by Wilder complained extensively that Martinson Gravel had defrauded Wilder because it entered the D-9 transaction without TOP    1 ABR 253  telling Wilder about the impending bankruptcy. Wilder has probably waived this because it presented little evidence on the subject. Judy Martinson said bankruptcy was not contemplated until after the lease of the D-9. Finally, the court cannot see how Wilder was set up by Martinson. Had Wilder filed a financing statement, Martinson Gravel's bankruptcy would not have created the problem that it does. The truth is that the faulty documentation of the D-9 deal by the lay persons involved is the source of Wilder's grief, and not the subsequent bankruptcy, even if not disclosed. Cf. Annot., Equipment Leases at 22, § 2[b], "Practice Pointers."

  Contents        4. CONCLUSION - The stay will not be lifted. Martinson Gravel may have to bring an action to challenge the lien of Wilder, but, given this memorandum, that should be a slam dunk.

      Wilder has also moved for adequate protection and for an order establishing a deadline to assume or reject the lease. Since the court has ruled against Wilder on the relief from stay, it follows that Wilder's other motions should also be denied.



DATED: October 25, 1990 
  
 _______________
 HERBERT A. ROSS
 Bankruptcy Judge


Serve: 
William D. Artus, Esq., for Debtor 
Randall Farleigh and Steven J. Shamburek, Esq., for Wilder Const. 
U.S. Trustee 
Jamilia George, Chief Dep. ClerkH3212(HAR/lp)


TOP    1 ABR 254    Contents   APPENDIX "A" - LEASE AGREEMENT
  Click here to see scanned image of Appendix A - Page 1
TOP    1 ABR 255  Click here to see scanned image of Appendix A - Page 2
 
TOP    1 ABR 256    Contents   APPENDIX "B" - OPTION AGREEMENT
  Click here to see scanned image of Appendix B