HERBERT A. ROSS
U.S. Bankruptcy Judge

Index				Page
1.	PROCEDURE AND HOLDING			244
2.	FACTUAL BACKGROUND			244
3.	DISCUSSION			247
	3.1.	Integration of the Lease and Option		247
	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 Transaction		252
	3.4.	Fraudulent Conduct by Debtor		252
4.	CONCLUSION			253
1 ABR 244
APPENDIX "A" - LEASE AGREEMENT				254
APPENDIX "B" - OPTION AGREEMENT				256

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      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.

      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     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     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.

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     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,     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).     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"].

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].

      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.

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