Problem 1
Assignment 23
The Scope of Article 9:
Bailments and Leases
Problem 1: Which Is Correct?
A. Second Bank can retain the suit and the fabric,
unless you pay off Taylor’s entire debt to Second Bank
B. Second Bank can retain the suit and the fabric,
unless you pay the amount you owe Taylor for the suit
C. Second Bank must return the suit and the fabric and
can’t require you to pay them anything
• You take a bolt of wool fabric to Taylor the Tailor,
who agrees to make you several suits
– You don’t file a UCC-1 covering the fabric
• Second Bank, which holds a perfected SI in all of
Taylor’s assets, repossesses them (including one of
your finished suits and the rest of the bolt of fabric)
after Taylor defaults
• Second Bank refuses to return the suit/fabric to you
unless you pay off Taylor’s debt to Second Bank
• The scenario in Problem 1 involves a bailment of
the wool fabric
– You = bailor; Taylor the Tailor = bailee
• The bailment raises an ostensible ownership
problem (you have ownership, but not possession)
• But, you do not have to file to solve this ostensible
ownership problem, b/c your interest is not a
“security interest” [§ 1-201(b)(35)]
– You are not retaining title to secure any obligation
Taylor owes you; you are retaining title b/c the wool
already belongs to you and you own it
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• Second Bank’s SI can attach to the wool only
to extent of Taylor’s interest as bailee
• Thus, Second Bank cannot demand that you
pay off Taylor’s debt in full
• If you haven’t already paid the agreed price for
the completed suit, Second Bank could require
you to pay the agreed price
– Your obligation to pay would be an “account”
belonging to Taylor, and
– Second Bank’s SI in Taylor’s assets would extend
to that account, which Second Bank could collect
• Crouch goes to Best Buy and signs an installment
K to purchase 90-inch flat screen TV
– Contract says: “Crouch agrees that until he has
made all payments under this contract, he is only a
bailee, and this contract creates only a bailment.”
• If Crouch does not make all of the agreed upon
payments, is Best Buy bound to comply with
Article 9 in repossessing/reselling the TV?
A. Yes, b/c Best Buy is a secured party
B. No, b/c Best Buy is only a bailor
Problem 2
Security Interest (“False” Bailment)
• Any interest in personal property that secures payment
of an obligation is a “security interest” [§ 1201(b)(35)] that must be foreclosed under Art. 9
• You rent a stretch Cadillac limo to your brother
for 6 months, but he fails to pay rent. When you
went to pick it up, another creditor had levied on it
and sold it to ABC Limo in a sheriff’s sale
• Can you demand its return from ABC Limo?
– This not a true bailment; Best Buy is retaining title only
to secure Crouch’s obligation to pay for the TV
– Retention of title by seller after delivery of possession
is limited to a “security interest” [§ 1-201(b)(35)]
– Location of title is irrelevant [§ 9-202]; creditor can’t
avoid Article 9 foreclosure process simply by “taking
title” to the property in advance
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Problem 2: Lease of Car
• In Problem 2, your lease to your brother created an
ostensible ownership problem, but it was a “true
lease,” so Article 9 didn’t apply to the transaction
(your interest was not a “security interest”)
– You didn’t retain title to the limo just to secure your
brother’s obligation to pay rent
– You retained title b/c after the six-month lease term, the
limo was fully yours (to sell, or rent to your brother or
someone else, or to use yourself)
Problem 3
• Smith Auto uses “lease agreements” w/customers
– Lease term = 4 years
– Lease payments = same amount that monthly car loan
repayments would have been, over the same period
– At end of the term, Lessee can buy car for $25
– Lease: “Lessee agrees that this transaction is a lease and
does not create an Article 9 security interest.”
• If “Lessee” defaults, does Smith have to conduct an
Article 9 foreclosure sale?
“True Lease”
• If a lease is a bona fide lease, then Article 9 does not
apply to it (it doesn’t create a security interest)
– Thus, the Lessor does not have to “perfect” (by filing or
otherwise) to protect its interest against creditors of the
Lessee or buyers from the Lessee
– If Lessee defaults, Lessor does not have to comply with
Article 9 (i.e., Lessor can repossess and sell the leased
goods without having to comply with Article 9)
– ABC Limo must give back the limo (at the sale, it acquired
only your brother’s rights as a tenant, which have expired)
• Clearly, Smith Auto is just selling cars and trying
to “disguise” the sales by calling them “leases”
– Each “Lessee” must pay all payments for 4 years, at
which time Smith Auto knows that the “Lessee”
will exercise its $25 option and buy the car
– Thus, Smith Auto never actually expects to get a car
back, unless the “Lessee” defaults
– Thus, Smith Auto is only retaining title to secure
the Lessee’s obligation to make payments, not b/c it
expects to have any residual ownership right
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UCC § 1-203
• Whether a “lease” is a “true lease” or instead
creates a “security interest” depends on facts and
circumstances of each case [§ 1-203(a)], but:
• § 1-203(b) “unsafe harbor”: a purported “lease”
of goods creates a SI if lessee is bound for entire
term of lease (i.e., lessee can’t cancel lease), and
– term of lease >>>> economic life of goods, or
– lessee is bound to acquire title to the goods at end
of term, or is bound to renew the lease for the
remaining economic life of the goods, or
– lessee has an option to buy the goods for “nominal”
consideration at end of lease term
Problem 3
• What if the car’s “option” price was $500
rather than $25?
– Is this “nominal”?
– It depends: at the time the “lease” is signed, what
was the expected value of the car at the end of the
lease term?
– If the expected value of the car was $5,000, a $500
option price is nominal; if the expected value of the
car is only $1,000, a $500 option price is not
nominal
• Smith’s Auto interest as “lessor” in Problem
3 is deemed to be only a security interest
– Thus, Smith Auto must perfect its SI to protect
itself vs. creditors of the “Lessee” (or buyers
from the “Lessee”)
– Smith Auto must also comply with Article 9 if
the “Lessee” defaults (i.e., Smith must give
notice, sale must be commercially reasonable)
• Any surplus proceeds after a foreclosure sale
would belong to the “Lessee” [§ 9-615(d)]
“Safety” Filing [§ 9-505]
• A lessor that thinks it has a true lease, but is uncertain, is
permitted to file a UCC-1 identifying itself as a “lessor”
[§ 9-505(a)]
– If a court later recharacterizes the lease as a SI under § 1-203,
this “safety filing” will perfect that SI [§ 9-505(b)], but it has
no “evidentiary” significance (can’t be taken as proof lessor
intended to create a SI)
• For titled goods, such a “safety filing” would have to be
done through the certificate of title system (identifying the
parties as “Lessor” and “Lessee”) rather than the UCC
records
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Rent-to-Own (RTO) Contracts
• You enter rent-to-own lease
w/Aaron’s for big-screen TV
– Month-to-month lease @
$149/month
– Each month, you can (1) keep
possession for another month
or (2) return it to Aaron’s
– If you renew for 24 months in
a row and make all payments
on time, you own the TV
Rent-toOwn Leases
• Is this a “true lease” or a
“disguised sale”?
Rent-to-Own as True Lease
• When you first sign this lease (month #1), it’s
likely a true lease
– The option to renew the lease each month (for $149) is
not for a “nominal” amount ($149 => fair rental value)
– We can’t really be certain if you will renew for 23
additional months (after only 1 month, you have little
or no practical “equity” in the TV), and some renters
actually just rent temporarily
• On the one hand, the contract contains a “zero
purchase option” (indicative of disguised sale)
• But, you are not required to renew the lease until
the zero purchase option arises (it arises only in
month #24)
• The Key Question: At beginning of the RTO
contract, is it reasonably certain you WILL keep
renewing each month for all 24 months?
– If so, lease is a “disguised sale” (because the “lessor” is
retaining title to secure “lease” payments)
“Rent-to-Own” as Disguised Sale
• Suppose you make 22 straight payments, and
renew (and pay) for month 23
– At this point, the “lease” is now a disguised sale
– You have option to buy for $149 (rent for month 24,
after which you will own the TV), which is <<< TV’s
expected value (so option is for “nominal”
consideration) [§ 1-203(b)(3), (4)]
– You are practically (economically) compelled to
exercise the option to protect your “equity” in the TV
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“RTO” Leases
• Because of the uncertain status of RTO leases,
many RTO lessors have successfully lobbied for
protective legislation
• E.g., RSMo § 407.661(6): “rental-purchase
agreement” (agreement for use of consumer goods
for initial period <= 4 months that is automatically
renewable w/payment for additional periods, and
that permits user to become owner of goods)
“shall not be construed to be … a security
interest governed by [Article 9]”
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