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AUTO & EQUIPMENT FINANCE SURVEY 2017

United States

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The Legal and Regulatory EnvironmentStephen Whelan assesses recent developments in the US equipment and auto finance market.

There have been several interesting developments in equipment and auto finance from various courtrooms. This article will discuss some noteworthy decisions.

TRAC auto leases

Commercial vehicle lessors received a rude surprise in re: Lightning Bolt Leasing, a federal court decision in Florida ignoring the existence of the Florida statute which declares that the mere presence of a TRAC (terminal rent adjustment clause) provision in a lease does not destroy true lease treatment.

The court sided with the bankrupt lessee, which argued that the TRAC provision gave it the upside and downside potential at expiration of the lease term. This decision runs counter to the weight of authority in many states, following enactment of TRAC statutes, but nevertheless sounds a cautionary note for vehicle lessors in the State of Florida.

Amended and restated: oops

In re: Fair Finance Company, decided in August 2016 by the United States Court of Appeals for the Sixth Circuit, forced a lender to litigate whether it had lost its security interest in the collateral, when it entered into an amended and restated loan agreement which declared that it “supersedes all prior oral or written agreements related to the subject matter hereof.”

The A&R agreement also contained additional “boilerplate” language that it was “intended by the [parties] to be the final, complete, and exclusive expression of the agreement between them.”

The lender neglected to file a new financing statement when the A&R agreement was signed. Perhaps it assumed that its original financing

statement remained adequate, because two years later it (timely) filed a continuation statement. The lender was repaid three years after the A&R agreement, from proceeds of a new financing. That should have ended the story.

Regrettably, the borrower had changed its business model since the original loan agreement and two years after the lender was paid off, the FBI raided the borrower’s headquarters. The borrower’s top three officers were convicted and received substantial prison sentences.

Several creditors of the borrower filed an involuntary petition to place the borrower in bankruptcy proceedings and the trustee in bankruptcy sued the lender, under Ohio law, to recover moneys which it had received (at and prior to the refinancing) while the borrower was insolvent.

The Court of Appeals ruled (left undisturbed by the bankruptcy court’s March 2017 ruling) that the bankruptcy trustee had demonstrated a “plausible claim…that all payments made by the [borrower]…under the [A&R agreement] amount to fraudulent transfers” under the applicable Ohio statute. Consequently, the lender was inadvertently harmed by the use of conventional “boilerplate” language.

Although the decision can be criticized, because the original loan agreement declared that its grant of a security interest was to be collateral for “all present…and future obligations of Borrower to Lenders intended as replacements or substitutions for said Obligations,” the implications for auto and equipment lessors and lenders are that they must include language in an A&R loan agreement to disclaim that it constitutes a novation and to reconfirm the grant of a security interest in both the original and any new collateral.

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Hell or high water: bundled contracts

CDK Global, LLC v. Tulley Automotive Group, Inc. involved a product increasingly in demand by equipment users: a so-called “bundled contract” under which the lessor provides not only the equipment, but also services and licensed software—the latter two elements often furnished by third parties to which the lessor has subcontracted these items.

The lessor had agreed, in a master agreement with the lessee, that (in addition to equipment “in good working order”) it would furnish software and services which would “conform to their respective functional and technical specifications”.

On that basis, the court denied the lessor’s motion to dismiss the lessee’s claims. Because of this kind of legal risk, many bundled contract lessors are including a hell or high water clause in their bundled contracts, thereby requiring customers to make the schedule contract payment in all events, and to pursue their claims for inadequate services or software against the third party providers thereof.

Waiver of defenses: maybe, maybe not

A corollary of a hell or high water clause is a waiver of defenses clause, under which the lessee or other account debtor waives—as against any third party receivables purchaser or financier--any defenses which it may against the originator of the contract.

This concept has been embodied in Uniform Commercial Code section 9-403, which generally provides that an agreement (such as a waiver of defenses clause) between an account debtor and an assignor (its counterparty) not to assert against an assignee any claims or defenses, which it may have against the assignor, is enforceable by a good faith assignee which takes for value and without notice of such claims or defenses.

Two decisions in the past twelve months produced divergent results. In a surprising result, the federal District Court sitting in Chicago, in React Presents, Inc. v. Sillerman, found that a guarantor had reserved

its right to assert defenses (to enforcement of the guaranty) based upon fraud.

Although the guaranty contained a waiver of defenses clause, it contained an exception for “(other than the defense of payment in full and fraud based defenses)”. The court ruled that, even where the contract contains a waiver of defenses clause, a “covenant of good faith and fair dealing is implied in every contract, absent express language to the contrary, even when a guaranty waives all defenses.”

The federal District Court sitting in Manhattan, NY reached a different result in Overseas Private Investment Corporation v. Moyer, where the waiver of defenses clause in the guaranty was “absolute, unconditional, irrevocable and continuing” and did not contain the “fraud based defenses” exception of the Sillerman case.

The decision notes that, under New York State law, “the only affirmative defenses that are not waived by an absolute and unconditional Guaranty are payment and lack of consideration.”

Electronic chattel paper

An increasing proportion of automobile installment sale contracts and loans are being documented electronically, using origination platforms such as DocuSign and electronic vaults such as those maintained by eOriginal, Inc.

Nevertheless, there has been a reluctance among many small ticket equipment lessors, and the lenders which provide financing, to accept the invitation of UCC section 9-105 and document those transactions exclusively using electronic records.

Although there have been no reported decisions, as of Summer 2017, involving enforcement of (or security interests in) electronic leases, two reported cases during the past twelve months have shed some light, in the context of electronic real estate mortgages.

In Riviera v. Wells Fargo Bank, N.A., the Florida state court ruled that Wells Fargo’s evidence “proved that Fannie Mae had control of the e-note by showing

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that the bank, as Fannie Mae’s servicer, employed a system reliably establishing Fannie Mae as the entity to which the e-note was transferred” and that “the bank’s system stored the e-note in such a manner that a single authoritative copy of the e-note exists which is unique, identifiable, and unalterable.” This conclusion, based on the Florida version of the Uniform Electronic Transactions Act, tracks the language of an important element under UCC section 9-105.

In New York Community Bank v. McClendon, a New York State court construed a different statute, the Electronic Signatures in Global and National Commerce Act, to conclude that the lender (in a foreclosure situation) had control of the e-note because “the transfer history, together with the copy

of the e-Note itself, were sufficient…to establish the identity of the person [or entity] having control of” the e-Note.

Admittedly, these are fact-based decisions which do not supply definitive guidance for those who would provide financing for electronic auto loans or equipment leases, but they would be useful precedents in the event that a financier faced a challenge to its having perfected its security interest via control of electronic chattel paper.

Stephen T. Whelan is a partner in the New York City office of law firm Blank Rome LLP (swhelan@blankrome.com) and a member of the ELFA Board of Directors.