## Facts

- Keith and Karrie Bailey filed a voluntary Chapter 13 petition on May 7, 2004.
- Before bankruptcy, Keith Bailey entered two written agreements with Lafayette Investments, Inc. for two tractors; the documents were labeled “leases” and contained a Missouri choice-of-law clause.
- The agreements required down payments and monthly payments for a set term, and placed responsibility for repairs and operating costs on Bailey.
- Each agreement included an end-of-term purchase option for approximately $2,230 and $2,080, while testimony indicated each tractor’s projected end-of-term value was about $15,000.
- The agreements imposed ongoing payment liability on Bailey after default, subject to Lafayette’s mitigation of damages.
- The Baileys’ Chapter 13 plan treated Lafayette as a secured creditor with secured claims against the tractors.
- Lafayette objected to confirmation, asserting the contracts were true leases requiring assumption and full performance under 11 U.S.C. § 365 (or surrender of the tractors), rather than treatment as secured claims in the plan.

## Issues

1. Whether the tractor agreements labeled as leases were true leases or disguised security agreements under Missouri’s U.C.C. lease-versus-security-interest test.
2. Whether, based on that classification, Lafayette had to be treated as a lessor under 11 U.S.C. § 365 or as a secured creditor subject to secured-claim treatment in Chapter 13.

## Decision

- The court applied Missouri law and evaluated the economic substance of the transactions rather than the contracts’ labels.
- The court held the agreements created security interests, not true leases.
- The court overruled Lafayette’s objection to confirmation to the extent it was based on lease treatment under § 365, permitting Lafayette to be treated as a secured creditor in the Chapter 13 plan.

## Legal Principles

- Whether a transaction is a lease or a security interest turns on economic realities under Missouri’s U.C.C. approach (including former U.C.C. § 1-201(37), now reflected in § 1-203), not the parties’ terminology.
- A purchase option price that is nominal in relation to the goods’ expected residual value is strong evidence the transaction is a secured financing, because the lessee is economically compelled to become the owner.
- Contract terms shifting typical ownership burdens to the debtor (maintenance and repair costs, and continuing payment obligations after default) support recharacterization as a secured transaction.
- If an agreement is a true lease, the debtor must assume or reject it under 11 U.S.C. § 365, and assumption generally requires curing defaults and assuring future performance.
- If an agreement creates a security interest, the creditor holds a secured claim that may be valued and treated under Chapter 13 confirmation standards, including 11 U.S.C. §§ 506 and 1325.

## Conclusion

The court treated the tractor “leases” as secured financings under Missouri U.C.C. principles because the purchase options were nominal compared to the tractors’ expected residual value and the debtor bore key incidents of ownership, so Lafayette was a secured creditor and its plan-confirmation objection premised on § 365 lease treatment was overruled.


In re Bailey, 326 B.R. 156 (Bankr. W.D. Ark. 2005)