## Facts

- QDS Components, Inc. (QDS) operated a manufacturing business in Ohio and used two Johnford TC-35 Turning Centers (lathes) in its operations.
- On May 18, 2000, QDS entered into two substantially identical written contracts with Intech Funding Corporation (Intech), each titled “Equipment Lease Agreement” (Lease One and Lease Two).
- The lathes were supplied by a third-party vendor, Absolute Machine Tools, Inc., and each lathe had a stated purchase price of $90,650.
- Under each agreement, QDS obtained the right to use a lathe in exchange for 60 monthly payments, with total payments of $110,425 per lease.
- Each agreement placed “net” payment duties on QDS, including responsibility for items such as taxes, insurance, and upkeep associated with the equipment.
- Each agreement included (1) an end-of-term option permitting QDS to purchase the equipment for $9,065 and (2) an alternative in which, if QDS did not purchase, QDS had to return the lathes to Intech or continue making monthly rental payments.
- The agreements also permitted QDS to terminate before the 60-month term and purchase the lathes under a formula set out in the contracts; however, even if QDS terminated early and bought the equipment, QDS still had to pay the remaining balance due under the agreements.
- The agreements authorized Intech to file copies of the contracts as financing statements, and Intech filed UCC financing statements covering the lathes.
- Intech later assigned one lease to Marcap Vendor Finance Corp. and the other to U.S. Bancorp Leasing & Financial (together, the lessors/assignees).
- QDS filed a Chapter 11 petition on December 6, 2000.
- The bankruptcy court authorized the sale of QDS’s assets to Lakin Manufacturing Company (Lakin). The sale order excluded assets “subject to a capital lease.”
- Lakin argued the lathe agreements were not capital leases (true leases) but were instead disguised security agreements, meaning the lathes should be treated as assets included in the sale rather than property subject to lessor rights.
- The parties supplied stipulations about fair market value and costs associated with return of the lathes, but did not present evidence showing what the parties expected those values and costs to be when the agreements were signed.

## Issues

1. Under Ohio’s enactment of revised UCC § 1-201(37), were the two “Equipment Lease Agreements” true leases or transactions creating security interests?
2. Did Lakin, as the party seeking recharacterization, prove that the end-of-term purchase options were “nominal” based on the facts and expectations at the time the agreements were entered?
3. If the agreements were true leases, were the lathes excluded from the asset sale as property “subject to a capital lease”?

## Decision

- The bankruptcy court held the agreements were true leases, not disguised security agreements.
- The court found the agreements satisfied the statute’s threshold requirement that QDS’s payment obligation for the lease term was not meaningfully terminable, because early termination and purchase still required payment of the remaining balance due.
- The court ruled Lakin did not carry its burden to prove the end-of-term option price was “nominal” as measured when the agreements were made, given the absence of evidence about expected end-of-term value and expected return/remarketing costs at inception.
- The court treated the filing of UCC financing statements and the presence of “net lease” terms as consistent with either a lease or secured financing and not controlling under the statutory test.
- Because the agreements were true leases, the lessors/assignees retained a meaningful residual interest in the lathes, and the lathes were not treated as assets transferred to Lakin free of the lessors’ lease rights.

## Legal Principles

- Under revised UCC § 1-201(37) (as adopted in Ohio), a transaction in the form of a lease creates a security interest only if (a) the lessee’s obligation for the lease term is not subject to termination and (b) one of the statute’s listed conditions is met (such as a purchase option for nominal consideration or a lease term that effectively consumes the goods’ remaining economic life).
- Whether an option price is “nominal” is evaluated at the time the transaction is entered into, using the economics expected at that time rather than later market values or later-developed costs.
- The party asserting that an agreement labeled as a lease should be treated as a secured transaction bears the burden of proof.
- Terms commonly found in finance leases—such as placing taxes, insurance, and maintenance obligations on the lessee—do not, without more, convert a lease into a security interest under the statutory test.
- A lessor’s meaningful residual interest at the end of the term weighs in favor of true-lease treatment; the lessee’s lack of equity in the goods and the lessor’s ability to recover and remarket the goods if the option is not exercised support that result.
- A lessor’s precautionary filing of a financing statement does not, by itself, determine whether the transaction is a lease or a secured financing.

## Conclusion

In re QDS Components, Inc. held that two agreements for lathes labeled as leases were true leases under Ohio’s revised UCC § 1-201(37) because, although QDS’s payment obligation was effectively non-terminable, Lakin failed to prove the purchase options were nominal when the agreements were made; therefore, the lessors retained residual rights in the equipment and the lathes were excluded from the asset sale as property subject to a capital lease.


In re QDS Components, Inc., 292 B.R. 313 (2002)