## Facts

- In August 2008, Warne (the debtor) entered into a written agreement with Dakota Financial, L.L.C. (Dakota) to use a semi-tractor truck owned by Dakota.
- The agreement stated the parties intended it to be construed as a lease rather than a secured purchase.
- Warne paid a $31,100 security deposit and agreed to make periodic rental payments over a five-year term.
- Warne’s payment obligation was not subject to termination during the lease term.
- Warne bore the risk of loss for the truck during the lease term.
- At the end of the term, Warne was not required to renew the agreement.
- The security deposit was to be applied to damage or excessive wear, with any remaining balance refunded to Warne.
- Warne had an option to purchase the truck at lease end for $31,100.
- The truck’s projected fair market value at the end of the term was estimated to be between $20,000 and $40,000.
- About one year into the term, Warne filed for bankruptcy.
- Dakota filed a motion asking the bankruptcy court to compel assumption or rejection of the agreement as an unexpired lease.

## Issues

1. Whether the truck agreement was a true lease or a transaction creating a security interest under U.C.C. § 1-203 (as adopted in Kansas).
2. If the agreement was a true lease, whether it had to be treated as an unexpired lease subject to assumption or rejection under 11 U.S.C. § 365.

## Decision

- The court determined the agreement was a true lease, not a disguised secured transaction.
- The court concluded the end-of-term purchase option price ($31,100) was not nominal when compared to the projected residual value range ($20,000–$40,000).
- The court found the lessor retained a meaningful interest in the truck at the end of the term, consistent with lease treatment.
- Because the agreement was a true lease, the court treated it as an unexpired lease governed by § 365’s assumption-or-rejection framework in bankruptcy.

## Legal Principles

- Under U.C.C. § 1-203, a non-terminable obligation to make payments is required for recharacterization, but it does not by itself convert a lease into a security interest.
- A transaction is more likely a security interest when additional statutory conditions are met (for example, a term that effectively consumes the goods’ remaining economic life or an option to purchase for nominal consideration).
- In assessing whether an option price is nominal, courts look to the economics of the bargain, including the anticipated fair market value at the end of the term and whether the option would effectively compel exercise.
- A refundable security deposit that can be applied to damage or wear does not, standing alone, make the option price nominal or convert the transaction into a secured sale.
- Even where the lessee bears operating responsibilities and risk of loss, the agreement can remain a true lease if the lessor keeps meaningful residual-value exposure and a real reversionary stake.

## Conclusion

In *In re Warne*, the bankruptcy court classified Dakota’s semi-tractor agreement as a true lease under Kansas’s version of U.C.C. § 1-203, largely because the $31,100 purchase option was not nominal in light of the projected end-of-term value range and because Dakota retained meaningful residual interest; accordingly, the agreement was an unexpired lease subject to assumption or rejection under 11 U.S.C. § 365.


In re Warne, 2011 WL 1303425 (2011)