In Rе: LEE H. PURDY, Debtor. SUNSHINE HEIFERS, LLC, Appellant, v. CITIZENS FIRST BANK, Appellee.
No. 13-6412
UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT
August 14, 2014
RECOMMENDED FOR FULL-TEXT PUBLICATION Pursuant to Sixth Circuit I.O.P. 32.1(b). File Name: 14a0186p.06. Appeal from the United States District Court for the Western District of Kentucky at Bowling Green. No. 1:13-cv-00049—Joseph H. McKinley, Jr., Chief District Judge.
COUNSEL
ON BRIEF: David A. Warfield, THOMPSON COBURN LLP, St. Louis, Missouri, for Appellant. Scott A. Bachert, Ashley D. Belcher, HARNED BACHERT & MCGEHEE PSC, Bowling Green, Kentucky, for Appellee.
MOORE, J., delivered the opinion of the court, in which COLE, J., joined. DRAIN, D.J. (pp. 11-14), delivered a separate dissenting opinion.
KAREN NELSON MOORE, Circuit Judge. Between 2009 and 2012, Sunshine Heifers, LLC (“Sunshine“) and Lee H. Purdy, a dairy farmer, entered into several “Dairy Cow Leases.” Purdy received a total of 435 cows to milk, and, in exchange, he рaid a monthly rent to Sunshine. Unfortunately, Purdy‘s dairy business faltered in 2012, and he petitioned for bankruptcy protection. When Purdy filed this petition, Sunshine moved to retake possession of the leased cattle. Citizens First Bank (“Citizens First“), however, had a perfected purchase money security interest in Purdy‘s equipment, farm products, and livestock, and it claimed that this perfected security interest gave Citizens First priority over Sunshine with regard to the 435 cattle. In particular, Citizens First argued that the “leases” between Sunshine and Purdy were disguised security agreements, that Purdy actually owned the cattle, and that the subsequently acquired livestock were covered by the bank‘s security interest. The bankruptcy court ruled in favor of Citizens First, finding that the leases were per se security agreements. Given that the terms of agreements expressly preserve Sunshine‘s ability to recover the cattle, we disagree, REVERSE the bankruptcy court‘s decision, and REMAND for further proceedings consistent with this opinion.
I. BACKGROUND
Purdy operated his dairy farm in Barren County, Kentucky. In 2008, he entered into a loan relationship with Citizens First, using his herd of dairy cattle as collateral. Purdy refinanced his loan on July 3, 2009, executing an “Agricultural Security Agreement” in exсhange for additional principal in the amount of $417,570. R. 20-11 at 1 (2009 Security Agreement) (Page ID #326). As part of the security agreement, Purdy granted Citizens First a purchase money security interest in “all Equipment, Farm Products, [and] Livestock (including all increase and supplies) . . . currently owned [or] hereafter acquired . . . .” Id. Three days later, Citizens First perfected this purchase money security interest by filing a financing statement with the Kentucky Secretary of State. R. 20-12 at 1 (2009 Financing Statement) (Page ID #333). Purdy and Citizens Bank executed two similar security agreements in August 2010 and May 2012. See
Shortly after refinancing his loan with Citizens First in 2009, Purdy decided to increase the size of his dairy-cattle herd. He contacted Jeff Blevins of Sunshine regarding the prospect of leasing additional cattle. Sunshine was amenable to the idea, and on August 7, 2009, Purdy and Sunshine entered into the first of five contracts, three of which are relevant here: (1) a July 21, 2011 agreement, involving fifty head of cattle; (2) a July 14, 2012 agreement, rolling up two prior agreements аnd involving 285 head of cattle; and (3) another July 14, 2012 agreement, involving 100 head of cattle. See R. 20-17 (50 Cattle Agreement) (Page ID #351); R. 20-18 (285 Cattle Agreement) (Page ID #369); R. 20-19 (100 Cattle Agreement) (Page ID #386).1
Each of these agreements is titled a “Dairy Cow Lease,” and under their terms, Purdy received a total of 435 cattle for fifty months in exchange for a monthly rent. See, e.g., R. 20-17 at 2 (50 Cattle Agreement) (Page ID #351). The agreements prohibited Purdy from terminating the leases, and Purdy agreed to “return the Cows, at [his] expense, to such place as Sunshine designate[d]” at the end of the lease term. Id. at 2-3 (Page ID #352). Additionally, Purdy guaranteed “the net sales proceeds from the sale of the Cows . . . at the end of the Lease term [would] be [a set amount between $290 and $300] per head (the ‘Guaranteed Residual Value‘).” Id. at 11 (Page ID #360). Purdy further promised to maintain insurance on the cattle, to replace any cows that were culled from the herd, and to allow Sunshine the right to inspect the herd. Id. at 3 (Page ID #352). When the parties signed these contracts, they also executed security agreements, and Sunshine filed financing statements with the Secretary of State. See, e.g., id. at 13-18 (Page ID #362-367).
In the dairy business, farmers must “cull” a portion оf their herd every year, replacing older and less productive cows with younger, healthier ones. Many times, dairy farmers will
In the fall of 2012, the price of cattle feed rose, and milk production became less profitable. Id. at 534. Purdy responded by selling off cattle, including many bearing Sunshine‘s brand, at a faster rate. Unfortunately, Purdy could not keep his operation above water, and on November 29, 2012, he filed a voluntary petition for Chapter 12 bankruptcy relief, and the bankruptcy court issued an automatic stay, preventing the removal of assets from the farm. Id. at 535. A week later, representatives of Citizens First and Sunshine inspected the 389 cattle still on the farm. Of the cows on the property, 289 had white ear tags (indicating that they were covered by Citizens First‘s security interest) and Sunshine‘s brand, 99 had only white ear tags, and one cow had neither a tag nor a brand. R. 21-22 at 46:2-14 (Hr‘g Tr.) (Page ID #1186). A short time later, another farmer returned forty-three cattle that had been taken in violation of the bankruptcy court‘s stay. Id. at 46:13-20 (Page ID #1186). Sunshine claimed that thirty-nine of those cattle bore Sunshine‘s brand. Id. at 101:7 (Page ID #1241).
Citizens First argued that Purdy owned all of these cattle and, therefore, that they were covered by the bank‘s perfected purchase money security interest. Sunshine contended that it maintained ownership of the cattle, that Purdy had only a leasehold interest in the cattle, and therefore that the cattle fell outside of Citizen First‘s security interest. Both Citizens First and
On January 22, 2013, the bankruptcy court held a hearing on various motions. The dispute between Citizens First and Sunshine turned on whether the leases between Purdy and Sunshine were true leases or disguised security agreements. The bankruptcy court issued its decision on March 1, 2013, finding that
The original term of the Lease was for 50 months. Clearly, 50 months is longer than the economic life of the goods [the cows]. Uncontradicted testimony indicated that a dairy herd is culled annually at an approximate rate of 30 percent. Within three years an entire herd is extremely likely to have been entirely replaced and certainly befоre the end of 50 months. Because [Purdy] met this term of the statute, the transaction is a per se security agreement and the Court‘s analysis ends here.
In re Purdy, 490 B.R. at 536. Consequently, the bankruptcy court determined that Citizens First‘s “prior perfected liens attach[ed] to all cows on [Purdy‘s] farm on the date the Petition was filed,” and it denied Sunshine‘s motion to lift the stay. Id. at 540. The bankruptcy court eventually granted Citizens First relief from the stay, however, and the bank foreclosed on the herd. Citizens First auctioned the cattle for $402,353.54, and the bankruptcy trustee awarded these proceeds to Citizens First, which applied them toward Purdy‘s outstanding debt. See Appellant Br. at 9.
Sunshine appeаled to the federal district court nine days after the auction sale. R. 1 at 48-55 (Notice of Bankr. Appeal) (Page ID #48-55). Because the cattle had already been auctioned, Sunshine requested a percentage of the sale proceeds equivalent to its share of the cattle sold. Ultimately, the district court affirmed the bankruptcy court‘s decision on September 25, 2013. R. 54 at 1 (D. Ct. Op.) (Page ID #2287). Sunshine now appeals.
II. STANDARD OF REVIEW
“When reviewing an order of a bankruptcy court on appeal from a decision of a district court, we review the bankruptcy court‘s order directly and give no deference to the district court‘s decision.” Hamilton v. Herr (In re Hamilton), 540 F.3d 367, 371 (6th Cir. 2008). We
III. ANALYSIS
The main question in this case is whether the agreements between Purdy and Sunshine are “true leases” or merely “security agreements.” “A lease involves payment for the temporary possession, use and enjoyment of goods, with the expectation that the goods will be returned to the owner with some expected residual interest of value remaining at the end of the lease term.” In re QDS Components, Inc., 292 B.R. 313, 322 (Bankr. S.D. Ohio 2002) (quoting James J. White & Robert S. Summers, Unifоrm Commercial Code § 30-3, vol. 4 (5th ed., West 2002)). “‘In contrast, a sale involves an unconditional transfer of absolute title to goods, while a security interest is only an inchoate interest contingent on default and limited to the remaining secured debt.‘” Id. (quoting White & Summers, Uniform Commercial Code § 30-3). If the agreements are true leases, then Sunshine has a reversionary interest in 435 head of cattle and is entitled to approximately $309,000 from the cattle auction. See Appellant Br. at 35; see also 4 James J. White, Robert S. Summers & Robert A. Hillman, Uniform Commercial Code § 30-3(a)(1) (6th ed., West 2013) (distinguishing between reversionary interest аnd security interest). If the agreements represent the sale of the cattle and Sunshine‘s retention of a security interest, then Citizens First‘s perfected agricultural security interest trumps Sunshine‘s interest, and the bank keeps all of the proceeds from the cattle auction.
In deciding whether these “Dairy Cow Leases” are true leases or disguised security agreements, we look to the relevant state law. Butner v. United States, 440 U.S. 48, 54 (1979). The agreements’ choice-of-law provisions, in turn, direct us to the laws of Arizona. See, e.g., R. 20-17 at 2 (50 Cattle Agreement) (Page ID #351).
Under Arizona law, “the facts of each casе” dictate whether an agreement is a true lease or a security agreement,
A. Bright-Line Test
No one debates that Purdy lacked the ability to terminate the lease. The question is whether the lease term of fifty months exceeds the economic life of the cattle. The bankruptcy court fixated upon Purdy‘s testimony that he culled approximately thirty percent of the cattle each year, meaning that the entire herd would turn over in forty months. See In re Purdy, 490 B.R. at 536. As a result, the bankruptcy court concluded that the lease term exceeded the eсonomic life of the cattle that Sunshine initially gave Purdy and, therefore, that the lease was a per se security agreement. Id. We disagree and hold that the bankruptcy court erred in its analysis of the cattle‘s economic life because the court focused upon the economic life of the individual cows originally leased to Purdy, instead of the life of the herd as required by the agreements.
According to the text of the agreements between Purdy and Sunshine, Purdy had a duty to return the same number of cattle to Sunshine that he originally leased, not the same cattle. See, e.g., R. 20-17 at 2 (50 Cattle Agreement) (Pagе ID #351) (“Lessee hereby leases from Sunshine . . . the number of cows shown above (‘the Cows‘), each of which is identified by . . . Sunshine‘s brand and ear tag . . ., whether part of the Lease originally or a replacement.“); id. at 3 (Page ID
B. Economics-of-the-Transaction Test
The precise contours of the economics-of-the-transaction test are rather unclear, but courts have largely focused upon two particular factors: (1) whether the lease contains a purchase option price that is nominal; and (2) “whether the lessee develops equity in the property, such that the only economically reasonable option for the lessee is to purchase the gоods.” Phoenix Equip., 2009 WL 3188684, at *10 (internal quotation marks omitted); see also QDS Components, 292 B.R. at 342; Addison v. Burnett, 49 Cal. Rptr. 2d 132, 137 (Cal. Ct. App. 1996); 4 White, Summers & Hillman, Uniform Commercial Code § 30-3(d). The ultimate question for us, however, is whether Sunshine kept a meaningful reversionary interest in the herd. See QDS Components, 292 B.R at 340-41; Phoenix Equip., 2009 WL 3188684, at *10. On the facts presented to us, we hold that Citizens First has also failed to carry its burden of establishing that the actual economics of the transactions indicate that the leases were disguised security agreements.
Additionally, the fact that there is no purchase option also distinguishes this case from In re Buehne Farms, Inc., 321 B.R. 239 (Bankr. S.D. Ill. 2005), which the bankruptcy court relied upon heavily. In that case, the court was swayed by the fact that the purported leases allowed the lessee to purchase the cattle at the end of the lease for approximаtely $160 per cow. Id. at 244. The court noted that the lessee had spent approximately $500,000 in rental payments over the life of the lease and that spending just six percent of that would give the lessee title to the cows. Id. at 246. Considering that the lessee had spent significant money to replace culled cattle already, the Buehne Farms court reasoned that the lessee would be irrational not to exercise the purchase option. Id. This situation indicated that the “rental payments” were actually installment payments and that the “purchase option” was really a сleverly disguised final payment. In stark contrast, Purdy‘s rental payments were just that—payments per a lease. Purdy had no legal right to purchase Sunshine‘s herd; there was no purchase option that he could exercise. Under the terms of the agreements, Purdy had to return the same number of cows that he originally leased in fair condition as indicated by the Residual Guaranty. At approximately $300 per cow, this herd had a minimum value of $130,500. It sold at auction for approximately $309,000. See
Finally, whether the parties adhered to the terms of these leases in all facets, in our view, is irrelevant to determining whether the agreements were true leases or disguised security agreements. Neither the bankruptcy court nor the parties have sufficiently explained the legal import of Purdy‘s culling practices or put forward any evidence that the parties altered the terms of the leases making them anything but what they proclaim to be. Moreover,
IV. CONCLUSION
For the foregoing reasons, we conclude that Citizens First has failed to demonstrate that the “Dairy Cow Leases” were actually security agreements in disguise. Because the bankruptcy court found to the contrary, we REVERSE and REMAND to the bankruptcy court for further proceedings consistent with this opinion.
DRAIN, District Judge, dissenting. In this case, I respectfully disagree with the majority‘s decision on the application of the facts to the tests to be applied. I would affirm the bankruptcy court‘s decision finding that the transactions involved in this case were disguised security agreements as opposed to true leases.
A. Bright-Line Test
I agree with the bankruptcy court, and find In re Buehne Farms instructive. That case involved a dairy farmer/debtor who argued his fifty-month cattle leases were disguised as security agreements when his lessors motioned the bankruptcy court to extend the time for the debtor to assume or reject fifty month cattle leases. In re Buehne, 321 B.R. 239 at 240. The debtor obtained his cattle via two leases with third party buyers. Id. at 241. The Buehne Farms leases are almost identical to Purdy‘s leases. Id. The In re Buehne court found that the average dairy farmer culls at an annual rate of twenty to thirty percent and the debtor‘s cows had a forty-eight month economic life. Id. at 242. The In re Buehne Farms court found the economic life of a dairy cow could range from thirty-six to sixty months. Id.
Sunshine argues this case is distinguishable because the leases Purdy signed did not have purchase options. Although this is true, I find this case is instructive because it offers guidance on the ecоnomic life of dairy cows given a farmer‘s culling practices.
We review the bankruptcy court findings of fact under the clear-error standard. B-Line, LLC v. Wingerter (In re Wingerter), 594 F.3d 1931, 935-36 (6th Cir. 2010) (citing Behlke v. Eisen (In re Behlke), 358 F.3d 429, 433 (6th Cir. 2004)). Under this standard, the reviewing court must ask whether the bankruptcy court‘s factual findings were erroneous.
The bankruptcy court in this case heard similar testimony about cull rates and the practices on the Purdy farm. Id. at 537. The bankruptcy court determined that Purdy had a thirty percent cull rate. Id. at 533. This rate causes nearly complete herd turnover after thirty-six
B. Economic Realities of the Transaction
The majority finds that the leases fail the Bright-Line test. A lease agreement can fail the Bright-Line test, which is inevitable when the herd is the relevant good, and the court can still find that an agreement creates a security interest.1 See
The UCC and its Arizona adaptation offer very little guidance to courts on how to analyze the economics of a transaction. A common factor courts use is whether the lessor has a reversionary interest in the leased goods or an option to purchase. Id. Courts are not limited to these factors. In re WorldCom, Inc., 339 B.R. 56, 72 (Bankr. S.D.N.Y. 2006). In fact, by limiting itself to these factors, the court conducts a similar analysis to the Bight-Line test.
In re Phoenix Equipment Co. Inc. is distinguishable from this matter because it also involves a purchase option. Id. at *11. The In re Phoenix Equip. Co., Inc. leases did not provide for an option in the language of the lease, but the court inferred the option by analyzing the parties’ course of dealings. Id. When the parties could not establish whether the purchase price on the option was nominal, the In re Phoenix Equipment Co., Inc. court focused on the structure and effect of the parties’ transactions. Id. (stating the court must consider the agreements within the context of the parties’ relationship). The debtor needed capital in order to run his operation and entered into transactions in which he transferred title of equipment to his creditor in exchange for the capital. Id. The court concluded the nature of the transactions showed that the debtor did not need a lease agreement, but needed capital to continue operating. Id. at *12.
In the three relevant leases, third parties sold cattle to Purdy. Sunshine reimbursed Purdy for the cost of the cattle. Sunshine knew Purdy did not adhere to the replacement cattle provisions in its agreements, but chose to ignore his non-compliance. Sunshine was aware of Citizens’ lien at the time it entered into the transactions and filed its statements. Thе facts of the case at the time of the transaction indicate that Purdy needed money to place cows on the farm. Sunshine, by the way it forwarded funds to Purdy, appears to have supplied Purdy with funds rather than the actual cattle. Sunshine received a lien on the cattle whose acquisition it financed. These facts indicate the parties entered into three financing transactions rather than three lease transactions.
Furthermore, the reimbursement sheds doubt on Sunshine‘s characterization of the leases as finance leases under Article 2A. Under Arizona‘s adaptation of the UCC, finance leases have three characteristics.
Purdy purchased the cattle, and there is no indication in the record Purdy approved or saw a contract or any warranties or promises the third-party buyer would have given to Sunshine. Sunshine only has invoices and bills to indicate it paid for cattle that Purdy already had on his farm. Sunshine has not shown its leases meet the statutory requirements of the finance lease. Thus, the bankruptcy court did not err by relying on the parties’ post lease conduct in reaching its conclusion. Testimony reveals Sunshine acquiesced in Purdy‘s decision to sell the cattle, and use the funds to either purchase more cattle or deposit the sale proceeds in his Citizens’ account. It was not error for the bankruptcy court to rely on the fact that Purdy acquired the cattle from third parties and Sunshine reimbursed these parties. This arrangement was tantamount to Sunshine financing the acquisition of cattle for Purdy‘s dairy operation. Moreover, Sunshine failed to come forward with evidence it actually owned the cattle delivered by the third party buyers, which calls into question the leases status as finance leases. I would hold the economics of the transaction support a finding that the parties entered into security agreements for the cattle rather than leases.
For these reasons, I respectfully dissent and would affirm the bankruptcy court‘s decision.