In a 9-page opinion released December 30, 2014 in the Xchange Technology Group bankruptcy (Bank. D. Del. 13-12809), Judge Gross provides a reminder that capital leases are not treated the same as a true lease (or operating lease). Judge Gross’ opinion is available here (the “Opinion”). The Opinion decided the motion (“Motion”) of Winthrop Resources Corporation (“Winthrop”) for an order directing the receiver to comply with the terms of a previously entered sale order.
Winthrop filed the Motion in an effort to collect past and future amounts due from the Debtor. However, as argued by the Debtors and agreed to by Judge Gross, there were two issues with the movant’s arguments: “First … the Lease Agreement is not an operating lease but a capital lease. Second, the relief Winthrop seeks would lead to an inequitable forfeiture.” Opinion at *7.
Determining if a lease is an operating lease, or a financing lease, the bankruptcy court looks to applicable state law. Opinion at * 7. Pursuant to Judge Gross’ analysis of Minnesota law (which governed pursuant to the lease agreement, Opinion at * 7), the lease in question had all the hallmarks of a financing lease. Judge Gross does not expand on the result of the lease being a finance lease rather than an operating lease. However, other Courts have provided extensive discussion of the difference. For example, Bankruptcy Judge Wedoff provided extensive analysis in United Air Lines, Inc. v. HSC Bank USA (In re UAL Corp.), 307 B.R. 618 (Bankr. N.D. Ill. 2004).
The second of the Debtors’ arguments in these case carried the day even more strongly. As the Debtors had already paid the lease in full, “if the Court were to grant the relief Winthrop seeks, Winthrop would receive a windfall, a forfeiture which Minnesota law does not countenance.” Opinion at * 9. For these reasons, Judge Gross ruled against Winthrop and in favor of the Debtors.
While the Bankruptcy Court is certainly sophisticated enough to sort through highly technical arguments like those presented by Winthrop, any party appearing before the Court should keep in mind that bankruptcy courts are courts of equity. Thus, regardless of the strength of an argument under the law, if the result is inequitable, the Bankruptcy Court can turn to the fairly broad powers of 11 U.S.C. 105 to ensure that the most equitable argument wins the day.