ATTORNEYS FOR PETITIONER: ATTORNEYS FOR RESPONDENT:
B. KEITH SHAKE JEFFREY A. MODISETT
KERRY L. WAGNER Attorney General of Indiana
HENDERSON DAILY WITHROW & Indianapolis, Indiana DeVOE
Indianapolis, Indiana VINCENT S. MIRKOV
Deputy Attorney General
W. H. PAIGE & CO., ) ) ) Petitioner, ) ) v. ) Cause No. 49T10-9611-TA-00157 ) STATE BOARD OF TAX COMMISSIONERS, ) ) Respondent. ) _____________________________________________________________________COMMISSIONERS _____________________________________________________________________
ON APPEAL FROM A FINAL DETERMINATION OF THE STATE BOARD OF TAX
may exercise the early purchase option by tendering payment of the listed purchase
price of the musical instrument minus the trial period rental payment and 70% of the
monthly rental payments received by the date of purchase. The rent-to-own lease also
allows the lessee to return the musical instrument at any time during the second lease
term and incur no further obligation. During both lease terms, Paige retains title to the
musical instrument until the lessee pays the amounts necessary for the lessee to
become the owner of the musical instrument.
Some samples of actual rent-to-own lease agreements were attached to the affidavit of Mr. Garry L. Seidner that Paige designated as evidence in support of its summary judgment motion. In one of those lease agreements, the customer leased a new Bach Trumpet. The Bach Trumpet had a retail price at the time of the agreement of $595.00. The customer was obligated for a two-month trial rental period for which he was to pay $58.70 at the time of entering the lease agreement. After the trial rental period, the customer could enter a month-to-month renewable lease by making the first monthly rental payment of $28.35. If the customer renewed the lease for thirty consecutive months, the customer could purchase the Bach Trumpet for $14.73. This payment is 7.67% of the fair market value ($192.00) of the Bach Trumpet at the end of the thirty-month term.See footnote 1
On March 1, 1995, a State Board field auditor recommended to the State Board
that Paige be assessed for personal property tax for the instruments that Paige rents to
its customers pursuant to the Monthly Rent-to-Own Program. Paige timely filed an
objection to the field auditor's recommended assessment, and on August 27, 1996, the
State Board held a hearing on Paige's objection. On September 27, 1996, the State
Board issued its final determination. In that final determination, the State Board
concluded that Paige was liable for personal property tax on the musical instruments
and that Paige was also liable for undervaluation penalties and for failure to file
required personal property tax returns. See Ind. Code Ann. § 6-1.1-37-7 (West Supp.
1997) (amended 1998). This original tax appeal ensued. The parties have filed cross-
motions for summary judgment.See footnote
Additional facts will be added as necessary.
Dana Corp. v. State Bd. of Tax Comm'rs, 694 N.E.2d 1244, 1246 (Ind. Tax Ct. 1998).
Cross-motions for summary judgment do not alter this standard. See Hyatt Corp. v.
Department of State Revenue, 695 N.E.2d 1051, 1052-53 (Ind. Tax Ct. 1998), review
of property taxation. Under Ind. Code Ann. § 6-1.1-1-9(b) (West 1989), the general
rule is that the owner of tangible personal property is the legal title holder to the
property. One exception to the general rule occurs when tangible personal property is
security for a debt and the debtor is in possession of the property. In those instances,
the debtor is the owner of that property. Ind. Code Ann. § 6-1.1-1-9(e) (West 1989).
Paige contends that notwithstanding the language in the rent-to-own lease stating that Paige is the holder of legal title of the musical instruments, subsection 6- 1.1-1-9(e) requires the conclusion that Paige is not the owner of the musical instruments for purposes of the personal property tax. In support of this contention, Paige notes that this Court has previously looked to the law of security interests for guidance in determining the owner of property under subsection 6-1.1-1-9(e). See Kimco Leasing, Inc. v. State Bd. of Tax Comm'rs, 656 N.E.2d 1208 (Ind. Tax Ct. 1995), review denied. In Paige's view, application of the law of security interests leads to the conclusion that the rent-to-own leases actually constituted conditional sales and that Paige's retention of title to the musical instruments in the rent-to-own lease agreements constituted disguised security interests. Therefore, in Paige's view, the musical instruments secured debts owed to Paige and, as a result, Paige is not the owner of the musical instruments under subsection 6-1.1-1-9(e).
In response, the State Board advances two arguments. The State Board contends that although the Court has previously looked to the law of security interests in determining questions of ownership arising under subsection 6-1.1-1-9(e), the Court may not do so in this case because the law of security interests by statute does not
apply to the rent-to-own lease agreements at issue in this case and that, in any event,
application of the law of security interests leads to the conclusion that the rent-to-own
lease agreements are true leases and do not grant Paige security interests in the
The parties agree that the rent-to-own lease agreements at issue in this case constitute rental purchase agreements as that term is defined in Ind. Code Ann. § 24-7- 2-9 (West 1995). Consequently, under Ind. Code Ann. § 24-7-1-2 (West 1995), the law of security interests does not apply to the rent-to-own lease agreements.See footnote 3 This leads to the question of whether the Court may look to the law of security interests to determine the owner of the musical instruments for purposes of property taxation.See footnote 4
(a) the original term of the lease is equal to or greater than the remaining economic life of the goods;
(c) the lessee has an option to renew the lease for the remaining
economic life of the goods for no additional consideration upon compliance with
the lease agreement; or
(d) the lessee has an option to become the owner of the goods for no
additional consideration or nominal additional consideration upon compliance
with the lease agreement.
A transaction does not create a security interest merely because it provides that:
(a) the present value of the consideration the lessee is obligated to pay
the lessor for the right to possession and use if the goods is substantially equal
to or is greater than the fair market value of the goods at the time the lease was entered into;
(b) the lessee assumes risk of loss if the goods, or agrees to pay taxes,
insurance, filing, recording, or registration fees, or service or maintenance costs
with respect to the goods;
(c) the lessee has an option to renew the lease or to become the owner of
(d) the lessee has an option to renew the lease for a fixed rent that is equal to or greater than the reasonably predictable fair market for the use of the goods for the term of the renewal at the time the option is to be performed; or
(e) the lessee has the option to become the owner of the goods for a fixed
price that is equal to or greater than the reasonably predictable fair market value of the goods at the time the option is to be performed.
In Kimco Leasing, 656 N.E.2d at 1217, this Court construed this statutory provision as
embodying two separate tests for determining whether a lease is a true lease or a
disguised security interest.
Under the first test, which this Court in Kimco called the bright line test, a lease creates a security interest if: 1) the lessee is obligated to perform for the full length of
the lease without being able to voluntarily terminate it, and 2) one of the four
enumerated conditions in subsection 26-1-1-201(37) is present. Id. (citing Ind. Code
Ann. § 26-1-1-201(37); In re Zaleha, 159 B.R. 581, 584 (Bankr. D. Idaho 1993); In re
Lerch, 147 B.R. 455, 457 (Bankr. C.D. Ill. 1992)). In this case, as Paige concedes, the
lessees are not obligated to perform for the full length of the leases. As a result, the
rent-to-own leases cannot create security interests under the bright line test.
The second test is called the meaningful residual interest test. Under that test, the Court must determine whether the lessor can reasonably expect to receive back anything of value at the end of the lease term. Id. at 1218. If so, then the lease is a true lease, if not, then the lease creates a security interest. See id. (citing Zaleha, 159 B.R. at 584). In evaluating whether the lessor can expect to receive back anything of value when the lease term ends, the court must consider: 1) whether the lease contains an option to purchase for no or nominal consideration, and 2) whether the lessee develops equity in the leased property such that the only sensible decision economically is to exercise the purchase option. Id. (citing Zaleha, 159 B.R. at 584). The reason behind this formulation is that if these two conditions are met, it may be presumed that the lessee will exercise the purchase option and that at the end of the lease term, the lessor will only receive very little or nothing at all. Thus, retention of title by the lessor can only be looked upon as means of securing payments due under the lease contract. See TKO Equip. Co. v. C & G Coal Co., 863 F.2d 541, 544-45 fn* (7th Cir. 1988) (where payments under lease contract are mandatory and are equivalent of debt and an option to purchase at a trivial cost follows the mandatory
payments, the lease contract is intended for security). Paige contends that the rent-to-
own leases satisfy the meaningful residual interest test thereby creating a security
interest. This, in Paige's view, would mean that under subsection 6-1.1-1-9(e), Paige is
not the owner of the musical instruments for property taxation purposes and thus is not
liable for personal property tax on them. The Court cannot agree.
There can be no doubt that in this case Paige's customers build up equity in the musical instruments they lease as they renew the rent-to-own lease agreements and that they may purchase the musical instruments for a small amount of consideration (when compared to the fair market value of the musical instruments) at the end of the lease term. Therefore, if Paige's customers choose to renew the rent-to-own lease agreements for the entire term, then the only sensible option at the end of the lease term would be to purchase the musical instruments for the purchase option price. For example, at the end of the thirty-month lease term, the customer may purchase the leased Bach Trumpet with a fair market value of $192 for $14.73. The customer would, of course, be well-advised to exercise the purchase option. This conclusion is borne out by Mr. Seidman's affidavit, in which he states that he is unaware of any customer who renewed the rent-to-own lease for the entire term and failed to exercise the purchase option.
This would seem to satisfy the meaningful residual interest test and thereby compel the conclusion that the rent-to-own lease agreements create security interests. But there is a missing element in this analysis, namely, the fact that the lessees are not required to complete the lease term. Paige maintains that the lessees' ability to
terminate the lease prior to the completion of the lease term is irrelevant to the
meaningful residual interest test. In support of this position, Paige correctly notes that
in Kimco, this Court did not make any reference to whether the lessees in that case
could terminate their leases when analyzing the leases at issue under the meaningful
residual interest test.
However, in Kimco, the leases at issue in that case were not terminable by the lessee. Therefore, this Court was not called upon to deal with the relevance of a lessee's ability to terminate a lease in determining whether the lease really creates a disguised security interest. As a result, Paige's argument that the lessees' ability to terminate the rent-to-own lease agreements before the completion of the lease term is irrelevant is nothing more than an attempt to make an affirmative statement from Kimco's silence on the point.See footnote 6 In addition, the Court notes that when subsection 26-1- 1-201(37) was amended in 1991, the Legislature added language concerning leases not subject to termination by the lessee. See Act of May 5, 1991, No. 189, § 2, 1991 Ind. Acts 2800, 2804-05. In light of this amendment, it can hardly be argued that the Paige's customers' ability to terminate the lease with no further obligation is irrelevant. Instead, as the State Board points out, Paige's customers' ability to terminate the rent-to-own lease agreements goes to the heart of the matter. Because Paige's
customers can terminate the rent-to-own lease agreements, there is simply no
obligation to secure, and therefore there can be no security interest created by these
rent-to-own lease agreements. See In re Powers, 983 F.2d 88, 90 (7th Cir. 1993)
(where . . . a lessee has the right to terminate the lease before the option to purchase
the property for no or nominal consideration, the lease is a true lease and not a
conditional sale) (citing In re Marhoefer Packing Co., 674 N.E.2d 1139, 1142-43 (7th
Cir. 1982)); In re Mahoney, 153 B.R. 174, 177-78 (E.D. Mich. 1992); In re Morris, 150
B.R. 446, 448-49 (Bankr. E.D. Mo. 1992); In re Spears, 146 B.R. 772 (S.D. Ill. 1992); cf.
In re Jarrells, 205 B.R. 894 (Bankr. M.D. Ga. 1997) (holding rent-to-own lease a true
lease after examining facts of the case). This is not a technical defect to be overlooked
by invoking the economic realities of these transactions. Without an obligation to
secure, how is it possible to have a security interest? The answer is that it is not
possible unless one does violence to the plain language of subsection 26-1-1-201(37),
which requires the securing of a payment or performance of an obligation in order for a
security interest to exist. Looking to the facts of each case, as subsection 26-1-1-
201(37) directs, does not make the fundamental requirement of an obligation any less
fundamental, nor does it allow that requirement to be ignored.
In arriving at this conclusion, the Court is not unaware of the contrary decisions of some courts. For example, in In re Barnhill, 189 B.R. 611 (Bankr. D.S.C. 1992), the Court concluded that a rent-to-own agreement similar to the one at bar created a security interest despite the fact that the lessee could terminate the lease at will. Another example is found in In re Puckett, 60 B.R. 223 (Bankr. M.D. Tenn. 1986), aff'd
838 F.2d 471 (6th Cir. 1988), where the court found an obligation to buy the leased
goods despite the fact that the lessee could terminate the lease agreement at will. The
The right to terminate has historical significance, but the argument that a termination clause negates the existence of a real obligation is unpersuasive where the customer's choice is to continue making payments or to forfeit substantial rights and interests in the collateral. * * * Where the right to terminate involves a forfeiture, the option on paper cannot overcome the substance of the transaction: the termination option has simply been paid for by the debtor as part of the underlying sale.
Puckett, 60 B.R. at 239-40; see also South Carolina Rentals, Inc. v. Arthur, 187 B.R. 502 (D.S.C. 1995) (finding security interest despite fact that lessee could terminate rent-to-own purchase agreement at will); In re Fogelsong, 88 B.R. 194 (Bankr. C.D. Ill. 1988) (same). This point of view may have merit if one is attempting to rescue an insolvent lessee from the harsh consequences of forfeiture.See footnote 7 Cf. Skendzel v. Marshall, 261 Ind. 226, 301 N.E.2d 641, 650 (1973) ([F]orfeiture [in a land sale contract] may only be appropriate under circumstances in which it is found to be consonant with notions of fairness and justice under the law.), cert. denied, 415 U.S. 921, 94 S.Ct. 1421 (1974). However, the tug on the heartstrings (and the attractiveness of those cases) is considerably less powerful in situations where a lessor is attempting to
disclaim the language of a contract it drafted.See footnote
See TKO Equip. Co., 963 F.2d at 544-
45. Furthermore, the Court notes that these cases were decided under a previous
version of UCC § 1-201(37), which contained language (now deleted) directing the
Court to examine the intent of the parties and which did not contain the language
concerning leases not subject to termination by the lessee.See footnote
Accordingly, these cases
are not persuasive.
Also, even if the Court were to apply the reasoning of Barnhill, Puckett, Arthur and Fogelsong to this case, the conclusion that these rent-to-own lease agreements do not create security interests would not change. As both parties correctly note, the Court must determine whether the rent-to-own lease agreements are true leases or create security interests by examining the conditions at the inception of the lease agreements. See Kimco Leasing, 656 N.E.2d at 1215. Were that not the case,
intervening events could change what was originally a true lease into a security
interest, or vice versa. See id.
As Paige notes (and the State Board implicitly acknowledges), it is undoubtedly true that at the end of the lease term Paige's customers would be foolish to fail to exercise the purchase option that they have bargained for. However, under Kimco, the Court must analyze the situation existing when the agreement is made, not the situation existing at the end of the lease term. At the inception of the lease agreement, Paige's customers are not bound by contract to see the lease agreements through to completion. Nor are they bound to do so by the economic realities of these agreements. Nothing compels Paige's customers to keep paying until the musical instruments may be purchased for a nominal price.See footnote 10 This is amply demonstrated by the fact that 40% of Paige's customers who enter into the rent-to-own lease agreements terminate these agreements prior to the completion of the lease term.See footnote 11 Cf. Marhoefer Packing Co., 674 F.2d at 1143 n.3 (in order for transaction to constitute a conditional sale, buyer must be bound to take title or pay purchase price, therefore
where buyer can terminate transaction, lease cannot constitute a conditional sale)
(quoting S. Williston, The Law Governing Sales of Goods at Common Law and
Under the Uniform Sales Act § 336, at 528 (1908)). As the State Board put it, it is
difficult to believe that these lessees are making an illogical economic decision. (State
Bd. Final Determination ¶ 13). Therefore, even if the Court were to look at the
economic realities of these agreements, as Paige asks, the Court could still find no
economic compulsion that would satisfy the requirement of an obligation on the part of
Finally, even assuming that these rent-to-own lease agreements create security interests under the law of security interests, this would not be dispositive in determining the application of subsection 6-1.1-1-9(e) to this case. As stated above, the Court is only looking to the law of security interests for guidance in this area. Subsection 6-1.1- 1-9(e) requires that the property secure payment of a debt. In no way can these rent- to-own lease agreements be said to make (other than for the trial rental period) debtors out of Paige's customers. Therefore, the requirement of subsection 6-1.1-1-9(e) that there be a debt to secure is not satisfied in this case. Accordingly, the Court holds that subsection 6-1.1-1-9(e) does not relieve Paige of its ownership of the musical instruments at issue for property taxation purposes.
Up until now, the Court has focused on Paige's arguments concerning the operation of subsection 6-1.1-1-9(e). However, this case raises another issue, which is alluded to, but not fully discussed, in Paige's briefs. As noted above, under section 6- 1.1-2-4, the owner and possessor of personal property are jointly liable for personal
property tax. See Jewell Grain Co., 556 N.E.2d at 922. This coupled with the exclusion
of consumer personal property from personal property tax also described above leads
to an interesting problem. If the musical instruments are subject to personal property
tax because they are owned by Paige and thus are used in the production of income,
then under the plain language of section 6-1.1-2-4, Paige's customers may become
liable for the tax, despite the fact that if Paige's customers owned the musical
instruments outright, they would not be liable for the tax.
However, the Court need not delve further into this issue. In this case, the State Board has not pursued Paige's customers for payment of the tax and Paige has no right of action against its customers to reimburse Paige for payment of the tax. See Ind. Code Ann. § 6-1.1-2-4 (allowing possessor to recover taxes paid from owner unless owner and possessor have agreed to other terms in a contract). Consequently, the Court is not called upon to determine if section 6-1.1-2-4 is to be applied literally if the State Board chose to pursue Paige's customers for payment of the tax. Moreover, the mere fact that section 6-1.1-2-4 may not be applied literally with respect to certain possessors does not change the operation of section 6-1.1-1-9 or section 6-1.1-2-4 with respect to an owner.
(4) IC 26-1-2 concerning the creation of a security interest in property; [and]
(5) IC 26-1-9
. . .
do not apply to a rental purchase agreement.
security interests does not apply in this case, the State Board used the law of security
interests in arriving at its conclusion that Paige owned the musical instruments and was
subject to property tax on them. Thus, the State Board's litigation position conflicts with
the reasoning of its own final determination.
The Court notes that Paige has failed to address the post hoc nature of the State Board's argument in its brief. Ordinarily, this would result in waiver of the issue. However, because this issue would likely arise in the future, the Court chooses to decide the issue on the merits.
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