Most lawyers are generally familiar with the concept of a floating lien under the Uniform Commercial Code. A secured creditor takes a lien in a collateral category that changes from time to time as items are added or subtracted. A common example is a working capital loan, in which financed inventory is produced and sold, then becoming an account, which is collected to provide the funds to produce new inventory. A secured creditor may perfect a lien in the changing mass of inventory and receivables, as each category exists from time to time.
We are also generally familiar with disputes as to whether a given financing transaction is a lease or a disguised security interest. Among the key factors for determining that issue is whether the putative lease extends beyond the useful life of the asset being leased.
The Sixth Circuit recently decided a case involving a “Dairy Cow Lease” where the question before the Court was whether the transaction should be viewed as a true lease or a disguised security interest. Sunshine Heifers, LLC v. Citizens First Bank (In re Purdy),. The evidence in the record established that the debtor/farmer “culled” or replaced approximately one third of the animals each year. Thus, over the 50-month term of the agreement, the entire herd would have been replaced.
The majority opinion from the Sixth Circuit found that the “good” treated under the agreement was the herd and not individual cattle. Based on that conclusion, the Court ruled that the agreement failed a “bright line” test for a security interest since, notwithstanding the culling process, the term of the agreement did not exceed the useful life of the goods covered by the agreement.
The UCC concept of a floating lien developed to better recognize and accommodate the evolving nature of business finance. However, that notion seems difficult to extend to the idea of a lease, where the lessee pays the lessor for the use of lessor’s goods for a stated term and then returns the goods at the end of the lease term. The structure seems much more appropriate for a tangible item that is owned by the lessor, used by the lessee for the lease term and then returned. If, in fact, the “good” is an evolving herd of dairy cows, then its useful life would be functionally eternal. In that situation, one classic means of differentiating between a lease and a security interest would be rendered completely superfluous.
Since the “Dairy Cow Lease” contained no option for the debtor/lessee to purchase the herd at the end of the term, and since the debtor/lessee was required to maintain a stated minimum value for the herd throughout the term, the Court concluded that the economics of the transaction more closely fit a lease than a security interest.
It seems hard to imagine a “working capital lease,” by which an obligor “leased” an evolving mass of inventory and receivables from the financing party. In that very same way, it seems difficult to comprehend how lease principles appropriately apply to an evolving herd of dairy cows. But that result is the outcome of the Court’s decision.