UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK
October 4, 1974
In the Matter of SHERWOOD DIVERSIFIED SERVICES, INC., Debtor
Werker, District Judge.
The opinion of the court was delivered by: WERKER
WERKER, District Judge.
On April 23, 1974, the Honorable Asa S. Herzog, Bankruptcy Judge, entered an Order expunging a priority claim
filed by the New York State Tax Commission ("Tax Commission") in the amount of $1,350,870.56
for sales and/or compensating use tax allegedly owed by Sherwood Diversified Services, Inc. ("Sherwood"), the debtor in possession. The Bankruptcy Judge concluded that Sherwood was in the business of financing the purchase of machinery and equipment by third parties from manufacturer-vendors, and that Sherwood, as a financing agency, had no responsibility to collect sales tax. The Tax Commission appeals from the Order expunging its priority claim.
For the purpose of this appeal, this Court adopts the description of Sherwood's business activities as set forth on pages 2 and 3 of the Bankruptcy Judge's Opinion:
The debtor commenced operations in 1961 as Sherwood Leasing Corporation, engaged in the business of financing the purchase by third parties of machinery and equipment from manufacturer-vendors. Although its business became diversified over the succeeding years, the debtor continued its financing operations and it is those operations which are the basis of the present controversy. The financing transactions arose in this manner:
Persons desirous of purchasing equipment or machinery, who were unable to finance the transactions themselves, or unable to obtain bank financing, applied to the debtor for a loan in order to effect the purchase. If debtor was satisfied with the nature of the transaction, the responsibility of the purchaser and the character of the collateral, it made a commitment to advance the money necessary for payment to the manufacturer-vendor of the purchase price plus applicable sales tax. The equipment was shipped by the vendor directly to the purchaser and the invoice sent to the debtor. The debtor thereupon entered into a security agreement with the purchaser which took the form of a document characterized as an "equipment lease,"* and upon advice from the purchaser that the equipment had been received in good condition, debtor remitted the full purchase bill plus any applicable sales tax to the manufacturer-vendor. Concurrently with the execution and delivery of the aforesaid "equipment lease," U.C.C. financing statements were executed and delivered to the purchaser and filed by the debtor.
The monthly payments called for by the "equipment lease" were calculated to return to the debtor over the term of the agreement: (1) the purchase price, (2) sales tax or other charges paid at the time of the purchase from the manufacturer-vendor, (3) interest on the moneys advanced, and (4) filing fees.
The purchaser, who was characterized in the agreement as a "lessee" was given an option to purchase the equipment at the end of the term of the agreement for a nominal consideration of $1.00 to $10.00.
In some instances there were sale and lease-back arrangements in which the debtor entered into the financing transaction after the borrower had already purchased the equipment from the manufacturer-vendor and had obtained delivery thereof. In these situations, where the State of New York was involved, the purchaser of the equipment paid all applicable sales tax to the manufacturer-vendor at the time of the purchase of the equipment.
The initial question to be answered on this appeal is whether the "equipment leases" were in fact true leases or simply financing agreements. Under § 1105(a) of the New York Tax Law (McKinney's Consol.Laws, c. 60, 1966) [hereinafter cited as "Tax Law"], a tax is imposed on retail sales of tangible personal property in New York State. For the purposes of the Tax Law, a true lease constitutes a sale,
and the seller has the responsibility of collecting the tax and remitting it to the state.
Section 1-201(37) of the New York Uniform Commercial Code (McKinney 1964) draws a distinction between a true lease and a lease intended as security:
"Whether a lease is intended as security is to be determined by the facts of each case; however, (a) the inclusion of an option to purchase does not of itself make the lease one intended for security, and (b) an agreement that upon compliance with the terms of the lease the lessee shall become or has the option to become the owner of the property for no additional consideration or for a nominal consideration does make the lease one intended for security."
The evidence adduced during the proceedings below shows that in substantially all of the transactions between Sherwood and its customers, nominal purchase options of from $1.00 to $10.00 were given to the purchaser-lessees. See Transcript of Adjourned Hearing on Objections to Claim of State of New York (No. 1608), February 15, 1974, at 7 [hereinafter cited as "Transcript"]. The importance of the options is emphasized by Professor Hawkland:
UCC section 1-201(37) makes it clear that an intention of the parties test is the appropriate one to distinguish true leases from leases intended as security, and that the presence or absence of an option to purchase is a strong factor in determining that intention.
Both the Bankruptcy Judge in his Opinion and Sherwood in its brief cite numerous authorities in support of the test outlined in section 1-201(37).
The Tax Commission seeks to avoid the thrust of Sherwood's argument by pointing to the boilerplate provisions of the equipment leases. Mr. Max Mulberg, who conducted an audit of Sherwood's financial records,
concluded that Sherwood was in the leasing business because:
"The agreement is entitled "Equipment Lease"; with the parties known as lessor and lessee, and also stipulated monthly lease rentals.
In addition the lease agreement states, paragraph 7, that the equipment shall at all times remain the property of the lessor, and that at the expiration of the lease the lessee shall return the equipment unencumbered to the lessor."
Transcript at 27.
Mr. Mulberg had adopted the same position during his own deposition:
Q. Mr. Mulberg, is it your position that if a contract refers to, and use [sic] the terminology lease, lessor, lessee, monthly rental, it therefore is in fact a lease for the purpose of the State sales tax.
A. That's correct.
Deposition of Max Mulberg, February 4, 1974, at 59 [hereinafter cited as Mulberg deposition].
The Tax Commission would have this Court look to the "four corners" of the lease and conclude that the intent of the parties was to enter into a true lease transaction, and not a financing agreement. The overwhelming weight of judicial authority and the language of section 1-201(37) necessitate a rejection of this approach. All of the "facts of each case" must be examined to determine the intention of the parties, and the Court may properly consider "factors outside of the lease as well as the contents of the lease itself . . . ."
In re Leasing Consultants, Inc., 486 F.2d 367, 373 (2d Cir. 1973), quoting In re Walter Willis, Inc., 313 F. Supp. 1274, 1278 (N.D.Ohio 1970), aff'd 440 F.2d 995 (6th Cir. 1971).
The Tax Commission also argues that even if this Court finds that the intention of the parties was to create a security interest, the provisions of the Sales Tax Law would still apply. The Tax Commission's argument can be summarized as follows: if the leases were in fact intended as security, then the transactions between Sherwood and its customers were conditional sales,
with Sherwood retaining a security interest in the collateral; since a conditional sale is in fact a "sale," then Sherwood had the responsibility to collect sales tax from its customers.
The viability of this argument, of course, depends upon whether Sherwood can be characterized as a "seller."
Sherwood argues that it was not a "seller," but merely a financing agency,
and as such it never "purchased" the equipment from the manufacturer-vendors, or "sold" it to the purchaser-lessees. To Sherwood, the equipment leases were security agreements whereby Sherwood received a security interest
in the equipment to secure the advances made to the purchaser-lessees.
The Uniform Commercial Code, § 2-104(2) defines a "financing agency" as:
"[A] bank, finance company or other person who in the ordinary course of business makes advances against goods or documents of title or who by arrangement with either the seller or the buyer intervenes in ordinary course to make or collect payment due or claimed under the contract for sale, as by purchasing or paying the seller's draft or making advances against it or by merely taking it for collection whether or not documents of title accompany the draft. 'Financing agency' includes also a bank or other person who similarly intervenes between persons who are in the position of seller and buyer in respect to the goods. (Section 2 -- 707)."
Sherwood, if acting as a financing agency, would not be considered a buyer or seller of the goods. The pivotal issue, then, is to determine whether Sherwood was acting as a financing agency or as a seller. This Court agrees with the Bankruptcy Judge that the proper method for analyzing the transactions in question is to "look through" the form of the agreement and to examine the intent of the parties and the facts and circumstances which existed at the time of the agreements.
Pursuant to this approach, the following factors become pertinent: (1) the equipment ordered by the purchaser-lessees was shipped directly to them by the manufacturer-vendors; (2) Sherwood would remit the full sales price plus any applicable sales tax to the manufacturer-vendors; (3) the purchaser-lessees had often placed purchase orders with the manufacturers-vendors prior to approaching Sherwood for financing; (4) Sherwood did not select or inspect any of the equipment; (5) the lessees were given options to purchase the equipment for nominal sums, usually from $1.00 to $10.00; (6) U.C.C. financing statements were executed and delivered to the lessees and filed by Sherwood; (7) the agreements were almost always discounted with a bank or other lending institution; (8) the monthly payments under the lease were calculated to return to Sherwood the purchase price, sales tax, interest and filing fees; (9) Sherwood does not maintain a warehouse for the storage of machinery and equipment; (10) Sherwood did not carry the leased property as assets on its books but rather as accounts receivable; (11) Sherwood did not take any depreciation deductions on the equipment; and (12) Sherwood has never taken possession of any of the leased equipment at the end of the leased term.
The combined effect of these factors supports not only the conclusion that the equipment lease transactions were security agreements, but also the fact that Sherwood was a "financing agency" and not a "seller" of the equipment. As such, Sherwood had no responsibility to collect sales tax.
As a final point, the Tax Commission argues that Sherwood owes $750 plus interest in compensating use tax for personal property leased from its landlord, Metromedia.
The lease provided that Metromedia would make available to Sherwood certain leasehold improvements, fixtures and equipment. It was Mr. Mulberg's conclusion that 10% of the $125,000 rental agreement "was for tangible personal property and thus subject to a compensating use tax." Mulberg Deposition at 78.
Mr. Mulberg also testified as to the following: the 10% figure was an estimate, "an approximation"; Sherwood had vacated the premises, so no inspection was ever made; he did not know what equipment was on the premises, or the amount of space rented by Sherwood, or the amount of rent per square foot. More importantly, Mr. Mulberg admitted that a figure of 7 1/2% or 15% could just as easily have been used as 10%. Mulberg Deposition at 77-81. Based on this testimony, it is the Court's conclusion that the $750 assessment was arbitrarily made, with little or no factual support, and must therefore be expunged.
The Order of the Bankruptcy Judge is affirmed.