In Re QDS Components, Inc.

MEMORANDUM OPINION

Prior to filing this Chapter 11 case, QDS Components, Inc. (“QDS” or the “Debtor”) entered into agreements, denominated leases, providing for the use of two John-ford TC-35 Turning Centers (the “Lathes”). The issue before the Court is whether the agreements constitute true leases or, as alleged by Lakin Manufacturing Company (“Lakin”), disguised security agreements.

This memorandum opinion constitutes the Court’s findings of fact and conclusions of law. Fed.R.Civ.P. 52 (made applicable here by Fed. R. Bankr.P. 7052 and 9014).

I. Jurisdiction

The Court has jurisdiction over this contested matter pursuant to 28 U.S.C. §§ 157 and 1334 and the general order of reference entered in this district. This is a core proceeding. 28 U.S.C. § 157(b)(2).

II. Factual and Procedural Background

QDS filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code on December 6, 2000 (the “Petition Date”). Prior to the Petition Date, QDS was engaged in the manufacture and sale of non-powered hubs and spindles for the agricultural market and rubber torsion axles used for agricultural equipment, recreational vehicles, and medium-weight trailers. As of the Petition Date, the Debtor’s manufacturing operations were conducted at a *316 plant located in Jackson Center, Shelby County, Ohio (the “QDS Facility”).

On May 18, 2000, approximately seven months before the Petition Date, QDS and Intech Funding Corp. (“Intech”) entered into the agreements in question — two substantially identical contracts entitled “Equipment Lease Agreement Number L0002447” (“Lease One”) and “Equipment Lease Agreement Number L0002448” (“Lease Two”) (collectively, the “Lease Agreements”). Under the Lease Agreements, QDS obtained the use of the Lathes, which were supplied by a third-party (Absolute Machine Tools, Inc.). The purchase price of each Lathe was $90,650.

The terms of the Lease Agreements are identical. Each of the Lease Agreements requires QDS to make payments to Intech totaling $110,425. Specifically, under each of the Lease Agreements, QDS is required to make: (1) prepayments totaling $27,195, consisting of a one-time, lump-sum payment of $24,326, plus an additional $2,870, which represents the advance payment of two regular monthly installments of $1,435; and (2) 58 monthly payments of $1,435. At the end of the 60-month term of the Lease Agreements, QDS has the option to purchase each Lathe for $9,065 (the “Option Amount”) plus applicable taxes. The Lease Agreements provide that, if QDS does not exercise its purchase option, it may either: (1) deliver the Lathes to Intech; 1 or (2) continue in possession of the Lathes, in which case the Lease Agreements automatically renew for successive one-month terms at the regular monthly installment amount of $1,435. Lease Agreements, ¶ 15.

The Lease Agreements contain an “Early Termination” provision that states, in relevant part:

EARLY TERMINATION. If no default exists under this Lease, you have the right upon thirty (30) days written notice to purchase all the Equipment, but not less than all the Equipment, and terminate the Lease. The purchase price will be the sum of (a) + (b) + (c) as follows: (a) the net present value of all unpaid Lease payments for the remainder of the term discounted at 7.0% A.P.R.; (b) the net present value of the purchase option discounted at 7.0% A.P.R.; (c) all other amounts due or that become due under the Lease. Upon our receipt from you of the purchase price calculated as (a) + (b) + (c) above we shall transfer our interest in the Equipment to you without representation, recourse, or warranty as is, where-is and we shall deliver all documents reasonably requested to transfer our interest in the Equipment to you.

Lease Agreements, ¶ 10.

Under the Lease Agreements, Intech expressly disclaimed all warranties. Id., ¶ 8. QDS bore the full risk of loss and was required to insure the Lathes at its own expense. Id., ¶¶ 11 and 12. In addition, QDS had to pay directly or reimburse Intech for all applicable taxes and fees. Id., ¶ 13. QDS also was responsible for paying all maintenance expenses. Id., ¶ 14. In the event of a default by QDS, the Lease Agreements afforded Intech the following remedies:

(a) [Intech] may cancel or terminate this Lease or any or all other agree *317 ments that we have entered into with you; (b) we may require you to immediately pay us, as compensation for loss of our bargain and not as a penalty, a sum equal to (i) the value of all unpaid Lease Payments for the remainder of the term plus the value of our anticipated residual interest in the Equipment, plus (ii) all other amounts due or that become due under this Lease; (c) we may require you to deliver the Equipment to us as set forth in Section 14; (d) we or our agent may peacefully repossess the Equipment without court order and you will not make any claims against us for damages or trespass or any other reason; and (e) we may exercise any other right or remedy available at law or in equity.

Id., ¶ 18.

The Lease Agreements recite that In-tech is the owner of the Lathes:

TITLE; RECORDING. [Intech is] the owner of and will hold title to the Equipment. You will keep the Equipment free of all liens and encumbrances. Unless the Purchase Option price shown on the front of this Lease is $1.00, you agree that this transaction is a true lease. However, if this transaction is deemed to be a lease intended for security, you grant us a purchase money security interest in the Equipment (including any replacements, substitutions, additions, attachments and proceeds) and the equipment shall secure, in addition to the lease obligations, any indebtedness at any time owed by you to us. You will deliver to us signed financing statements or other documents we request to protect our interest in the equipment. YOU AUTHORIZE U.S. TO FILE A COPY OF THIS LEASE AS A FINANCING STATEMENT AND APPOINT U.S. OR OUR DESIG-NEE AS YOUR ATTORNEY-IN-FACT TO EXECUTE AND FILE, ON YOUR BEHALF, FINANCING STATEMENTS COVERING THE EQUIPMENT.

Id., ¶ 15. Pursuant to the foregoing provision, Intech filed financing statements covering the Lathes with the Ohio Secretary of State and the Shelby County Recorder.

On May 24, 2000, Intech assigned Lease One to Mareap Vendor Finance Corp. (“Marcap”). Two days later, on May 26, 2000, Intech assigned Lease Two to U.S. Bancorp Leasing & Financial (“U.S. Ban-corp”). At approximately the same time that Intech assigned Lease Two to U.S. Bancorp, Heller Financial, Inc. (“Heller”), which held a blanket lien on all the assets of the Debtor, transmitted a letter to U.S. Bancorp acknowledging Heller’s agreement to subordinate its security interest in the Lathe that is the subject of Lease Two (the “U.S. Bancorp Lathe”) to the security interest granted to U.S. Bancorp under the Lease Agreement.

After determining that a reorganization of its business would not be possible, QDS sought and obtained Court authority to sell substantially all of its assets to Lakin pursuant to § 363(b) of the Code (the “Asset Sale”). The order authorizing the Asset Sale, which was entered on January 17, 2001 (the “Sale Order”), also granted the Debtor authority to assume and assign to Lakin its lease of the QDS Facility and a “Gas Vessel Rental Agreement” with BOC Gases. The Sale Order contained the following provision: “Any of the Purchased Assets that are subject to a lease will be transferred and conveyed to [Lakin] without further consideration in the event that the lease is deemed to be a capital lease as compared to a true lease or operating lease” (the “Capital Lease Provision”).

After the Asset Sale closed, the Debtor requested and obtained an order authorizing it to assume and assign to Lakin ten *318 unexpired leases and executory contracts. The Debtor also filed a motion seeking authority to reject certain of- its remaining unexpired leases and executory contracts, including the Lease Agreements (the “Rejection Motion”). Shortly before.the Rejection Motion was filed, U.S. Bancorp filed a motion for relief from the automatic stay, seeking an order authorizing it to recover the U.S. Bancorp Lathe (the “U.S. Bancorp Motion”). Invoking the Capital Lease Provision, Lakin opposes both the Rejection Motion (insofar as it requests authority to reject the Lease Agreements) and the U.S. Bancorp Motion. Lakin asserts, based on the Capital Lease Provision, that the Lease Agreements are, in fact, disguised security agreements. In Lakin’s view, the Lathes are property of QDS (subject to the security interests of U.S. Bancorp, Marcap, and Heller) properly transferred to Lakin by way of the Sale Order. U.S. Bancorp and Heller take the contrary position, asserting that the Lease Agreements are true leases.

Following discovery, U.S. Bancorp, Heller, and Lakin agreed to submit the dispute upon the following stipulated facts (the “Initial Stipulation”):

(1) The fair market value of the U.S. Bancorp Lathe will be $12,000 at the expiration of the Lease Agreements — i.e., in May 2005;

(2) The cost of shipping and rigging the U.S. Bancorp Lathe from its present location at the QDS Facility to either Portland, Oregon or Los Angeles, California would not exceed $7,200 (including insurance);

(3) The cost of shipping and rigging the U.S. Bancorp Lathe from its present location to a local storage facility would be approximately $1,500 to $2,500 and would cost approximately $100 per month to store (including insurance); and

(4)The remaining useful life of the U.S. Bancorp Lathe is at least five to six years — i.e., its useful life will extend until at least 2006.

In addition to the Initial Stipulation, the Court also received briefs from the Debt- or, Lakin, U.S. Bancorp, and Heller addressing the issue of whether the Lease Agreements are true leases or disguised security agreements.

After the Court took the U.S. Bancorp Motion under advisement, Marcap filed a motion for relief from stay (the “Marcap Motion”), seeking an order authorizing it to recover the Lathe that is the subject of Lease One (the “Marcap Lathe”). Lakin opposed the Marcap Motion, again arguing that, because the Lease Agreements are in fact disguised security agreements, the Marcap Lathe had been transferred to La-kin free and clear of liens pursuant to the Sale Order. After the Marcap Motion was filed, the parties asked the Court to consolidate the U.S. Bancorp and Marcap Motions. Because the Lease Agreements are identical, and the U.S. Bancorp and Mar-cap Motions present the same legal issue, the Court agreed to the consolidation of the Motions.

On June 10, 2002, Lakin and Marcap filed a stipulation with the Court that essentially tracks the Initial Stipulation, under which Lakin and Marcap agreed to submit the Marcap Motion upon the following facts:

(1) The fair market value of the Marcap Lathe will be $12,000 at the expiration of the Lease Agreements — i.e., in May 2005;

(2) The cost of shipping and rigging the Marcap Lathe from its present location at the QDS Facility to either Portland, Oregon or Los Angeles, California would not exceed $7,200 (including insurance);

*319 (3) The cost of shipping and rigging the Marcap Lathe from its present location to a local storage facility would be approximately $1,500 to $2,500 and would cost approximately $100 per month to store (including insurance); and

(4) The remaining useful life of the Mar-cap Lathe is at least five to six years — i.e., its useful life will extend until at least 2006. 2

III. Arguments of the Parties

Lakin asserts that the Lease Agreements constitute disguised security agreements rather than true leases. Thus, according to Lakin, the Lathes were: (1) owned by QDS at the time of the Asset Sale, subject to secured loans in favor of U.S. Bancorp and Marcap (collectively, the “Lessors”); and (2) transferred to Lakin pursuant to the Sale Order free and clear of liens, claims, and encumbrances, with the liens granted to the Lessors attaching to the proceeds of the Asset Sale. In La-kin’s view, the proceeds of the Asset Sale should be distributed either to the Lessors or Heller, based upon the Court’s determination of the relative priority of their security interests in the Lathes.

Lakin advances several arguments in support of its contention that the Lease Agreements are, in fact, disguised security agreements. First, Lakin maintains that, under § 1-201(37) of the Uniform Commercial Code (“UCC”), the Lease Agreements are conclusively presumed to have created security interests because QDS: (1) could not terminate its obligation to make payments for the entire term of the Lease Agreements; and (2) had the contractual right to become owner of the Lathes for nominal consideration. In support of its contention that the Option Amount contained in the Lease Agreements is nominal, Lakin relies on UCC § l-201(37)(x), arguing that the Option Amount is less than the Debtor’s “reasonably predictable cost of performing under the [L]ease [A]greement[s] if the [purchase option] is not exercised.” UCC § 1-201(37)(x) (West 2002). According to La-kin, the nominality of the Option Amount is also demonstrated by the application of “percentage tests”- — which require a comparison of: (1) the Option Amount and cost of the Lathes; (2) the Option Amount and the total stream of rental payments made by QDS under the Lease Agreements; and (3) the total payment stream and the Lathes’ original cost.

Alternatively, Lakin asserts that even if UCC § l-201(37)’s conclusive presumption does not apply, the Lease Agreements should nonetheless be found to be disguised security agreements because the economics of the transactions reveal that neither Intech (the assignor of the Lease Agreements) nor the Lessors retained a meaningful reversionary interest in the Lathes. Given the cost involved to ship the Lathes back to the Lessors upon termination of the Lease Agreements and the Lathes’ remaining economic life, Lakin maintains that Intech could not have reasonably expected to receive the Lathes back from QDS when the Lease Agreements terminated. Lakin also argues that Intech’s failure to retain a meaningful re-versionary interest in the Lathes is evidenced by “net lease terms” in the Lease Agreements — i.e., the Lease Agreements’ provisions requiring QDS to: (1) pay all applicable taxes, fees, and maintenance expenses; (2) bear the risk of loss; and (3) insure the Lathes. Finally, Lakin points to the subordination agreement between *320 Heller and U.S. Bancorp, the large upfront payment QDS was required to pay Intech, and the fact that the Lathes were supplied by a third party as evidence that the Lease Agreements are, in fact, disguised security agreements.

U.S. Bancorp and Heller challenge La-kin’s contention that UCC § 1-201(37)’s conclusive presumption applies. To trigger the statutory presumption, Lakin must show that: (1) QDS could not terminate its payment obligation under the Lease Agreements; and (2) the Option Amount is nominal. According to U.S. Bancorp and Heller, Lakin has failed on both counts. First, Heller points out that the Lease Agreements afford QDS a contractual right of termination. Second, U.S. Ban-corp and Heller also contend that Lakin has not demonstrated that the Option Amount is nominal. They take issue with the methodology that Lakin employs to establish the Option Amount’s nominality, which factors in the economic value of the Lathes that QDS will forego if it elects not to exercise the purchase option. U.S. Ban-corp and Heller argue that the lost economic value of the Lathes is not a “cost of performing under the [L]ease [AJgree-ments” within the meaning of UCC § 1-201(37)(x).

U.S. Bancorp and Heller also maintain that Lakin’s reliance on percentage tests is misplaced, asserting that percentage tests have been rejected as an unreliable measure of nominality by courts and commentators alike. According to Heller, the most accepted and appropriate test for determining whether a purchase option amount is nominal requires a comparison of the option price with the projected fair market value of the “leased” goods at the time the option arises. Under this test, the option price is not nominal if it bears a reasonable relationship to the predicted residual value. Lakin has failed to demonstrate the nominality of the Option Amount under this standard, Heller argues, because it offered no evidence establishing what the original contracting parties projected the fair market value of the Lathes would be at the end of the term of the Lease Agreements. U.S. Bancorp further contends that a comparison between the stipulated fair market value of the Lathes at the end of the lease term and the Option Amount negates Lakin’s nomi-nality argument. According to U.S. Ban-corp, while the $9065 Option Amount is less than the $12,000 stipulated fair market value of the Lathes, an Option Amount representing over three-fourths of stipulated fair market value is clearly not nominal.

U.S. Bancorp and Heller also argue that the Lessors did in fact retain a meaningful reversionary interest in the Lathes. They contend that the following factors demonstrate that the Lessors fully expected to receive something of value back from QDS upon expiration of the term of the Lease Agreements: (1) the Lathes’ economic life extends beyond the term of the Lease Agreements; and (2) QDS is required to maintain, and insure the Lathes and return them to the Lessors at the end of the lease term. Moreover, according to U.S. Bancorp and Heller, the fact that the Lease Agreements are “net leases” — i.e., QDS is required to pay all applicable taxes and fees, pay all maintenance expenses, and bear the full risk of loss of the Lathes — simply does not establish that the Lessors relinquished their reversionary interest in the Lathes. They cite decisions holding that the inclusion of net lease terms in a purported lease does not constitute a valid basis for recharacterizing the agreement as a disguised secured sale. Heller also asserts that the fact that the Lathes were obtained from a third-party supplier should not be factored into the *321 Court’s lease versus disguised security agreement calculus.

Finally, U.S. Bancorp raises several procedural arguments. First, it asserts that it was not afforded the opportunity to fully protect its rights because it did not receive notice — from either the Debtor or Lakin— prior to the hearing to consider approval of the Asset Sale (the “Sale Hearing”) that Lakin would invoke the Capital Lease Provision and ask the Court to recharacterize the Lease Agreements. Had it received notice of Lakin’s intentions, U.S. Bancorp argues, it would have opposed the Asset Sale. Second, U.S. Bancorp submits that Lakin should have been required to commence an adversary proceeding or an “independent contested matter” in order to challenge U.S. Bancorp’s status as a true lessor. U.S. Bancorp Reply Brief (Doc. No. 104-1) at 6.

IV. Legal Analysis

A. The True Lease vs. Disguised Security Agreement Conundrum

1. Preliminary Statement

a. Applicable Law

The existence, nature, and extent of a security interest in property is governed by state law. Butner v. United States, 440 U.S. 48, 55, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979). Thus, “whether a ... lease constitutes a security interest under the bankruptcy code will depend on whether it constitutes a security interest under applicable State or local law.” Powers v. Royce, Inc. (In re Powers), 983 F.2d 88, 90 (7th Cir.1993) (quoting S.Rep. No. 989, 95th Cong., 2d Sess. 26 (1978), U.S.Code Cong. & Admin.News 1978, 5787, 5812; H.R.Rep. No. 595, 95th Cong., 1st Sess. 314 (1977), U.S.Code Cong. & Admin.News 1978, 5963, 6271). See also In re Kim, 232 B.R. 324, 328 (Bankr.E.D.Pa.1999) (“It is well established that the question of whether an agreement that appears on its face to be a lease is in reality a security agreement is to be determined by reference to state law.”). The Lease Agreements contain a California choice of law clause, and the parties agree that California law governs. 3

UCC § 1-201(37), which is set forth in full infra at pp. 330-31, defines the term “security interest” and provides a test for distinguishing a true lease from a disguised security agreement. In 1988, California adopted the current version of UCC § 1-201(37), which had been amended as a uniform law in 1987. 4 PSINet, Inc. v. Cisco Sys. Cap. Corp. (In re PSINet, Inc.), 271 B.R. 1, 43 (Bankr.S.D.N.Y.2001); Addison v. Burnett, 41 Cal.App.4th 1288, 1294, 49 Cal.Rptr.2d 132, 136 (1996).

b. Burden of Proof

As the party asking the Court to characterize the Lease Agreements as “other than what [they] purport[] to be [,]” Lakin bears the burden of proof. In *322 re Murray, 191 B.R. 309, 316 (Bankr.E.D.Pa.1996). See also In re Triplex Marine Maint., Inc., 258 B.R. 659, 664 & n. 8 (Bankr.E.D.Tex.2000) (placing burden of proof on trustee “who is the party who asserts that the transaction is other than what it purports to be in a written agreement”); In re Owen, 221 B.R. 56, 60 (Bankr.N.D.N.Y.1998) (“The Debtors have the burden of demonstrating that the transaction was other than what it purports to be in the agreement.”); In re Edison Bros. Stores, Inc., 207 B.R. 801, 812 & n. 14 (Bankr.D.Del.1997) (imposing the burden of proof on the debtor “as the party seeking to characterize the Lease Agreement as an instrument other than a lease”).

c. Definitions of “Lease” and “Security Interest”

The authors of a leading treatise on the UCC define a lease, a sale, and a transaction creating a security interest as follows:

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 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.

James J. White & Robert S. Summers, Uniform Commercial Code vol. 4, § 30-3, 14 n. 18 (5th ed., West 2002). The hallmark of a lease is that it grants the lessee the right to use property for a period less than its economic life with the concomitant obligation to return the property to the lessor while it retains some substantial economic life. See In re Marhoefer Packing Co., 674 F.2d 1139, 1145 (7th Cir.1982) (“An essential characteristic of a true lease is that there be something of value to return to the lessor after the term. Where the term of the lease is substantially equal to the life of the leased property such that there will be nothing of value to return at the end of the lease, the transaction is in essence a sale.”); In re APB Online, Inc., 259 B.R. 812, 817 (Bankr.S.D.N.Y.2001) (“[W]hen we speak of the intent to sell or lease, we mean the intent to convey the use of the property for its remaining useful life to the lessee, or alternatively, to vest a reversionary interest in the lessor at the end of the term.”); E. Carolyn Hoehstadter Dicker & John P. Campo, FF & E and the True Lease Question: Article 2A and Accompanying Amendments to UCC Section 1-201(87), 7 Am Bankr.Inst. L.Rev. 517, 533 & n. 48 (Winter 1999) (“[T]he principal characteristic of a lease, which distinguishes it from a secured transaction, is that it allows the lessee the right to use the leased property with an attendant opportunity to return the property to the lessor while it still has some ‘substantial economic life.’ ” (quoting In re New Items Co., Inc., 72 B.R. 1017, 1019 (Bankr.N.D.Ohio 1987))). 5

While the foregoing concepts appear at first blush to be deceptively simple, courts have had great difficulty distinguishing a true lease from a disguised security agreement. See Ronald M. Bayer, Personal Property Leasing: Article 2A of the Uniform Commercial Code, 43 Bus. Law. 1491, 1497 (August 1988) (referring to an *323 “enormous amount of confusion” in the caselaw); Michael W. Gaines, Security Interests Under Article %A: More Confusion in the Leasing Arena, 18 Stetson L.Rev. 69, 69 (Fall 1988) (describing “the plethora of litigation regarding lease agreements and leased equipment”); Peter J. Coogan, Reflections of a Drafter, 43 Ohio St. L.J. 545, 550 (1982) (observing that courts “struggle with the idea of whether a lease with certain attributes is a ‘true lease’” and noting the existence of “loads of cases that just cannot be reconciled”). Indeed, the issue of whether an arrangement is a true lease or a disguised security agreement is one of the most vexatious and offc-litigated issues under the UCC. See Morris v. U.S. Bancorp Leasing & Fin. (In re Charles), 278 B.R. 216, 221 (Bankr.D.Kan.2002) (“The issue of whether so-called ‘finance leases’ are in reality security agreements has vexed the courts for many years.”); Carlson v. Giacehetti, 35 Mass.App.Ct. 57, 616 N.E.2d 810, 810 (1993) (“Whether, under the Uniform Commercial Code, an equipment lease is to be treated as a ‘true lease’ or as a security agreement is an issue that has been litigated extensively for two decades.... ”); White & Summers, § 30-3, at 12 (“The ‘lease vs. security interest’ issue [is] one of the most frequently litigated issues under the Uniform Commercial Code.”).

To fully address and effectively dispose of the arguments raised by the parties, the Court must briefly explore the history of the governing statute — § 1-201(37) of the UCC. The Court traces the development of the current version of § 1-201(37) and the body of hopelessly irreconcilable decisions construing it and the former version of the statute 6 not simply to provide historical perspective. The parties urge the Court to apply a number of different legal tests to determine whether the Lease Agreements are in fact true leases. It is therefore necessary to review the genesis and evolution of the various decisional standards in order to determine which of these various tests provides a sound basis for distinguishing a true lease from a disguised security agreement.

2. Distinguishing a True Lease From a Disguised Security Agreement Under “Old § 1-201(37)”

Prior to the 1987 revision to UCC § 1-201(37), the statute (“Old § 1-201(37)”) read as follows:

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.

UCC § 1-201(37) (West 1986) (amended 1987). Old § 1-201(37) provided only the few express guidelines for distinguishing a true lease from a disguised security agreement listed below:

(1) Whether a lease is intended for security is to be determined by the facts of each case;

*324 (2) The existence of an option to purchase does not create a security interest as a matter of law; and

(3) An option to purchase for no or nominal consideration does make the lease a security interest as a matter of law.

These limited decisional guideposts, as well as the statute’s reference to the intent of the parties, resulted in a “profusion of inconsistent views among the courts regarding the proper criteria to be applied in determining whether an agreement denominated as a lease created a true lease or a security interest.” Kim, 232 B.R. at 329. See also Corinne Cooper, Identifying a Personal Property Lease Under the UCC, 49 Ohio St. L.J. 195, 199 (1987) (noting that under Old § 1-201(37) “the basis in law for distinguishing ... [a sale, a lease, or a security interest] has become hopelessly blurred”).

Courts applying Old § 1-201(37) formulated a variety of tests to distinguish a true lease from a disguised security agreement. The decisions under Old § 1-201(37) generally fall into two broad categories: (1) cases in which courts distinguish a true lease from a disguised security agreement by applying a laundry list of factors (the “Multiple-Factor Approach”); and (2) cases in which courts distinguish a true lease from a disguised security agreement by utilizing various common law tests to determine whether the purchase option amount stated in a purported lease agreement is nominal. See generally White & Summers, § 30-3, at 20 (noting that “courts have often used a list of factors to distinguish a lease from a security agreement”); Laurie L. Dawley, The Continuing Debate Regarding the Lease Versus Disguised Security Interest Issue: Did the Edison Court Correctly Find a True Lease?, 24 J. Corp. L. 169, 182-83 (1998) (observing that “to uncover the economic realities of a transaction,” some courts “apply a multi-factored approach”); Am. President Lines, Ltd. v. Lykes Bros. S.S. Co. (In re Lykes Bros. S.S. Co.), 196 B.R. 574, 581 (Bankr.M.D.Fla.1996) (describing the various common law tests “[c]ourts have adopted ... to determine whether the option to purchase is nominal”); Cooper, 49 Ohio St. L.J. at 224 (discussing various common law nominality tests).

a. The Multiple-Factor Approach

The bankruptcy court’s decision in KL.C., Inc. v. Brookside Drug Store, Inc. (In re Brookside Drug Store, Inc.), 3 B.R. 120 (Bankr.D.Conn.1980) exemplifies the Multiple-Factor Approach. There, the court set forth the following fist of 16 factors to be applied in determining whether an agreement created a true lease or a disguised security agreement:

(1) whether there was an option to purchase for a nominal sum;

(2) whether there was a provision in the lease granting the lessee an equity or property interest in the equipment;

(3) whether the nature of the lessor’s business was to act as a financing agency;

(4) whether the lessee paid a sales tax incident to acquisition of the equipment;

(5) whether the lessee paid all other taxes incident to ownership of the equipment;

(6) whether the lessee was responsible for comprehensive insurance on the equipment;

(7) whether the lessee was required to pay any and all license fees for operation of the equipment, and to maintain the equipment at his expense;

(8) whether the agreement placed the entire risk of loss upon the lessee;

(9) whether the agreement included a clause permitting the lessor to acceler *325 ate the payment of rent upon default of the lessee and granted remedies similar to those of a mortgagee;

(10) whether the equipment subject to the agreement was selected by the lessee and purchased by the lessor for this specific lessee;

(11) whether the lessee was required to pay a substantial security deposit in order to obtain the equipment;

(12) whether the agreement required the lessee to join the lessor, or permit the lessor by himself, to execute a UCC financing statement;

(13) whether there was a default provision in the lease inordinately favorable to the lessor;

(14) whether there was a provision in the lease for liquidated damages;

(15) whether there was a provision disclaiming warranties of fitness and/or merchantability on the part of the lessor; and

(16) whether the aggregate rentals approximated the value or purchase price of the equipment.

Id. at 122-23. See also Venn v. Howell’s Auto Repair Ctr. (In re Howell), 161 B.R. 285, 289 (Bankr.N.D.Fla.1993) (applying a 12-factor test); Amvest Funding Co. v. Rex Group, Inc. (In re Rex Group, Inc.), 80 B.R. 774, 779 (Bankr.E.D.Va.1987) (setting forth a nine-factor test for distinguishing a true lease from disguised security agreement); In re Standard Fin. Mgmt. Corp., 79 B.R. 100, 102 (Bankr.D.Mass.1987) (adopting the 16-factor test articulated in Brookside); Keydata Corp. v. Int’l Paper Credit Corp. (In re Keydata Corp.), 18 B.R. 907, 910 (Bankr.D.Mass.1982) (listing six factors that are indicative of a disguised security agreement); Cooper, 49 Ohio St. L.J. at 230 (identifying 10 factors that courts deem “to create a disguised security interest”); White & Summers, § 30-3, at 21-22 (identifying a 10-factor “laundry list”).

The rationale underlying the Multiple-Factor Approach is that certain rights and obligations — “incidents of ownership” — are allocated to one party under a lease and to the other in a sale. APB Online, 259 B.R. at 821. Courts following the Multiple-Factor Approach reason that a lessee’s assumption and discharge of substantially all the risks and obligations ordinarily associated with the outright ownership of the property is more indicative of a financing transaction than a true lease. See, e.g., Adelman v. Gen. Motors Acceptance Corp. (In re Tulsa Port Warehouse Co.), 690 F.2d 809, 811-12 (10th Cir.1982) (applying Multiple-Factor Approach and finding purported lease agreement created a security interest where “[t]he lessee is required to obtain comprehensive insurance in favor of the lessor; pay sales tax and all other licenses, registration, and title fees; pay for all maintenance and repairs; and indemnify the lessor against all loss” because “[a]s a practical matter, the lessee holds all incidents of ownership except bare legal title”); Taylor Rental Corp. v. John Deere Co. (In re Noack), 44 B.R. 172, 174 (Bankr.E.D.Wis.1984) (“If ... the proprietary interest in the property is weighted in favor of the party designated as lessee, then the document is in reality a security agreement. If, on the other hand, the balance of incidents of ownership tips toward the party designated as lessor, then the document is a true lease.”).

Among the factors that courts employing the Multiple-Factor Approach find indicative of a disguised security agreement are “net lease” terms — i.e., provisions in the purported lease agreement imposing on the lessee the obligation to bear risks of loss, pay taxes, insurance, and license/registration fees (“Net Lease Provisions”). See, e.g., HPSC, Inc. v. Wakefield (In re *326 Wakefield), 217 B.R. 967, 971 (Bankr.M.D.Ga.1998) (concluding that fact that “debtor bore the risk of loss or damage” and “was obligated ... to maintain insurance, and to pay all taxes” indicated that “agreement was not a true lease”); In re Maritt, 155 B.R. 12, 13 (Bankr.D.Idaho 1993) (holding that Net Lease Provisions in agreement, together with other factors, establish that the transaction is a sale).

The Multiple-Factor Approach has been criticized by many courts and commentators as being a flawed methodology for distinguishing a true lease from a disguised security agreement. See, e.g., In re Aspen Impressions, Inc., 94 B.R. 861, 868 (Bankr.E.D.Pa.1989) (noting that Multiple-Factor Approach is, “at best, inconclusive of the issue [of true lease status] as [the factors] can all legitimately appear in true leases”); In re Loop Hosp. P’ship, 35 B.R. 929, 936 (Bankr.N.D.Ill.1983) (“[I]t is unfortunate that the courts have relied on these so-called incidents or burdens of ownership. The factors are basically irrelevant as they can appear in true leases, and merely add to the confusion in analyzing these cases.”); White & Summers, § 30-3, at 22-23 (“There are two problems with the laundry list approach. First, some of the items on the list should not be there because they are equally consistent with a document’s being a security interest or a lease.... A second problem with the laundry list is its vagueness. A list of ten factors necessarily makes it more difficult to predict how a judge will characterize the arrangement.”); Cooper, 49 Ohio St. L.J. at 230 (“Rather than focusing upon any of the economic distinctions between these two transactions, the courts have developed a laundry list of factors they rely upon to find that a lease is subject to Article 9 [of the UCC].”). Further, the better reasoned decisions hold that the presence in an agreement of Net Lease Provisions does not necessarily signal a disguised security agreement. See Marhoefer Packing, 674 F.2d at 1146 (“Although [the debtor] was required to pay state and local taxes and the cost of repairs, this fact does not [suggest that agreement is a sale rather than true lease]. Costs such as taxes, insurance and repairs are necessarily borne by one party or the other. They reflect less the true character of the transaction than the strength of the parties’ respective bargaining positions.”); Ford Motor Credit Co. v. Hoskins (In re Hoskins), 266 B.R. 154, 162 (Bankr.W.D.Mo.2001) (“[T]he [debtors’] obligation to insure the vehicle during the lease term, maintain and repair the vehicle and pay all license, title and registration costs does not transform the lease into security for a conditional sales contract.”); Rainier Nat’l Bank v. Inland Mach. Co., 29 Wash.App. 725, 631 P.2d 389, 395 (1981) (“The lessor is either going to include those costs within the rental charge or agree to a lower rent if the lessee takes responsibility for them.”); "White & Summers, § 30-3, at 27 (“[L]esse