The leases covered by the Uniform Commercial Code (UCC) are for personal property, or what the Code calls "goods." These goods include:
The UCC, however, does not cover real estate leases. Most of the rules for commercial lease contracts are in Article 2A, which has nearly 80 individual sections. Additional relevant rules are located in other parts of the UCC, such as Article 1 (General Provisions) and Article 9 (Secured Transactions). Here we'll look briefly at some of the main UCC lease rules.
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A lease is when one person gives another person the right to possess and use a good in exchange for consideration (value), usually money. Lease contracts involve two parties:
A lease is different from a sale. A sale is when a person buys a good and receives title to the good with no intention of returning it. A lease is when a person uses a good but doesn't receive title and has the intention to return the good once the lease term ends.
There are three main types of leases under the UCC:
Both a consumer lease and a non-consumer lease can also be a finance lease. Finance leases have important characteristics that distinguish them from standard leases.
A finance lease agreement is usually between a financing company (the "lessor") and a business or consumer (the "lessee"). The UCC has special rules for finance leases.
A finance lease differs from a standard lease in multiple ways.
The parties involved. In a regular lease, you have two parties: the lessor and the lessee. In a finance lease, you have three parties: the lessor, the lessee, and a seller (also called a "supplier"). The lessor buys a good from a seller for the purpose of leasing the good to the lessee.
Who owns the good in the beginning. The process of a finance lease starts when the lessee finds a good that they want to lease. At the time the lessee identifies the good, someone else who's not the lessor—but is instead a seller or manufacturer—owns the good. Once the lessee picks the good out, the lessor then buys the good from the seller. Whereas in a typical lease, the lessor owns the good from the beginning.
The parties' trade and industry. In a finance lease, the lessor is usually a financing company that doesn't have any expertise in or knowledge about the leased good. Their primary trade is in providing financing, not in supplying or manufacturing goods. In a regular lease, the lessor is usually someone who buys and leases goods—such as a car dealership—or manufactures goods.
The parties' involvement in the goods. In a regular lease, because the lessor owns the goods and trades in the goods, they have a better knowledge of the goods. The lessor supplies the lessee with information about the goods, including the associated warranties. In a finance lease, the lessor's role is limited. Instead, it's the seller (supplier) who provides the information about the goods as well as the promises and warranties. Often, the lessee will talk to the supplier about the goods and negotiate a price before the lessor purchases the goods. The lessor simply provides a way for the lessee to obtain the goods.
Now that we've gone over a few of the differences, let's look at how a finance lease works.
With a finance lease, typically the following occurs:
Before the lessee signs a lease agreement with the lessor, the lessee will either:
(U.C.C. § 2A-103 (2023).)
So while the lessee isn't a party to the sales contract for the good, the lessor does involve the lessee in the process. The lessee is the one who picks out the good and inspects the good to make sure it's the one they want to lease. Generally, the lessee also has access to the sales contract and usually has the same information about the goods that the lessor does.
If the lease isn't a consumer lease, then the UCC puts more stringent requirements on the lessor. As mentioned previously, a "consumer lease" is one where the lessee is using the goods primarily for personal, family, or household purposes. So, if you're using the goods for business purposes, then these additional requirements would likely apply to your lease.
If the lease isn't a consumer lease, then the lessor—before the lessee signs the lease agreement—must inform the lessee in writing:
(U.C.C. § 2A-103 (2023).)
These additional requirements somewhat overlap with the general requirements associated with a consumer finance lease. For example, if the lessee receives a copy of the lessor's sales contract, then they'd probably already know who the seller is and potentially the warranties and promises associated with the goods. But these additional requirements assure that the lessor has this information in writing and is entitled to these promises and warranties—rather than just being aware of their existence.
One specific rule to note about non-consumer finance leases is that they're irrevocable. Once the lessee accepts the goods, they must perform their obligations under the contract. (U.C.C. § 2A-407 (2023).) The reasoning for the contract being irrevocable is because the lessee was the one who picked out the goods and the lessor purchased the goods and arranged the transaction based on what the lessee wanted. Also, the lessor usually isn't a regular seller or manufacturer of that good so it might not make as much sense for the lessor to guarantee anything about the goods beyond what the seller or supplier guarantees.
Sometimes determining whether something's a lease or a secured transaction can be difficult. In fact, there are many court cases surrounding that particular issue. The UCC makes an important distinction between leases and secured transactions—and explicitly says that a lease that creates a security interest isn't a lease.
True lease. If a business is truly leasing an item, the lessor keeps title to the item and has the right to repossess the item if the business runs out of money. With a true lease, there's an expectation that the lessee will return the item at the end of the lease term.
Secured transaction. If a business is actually buying an item over time on credit, then it's the business that has title to the item. If the business runs out of money, other creditors besides the lessor could have rights to take the item to satisfy unpaid debts.
Generally, the question of whether a lease is a true lease or a secured transaction comes up when:
If the lease creates a security interest in the goods, then the lease becomes a secured transaction. The contract would then be governed by UCC Article 9 instead of Article 2A.
A lease for goods will create a security interest in the goods if the lessee (buyer) is obligated to make payments on the goods for the entire term of the lease without a right to early termination. In other words, a lease isn't a security interest if the lessee can cancel the lease early.
In addition to meeting the above requirements, to create a security interest, a lease must also have at least one of the following features:
(U.C.C. § 1-203 (2023).)
This rule might appear somewhat complicated but can be explained with a few short examples.
Example one: Your business signs a three-year "lease" for a very old office machine that only has an additional two-year useful life. This "lease" is, in fact, a sale on an installment plan and—per the first listed item above—creates a security interest.
Example two: Your business signs a two-year "lease" for the same old office machine as in example one. The lease can be renewed at the end of the two years, at no additional charge. This transaction is effectively a sale and—per the third listed item above—creates a security interest.
Example three: Your business signs a five-year "lease" for a different office machine that gives you the option to become the owner of the machine at the end of the five-year period at no additional charge. Again, this is effectively a sale and—per the last listed item—also creates a security interest.
These features typically indicate that someone is buying a good—and someone is selling it—rather than leasing it. If the transaction was a lease, usually the parties would act in a way that showed that the lessor had plans to or was open to leasing the good to someone else after the lease term was over.
Transactions might superficially appear to be lease contracts but in fact, are secured transactions. In these situations, "lessors" (actually, sellers) need to take additional steps to protect their interests in the goods. Many lessors will preemptively take these steps in case a court determines that their lease is actually a secured transaction.
Usually, if it's been determined that a lease is actually a secured transaction, then the seller has already attached the security interest. Specifically, the buyer has:
Once the security interest attaches, the seller needs to take an additional step to perfect the security interest. Perfecting their security interest will ensure that the seller receives higher priority over other unperfected creditors in regard to their rights and claims to the goods.
For example, suppose the seller has perfected their security interest in the goods. These goods are also serving as collateral for the purchase. The buyer stops making payments and the seller wants to repossess the good to satisfy the debt. But another creditor who hasn't perfected their security interest in the good also wants to lawfully repossess the goods. In this case, the seller would have the right to repossess the goods over the unperfected creditor because they have perfected their security interest.
To perfect their security interest, the seller should file a UCC financing statement with the appropriate government office.
For more information, see how to attach and perfect a security interest under the UCC.
Generally speaking, the UCC applies its warranty rules for the sale of goods to leases. So, just like there are rules for express warranties and implied warranties when goods are sold, there are rules for express warranties and implied warranties when goods are leased.
Generally, there are three main types of warranties:
The rules for these warranties—including how they're created, modified, disclaimed, and breached—are all nearly identical for sales and for leases. The rules regarding the exclusion of warranties in lease contracts are also quite similar to the exclusion rules for sales contracts.
It's important to note that the implied warranties of merchantability and fitness for a particular purpose don't apply to finance leases.
Implied warranty of merchantability. With a finance lease, the lessor is typically a financial institution that doesn't regularly trade in the associated goods. Therefore, the lessor isn't a merchant. Since the implied warranty of merchantability only applies to merchants, finance leases are excluded. (U.C.C. § 2A-212 (2023).)
Implied warranty of fitness for a particular purpose. Similarly, the lessor in a finance lease doesn't usually have any skill or knowledge in the good being leased. Instead, normally the lessee relies on their own knowledge and skill or on that of the supplier when picking a good to lease. So, an implied warranty of fitness for a particular purpose wouldn't be created between the lessor and lessee. (U.C.C. § 2A-213 (2023).)
For additional information about lease warranties, read about the warranties for sales contracts.
In legal lingo, a law requiring a contract to be in writing is known as a "statute of frauds." The UCC has a statute of frauds for leases. (U.C.C. § 2A-201 (2023).)
The general rule is that if the total payments to be made under the lease, excluding payments for options to renew or buy, are $1,000 or more, the lease must be in writing. The requirements for the enforceability of a lease are relatively flexible, allowing for omission or incorrect statements of certain terms. For example, if you left out a delivery date on the lease, then it'd probably still be enforceable.
There are exceptions to the $1,000 or more rule. Most notably, in cases involving "specially manufactured" goods or goods that have already been received and accepted by the lessee, you don't need a written contract—regardless of the total payment amount.
As discussed earlier, if the contract is for a non-consumer finance lease, then the lessor is required to provide the lessor with certain information in writing.
For more information, read about when UCC contracts must be in writing.
A party is in default on a lease if they fail to meet their obligations under the lease contract. A lessor's obligations under a lease contract are very similar to a seller's obligations under a sales contract. Likewise, a lessee's obligations under a lease contract are similar to a buyer's obligations under a sales contract.
When one party defaults on a lease contract, the other party has the right to a remedy for that default. If one party defaults, then the other party isn't required to provide them notice of the default unless the lease agreement calls for it. (U.C.C. § 2A-502 (2023).)
Unless agreed to otherwise, you must take action against the defaulting party within four years from the time when you discovered or should've discovered the default. (U.C.C. § 2A-506 (2023).)
If the lessor defaults, the lessee might be entitled to:
(U.C.C. § 2A-508 (2023).)
If the lessee defaults, the lessor might be entitled to:
(U.C.C. § 2A-523 (2023).)
When reviewing your lease or when considering making a lease, Article 2A of the UCC is often a good guide. Almost every state, with the exception of Louisiana, has adopted Article 2A into its commercial code. But states might have different variations of the code in their laws so it's important to check your state's specific laws.
If you have legal questions about your situation, consider talking to a business attorney. They can advise you on whether your lease is a true lease or a security agreement or they can draft a lease agreement for you.