July 21 2004
In a situation where a lessee defaults on a lease agreement, and the lessor has elected to retain the goods concerned or a disposition of the goods has occurred which does not comply with Section 2A-527 of the code, Section 2A-528 permits the lessor to recover the following as damages from the lessee:
However, if these damages do not put the lessor in as good a position as performance would have, damages may be calculated as follows:
If, after a lease default, the lessor elects to dispose of the leased goods, Section 2A-527(1) permits such disposition to take place by lease, sale or some other method. The disposition is subject to the discretion of the lessor and a function of the lessor’s commercial judgement.(6) If the lessor makes any profit on such a disposition, the lessor is not accountable to the lessee for that profit.(7) Even if the lessor fails to comply with one or more requirements of Article 2A of the Uniform Commercial Code, any subsequent lessee or buyer which in good faith and for value leases or buys the goods from the lessor takes the goods free of the original lease contract and any rights of the original lessee.(8)
Pursuant to Section 2A-527(2), if the disposition is by a new lease "substantially similar" to the original defaulted lease,(9) the lessor may recover the following as damages from the lessee:
If the lessor attempts to dispose of the goods concerned by lease agreement but fails to satisfy the criteria in Section 2A-527(2), or if the lessor disposes of the goods concerned by sale or by another method, Section 2A-527(3) allows the lessor to recover damages from the lessee as if the lessor had elected to proceed under Section 2A-528 and not dispose of the goods.(10)
Sections 2A-527 and 2A-528 are interrelated and provide for different methods of determining damages based on the lessor’s circumstances. However, as a prerequisite to recovery under Section 2A-527 or 2A-528, several additional requirements must be established. First, the default must be one of the following types:
Second, the lessor and lessee cannot have agreed to calculate damages in any one of the following ways: (i) by providing for liquidated damages in the lease agreement;(15) or (ii) by including rights and remedies for default to the exclusion of those provided in Article 2A of the code, or limiting or altering the measure of damages recoverable under Article 2A.(16)
If the parties to a lease include any of the above measures, the parties calculate damages in accordance with their agreement and do not use Sections 2A-527 and 2A-528. However, if any such damages provisions in the lease are deemed to be unenforceable or unconscionable, or fail in their essential purpose, the damage determination reverts to the applicable Uniform Commercial Code provisions.(17)
A lessor must meet additional requirements before it can recover damages under Section 2A-527(2). The new lease agreement with a third party must be both substantially similar to the original lease agreement and made in good faith and in a commercially reasonably manner. While 'good faith' and 'commercial reasonableness' are familiar terms in the code, the concept of 'substantial similarity' is not a familiar term.(18)
The determination that a new lease is substantially similar to an original lease is made on a case-by-case basis, and is guided by terms within the lease that allocate cost and risk between the parties to the lease. For example, such terms may be:
These terms are evaluated separately and not with scientific precision. Rather, commercial judgement is used to determine whether the lease terms, when viewed together, lead to a finding that the new lease is or is not substantially similar to the original lease. In comparing two leases, it is possible for a new lease to be substantially similar to the original lease, even if the terms of the new lease extend beyond the remaining terms of the original lease, and even if the beginning and ending dates of the two leases are not the same.(19)
Thus, if a lessee defaults on a lease agreement, the lessor has a variety of options under Sections 2A-527 and 2A-528 of the Uniform Commercial Code. Assuming the default meets certain statutory requirements, and assuming the parties have not contracted for a specific manner in which to calculate damages, the lessor can retain the goods or dispose of the goods. If the lessor disposes of the goods, it can do so by lease, sale or some other method. The lessor can choose which course of action to take, but the type and amount of damages that a lessor ultimately receives under the code will directly depend on what actions the lessor does take.
(2) A 'default' is different from an 'event of default'. The latter becomes the former only after the expiration of any relevant grace period and compliance with any notice requirements under Article 2A and the lease agreement, and depends on whether, as a matter of fact or law, the event of default has been waived, suspended or cured. UCC Section 2A-528 cmt 2.
(3) 'Present value' is defined as “the amount as of a date certain of one or more sums payable in the future, discounted to the date certain by use of either an interest rate specified by the parties if that rate is not manifestly unreasonable at the time the transaction is entered into or, if an interest rate is not so specified, a commercially reasonable rate that takes into account the facts and circumstances at the time the transaction is entered into”. UCC Section 2A-103(1)(aa).
(6) Section 2A-527 cmt 1. In New York, the lessor is given the specific election to proceed under Section 2A-527 or Section 2A-528 even if the disposition would otherwise qualify under Section 2A-527. NYUCC Section 2A-527(3) (McKinney 2004).
(7) UCC Section 2A-527(5). Also, a lessee that has rightfully rejected or justifiably revoked acceptance shall account to the lessor for any excess over the amount of the lessee’s security interest. Id (citing UCC Section 2A-508(4)).
(10) Under some of the circumstances where a lessor may proceed under Section 2A-528, the lessor may also be able to proceed under Section 2A-529 ("Lessor’s Action for the Rent"). UCC Section 2A-528 cmt 1.
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