When Is a Lease a "Lease"? The 7th Circuit's "Trilogy of the UAL Leases" Tackles This Perennial Question

To Shakespeare's Juliet, "a rose by any other name would smell as sweet."  To Gertrude Stein, "a rose is a rose is a rose."  In an article referenced here, titled "When Is a Lease Not a Lease? Seventh Circuit Adopts 'Substance Over' Form Test for True Lease Determination," Jones Day's Mark Douglas and  David Hatch reviewed the first of the 7th Circuit's rulings on whether UAL's airport leases were "true leases" or secured financings.

Last week, Judges Manion, Easterbrook, and Bauer, in the final installment of their "trilogy" on whether "a lease is a lease is a lease by any other name," concluded that the answer -- at least for airport leases -- depends on whether "the ground and facilities arrangements were addressed in separate documents."  United Air Lines, Inc. v. HSBC Bank USA (In re United Air Lines, Inc.), 2006 WL 1841461 (7th Cir. 7/6/06) (Manion, J.) (pdf).  Judge Manion, writing on behalf of the same unanimous panel that decided the previous two installments of the trilogy, summarized the facts and issues presented as follows:

In 1992, to operate at the then-new Denver International Airport, United Air Lines, Inc., entered an agreement entitled the "Special Facilities and Ground Lease" with the City and County of Denver (collectively "Denver"). Through this agreement, United leased ground space and also certain, to-be-built facilities at the airport. Instead of building the facilities at issue itself, Denver agreed to have United build the facilities that United would be using. To fund this construction by United, Denver issued tax-exempt municipal bonds, raising $261,415,000 for the project. United services these bonds indirectly through the payment of "facilities rentals" under the lease. After United entered bankruptcy in 2002, the true nature of this agreement became a point of dispute. In an adversary proceeding before the bankruptcy court, United sought to have the bond-related portions of the agreement severed from the rest of the agreement and treated as a loan rather than a lease for purposes of § 365 of the Bankruptcy Code, 11 U.S.C. § 365....  There is no dispute that, to reach such a result in the context of this case, United must clear two hurdles. First, the bond-related portions of the agreement must be severable from the rest of the agreement, which, with its traditional ground rentals, is indisputably a lease. Second, the substance of the agreement's facilities provisions must genuinely be that of a loan and not a lease.

As followers of the United bankruptcy saga will know, we confronted an issue similar to the second point above in each of our two prior published opinions concerning United's airport leases. The first two opinions of what is now a trilogy pertained to the San Francisco International Airport, United Airlines [v. HSBC Bank USA, NA (In re United Airlines, Inc.)], 416 [F.3d] 609 [(7th Cir.2005) ] (pdf), and the Los Angeles International Airport, In re United Air Lines, Inc., 447 F.3d 504 (7th Cir.2006) (pdf).  While the cases share similarities, a critical distinction is the fact that the parties in the present case cemented their deal into one document. In the San Francisco and Los Angeles cases (in which we held two supposed lease arrangements to be secured loans), the underlying ground leases were addressed in separate documents. See United Airlines, 416 F.3d at 611, 618; In re United Air Lines, 447 F.3d at 505-06. Not so here. As recounted above, Denver and United tied their ground and facilities arrangements into a single contract. Therefore, the first order of business in this opinion is to determine if this knot should, or even can, be untied.

In agreeing with Judge Wedoff that, unlike the prior cases, UAL's arrangement with the Denver Airport was a true lease and not a disguised financing, Judge Manion wrote:

On its face, this contract is an inherently integrated bargain: an agreement for a leasehold coupled with a bond arrangement to improve that leasehold. Importantly, given the context of this case, the parties' bond arrangement ... is not and could not have been a lone-standing bargain. In other words, the parties would not have entered the bond-related portion in the complete absence of the leasing portion. Under no conceivable circumstances would Denver have given the proceeds of its bonds to United in this manner to develop airport facilities if United did not also have a leasehold at the new airport upon which to build and then operate those facilities. By the same token, United is in the business of flying airplanes, not constructing airport facilities, and United would never have undertaken the bond-related obligations in this deal if it did not also have a leasehold upon which to operate at the new airport. Simply stated, without a ground lease, there was no need for this particular bond arrangement. Even though, similar to situations in [two other previously cited cases], Denver and United could have separated this deal into two contracts, they did not, and their decision to unite their interdependent ground and facilities objectives into a single contract at the outset cannot now be undone after the fact under Colorado law. Therefore, we view this joint lease-and-bond agreement "as a single whole" because "there would have been no bargain whatever, if [the lease-related] promises were struck out."  It cannot be severed.  (Citations omitted)....

Having reached that conclusion, our resolution of the rest of the case becomes elementary. Since the agreement must be treated as one indivisible whole, the issue then becomes whether that whole should be treated as a lease under § 365. In that regard, United concedes that the agreement's ground lease provisions constitute a true lease. Furthermore, under no circumstances could those ground lease provisions (which dominate the agreement's subordinate facilities provisions) be considered a financing arrangement and thereby allowed to escape the rigors of § 365. United offers no argument to the contrary on this point. Accordingly, as the bankruptcy court correctly concluded, the Denver-United agreement as a whole must be treated as a true lease for purposes of § 365.

So, the mess that started for UAL at Denver's Stapleton Airport remains one to this very day, yet smelling much less sweet based on this last installment of the 7th Circuit's UAL Lease Trilogy.

For those interested, you'll find previous posts on UAL's confirmation proceedings here, here, here, here. here, and here.

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