Indiana Law Review


Indiana Adds Articles 2A and 4A of
Uniform Commercial Code

Harold Greenberg*

During the past two decades, the Uniform Commercial Code (U.C.C.),

which became part of Indiana law in 1963, ' has undergone major study

and revision by its sponsors, the National Conference of Commissioners

on Uniform State Laws and the American Law Institute. Twenty years
ago, the sponsors made major revisions to Article 9—Secured Trans-
actions and made corresponding changes in other Articles, all of which
became part of Indiana's version of the U.C.C. in 1986. 2 More recently,
the sponsors have drafted two completely new Articles, 2A—Leases and
4A—Fund Transfers (the subjects of this Article), have made major
revisions in Articles 3—Negotiable Instruments and 4—Bank Collections, 3
and have recently appointed a drafting committee to review and redraft

Article 2—Sales.4
In 1991, the legislature added the two new Articles to the Indiana

version of the U.C.C. as Chapters 2.1—Leases and 4.1—Funds Transfers
and made corresponding changes in sections of the current Code which
are affected by these additions. 5 Chapter 2.1, which deals with leases

of goods, is virtually identical to the 1990 Official Text of Article 2A. 6

* Professor of Law, Indiana University School of Law—Indianapolis. A.B. Tem-
ple University; J.D., University of Pennsylvania. The author acknowledges the help of

his research assistant, Christopher J. Dull, Class of 1993, and expresses special thanks

to his colleague, Prof. James P. Nehf, for his helpful comments.

1. 1963 Ind. Acts ch. 317. The U.C.C. appears at Ind. Code §§ 26-1-1-101 to
-10-106 (1988 & Supp. 1991). Hereafter, reference to sections of the U.C.C. will be to
the generic section numbers rather than to the Indiana Code section numbers, e.g., § 1-

201(37) rather than § 26-1-1-201(37), unless the Indiana Code differs significantly from

the 1991 U.C.C. Official Draft.

2. See 1985 Ind. Acts 769-830.

3. See U.C.C. Rev. Art. 3 prefatory note, 2 U.L.A. 7-8 (Supp. 1991).

4. See Fred H. Miller, The UCC Today: Revisions, Planned Revisions, and State
Enactments, UCC Bull. No. 1, 1-2 (Jan. 1992).

5. 1991 Ind. Acts 2800-88. These new chapters appear at Ind. Code §§ 26-1-2.1

and 26-1-4.1 (Supp. 1991). As indicated supra note 1, reference to sections of these new
chapters will be to the generic U.C.C. citation, 2A, rather than to the Indiana citation,

§ 1-26-2.1, unless the Indiana version differs significantly from the U.C.C. Official Draft.

6. Article 2A was originally promulgated in 1987. See U.C.C. Article 2A foreword,
IB U.L.A. 648-49 (1989); Amelia H. Boss, The History of Article 2A: A Lesson for
Practitioner and Scholar Alike, 39 Ala. L. Rev. 575 (1988). After much study and
commentary, e.g., Corinne Cooper, Identifying a Personal Property Lease Under the UCC,
49 Ohio St. L.J. 195 (1988); Robert D. Strauss & Lawrence F. Flick, II, Leases, 46 Bus.



1030 INDIANA LAW REVIEW [Vol. 25:1029

As of fall 1991, Indiana was one of at least nineteen states to have

adopted Article 2A. 7 Chapter 4.1, which deals with major electronic

funds transfers, is virtually identical to the 1989 Official Text of Article

4A.8 Indiana is one of at least twenty-eight states to have enacted that

Article.
9

A complete analysis of the two new chapters would require a book-
length work. 10 This Article will principally highlight the manner in which

Chapter 2.1 (Article 2A) affects or changes the law of Indiana with

some additional comment about Chapter 4.1 (Article 4A).

Law. 1509 (1991); Symposium, Article 2A of the Uniform Commercial Code, 39 Ala.

L. Rev. 559 (1988) (an excellent collection of 10 scholarly articles on the 1987 version

of Article 2A plus the Report of the U.C.C. Committee of the Business Law Section of
the State Bar of California), the drafters substantially amended both text and official

comments in 1990. See U.C.C. § 2A-101 official cmt., IB U.L.A. 44 (Supp. 1991). The

Indiana Legislature enacted the 1990 version. The only major textual differences which

the author and his research assistant discovered in proofreading the 1990 Official Text

against the Indiana enactment relate to gender references or Indiana's own statutory
citation references. Neither of these differences affect the substance of the legislation.

Compare, e.g., U.C.C. § 2A-405(b) ("If the causes mentioned in paragraph (a) affect

only part of the lessor's or the supplier's capacity to perform, he for she] shall allocate

production and deliveries among his [or her] customers . . .") with Ind. Code § 26-1-

2.1-405(b) (Supp. 1991) ("If the causes mentioned in subdivision (a) affect only part of

the lessor's or the supplier's capacity to perform, the lessor or supplier shall allocate

production and deliveries among the lessor's or supplier's customers . . . .").

7. See U.C.C. Rep. Serv. (Callaghan), State Correlation Tables, Table of State

Enactments of 1987 Amendments (Article 2A) xiii (1991). The table lists Indiana, California,

Colorado, Florida, Hawaii, Kansas, Kentucky, Minnesota, Montana, Nebraska, Nevada,

North Dakota, Oklahoma, Oregon, Rhode Island, South Dakota, Utah, Virginia, and

Wyoming. The effective dates vary from November, 1988 (Oklahoma) to July, 1993 (North

Dakota).

8. See Ind. Code Ann. §§ 26-1-4.1-101 to -507, Historical and Statutory Notes

(West Supp. 1991). All of the sections of Chapter 4.1 are noted as being "identical with"

those of Article 4A of the Uniform Commercial Code, except for § 26-1-4.1-205, which
is noted as "similar to" § 4A-205. The only real difference between the two sections is

Indiana's use of the word "obligated" in place of the U.C.C. 's use of "obliged."

9. See U.C.C. Rep. Serv. (Callaghan), State Correlation Tables, Table of State

Enactments of 1989 Amendments (Article 4A) xvii (1991).
10. See infra notes 90-92 and accompanying text (indicating that Article 2A is

essentially a modification and expansion of Article 2—Sales for application to lease
transactions). Several books deal only with Article 2, and some are limited even further

to specific topics within the article. See, e.g., Barkley Clark & Christopher Smith,
The Law of Product Warranties (1984); Harold Greenberg, Rights and Remedies
under U.C.C. Article 2 (1987); Robert J. Nordstrom, Handbook of the Law of
Sales (1970); George I. Wallach, The Law of Sales under the Uniform Commercial
Code (1981 Supps.); Douglas J. Whaley, Warranties and the Practitioner (1981).



1992] U.C.C. 1031

I. Article 2A

—

Leases

A. Background

Since the promulgation of the first official text of the U.C.C. in

1951" and Indiana's adoption of the Code in 1963, 12 equipment leasing

has become a major part of the United States economy. 13 The reasons

for this growth are many, although the most prominent include the

lessee's reduced cash outlay when equipment is leased rather than pur-

chased, some favorable tax consequences for the lessee, and the lessor's

apparently favorable position in the event of a lessee's bankruptcy. These

are of particular importance in times of economic difficulties. 14

Despite this tremendous growth, the development of law specifically

applicable to leasing was something of a patchwork that depended to

a great extent on the common law of bailment and occasional analogy
to the law of sales in the Code's Article 2. In the process of codifying

the law of leases, the drafters perceived three basic issues to be resolved,

none of which was clear under then existing law: (1) Is the transaction

a lease or a security interest? (2) Has the lessor made any warranties

to the lessee? and (3) What are the remedies available when the lessee
(or the lessor) is in default?

15
If the response to the first question is

that the transaction creates a security interest rather than a lease, the

"lessor" is required to comply with the secured transactions provisions

of the Code's Article 9 in order to protect her interest in the goods

with respect to both the "lessee" and third parties. If the transaction

creates a lease, Article 9 does not apply. As to questions 2 and 3, the

warranty and remedies provisions of Article 2 apply directly to sales,

not to leases, and the Article 9 provisions on warranties and remedies

apply only to secured transactions. If the transaction is a secured trans-

11. See U.C.C, General Comment of the N.C.C.U.S.L. and the A.L.I., 1 U.L.A.
xv (1989).

12. See supra note 1.

13. See, e.g., Boss, supra note 6, at 576-77. Professor Boss, one of the leading

scholars in this field, notes that by 1988, approximately one-third of all new equipment

in the United States was leased and that leasing has become a multi-billion dollar industry.

Id.

14. See id.

15. See U.C.C. § 2A-101 official cmt. The official comments, although not enacted

by any legislature, including that of Indiana, are the product of the drafters of the Code

and constitute the first line of interpretation of the meaning of the Code's language. This

is particularly true of Article 2A. See Donald J. Rapson, Deficiencies and Ambiguities

in Lessors' Remedies under Article 2A: Using Official Comments to Cure Problems in
the Statute, 39 Ala. L. Rev. 875 (1988). The official comments do not appear in the

Indiana Code or the Burns Indiana Statutes Annotated, but are reproduced in West's

Annotated Indiana Code.



1032 INDIANA LAW REVIEW [Vol. 25:1029

action, the rights and duties of both "lessor" and "lessee" are governed

by Article 9, and if a sale is involved, also by Article 2. If the transaction

is a lease, the answers are uncertain. 16

During the drafting process, the drafters borrowed extensively from

Article 2 and in some instances carried over entire sections with changes
made only to reflect the differences between sales and leases. Thus,
decisions interpreting Article 2 may be helpful or even persuasive in
applying similar provisions of Article 2A. 17 As persons familiar with
Article 2 well know, that Article is far from perfect. Problems with

some of its provisions have arisen since its promulgation forty years

ago, and the Article is, at the present time, itself the subject of study

by the Code's sponsors. 18 However, the drafters of Article 2A elected
not to remedy the Article 2 problems when incorporating Article 2
provisions into Article 2A unless absolutely compelled to do so. 19 This
being so, if and when Article 2 is revised, it will be necessary to make
corresponding modifications or amendments to Article 2A.

In addition to codifying the rules relating to the formation of leases

and the rights, duties, and remedies of the parties, including some third
parties, the drafters of Article 2A attempted to clarify the distinction
between leases and other transactions by redefining the line between

leases and secured transactions and by establishing a new definition of
"finance lease," 20 which also helps in distinguishing a true lease from

a secured transaction. The drafters' ultimate success in drawing these
lines can be judged only over time.

B. The Definitions

1. Lease or Secured Transaction.—One of the most difficult and

16. See U.C.C. § 2A-101 official cmt.

17. Id.

18. See Boss, supra note 6, at 600-04; Edwin E. Huddleson, III, Old Wine in

New Bottles: UCC Article 2A—Leases, 39 Ala. L. Rev. 615, 620-21 (1988); Homer Kripke,
Some Dissonant Notes about Article 2A, 39 Ala. L. Rev. 791, 792-93 (1988). In fact,
the drafting of Article 2 began more than 50 years ago as a revision of the Uniform

Sales Act of 1905. See Harold Greenberg, Specific Performance under Section 2-716 of
the Uniform Commercial Code: "A More Liberal Attitude" in the "Grand Style," 17
New Eng. L. Rev. 321, 327-30 (1982).

19. See U.C.C. Art. 2A foreword, IB U.L.A. 649 (1991); Peter A. Alces, Sur-
reptitious and Not-So-Surreptitious Adjustment of the UCC: An Introductory Essay, 39
Ala. L. Rev. 559, 566 (1988); Boss, supra note 6, at 601; Steven L. Harris, The Rights

of Creditors Under Article 2A, 39 Ala. L. Rev. 803, 816-17 n.48 (1988) (The drafters

generally adhered "to the 'gag rule': the provisions of Article 2 would be followed unless

they were so bad that they caused one to gag.").

20. U.C.C. § 2A-103(l)(g). See the discussion of finance leases, infra notes 30-34

and accompanying text.



1992] U.C.C. 1033

controversial problems prior to the promulgation of Article 2A was the
actual task of distinguishing between leases and secured transactions. 21

Consequently, an important part of the new Article 2A package is the
substantial expansion of the Article 1 definition of "security interest"

in section 1-201(37)22 from a single paragraph to a multi-paragraph,

subsectioned provision roughly five times as long.
23 The new definition

is much more detailed and attempts to draw a clear distinction between
a security interest or lease intended as security, which is governed by

Article 9 (and Article 2 if a sale is also involved) and a true lease,

which is governed by Article 2A. As noted by the drafters, if the

transaction is a lease, the lessee's interest is possessory only. The residual

interest belongs to the lessor who need not file a financing statement,
but whose ownership of the goods is protected against the lessee's

creditors and a trustee in bankruptcy.24 Thus, the determination of

whether the transaction is a lease or security interest is the first step in

any analysis.

The focus of the definition is on the facts and economics of the

transaction, rather than on the specific intent of the parties. As stated

by the drafters:

Reference to the intent of the parties to create a lease or security

interest has led to unfortunate results. In discovering intent,

21. See, e.g., Amelia H. Boss, Panacea or Nightmare? Leases in Article 2, 64

B.U. L. Rev. 39 (1984); Amelia H. Boss, Leases & Sales: Ne'er or Where Shall the Twain
Meet?, 1983 Ariz. St. L.J. 357; Peter F. Coogan, Is There a Difference Between a Long-

Term Lease and an Installment Sale?, 56 N.Y.U. L. Rev. 1036 (1983); Cooper, supra

note 6.

22. Article 1 of the U.C.C, Ind. Code § 26-1-1 (1988), contains general provisions
which are applicable to the entire Code.

23. Compare Ind. Code § 26-1-1-201(37) (1988) (old § 1-201(37)) with Ind. Code

§ 26-1-1-201(37) (Supp. 1991) (new § 1-201(37)). Until the 1991 revision, the section stated:

(37) "Security interest" means an interest in personal property or fixtures which

secures payment or performance of an obligation. The retention or reservation

of title by a seller of goods notwithstanding shipment or delivery to the buyer

... is limited in effect to a reservation of a security interest. . . . Unless a

lease or consignment is intended as security, reservation of title thereunder is

not a security interest but a consignment is in any event subject to the provisions

on consignment sales .... Whether a lease is intended as a security interest 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 relevant portions of the definition in new § 1-201(37) are discussed in the text which

follows this note.

24. U.C.C. § 1-201(37) official cmt. 37.



1034 INDIANA LAW REVIEW [Vol. 25:1029

courts have relied upon factors that were thought to be more

consistent with sales or loans than leases. Most of these criteria,

however, are as applicable to true leases as to security interests.

Examples include the typical net lease provisions, a purported

lessor's lack of storage facilities or its character as a financing

party rather than a dealer in goods. Accordingly, amended Sec-
tion 1-201(37) deletes all reference to the parties' intent.25

The most important factor that distinguishes a true lease from a sale

or loan is whether there is a meaningful residual interest in the goods

at the conclusion of the lease term, followed by the determination of

who is entitled to that interest. If a meaningful residual interest remains
in the lessor at the end of the lease term, the transaction is a lease. If

that residual interest is in someone other than the lessor because the

lessee may acquire the goods at little or no additional cost or there is
no residual interest at all because the goods have no remaining economic

life, it is a secured transaction.26 Accordingly, the Code states a definition
of "secured transaction" based upon where the residual interest in the
goods will be at the end of the transaction as a matter of economic

reality.

Pursuant to new section 1-201(37), a transaction in the form of a
lease nevertheless creates a security interest as a matter of law if two

requirements are met: (1) the lessee's obligation to pay is not subject

to termination by her during the term of the lease and (2) any one of

the following is present: (a) the original term equals or exceeds the

remaining economic life of the goods; (b) the lessee is required to renew

for the remaining economic life of the goods or to become their owner;

(c) the lessee has an option to renew for the remaining economic life

of the goods either for no consideration or for nominal consideration;

or (d) the lessee has an option to buy the goods either for no consideration

or for nominal consideration. 27 Underlying these requirements is the idea

that if the nature of the transaction at its inception is such that the

lessee, in the ordinary course of events and as a matter of practical

economics, must become the owner of the goods at the end of the lease

period, or that there will be no residual economic value to the lessor

at the end of the lease, the transaction is a sale and secured transaction

rather than a lease. Conversely, if the lessee may terminate the lease
or the lease will expire at a time before practical economics clearly

dictate that she become the owner of the goods, the transaction is a
lease.

25. id.

26. See Cooper, supra note 6, at 208, 234; Huddleson, supra note 18, at 626.

27. U.C.C. § 1-201(37).



1992] U.C.C. 1035

The section also lists five provisions that do not create a secured

transaction merely because they are present in the lease. These provisions

are: (a) that the present value of the lessee's total payments equals or

exceeds the market value of the goods at the time of the lease; (b) that

the lessee assumes the risk of loss or agrees to pay taxes, insurance,

registration fees, or service or maintenance costs; (c) that the lessee has

an option to renew or to buy the goods; (d) that the lessee has an

option to renew for a rent that equals or exceeds the reasonably pre-

dictable fair market rent at the time the option is to be exercised; and

(e) that the lessee has an option to buy at a price that equals or exceeds

the reasonably predictable fair market value at the time the option is

to be exercised. 28 The drafters noted that although these factors are used

by courts in determining the intent of the parties, these factors are as

applicable to a true lease as they are to a secured transaction.
29 As the

discussion below indicates, courts have frequently relied on the presence

of one or more of these factors in concluding that a secured transaction

was created.

2. Leases and Finance Leases.—Article 2A defines "lease" as "a
transfer of the right to possession and use of goods for a term in return

for consideration, but a sale, including a sale on approval or a sale or

return, 30 or retention or creation of a security interest is not a lease." 31

The Article also creates a new definition, "finance lease." For a
transaction to be a "finance lease," it must first be a lease rather than

a sale or secured transaction. 32 It must then meet the following three

specific requirements: (1) "the lessor does not select, manufacture or

supply the goods"; (2) the lessor acquires the goods in connection with

the lease; and (3) any of the following: (a) the lessee receives a copy

of the contract by which the lessor obtained the goods; (b) the lessee's

approval of that contract is a condition to the lease; (c) before signing

the lease, the lessee receives a complete statement of the promises,

warranties, limitation of warranties, or damages, furnished to the lessor

pursuant to the aforementioned supply contract; or (d) before the lessee

signs the lease, if it is not a consumer lease, the lessor informs the

lessee of the identity of the supplier (unless selected by the lessee), that

28. Id. § 1-201(37), second (a)-(e). For some reason, § 1-201(37) contains subsections

(a)-(d) and a sentence fragment followed by (a)-(e), with no signal, letter, or number to

distinguish between the first group of subsections and the second. Later in the section,

there appear subsections (x)-(z), with nothing between (e) and (x).

29. See U.C.C. § 1-102(37) official cmt. (quoted in part in the text accompanying

supra note 25).

30. See id. §§ 2-326, 2-327.

31. Id. § 2A-103(l)(j).

32. Id. § 2A-103(l)(g) & official cmt. (g).



1036 INDIANA LAW REVIEW [Vol. 25:1029

the lessee is entitled to certain warranties, and that the lessee may
communicate with the supplier and receive a statement of the supplier's

promises and warranties." The Official Comment describes a finance
lease as

a three party transaction. The supplier manufactures or supplies

the goods pursuant to the lessee's specification, perhaps even

pursuant to a purchase order, sales agreement or lease agreement

between the supplier and the lessee. After the prospective finance

lease is negotiated, a purchase order, sales agreement, or lease

agreement is entered into by the lessor (as buyer or prime lessee)

or an existing order, agreement or lease is assigned by the lessee

to the lessor, and the lessor and the lessee then enter into a

lease or sublease of the goods. Due to the limited function
usually performed by the lessor, the lessee looks almost entirely

to the supplier for representations, covenants and warranties.
34

The Official Comment notes that many leases of goods back to their
seller (sale-leasebacks) are in fact finance leases.

35

3. The Cases.—The author has found six cases which directly involved

the determination whether, pursuant to then current Indiana law, a

transaction couched in lease terms was really a secured transaction under

old section 1-201 (37).
36 To a large extent, the new legislation codifies

the approach of one of these cases, In re Marhoefer Packing Co.,
31

which is a leading case in the field.

In Marhoefer, if the equipment lease at issue was a true lease, the

lessor could reclaim the equipment from the estate of the bankrupt

lessee. If it was a lease intended as security for the purchase price, the

lessor's failure to file a financing statement to perfect its security interest

under Article 9 rendered the lessor's position subordinate to that of the

bankruptcy trustee. 38 The lease was for an initial term of four years,

33. Id. § 2A-103(l)(g).

34. Id. official cmt. (g).

35. Id. For a pre-Article 2A discussion and analysis of finance leasing, see Fairfax
Leary, Jr., The Procrustean Bed of Finance Leasing, 56 N.Y.U. L. Rev. 1061 (1981).

36. TKO Equip. Co. v. C & G Coal Co., 863 F.2d 541 (7th Cir. 1988); In re
Marhoefer Packing Co., 674 F.2d 1139 (7th Cir. 1982); Morris v. Lyons Capitol Resources,

Inc., 510 N.E.2d 221 (Ind. Ct. App. 1987); McEntire v. Indiana Nat'l Bank, 471 N.E.2d

1216 (Ind. Ct. App. 1984); United Leaseshares, Inc. v. Citizens Bank & Trust Co., 470
N.E.2d 1383 (Ind. Ct. App. 1984); Bolen v. Mid-Continent Refrigerator Co., 411 N.E.2d

1255 (Ind. Ct. App. 1980).

37. 674 F.2d 1139 (7th Cir. 1982).

38. At the same time as the lease transaction, the lessee also purchased an identical

piece of equipment pursuant to a conditional sale contract. The seller/lessor retained a

security interest in this second machine and perfected that interest by an appropriate filing.

Title to that equipment was not an issue in the case.



1992] U.C.C. 1037

at the end of which the lessee could exercise one of two options: (1)

purchase the equipment for $9,968 or (2) renew the lease at $2,990 per

year for an additional four years, after which the lessee could purchase

the equipment for one dollar. There was, however, no requirement that

the lessee exercise either option, and the lessee could return the equipment

to the lessor at the conclusion of the initial lease term with no further

obligation. The bankruptcy occurred during the initial lease term.

The bankruptcy court found the transaction to be a true lease, but

the district court reversed and based on the option to buy for one dollar

at the end of the renewal term, concluded that as a matter of law

pursuant to old section 1-201 (37)(b),
39 the lease was intended as security.

The court of appeals agreed with the district court's interpretation of

the statute as a general matter, but declared that old section l-201(37)(b)

"does not apply where the lessee has the right to terminate the lease

before that option [to purchase for nominal consideration] arises with

no further obligation to continue paying rent." 40 Thus, because the lessee

in Marhoefer had no obligation to pay rent beyond the first four years,

the lease could be a true lease during its initial term.41 The court noted

that had the lessee renewed for the second four year period, at the end

of which it would have become the owner for only nominal consideration,

the renewal lease would have been a security interest disguised as a lease

pursuant to old section 1-201(37). 42

The court's approach is in close harmony with the intention of the

drafters of new section 1-201(37). The elements that demonstrate that

a lease is a security interest are the inability of the lessee to terminate

and either the lessee's ultimate ownership of the goods for little or no

consideration or the exhaustion of the economic life of the goods at

the end of the lease term. "An essential characteristic of a true lease
is that there be something of value to return to the lessor after the

term."43 It follows that if the lessee may terminate the lease before it
becomes economically unrealistic for him not to become the owner or
before the economic life of the goods is exhausted, there is something

of value to be returned to the lessor, and a true lease is created.

One issue not directly addressed by new section 1-201(37), but dealt
with by the court, is the "chameleon" lease. At its creation, a chameleon

39. See supra note 23.

40. Marhoefer, 674 F.2d at 1143-44.

41. There was also the question of whether the option price at the end of the

initial term was nominal, thereby making it economically realistic for the lessee to buy

the equipment, in which event the lease would be one intended for security.

42. Marhoefer, 674 F.2d at 1143.

43. Id. at 1145.



1038 INDIANA LAW REVIEW [Vol. 25:1029

lease is a true lease with a substantial residual going back to the lessor

at the end of the term but with an option to renew either to the end

of the economic life of the goods or for a term ending with a purchase

for nominal consideration. 44 The better view, and the one indicated by
the court, is that each term should be treated independently and that

the treatment of the new term should be based on the economic realities
as of the inception of that new term. 45 Thus, the fact that the lessee
might purchase for nominal consideration at the end of the second lease

term did not change the nature of the initial transaction. Had there
been a renewal, however, the lease would have become a secured trans-
action.

The court also considered the effect of the option to purchase for
approximately $9,600 at the end of the first term. If that purchase price

was nominal, the transaction might still be a secured transaction under

old section 1-201(37). This issue had not been addressed in the lower

courts. The court of appeals observed, "In determining whether an
option price is nominal, the proper figure to compare it with is not the

actual fair market value of the leased goods at the time the option

arises, but their fair market value at that time as anticipated by the

parties when the lease is signed."46 This, too, is in harmony with new
section 1-201(37), which states that a lease does not create a security

interest merely because the lessee has an option to buy "for a fixed

price that is equal to or greater than the reasonably predictable fair

market value of the goods at the time the option is to be performed"

and that "[additional consideration is not nominal if . . . when the
option to become the owner of the goods is granted to the lessee [usually,

as in Marhoefer, when the lease is created] the price is stated to be the
fair market value of the goods determined at the time the option is to

be performed."47

In Marhoefer, the option purchase price was less than the fair market

value at the time it was to be exercised. The Code drafters have observed
that when a fixed price is less than fair market value but more than
nominal, the determination of lease or security interest must be based

on the facts of the transaction. The drafters also noted expressly that
the rule of new section 1-201(37) did not deal with the specific facts
of Marhoefer because "it would unnecessarily complicate the defini-

tion." 48

44. See Cooper, supra note 6, at 246-47.

45. See Marhoefer, 674 F.2d at 1143-44; Cooper, supra note 6, at 246-47.

46. Marhoefer, 674 F.2d at 1144-45.

47. U.C.C. § l-201(37)(x). It would seem, however, that when the lease is for the
economic life of the goods, the fair market value at the end would be nominal and there

would be no residual interest in the lessor, thereby making the lease a secured transaction.

48. U.C.C. § 1-201(37) official cmt., para. 11.



1992] U.C.C. 1039

The Marhoefer court declared, first, that a purchase price of almost

$10,000, which was fifty percent of the fair market value, is not nominal,

and second, that the proper price for comparison to the stated option

price is not the fair market value at the time the option is to be exercised,

as the trustee contended, but the fair market value at the time of exercise

as previously predicted when the option was granted. The fair market

value at the time of exercise actually may be more or less than that
estimate, but that fact alone does not change the transaction from a

true lease to one given for security. 49 Indeed, making the actual com-

parison at the time the option is to be exercised could make the lease-

secured transaction distinction turn on the rise or fall of the market,

rather than on the nature of the transaction when entered into and could

make the rights and duties of the parties turn on fortuitous circumstances

rather than on planned consequences.

Finally, the court noted that old section 1-201(37) was silent as to

what facts, other than the nominal renewal or purchase price, are to

be considered in determining the lease or secured transaction issue.
50

It

looked at a list of factors that included the total rent, the lessee's possible

acquisition of equity in the goods, the useful life of the goods, the

lessor's business, and the payment of taxes and insurance, which are

usually the burden of the owner, and ruled that none of these factors

changed its conclusion that the lease was a true lease. 51 As observed

earlier, in new section 1-201(37), the drafters intended to discourage the

"laundry list" approach. 52 The court and drafters agree that the payment

of taxes, insurance, and other expenses, is neutral because the rental

will be adjusted according to which party is obligated to cover these

expenses. The lessee pays them pursuant to a "net" lease. 53

The remaining analysis of the court, particularly with reference to

the total rental, the non-acquisition of equity by the lessee, and the

useful life of the goods, was also in harmony with new section 1-201(37).

The court stated that because the lessee's total rent payment under the

first term was less than the purchase price of the goods with interest,

the lessee acquired no equity whatever, and because the term of the

lease was less than the useful life of the equipment, the transaction was

not the conditional sale urged by the bankruptcy trustee. 54 New section
2-201(37) states, as noted earlier, that without the right of the lessee to

49. Marhoefer, 674 F.2d at 1144-45.

50. Id. at 1145.

51. Id.

52. See supra text accompanying note 25.

53. See U.C.C. § 1-201(37), second (b) & official cmt., para. 9; Marhoefer, 674
F.2d at 1146.

54. Marhoefer, 674 F.2d at 1145-46.



1040 INDIANA LAW REVIEW [Vol. 25:1029

terminate, a lease for the full economic life of the goods is a secured

transaction as a matter of law. The mere fact that the total payout may
equal or exceed the fair market value of the goods, however, does not

create a secured transaction as a matter of law. 55 It is conceivable that

the lessor may be fully compensated for the purchase price of the goods
plus interest, yet there may be a significant residual value or economic
life at the conclusion of the lease.

Bolen v. Mid-Continent Refrigerator Co., 56 involved a straightforward

application of the old section l-201(37)(b) rule that if the agreement

permits the lessee to acquire the leased equipment at the end of the

lease term for nominal consideration — in this case, one dollar plus
sales tax — the lease was intended as security and the remedies for a
lessee's default are governed by Article 9. 57 Because the lease did not

grant the lessee a right to terminate before the conclusion of the lease

term, the result would be the same under new section 1-201(37). 58

The following three state court cases relied on, at least partially,

the laundry list approach that new section 1-201(37) seeks to eliminate.
In United Leaseshares, Inc. v. Citizens Bank & Trust Co. , 59 the dispute
was between a bank, which had initially financed a car dealer's acquisition

of four automobiles and ultimately perfected its security interest, and

the successor to a lessor under a sale-leaseback transaction in which the

dealer sold the cars to the lessor and leased them back. The Indiana

Court of Appeals affirmed the trial court's finding that the lease was

a security lease, unperfected under Article 9, and that the bank's security

interest was superior. 60 The court's ruling was based on the facts that

55. U.C.C. § 1-201(37).

56. 411 N.E.2d 1255 (Ind. Ct. App. 1980).

57. The lease agreement stated that it was for a term of four years at $62 per

month with an option for a maximum of five additional one year terms at $62 per year.
Exhibit A to Plaintiff's Amended Complaint, Brief for Appellant at 16-19, Bolen v. Mid-
Continental Refrigerator Co., 411 N.E.2d 1255 (Ind. Ct. App. 1980). The written shipping

order, however, recited that the lessee had the option at the end of the lease term to

purchase at one dollar plus sales tax. Exhibit B to Plaintiff's Amended Complaint, Brief
for Appellant at 20, Bolen v. Mid-Continental Refrigerator Co., 411 N.E.2d 1255 (Ind.

Ct. App. 1980). The briefs of the parties are in the collection of the library at Indiana

University School of Law—Indianapolis.
58. See supra text accompanying note 25.

59. 470 N.E.2d 1383 (Ind. Ct. App. 1984).

60. Id. at 1390. Unfortunately, there was a gap of several months in the perfection

of the financing bank's security interest in the cars it financed for the dealer because its

filed financing statement had expired, and the sale to the lessor took place during that

period. See Appendix to Brief of Appellant, Findings of Facts, Conclusions of Law and
Judgment of the Trial Court, Findings of Fact Nos. 42, 43, United Leaseshares, Inc. v.

Citizens Bank & Trust Co., 470 N.E.2d 1383 (Ind. Ct. App. 1984) [hereafter F.F.].
Otherwise, the matter might have been resolved simply on the basis of the bank's perfected



1992] U.C.C. 1041

the lessee had assumed most of the obligations of ownership, including

all operating expenses, insurance, title and other fees, taxes, and repairs,

as listed in Marhoefer, and that the only economically feasible course

for the lessee was to become the owner of the vehicles at the end of

the lease term due to the low lease end value established by the lessor. 61

The lease-secured transaction analysis was actually unnecessary to

the result because the lessor, who did not buy in the ordinary course
of business, knew that the sale was in violation of an existing security
interest in the automobiles. 62 Thus, the bank's position was superior to

that of the lessee. However, because the court explored the lease-secured

transaction issue so extensively, it is necessary to do so here. An analysis
of the case using new section 1-201(37) does not lead to the same
conclusion concerning the nature of the transaction.

Both the trial court and the court of appeals observed that the "low

lease-end value" made purchase of the automobiles the only "econom-
ically feasible course" for the dealer to follow.63 In the sale-leaseback

transaction, however, the dealer received $7,300 from the original lessor

for each of the four automobiles64 and, at the end of the two year lease

term, had the option to buy each back at $3,796, described by the lease

as the wholesale fair market value and by the trial court as being "very

conservative (low)."65 The trial court specifically found that the value

"was not nominal or free" and that as of the date of the trial, ap-

proximately six months after the inception of the two year lease, the

fair market value of the cars was $6,000 each. 66 Although it might make
good economic sense for the lessee to take advantage of a good deal,

security interest continuing in the automobiles which were sold to the lessor out of the

ordinary course of business. See U.C.C. §§ 9-306(2), 9-307(1).

61. United Leaseshares, 470 N.E.2d at 1387.

62. When the lessee received the proceeds of the sale-leaseback transaction, he
should have paid off the purchase money creditor (the bank), but did not. Of great
importance to the court were the facts that the cars never left the showroom of the dealer,

the lessor never received the certificates of title for the cars on which the lessor's security

interest should have been noted, see Ind. Code § 26-1-9-302(3) (1988), and the lessor
never registered the cars in its own name as owner. The certificates of title were in the
possession of the financing bank, not to be released until the debt for each car was paid.

Furthermore, the trial court found that the lessor "was aware that [the dealer-lessee] had

a floor plan financing arrangement with a bank, and that this bank would be holding a

security interest in [the dealer's inventory." F.F. No. 37.

63. United Leaseshares, 470 N.E.2d at 1387.

64. This was $80 per automobile less than the dealer received from the financing

bank. F.F. Nos. 2, 5.

65. F.F. Nos. 26, 27.

66. F.F. Nos. 29, 23, 24. The court did not state whether the $6,000 figure was

wholesale value or retail value.



1042 INDIANA LAW REVIEW [Vol. 25:1029

and the parties might have anticipated that he would do so, he was not

obligated to do so. The price was far from nominal and was, based on

any common understanding of automobile depreciation, probably fairly
close to what would have been the wholesale value of the cars after

two years. The residual value of the two-year-old cars to the lessor,
based on remaining economic life, was considerable. Thus, under new
section 1-201(37), the transaction appears to be a true lease.

One point not considered by the court was the fact that the lease
provided that if the lessee did not purchase the vehicles, the lessor would

sell them. If the sale price was less than the end price fixed in the lease,

the lessee would make up the difference. If it was greater, the lessee
would receive the excess. 67 This type of provision is referred to as a

"terminal rental adjustment clause" (TRAC), about which section 1-

201(37) is completely silent. 68 Whether or not a TRAC lease is a true
lease has not been resolved in Indiana. Courts in other jurisdictions are

divided on this issue.69

Once it is established that the transaction qualifies as a lease, the
fact that it is a sale-leaseback used by the seller-lessee as a financing

tool does not disqualify it or make it subject to Article 9. Article 2A
expressly recognizes sale-leaseback transactions as valid leases.

70 The

drafters note that "[m]any leases that are leases back to the seller of

goods (Section 2A-308(3)) will be finance leases."71

The court in McEntire v. Indiana National Bank12 stated that old
section 1-201(37) established two ways for determining if a lease is really

a conditional sale subject to Article 9: first, if the lessee has an option

to purchase at the end of the lease for only nominal consideration, and

second, if the transaction reflects certain court-established factors (the

67. F.F. Nos. 26.

68. See Huddleson, supra note 18, at 638-41.

69. Compare, e.g., In re Tulsa Port Warehouse Co., 690 F.2d 809 (10th Cir. 1982)

and Bill Swad Leasing Co. v. Stikes, 571 F.2d 1361 (5th Cir. 1978) (not a lease because

lessee takes all risk of appreciation or depreciation) with Budget Rent-A-Car v. Bergman,

175 Cal. Rptr. 286 (Cal. Ct. App. 1981) (a lease because lessor has substantial residual

interest). See Huddleson, supra note 18, at 638-41.

70. Section 2A-308(3) states in part: " [Retention of possession of the goods

pursuant to a lease contract entered into by the seller as lessee and the buyer as lessor

in connection with the sale or identification of the goods is not fraudulent if the buyer

bought for value and in good faith."

71. U.C.C. § 2A-103(l)(g) official cmt. (g). See the initial discussion of finance

leases, supra notes 32-35 and accompanying text.

72. 471 N.E.2d 1216 (Ind. Ct. App. 1984). If the lease in this case was in fact

a secured transaction, the guarantor was entitled to raise the defense that the sale of the

collateral was commercially unreasonable, an issue of fact which precluded summary
judgment for the lessor of telephone equipment.



1992] U.C.C. 1043

laundry list). 73 The court could not, as a matter of law, declare that

the option price of $710 was nominal because there was no evidence

of the fair market value of the leased telephone system at the time the

option to purchase would have been exercised. The following factors,

however, led the court to conclude that the lease was a secured transaction

as a matter of law: the lessee had an option to purchase; the lessor

purchased the system from a supplier; third parties were required to

sign a guaranty; the lessee was responsible for insurance, taxes, other

expenses, and risk of loss; the total rent equaled the purchase price plus

interest; the defaulting lessee could be held responsible for the total

unpaid rent or the balance less proceeds of resale; and the option price

was less than twenty-five percent of the list price. 74 The court referred

to the percentage of list price as an "economic realties" test. 75

Under new section 1-201(37), the only one of these factors which

might justify finding a secured transaction rather than a lease is the

option price, but not based upon that price being a particular percentage

of the original list price, as the court's "economic realities" test man-

dated. The drafters rejected proposals that would rely on artificial for-

mulae or specific percentages as determining factors. In particular, they

rejected a proposal that an option price below a fixed percentage of

original cost, such as ten percent, constituted nominal value and dem-

onstrated conclusively that the lease was a secured transaction. 76 In a

particular situation, nine percent of original cost could be fair market

value at the time of the exercise of the option and, therefore, not

nominal.

The problem created by the McEntire fact pattern, and perhaps in

Marhoefer and United Leaseshares as well, is that the option price fixed

in the lease ultimately may be more or less than the actual fair market
value at the time the option is to be exercised. If less, the provision

may give rise to a "bargain option," which, nevertheless, should be
construed as consistent with a true lease unless the consideration is indeed

nominal. 77 Only an extreme case should take a bargain option outside

the range of the reasonably predictable fair market value. The test remains
"whether, as a practical matter, at the outset of the transaction, the

lessor had an economically meaningful interest in the residual." 78 In

73. Id. at 1221-22.

74. Id. at 1222.

75. Id.

76. See Huddleson, supra note 18, at 628-33. The drafters also rejected a proposal

that an option price of 75% of the estimated fair market value demonstrated a true lease.
Id.

77. Id. at 636-38.

78. Id.



1044 INDIANA LAW REVIEW [Vol. 25:1029

McEntire, although "economic realities," to use the court's term, might

make the purchase a good deal for the lessee, the lease should be
considered a secured transaction only if the purchase was compelled by

a price of nominal consideration or if the economic life of the leased

goods was exhausted.

The other factors recited by the court to support its position would

not, under new section 1-201(37), justify finding a secured transaction
rather than a lease. That the lessee had an option to purchase and was

required to pay insurance, taxes, and other expenses does not demonstrate

that the lease was for security. 79 That the lessor purchased the equipment

from a supplier and required guarantors of payment resembles the

"finance lease" of Article 2A, which is a valid lease, not a secured

transaction. 80

In Morris v. Lyons Capitol Resources,81 the lessees agreed to lease

agricultural equipment for a total rent which exceeded the cost of the

equipment plus interest, agreed to pay for insurance, taxes, license fees,

and repairs, and had an option at the end of the lease term to renew

for another year at the fair rental value or to purchase the equipment

for its fair market value. Citing United Leaseshares and McEntire, and

referring to the factors listed in both cases, the court concluded that a

sufficient number of those factors were present to indicate that the lease

was intended as security. 82 As already noted, under new section 1-201(37),
none of these factors support a finding of a secured transaction rather

than a lease.

Also, because the option price was fair market value, the court said

it could not conclude that the price was nominal. 83 Neither could the

court conclude that the option price would have been less than twenty-

five percent of the original cost, one of the factors in McEntire, although

it noted that the challenged repossession and resale during the third year

of the five year term yielded $44,000 in a declining market for such

equipment.84 As with McEntire, the inquiry under the new provision

should be whether there is any meaningful residual economic life at the

end of the lease term, not the application of a particular formula based

on a percentage of cost.

Finally, because the original party with whom the lessees agreed
immediately assigned the agreement to a leasing company, the court

79. See U.C.C. § l-201(37)(b), (c).

80. See the discussion of finance leases at supra notes 32-35.

81. 510 N.E.2d 221 (Ind. Ct. App. 1987). As in McEntire, the issue was the
commercial reasonableness of the repossession and sale of the "leased" equipment and

the appropriateness of summary deficiency judgment for the lessor.

82. Id. at 223.

83. Id.

84. Id. at 223 n.3.



1992] U.C.C. 1045

concluded that the leasing company purchased the equipment from that

original party "in order to provide financing while retaining a security

interest." 85 As with McEntire, this more closely resembles the "finance

lease" of Article 2A than a secured transaction under Article 9.
TKO Equipment Co. v. C & G Coal Co., 86 adds an interesting twist

because the lessor argued that the transaction created a security interest,

not a lease, which is the reverse of the usual argument. The printed

lease for two earthmovers provided for a monthly rent of $15,000, a

minimum term of one month, and an option to purchase the equipment
for $90,000 at any time during the term of the lease with full credit

for rental payments previously made. The lease also expressly declared

that because the lessee was under no obligation to purchase the equipment,

the lease was not to be construed as creating a security interest. Despite

this disclaimer, the lessor immediately filed a financing statement asserting

that it had a security interest in the equipment.

It was necessary for the lessee to have substantial repairs performed

on the earthmovers, but the lessee was unable to pay the repair company.

After the lessee had made its sixth monthly payment, thereby becoming
entitled to ownership of the earthmovers, the repair company filed its
own financing statement. However, because the lessee was behind on
other payments to the lessor and (the parties assumed) the lessee had

previously signed a future advances clause, the right of the repair company
turned on whether the agreement was a lease or a secured transaction.

The district court characterized the transaction as a disguised sale-

secured transaction and held in favor of the lessor who had a prior
perfected security interest. The court of appeals concluded otherwise,

ruled that the transaction was a lease, and held in favor of the repair

company. 87 The latter court observed that this case was the reverse of

the usual situation in which the "lessor" claims the transaction is a

lease in order to recover the goods from a trustee in bankruptcy. 88 In

TKO, the "lessor" wanted the transaction to be secured, so that its
alleged prior perfected security interest would be superior to the security

interest of the repairer. If it was a lease, at the end of which the lessee

virtually automatically became the owner of the goods, the lessor's

attempt to perfect a prior security interest by filing would be ineffective

and irrelevant, and the repairer would prevail as having a prior perfected

interest in the equipment.

Of major importance to the court of appeals was the fact that the
language of the lease agreement emphatically denied that the transaction

85. Id. at 223 n.2.

86. 863 F.2d 541 (7th Cir. 1988).

87. Id. at 546.

88. Id. at 544.



1046 INDIANA LAW REVIEW [Vol. 25:1029

created a security interest, but the lessor, nevertheless, filed a financing

statement. The court refused to allow the lessor to have it both ways

and ruled, in effect, that the language used by the lessor estopped it

from claiming that a secured transaction was created. 89

Applying new section 1-201(37) and Article 2A to the transaction,
the agreement takes on the characteristics of a chameleon lease, discussed

earlier in connection with Marhoefer. At its inception, the transaction

fulfilled the definitional requirements of new section 1-201(37) that it
be terminable by the lessee with no further obligation and have a

substantial residual value to the lessor. By the time the sixth payment
of $15,000 was made, however, the lessee had the right to ownership,

and there was no residual value for the lessor. At some time during

the six month lease term, the lease changed into a secured transaction.
The questions a court should explore under the new statutory provisions
are whether the financing statement filed at the inception of the lease

term protected the lessor at the time of the change, whether the previously

perfected security interests of the lessor included this after acquired

equipment, or whether the lessor had an unperfected security interest,

subordinate to the security interest of the repairer who had filed. The
estoppel question might still be pertinent to whether the repairer was

induced by the security disclaiming language of the lease agreement (a)

to release its repairer's possessory lien, which would have been superior

to any other security interest, perfected or not, by returning the repaired

equipment to the lessee and (b) to gamble on the ability to perfect by

filing once the lessee acquired ownership rights in the equipment at the

end of the lease term.

C. The Substantive Provisions

In the view of the drafters of Article 2A, "[t]he lease is closer in

spirit and form to the sale of goods than to the creation of a security

interest." 90 Consequently, the drafters relied heavily on Article 2—Sales
for both format, including some numbering, and substantive provisions,

89. Id. at 544-46. Pursuant to U.C.C. § 9-408, a true lessor may file a financing
statement, "but its filing shall not of itself be a factor in determining whether or not

the . . . lease is intended as security (Section 1-201(37)). However, if it is determined for

other reasons that the . . . lease is so intended, a security interest of the . . . lessor which

attaches to the . . . leased goods is perfected by such filing." Id. The Official Comment
notes that a true lessor may "file for safety even while contending that the lease is a

true lease for which no filing is required." Id. § 9-408 official cmt. 2. Thus, the filing

is neutral, and other factors will determine the ultimate classification.

90. Id. § 2A-101 official cmt. statutory analogue.



1992] U.C.C. 1047

many of which were incorporated into Article 2A bodily, with only some
language changes to reflect the nature of the transaction as a lease rather

than a sale. 91 As with the Sales Article, the first digit of the three

number section designation following the article (or Indiana chapter)

number is an indicator of the general subject matter of that group of

sections. Thus, section 2.1-102 "Applicability" is in a group of general

provisions, and section 2.1-201 "Statute of Frauds" is in a group of

sections dealing with contract formation. 92

1. Part 1 — The General Provisions.—Of particular note in the
general provisions of Article 2A, in addition to the definition of "finance

lease" discussed earlier, 93 is the definition of "consumer lease," a lease

between a merchant lessor and an individual "who takes under the lease
primarily for a personal, family or household purpose, if the total

payments" excluding options do not exceed $25,000. 94 Unlike Article 2,
which does not contain any provisions directed specifically to consumer

issues, Article 2A contains a number of provisions directed only to
consumer leases. 95 One of these provisions makes unenforceable a choice
of law other than that of the residence of the consumer lessee. 96

Also of note is the inclusion of a provision expressly authorizing a

court to take appropriate action in the event the lease contract or any

clause in it was unconscionable when the contract was made. More
specifically, if the court finds that a consumer lease was induced by

unconscionable conduct or that unconscionable conduct occurred during

collection under a consumer lease, "the court may grant appropriate
relief."

97

91. See supra note 10 and accompanying text. With respect to the similarity in

numbering, for example, the Statutes of Frauds in the Sales and Leases articles are found

in §§ 2-201 and 2A-201, respectively, and the Parol Evidence Rules are found in §§ 2-

202 and 2A-202, respectively.

92. See IB U.L.A. 44 (Supp. 1991), which contains the heading, "Part 1 General

Provisions," preceding the § 2A-1 series of sections. The other headings are: "Part 2

Formation and Construction of Lease Contract," id. at 57; "Part 3 Effect of Lease

Contract," id. at 64; "Part 4 Performance of Lease Contract: Repudiated, Substituted

and Excused," id. at 84; and "Part 5 Default," id. at 87. Although the Indiana Code
utilizes individual section headings similar to those of the 1990 Official Draft, it does not

utilize the Part headings. Neither does the West annotation, although West is the publisher

of U.L.A. For an example of the difference in sections headings, compare § 2A-102

(Scope) with § 26-1-2.1-102 (Applicability).

93. See the discussion supra notes 32-35 and accompanying text.

94. See U.C.C. § 26-1-2. l-103(e). The 1987 Official Draft set the figure at $25,000;
the 1990 Official Draft leaves the amount blank for a determination by the enacting
state's legislature.

95. See id. § 2A-103 official cmt. (e) (citing a number of such sections).

96. Id. § 2A-106.

97. Id. § 2A- 108(2).



1048 INDIANA LAW REVIEW [Vol. 25:1029

2. Part 2 — Formation and Construction.—The statute of frauds,
parol evidence rule, general formation, firm offer, manner of acceptance,

course of performance, and modification provisions of Article 2A are
similar to those in Article 2. 98 The monetary floor above which a lease

must be evidenced by some writing, with enumerated exceptions, is
$1,000."

The drafters deemed it unnecessary to include a section similar to
section 2-207 on the "battle of the forms," apparently because they

thought that such battles are unusual in leasing transactions. 100 In Rock-

wood Manufacturing Corp. v. AMP, Inc., 101 however, the court was
confronted with precisely such a battle. Following discussions about the

leasing of a machine, the lessor sent a quotation to the lessee which

stated that it was not an offer and that all orders were subject to

acceptance by the lessor in accordance with its standard acknowledgement

form. The lessee sent a purchase order which incorporated the quotation

by reference and included a $14,000 check as requested therein. The

lessor returned its standard acknowledgement form which disclaimed

warranties and limited remedies. It also cashed the check.

The court of appeals affirmed the trial court's conclusion that the

U.C.C. did not apply, that the cashing of the $14,000 check did not

constitute an acceptance, and that because the acknowledgement form

contained terms additional to those in the purchase order, it constituted

a counter-offer which was accepted by the lessee when it took delivery

of the machine and did not object to the terms in the acknowledgement. 102

The court specifically declared that the "mirror image" rule applies in

Indiana and controlled the case. 103

Section 2-207 was specifically designed to do away with the mirror

image rule and the "last shot doctrine" which it perpetuates. 104 Unfor-

tunately, without a parallel provision in Article 2A, both will continue

to apply unless the courts, as a matter of common-law development,

are willing to deal with a battle of the forms in the manner suggested

by section 2-207 and the Restatement (Second) of Contracts. 105

98. Compare id. §§ 2A-201 to -208 with id. §§ 2-201 to -209.

99. Id. § 2A-201.

100. See Huddleson, supra note 18, at 620.

101. 806 F.2d 142 (7th Cir. 1986).

102. Id. at 144.

103. Id.

104. See, e.g., Uniroyal, Inc. v. Chambers Gasket & Mfg. Co., 380 N.E.2d 571
(Ind. Ct. App. 1978); Harold Greenberg, Rights and Remedies under U.C.C. Article
2 § 7.1 (1987); James J. White & Robert S. Summers, Uniform Commercial Code § 1-
3 (3d ed. 1988).

105. Restatement (Second) Contracts § 59 (1981), states "A reply to an offer which



1992] U.C.C. 1049

Article 2A includes all of the warranties created in Article 2, whether
express or implied. 106 However, if the lease is a finance lease, in which

the lessor is actually only a financing party and the lessee looks to the

supplier of the goods for performance of warranties, the finance lessor

does not make a warranty against infringement, 107 nor does the lessor

make either an implied warranty of merchantability or of fitness for
particular purpose. 108 Instead, the lessee under a finance lease is expressly

made the beneficiary of all promises and warranties by the supplier of
the goods to the finance lessor under the supply contract by which the

finance lessor obtains the goods in the first place. 109

Disclaimer or modification of warranties is the same as in Article

2, except that, unlike Article 2, Article 2A requires the disclaimer of
the implied warranty of merchantability to be conspicuous and in writing. 110

The strict horizontal privity requirements of Indiana's Article 2 have

been continued by the adoption of Alternative A to section 2A-216. 1 "
The Article 2A provisions concerning risk of loss, that is, which

party bears the loss in the event of damage or destruction of the goods
through no fault of either of them, have made little change in the
prevailing common law. The statute states that except in the case of a
finance lease, or unless the parties agree otherwise, risk of loss does

not pass to the lessee, but remains on the lessor. However, if the lease

is a finance lease, risk of loss passes to the lessee. 112

Prior to the enactment of Article 2A, leases of goods were governed

by the common law of bailment. If the goods were in good condition
when received by the bailee and in damaged condition when returned
or not returned at all, there was an inference that the loss was caused

by the negligence of the bailee. 113 The bailee had the burden of producing

purports to accept it but is conditional on the offeror's assent to terms additional to or

different from those offered is not an acceptance but is a counter-offer." The comment

adds, "[b]ut a definite and seasonable expression of acceptance is operative despite the

statement of additional or different terms if the acceptance is not made to depend on
assent to the additional or different terms," followed by a citation to § 2-207(1).

106. See U.C.C. § 2A-210 (express warranties); id. § 2A-211 (warranties against

interference and infringement); id. § 2A-212 (implied warranty of merchantability); id. §
2A-213 (implied warranty of fitness for particular purpose); id. § 2A-210, official cmt.

(purposes).

107. See id. § 2A-21K2).

108. See id. §§ 2A-212, -213.

109. See id. § 2A-209.

110. Compare id. § 2-316(2) with id. § 2A-214(2).
111. See U.C.C. § 2A-216, Alternatives A, B, and C, IB U.L.A. 689 (1989). Compare

id. § 26-1-2-318 with id. § 26-1-2.1-216.

112. Id. § 2A-219(1).

113. See Carl Subler Trucking, Inc. v. Splittorff, 482 N.E.2d 295, 297 (Ind. Ct.

App. 1985) (lease of tractor trailer).

-I

"i



1050 INDIANA LAW REVIEW [Vol. 25:1029

evidence, but not the burden of proof, that he was without fault. Once

the bailee produced evidence of lack of fault, the burden of proof was

on the bailor. If, indeed, the bailee was without fault, he was not liable

for the loss."
4 The obligations of the bailee, however, could be expanded

by agreement to impose liability for loss regardless of fault, as where

the lease agreement requires the bailee to return the goods in as good

condition as received, reasonable wear and tear excepted. 115 It is highly

likely that most leases under Article 2A will contain a similar provision
and that courts will continue to interpret such provisions as a contractual

modification of the statutory allocation of risk of loss. Automobile

lessors, for example, typically inform lessees that the lessees will be

responsible for any damage and try to persuade the lessees to purchase
additional insurance. Once it is determined that risk of loss will pass
from the lessor to the lessee, the provisions on when risk passes are
similar to those in Article 2. 116

3. Part 3 — Effect of the Lease Contract.—The 300 series in Article
2A deals primarily with the relationship between the lessor, lessee, and
third parties, and is derived from both Article 2 and Article 9. 117 Both

voluntary and involuntary transfers of either party's interest will be

effective, regardless of a lease term prohibiting any transfer. However,

a prohibited transfer may be a default under the lease, thereby entitling
the nontransferring party to various remedies. Even if not prohibited,

the transfer may adversely affect the rights or duties of the nontrans-
ferring party, thus entitling her to damages and/or cancellation of the

lease.
118

In a fashion similar to the ability of a holder of voidable title to

transfer good title under section 2-403, a subsequent lessee from a lessor

who had already leased the goods can obtain a good leasehold, subject
to the existing lease." 9 Similarly, a buyer or sublessee from a lessee

takes what the lessee had the power to transfer, subject to the lease

agreement. 120

In McDonald's Chevrolet, Inc. v. Johnson, 121 the lessee of a motor

home for a thirteen day term traded the home to a dealer as partial

114. See id.

115. See, e.g., Light v. Lend Lease Transp. Co., 156 N.E.2d 94, 99-100 (Ind. Ct.

App. 1959) (theft of leased automobile); Morrow, Inc. v. Paugh, 91 N.E.2d 858, 859-60

(Ind. Ct. App. 1950) (destruction of leased truck).

116. Compare U.C.C. §§ 2-509 to -510 with id. §§ 2A-219 to -220.

117. See id. §§ 2A-301 to -311 official cmts. uniform statutory source.

118. See id. § 2A-303 & official cmts.
119. See id. § 2A-304 & official cmts.
120. See id. § 2A-305(1) & official cmts.
121. 376 N.E.2d 106 (Ind. Ct. App. 1978).



616.

122. U.C.C. § 2-312(1).

123. McDonald's Chevrolet, 376 N.E.2d at 109.

124. Id.

125. Id.

126. See U.C.C. §§ 2A-306, 9-310.

127. See id. § 2A-307.

128. See id. §§ 2A-309, -310.

129. Id. § 2A-311.

130. See id. § 2A-309(9).

131. Compare id. §§ 2A-401 to -406 with id. §§ 2-609,

132. Id. § 2A-407(1).

-610, -611, -614, -615, -

•i

1992] U.C.C. 1051

payment for a truck. That dealer sold it to a second dealer who intended
to resell it. After the police seized the motor home from dealer two,
dealer two sued his seller (dealer one) for breach of the warranty of

title.
122 In applying section 2-403, the court determined that the trade-

in was a sale and that the sale by dealer one to dealer two could stand

only if dealer one had voidable title. 123 The court stated that the lessee

had only a possessory interest limited to the lease term of thirteen days

and that this possessory interest was all that he could transfer. 124 Ac-

cordingly, dealer one had void title and had breached the warranty. 125

The result would be the same under section 2A-305 because any sub- J

sequent buyer from a lessee takes subject to the lease. Upon the expiration
of the lease term, the lessee has no title whatever.

Article 2A is consistent with Article 9 in that a statutory possessory
lienholder (such as a repairman) has priority over the rights of the lessor

or lessee, 126 but other creditors of the lessee take subject to the lease

contract, as do creditors of the lessor under ordinary circumstances. 127

The remaining sections of Article 2A's 300 series contain detailed rules

regarding leased goods which become fixtures or accessions 128 and permit

the parties to agree to subordinate a priority. 129 Of special importance
with respect to goods which become fixtures is the provision permitting

the lessor to perfect his interest in the goods and obtain priority over

creditors of the lessee by filing a financing statement as a fixture filing

pursuant to the rules of Article 9 even though the lease agreement is

a true lease and not a security agreement. 130

4. Part 4 — Performance: Repudiated, Substituted, or Excused.—
The provisions on insecurity and adequate assurances of performance,

anticipatory repudiation and retraction thereof, substituted performance,

and excused performance (impracticability) are essentially the same under

Article 2A as under Article 2. 131
The promises of the lessee under a finance lease that is not a consumer

lease become irrevocable and independent of the lessee's acceptance of
the goods. 132 This provision is a codification of the "classic 'hell or

!:.



1052 INDIANA LAW REVIEW [Vol. 25:1029

high water' clause" by which the lessee must continue to pay the rent

regardless of any defect in the goods, failure of the goods, or failure

in the lessor's performance. 133 As noted earlier, the finance lessee has
the benefit of all promises made to the lessor by the supplier of the
goods, including any warranties of quality. 134

5. Part 5 — Default.—In its provisions on default and remedies,
Article 2A resembles both Articles 2 and 9. As provided in Article 2,
there may be a breach of the lease agreement by either party, thereby
entitling the nonbreaching party to a variety of remedies, including

damages. 135 As in Article 9, the lessor may be entitled to repossess the
goods in the event of a breach or default in the same manner as a
secured party. 136 Whether the lessee is in default and what remedies will

be available to the other party will be determined by provisions of both

Article 2A and the lease agreement itself. 137 These provisions are quite
detailed and will be discussed here only in summary fashion.

As in Article 2, a remedy may be limited or made exclusive by
agreement, but if any limitation of remedy fails of its essential purpose

or is unconscionable, the lessee may resort to all available remedies. 138

The parties may also liquidate damages either by a set amount or by
a formula based on anticipated harm. 139 Subject to any offset for actual

damages, a breaching nonconsumer lessee who has made some payments
but has not yet received the goods may recover, by way of restitution,
twenty percent of the present value of the total rent due under the lease;

a consumer lessee may recover the lesser of that figure or $500. 14°

The statute of limitations in Article 2A, like that in Article 2, is

four years from the accrual of the cause of action. 141 However, unlike

Article 2, the cause of action under Article 2A accrues when the default
or breach of warranty is or should have been discovered by the non-

breaching party. 142 Under Article 2, the cause of action accrues at the

time of delivery in the case of a breach of implied warranty or an

express warranty that does not extend to future performance. 143

133. See id. official cmts.

134. See id. § 2A-407 official cmt. 2. See also supra notes 106-09 and accompanying

text.

135. U.C.C. § 2A-501.

136. Id.

137. Id.

138. Compare id. § 2A-503 with id. § 2-719.

139. Id. § 2A-504(1).

140. See id. § 2A-501(3), (4).

141. Compare id. § 2A-506 with id. § 2-725.

142. Id. § 2A-506.

143. Id. § 2-725.



145. Id. § 2A-511(1).

146. Id. § 2-603.

147. Id. § 2A-516(2).

148. Id. official cmt. 1. See supra note 133 and accompanying text (discussion of

"hell or high water clause").

149. Compare id. § 2A-516(2), -517 with id. § 2-607, -608.
150. See id. § 2A-516(4), (5) & official cmt. This is similar to § 2-607(3) and to

§ 2-607(5) on vouching in.

151. Id. § 2A-517.

152. See id. §§ 2A-509 to -522.

153. Id. § 2A-508(4)-(6).

1992] U.C.C. 1053

The rules concerning the lessee's right to reject the goods, duties

with respect to rejected goods, cure by the lessor, acceptance of the

goods and the effect thereof, and rejection of the goods are substantially

similar to those set forth in Article 2, but have been rewritten to reflect

the fact that a lease is involved.
144 There are also some important changes.

For example, if the lessor fails to give instructions following rejection,

a merchant lessee must arrange to dispose of goods which threaten to

decline in value speedily, 145 whereas a buyer is expressly required to do

so only if the goods are perishable. 146

In the case of a finance lease, if the lessee has accepted the goods

with knowledge of a nonconformity, the lessee may not thereafter revoke
acceptance because of that nonconformity, 147 but the lessee will still have

his warranty claim against the supplier. 148 In any other case, or if a

finance lessee accepts the leased goods without knowledge of the non-

conformity, revocation is the same as under Article 2. 149 A lessee must
give notice of breach and, except for a consumer lessee, of possible

third party liability to the lessor. In the case of a finance lease, notice

must also be given to the supplier. Any remedy against the party not
notified will be barred. 150 Because, unlike a seller, a lessor may have
continuing duties under the lease, the lessee may be able to revoke
acceptance for breach of those duties. 151

Section 2A-508, in a manner similar to section 2-711, is an index

of the lessee's remedies in the event of rejection, revocation, lessor's

repudiation, or nondelivery. The remedies include cancellation of the

contract, recovery of any rent already paid, cover, damages for non-

delivery, recovery of identified goods, or specific performance. Each of

these is dealt with in more detail in a specific section. 152 The section

also lists a right to recover damages for breach of warranty, gives the

lessee a security interest in the goods for any rent, security, or expenses

incurred, and allows the lessee to deduct her damages from any rent

still owing. 153 Although based on the similar Article 2 remedies, each

144. Compare id. §§ 2A-509 to -517 & official cmts. with id. §§ 2-508, -601 to -
608, & 2-612.

i



1054 INDIANA LAW REVIEW [Vol. 25:1029

of these remedies is revised to reflect the terminology and circumstances

of leases rather than sales as in the use of the term "market rent"

rather than "market price." 154

The remedies of a lessor who still has control of the goods, i.e.,
when the lessee wrongfully rejects or revokes acceptance, fails to make
a payment when due, or repudiates, are similarly indexed in section 2A-
523. I55 Included in the lessor's remedies are the rights to cancel the lease,

to withhold delivery, to stop delivery, to dispose of the goods and

recover damages, to retain the goods and recover damages, or to resort

to any other remedies provided in the lease. 156 If the lessee's default

substantially impairs the value of the lease contract, the lessor may
resort to any of the remedies listed; otherwise, he may recover only the
loss resulting in the ordinary course of events. 157 Each of the specific

remedies is similar to those set forth in Article 2 but is redrafted to

reflect the fact that a lease, rather than a sale, is involved.

In a sale transaction, once the buyer has accepted conforming goods,

the seller has no interest in those goods and is entitled to recover their

price.
158 Only if the sale is part of a secured transaction does the seller

(or other financing party) have any interest in the goods. In the true

lease situation, however, the lessor has a residual interest in the goods

which, in the event of a default by the lessee, the lessor will seek to

protect. It is at this point that the drafters of Article 2A turned from
Article 2 to Article 9 as a model.

The lessor's remedies, upon a default by the lessee which substantially

impairs the value of the lease to the lessor are quite detailed. In summary,

the lessor may retake possession of the goods or, without removal,
"render unusable any goods employed in trade or business." 159 The lessor

need not resort to the courts if either of these courses may be achieved
without a breach of the peace. 160 The subsequent remedies available to

the lessor are similar to those in Article 2, pursuant to which the aggrieved

seller may either resell and recover the difference between the resale and
the contract prices 161 or retain the goods and recover the difference

between the market and contract prices. 162

The aggrieved lessor who has control of the goods may dispose of
the goods either by lease or sale and recover accrued and unpaid rent,

154. Compare id. § 2A-519 with id. §§ 2-513, 2-514.

155. Compare id. § 2A-523 with id. § 2-703.

156. Id. § 2A-523(1).

157. Id. § 2A-523(2), (3).

158. Id. §§ 2-607(1), 2-709(1).

159. See id. § 2A-525(2) & official cmt. Cf. id. § 9-503.
160. Id. § 2A-525(3).

161. Id. § 2-706.

162. Id. § 2-708.



Ik,

1992] U.C.C. 1055

the present value of the rent for the remaining lease term less the present

value of the new lease, and incidental damages. 163 Alternatively, he may
keep the goods and recover any accrued and unpaid rent, the present

value of the rent for the remaining lease term less the present value of

the market rent for the same lease term, and incidental damages. 164 This

latter measure of damages is also appropriate if the lessor's disposition

of the goods does not qualify for the release or resale measure of

damages. 165

Finally, just as the Article 2 seller may recover the price of the
goods under limited circumstances, 166 the aggrieved lessor may recover
accrued and unpaid rent, the present value of the rent remaining under

the lease, and incidental damages for goods accepted by the lessee and

not repossessed by the lessor or for goods identified to the contract if,

after reasonable efforts to dispose of them, the lessor is unable to or

highly unlikely to dispose of them at a reasonable price. 167 The lessor

must hold the goods for the lessee for the remaining term of the lease,

although the lessor may dispose of the goods before the end of the
term, in which event damages will be measured by the provisions discussed

in the preceding paragraph. 168

V

m

II. Article 4A

—

Funds Transfers

The primary focus of Article 4A is on wholesale electronic transfers
of funds which typically involve large sums of money and are principally
between sophisticated business or financial institutions. 169 It is new law

based on technology which did not exist when the U.C.C. was drafted

and for which there had previously been no single body of law to define

the rights and obligations of the parties to these transfers. 170

A typical funds transfer is described by the drafters as follows:

X, a debtor, wants to pay an obligation owed to Y. Instead of
delivering to Y a negotiable instrument such as a check or some
other writing such as a credit card slip that enables Y to obtain

163. Id. § 2A-527.

164. Id. § 2A-528.

165. Id.

166. Id. § 2-709(1).

167. Id. § 2A-529(1).

168. Id. § 2A-529(3).

169. See U.C.C. Art. 4A prefatory note, 2B U.L.A. 457-59 (1991). More than one
trillion dollars per day is transferred over the wire payment systems of the Federal Reserve

wire transfer network and the New York Clearing House Interbank Payments Systems.
Id.

170. Id. at 458.



1056 INDIANA LAW REVIEW [Vol. 25:1029

payment from a bank, X transmits an instruction to X's bank
to credit a sum of money to the bank account of Y. In most
cases X's bank and Y's bank are different banks. X's bank may
carry out X's instruction by instructing Y's bank to credit Y's

account in the amount that X requested. . . . The instruction
that X issues to its bank is a "payment order." X is the "sender"
of the payment order and X's bank is the "receiving bank"
with respect to X's order. Y is the "beneficiary" of X's order.
When X's bank issues an instruction to Y's bank to carry out
X's payment order, X's bank "executes" X's order. . . . The
entire series of transactions by which X pays Y is known as the
"funds transfer. . . ." With respect to the funds transfer, X is
the "originator," X's bank is the "originator's bank," Y is the
"beneficiary" and Y's bank is the "beneficiary's bank." 171

Although this transaction may, in some ways, resemble payments
made by check, covered by Articles 3 and 4, or by consumer electronic
transfers (bank-by-phone or automated teller machines), covered by the

Federal Electronic Fund Transfer Act, 172 which are excluded from Article
4A, 173 Article 4A treats the funds transfer "as a unique method of
payment that is governed by unique principles of law that address the

operational and policy issues presented by this kind of payment." 174

Among the problems facing the drafters of Article 4A were the
liability of the receiving bank (X's bank) for consequential damages in

the event of failure properly to transmit the payment order, allocation

of risk of loss in the event of unauthorized or fraudulent payment orders,

misdescription of the beneficiary, errors made in the course of the wire
transfer (such as duplicate transmissions), payment to an unintended

beneficiary, and transfer of an incorrect amount. 175 Each of these prob-

lems is dealt with by a set of "precise and detailed rules" rather than

broad, general principles and were drafted to enable the parties to a

171. Id. at 457. For these and additional definitions, see U.C.C. §§ 4A-104, -105.

172. 15 U.S.C. § 1693 (1988).

173. U.C.C. § 4A-108.

174. U.C.C. Art. 4A prefatory note, 2B U.L.A. 457 (1991).
175. See Tina E. McKelvy, Note, Article 4A of the Uniform Commercial Code:

Finally, Banks and Their Customers Know Where They Stand and Who Pays When a
Wire Transfer Goes Awry, 21 Mem. St. U. L. Rev. 351 (1991). See also Robert G. Ballen
& Natalie H. Diana, Duties of the Beneficiary's Bank, 45 Bus. Law. 1467 (1990); Thomas
C. Baxter, Jr. & Raj Bhala, Proper and Improper Execution of a Payment Order, 45
Bus. Law. 1447 (1990); J. Kevin French, Unauthorized and Erroneous Payment Orders,

45 Bus. Law. 1425 (1990); Norman R. Nelson, Settlement Obligations and Bank Insolvency,
45 Bus. Law. 1473 (1990).



1992] U.C.C. 1057

funds transfer "to predict risk with certainty, to insure against risk, to

adjust operational and security procedures, and to price funds transfer

services appropriately."
176

Of prime importance is the establishment by the parties of a "security
procedure" of some kind, whether by way of codes, callbacks, or other
devices, to assure that the payment order or other communication is

that of the customer and is correct. 177 The remaining rights and obligations

of the various parties, particularly with reference to allocation of their

respective risks, are quite detailed. To attempt to summarize would
require essentially a repetition of the language of both the statutory

sections and the Official Comments, many of which contain compre-
hensive examples and descriptions of the type of transaction or problem

involved. The reader is urged to consult both in dealing with funds

transfers problems.

III. Conclusion

As we move toward the twenty-first century, the sponsors of the
U.C.C. have continued their review and updating to keep the law of

commercial transactions as modern, effective, and efficient as possible.

By enacting Articles 2A and 4A in 1991, the Indiana Legislature has
followed the sponsors' lead. It is hoped that the legislature will continue

to do so as new or revised Articles of the U.C.C. are promulgated.
Next will likely come the adoption of newly revised Articles 3 and 4,
and ultimately, a revised Article 2. 178 And in another forty or fifty years,
the process will begin again.

176. U.C.C. § 4A-102 official cmt.

177. See id. § 4A-201 & official cmt.
178. Gerald R. Bepko, Chancellor of Indiana University's Indianapolis campus and

former Dean of I.U. School of Law—Indianapolis, is a member of the N.C.C.U.S.L.
Article 2 Drafting Committee, whose work is well under way. He predicts that the new
versions of Articles 3 and 4 will be introduced in the Indiana Legislature during the 1993

session. The introduction of a new Article 2 will take a bit longer.