# Petition for Writ of Certiorari — HSBC Bank USA v. United Air Lines, Inc. (No. 05-690)

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition for Writ of Certiorari
- **Published:** January 1, 2005

## Text

5

In re Pillowtex, Inc., 349 F.3d 711 (3d Cir. 2003), and
disagreed with the Second and Ninth Circuits. App. at 12
(citing In re PCH Associates, 804 F.2d 193 (2d Cir. 1993),
and In re Moreggia & Sons, Inc, 852 F.2d 1179 (9th Cir.
1988)).

The court, however, ultimately paid only lip service to
Butner and disregarded governing California law that
forbids recharacterization of agreements in the form of a
lease absent clear and convincing evidence of the parties’
contrary intent. The court reasoned that blur ens of
proof and persuasion are supplied by the forum, not by the
source of substantive law.” App. at 13. This directly con-
tradicts Raleigh v. Illinois Department of Revenue, 530
U.S. 15, 20-21 (2000) (“we have long held the burden of
proof to be a ‘substantive’ aspect of a claim” established by
the source of substantive law that provides the rule of
decision).

The court also held that the Bankruptcy Code pre-
empted California’s statute of limitations for challenges to
government contracts like the Facilities Lease (which had
expired long before United filed its bankruptcy case),
concluding that state procedures do not matter in
bankruptcy.” App. at 17. This contravenes both Butner,
which requires that state law be applied, and Guaranty
Trust Co. v. York, 326 U.S. 99 (1945), which holds that
state statutes of limitation are part of the substantive law
to be applied whenever state law provides the rule of
decision.

Finally, the court altogether ignored the contrary
Eleventh Circuit decision of Jn re Martin Brothers Tool-
makers, Inc., 796 F.2d 1435 (11th Cir. 1986), which re-
jected a challenge very similar to that made by United in

6

this case. In direct contrast to the opinion below, the
Eleventh Circuit holds that transactions consummated
with the purpose of improving public property (like the
San Francisco airport) and enhancing the public welfare
(as every transaction involving the Authority must) are
not susceptible to judicial second guessing like that sanc-
tioned by the court of appeals here.

. „ *

The court of appeal, decision has far-reaching ramifi-
cations. It improperly extends federal law into areas that
this Court has said are specifically governed by state law,
namely the burden of proof for and statute of limitations
on claims where state law provides the rule of decision.
The decision broadly affects the application of the laws of
all states applied in bankruptcy and other areas where
federal courts are required to respect state law, and it
creates the untenable situation in which federal courts
and state courts purportedly applying the same state-law
rule of decision will reach different results.

The decision also has broad implications for the public
finance markets, potentially impacting billions of dollars
of bonds and extending far beyond the parties to this
litigation. Although the immediate concern to the parties
is that United is now able to remain in possession of
leased airport property without paying rent, the decision
means that United may reap a similar windfall with
respect to its other leases that back hundreds of millions of
dollars of government bonds. Indeed, the same panel that
decided this case already has nullified a United lease at
John F. Kennedy airport in New York, and cases involving
leases at the Los Angeles and Denver International Air-
ports are now pending before that panel. More broadly, the

7

court has thrown into question the validity of all public
bonds issued with lease revenue structures, thereby
jeopardizing a time-honored method of financing im-
provements of all sorts of public property.

The court of appeals’ disregard of this Court’s prece-
dents requiring the application of state law, the clear
conflicts among the circuits, and the far-reaching implica-
tions of the decision all strongly suggest that review by
this Court is necessary and appropriate.

*

REASONS FOR GRANTING THE WRIT

There are three primary reasons to grant this Peti-
tion. The first is to enable the Court to resolve an impor-
tant question of bankruptcy law that results in a different
answer (and a different justification for the answer) nearly
every time it is confronted by a lower court. In this case,
the court of appeals took it upon itself to rewrite and
recharacterize a contract in a manner that conflicts with
the original intent of the sophisticated contracting parties.
By so doing, it not only created a new legal test — one
neither briefed nor argued by the parties — it established
an entirely new property right by which a debtor may
occupy property without being either an owner or a ten-
ant. The court’s new doctrine adds to a string of conflict-
ing, confusing opinions (both at the circuit level and lower)
regarding the seemingly straightforward question of which
types of agreements are to be enforced as “leases” in a
bankruptcy case and which law is to be applied to answer
that question.

The second reason for granting the writ is to correct
the court of appeals’ manifest disregard of state law in

8

violation of the clear mandates of this Court. The court’s
sweeping pronouncements that “[bjurdens of proof and
persuasion are supplied by the forum, not by the source of
substantive law,” and that “[s]tate procedures do not
matter in bankruptcy,” are directly at odds with the
decisions of this Court. The court's error in this regard was
outcome determinative, as it resulted in a purported
application of “state law” (as required by Butner) that
rejected fundamental, substantive components of the
California rule of decision. The district court in fact held in
favor of the petitioners precisely because United had failed
to satisfy its state-law burden of clear and convincing
proof.

The final reason for granting this Petition relates to
the vast implications of the court’s de facto nullification of
a widely-employed method of financing renovations to
airports and other essential public properties. The court’s
decision severely and negatively impacts billions of dollars
of airport lease revenue bonds outstanding in the capital
markets, and is likely to make it more expensive and
difficult to build and improve airports and a wide range of
other public facilities.

I. The Opinion Below Adds Confusion To An Al-
ready Conflicting And Incoherent Body Of Cir-
cuit-Level Precedent Regarding An Important
And Recurring Question Of Bankruptcy Law.

This case involves the meaning of the term “lease of
nonresidential real property.” Section 365(d\3) of the
Bankruptcy Code provides, in relevant part, that a trustee
(or, in a chapter 11 reorganization like this case, the
debtor in possession) “shall timely perform all the obliga-
tions of the debtor .. arising from and after the order for

9

relief under any unexpired lease of nonresidential real
property.” 11 U.S.C. § 365(d)(3). In contrast, the Code
generally does not require a debtor to perform under other
pre-bankruptcy contracts that govern a debtor’s interests
in property (like a mortgage)

The Code states that “leases of real property shall
include any rental agreement to use real property,” 11
U.S.C. § 365(m), but does not further define the term.
Accordingly, the statutory language must be read consis-
tently with its plain meaning. E. g., United States u. Ron
Pair Enterprises, 489 U.S. 235, 241 (1989) (in bankruptcy,
“where, as here, the statute’s language is plain, the sole
function of the courts is to enforce it according to its
terms”) (quotation omitted).

A “lease” is commonly defined as “a contract granting
the use or occupation of property during a specified period
in exchange for a specified rent.” AMERICAN HERITAGE
DICTIONARY (2d ed. 1985) at 721. There is no question that
the Facilities Lease fits squarely within that definition - it
grants United the right to possess the maintenance facility
for a term of forty years in exchange for the payment of a
specified rent. If United fails to pay that rent, it may be
evicted and the property may be re-leased to another.

This is part of bankruptcy’s set of trade-offs for landlords. On one
hand, a landlord is entitled to ongoing payment of rent during the case
(at least until rejection of the lease). On the other hand, the debtor is
authorized to reject the lease and have the landlord's claim for damages
converted into a general unsecured claim and capped at a maximum of
one year's rent or 15% of the total remaining rent under the lease. 11
U.S.C. $§ 365(g), 502(bX6), 502(g). In comparison, the holder of a
mortgage is not automatically entitled to current payment, but is
entitled to recovery of the full value of its interest in the debtor's
property. 11 U.S.C. § 506

10

The court of appeals deviated from the plain language
approach and concluded that the term “lease” as used in
the statute is merely a meaningless label. App. at 6
(“lease’ is a label rather than a form”). The court con-
cluded that the Bankruptcy Code honors only what it
called “true leases,” and it thus moved beyond the lan-
guage of the statute (and the agreement negotiated by the
parties) to a determination of whether the Facilities Lease
“functioned” more like a “true lease” or a mortgage. App.
at 8.

In the process, the court of appeals minted a brand
new doctrine. It concluded, without argument from the
parties or citation to relevant precedent, that an inquiry
into whether or not an agreement is a “true lease” de-
pended upon what the court deemed to be the Bankruptcy
Code’s “system of separating financial from economic
distress.” App. at 11. The court held that bankruptcy relief
is available to a debtor in “financial” distress by enabling
the “write down” of a debtor’s pre-bankruptcy obligations,
but only when the debtor is not in “economic” distress and
is able to pay its bills on an ongoing basis. App. at 6-8. The
court concluded that a “true lease” is one that payls]l for
new inputs” by giving the debtor the right to occupy
property it otherwise would not be able to occupy. App. at
7. In contrast, the court held that a lease with rent “that
represents the cost of funds for capital assets for past
production or past operations rather than ongoing inputs
into production has the quality of debt” and therefore is
not a “true lease” under which a debtor must continue to
pay rent. App. at 7. Applying this new “economic” analysis,
the court concluded that the Facilities Lease did not
qualify as a “true lease” under its financial/economic
distress rubric because, in the lease-sublease transaction,

11

United had used its leasehold interest in the maintenance
facility “to secure an extension of credit” and, as a result,
the Facilities Lease rent did not qualify as payment for
“new inputs.” App. at 16.

The court of appeals committed numerous errors.
First, a financial/economic distress dichotomy is not a
touchstone for a “true lease.” The text of the Bankruptcy
Code makes no reference to or distinction between “finan-
cial distress” and “economic distress” nor, to the petition-
ers’ knowledge, does any reported decision. This Court, on
the other hand, has made it abundantly clear that the
“(ulniform treatment of property interests by both state
and federal courts within a State” is of paramount impor-
tance. Butner, 440 U.S. at 55 (quotation omitted). The
court of appeals violated this fundamental rule by apply-
ing its new, anti-textual analysis to sweep aside property
interests that, as explained in Section II below, clearly
would be enforceable by the petitioners under state law.
The court’s decision is al! the more pernicious as a result
of the distinguished panel that issued it, providing, as it
were, an economic rationalization for future courts to
ignore the dictates of a state’s real property law with
which they do not agree.

This false dichotomy resulted in the first decision to
“recharacterize” a lease in bankruptcy in the absence of
any claim of ownership in the subject property by the
debtor. All of the cases cited by United below involved
“leases” that provided the debtor-“lessee” with an option to
purchase “leased” property for a nominal amount, or that
had a lease term that extended for the total useful life of
the property. Those agreements, while in the form of a
lease, were held to represent transactions in which the
debtor in substance owned or would entirely consume the

12

property.’ Until the court of appeals’ decision in this case,
courts enforced leases absent such a determination that
the debtor actually owned the “leased” property. This
makes sense because debtors, like others, can occupy
property in only one of two ways - they can own it or rent
it. Under the court of appeals’ new doctrine, debtors like
United may stay in possession of property that they do not
own or lease, without paying anything for the privilege.
This is as unprecedented as it is unfair

More importantly for purposes of this Petition is the
fact that other courts have looked at this issue in com-
pletely different ways, reaching different conclusions with
different rationales. The Ninth Circuit, for example, holds
that state law is irrelevant to the question of whether an

See, eg. In re PCH Associates, 804 F.2d 193 (2d Cir. 1986)
(“lease” that separated a hotel from the underlying land on which it was
built, with a total term of 165 years (more than the useful life of the
leased structure)); /nternational Trade Administration v. Rensselaer
Polytechnic Institute, 936 F.2d 744 (2d Cir. 1991) (“lease” with a 99-year
term, with all “rent” paid in the first 3 years); In re Moreggia & Sons,
Inc., 852 F.2d 1179 (Sth Cir. 1988) (“lease” where all rent was prepaid
with a thirty-year term remaining and with no remaining rights to evict
and re-let).

* The legislative history of the Bankruptcy Code confirms that
ownership is a key consideration in the lease/financing analysis. The
legislative history states that the statutory term “lease of real property”
is to apply “only to a ‘true’ or ‘bona fide’ lease and not... to financ-
ing leases of real property.” S. Rep. 95-989 (1978), at 64. It goes on to
state, however, that “lease financing” transactions are those “where, in
substance, the ‘lease’ involves a sale of the real estate and the rental
payments are in substance the payment of principal and interest on a
secured loan or sale.” Jd. Congress used the term “financing lease”
(which never appears in the text of the Bankruptcy Code itself) as the
common shorthand description of a transaction in which the “lessee”
finances its purchase of the “leased” property, not as a description of
every lease executed as part of a financing transaction.

13

agreement is a lease for purposes of the Bankruptcy Code,
and that the key question is whether the parties intended
to create an “ordinary landlord/tenant relationship.”
Moreggia, 852 F.2d at 1182-86. The Second Circuit appears
to apply an amalgam of state and federal law in an effort
to answer the ultimate question of whether the “economic
substance” of the transaction is that of a “true lease.” PCH
Associates, 804 F.2d at 196-201. The Third Circuit holds
that state law governs exclusively. In re Pillowtex, Inc.,
349 F.3d 711, 716 (3d Cir. 2003).

The Eleventh Circuit, meanwhile, completely rejects
the notion that a court can cast aside the form of agree-
ment negotiated by a governmental entity, at least where
the transaction at issue was not consummated solely for
the benefit of private parties but instead in furtherance of
broader interests like the improvement of public property.
The Eleventh Circuit holds that “[t}he application of
bankruptcy principles in this context would be particularly
inappropriate, because such principles are developed in
the context of only two competing private interests, and in
this case we have a third, public, interest.” Martin Broth-
ers, 796 F.2d at 1440.

Moreover, the Seventh Circuit is now in conflict with
itself as a result of the court’s opinion in this case. In Jn re
Kassuba, 562 F.2d 511 (7th Cir. 1977), a case not cited in
the decision below, the Seventh Circuit rejected an “eco-
nomic substance” analysis in favor of an inquiry based
upon the intent of the parties, concluding that the lease
portion of a sale-leasebeck transaction was a “true lease”
for bankruptcy purposes: “[T]he parties by contract may
create a set of mutual economic benefits that is similar to
a mortgage without conferring on each other the rights
and liabilities of judicial foreclosure, if that is what they

14

actually intend. The substance of the transaction that a
court of equity will examine is not its economic effect,
which the parties determine by their agreement, but
instead it is what their agreement is.” Jd. at 514.°

Finally, when this Court last addressed the “true
lease” issue (in the tax context), it applied an analysis
completely at odds with the decision below:

Wie hold that where, as here, there is a genuine
multiple-party transaction with economic sub-
stance which is compelled or encouraged by
business or regulatory realities, is imbued with
tax-independent considerations,’ and is not
shaped solely by tax-avoidance features that
have meaningless labels attached, the Govern-
ment should honor the allocation of rights and
duties effectuated by the parties.

Frank Lyon Co. v. U.S., 435 U.S. 561, 583-84 (1978)
(emphasis added).

The lower courts are in similar disarray. Compare In re Omne
Partners II, 67 B.R. 793 (Bankr. DN. H. 1986) (“bankruptcy judges [do
not] have a warrant from Congress to run roughshod over the economic
landscape recharacterizing commercial transactions entered into by
sophisticated parties - restating them in terms of their ‘economic
substance’ contrary to their negotiated and agreed form — in the
absence of some triggering factor permitting such recharacterization”);
with In re Petroleum Prods., 72 B. R. 739 (Bankr. D. Kan. 1987) (follow-
ing state law to hold that agreement is a lease even though, in court's
view, the “economic realities” of the agreement were that of a mort-
gage); with In re Barney’s, Inc., 206 B. R. 328 (Bankr. S. D. N. v. 1997) (it
is not appropriate to recharacterize a lease without consideration of
extrinsic evidence); with In re Hotel Syracuse, Inc., 155 B.R. 824 (Bankr.
N. D. N. V. 1993) (refusing to follow state law and concluding, from the
face of the documents, that an agreement was not a lease).

15

Thus, the courts have created conflicting rules to
apply when a debtor files for bankruptcy and claims that
an agreement it signed before bankruptcy is not enforce-
able as a lease even though it is called a lease, is in the
form of a lease, and has the normal attributes of a lease.
The outcome of any such challenge is likely to turn not on
established state law property rights (as it should) but
instead on the location of the bankruptcy court (or even
the predilections of the bankruptcy judge).

This arbitrariness is contrary to the uniform applica-
tion of state law mandated by the Court in Butner:

Property interests are created and defined by
state law. Unless some federal interest requires a
different result, there is no reason why such in-
terests should be analyzed differently simply be-
cause an interested party is involved in a
bankruptcy proceeding. Uniform treatment of
property interests by both state and federal
courts within a State serves to reduce uncer-
tainty, discourage forum shopping, and to pre-
vent a party from receiving a windfall merely by
reason of the happenstance of bankruptcy.

Butner, 440 U.S. at 55 (quotation omitted). As things now
stand, there is no “uniform treatment” of leases among the
circuits. This results in precisely that which Butner
condemned: it fosters uncertainty, encourages forum
shopping, and enables debtors like United to receive a
windfall “merely by reason of the happenstance of bank-
ruptcy.”

The Court should clarify and resolve this important
issue.

16

II. The Court’s Failure To Appiy The State Burden
Of Proof And Statute Of Limitations Contra-
venes Butrer u. United States, Raleigh v. Ni-
nois Department Of Revenue, And Guaranty
Trust Co. v. York.

As noted above, this Court long ago established that,
in bankruptcy, “property interests are created and defined
by state law.” Butner, 440 U.S. at 55; accord, e.g., Barnhill
b. Johnson, 503 U.S. 393, 398 (1992).

The court of appeals noted the Bankruptcy Code’s
silence as to the definition of a lease and correctly held
that state law governs the question of whether or not an
agreement is a “true lease”: “Leases are state-law instru-
ments, after all, and the norm in bankruptcy law is that
contracts (of which leases are a species) and property rights
in general have the same force they would have in state
court, unless the Code overrides the state entitlerrent.” App.
at 11 (emphasis added). Thus, it held that California law,
which the parties chose in the Facilities Lease to apply,
provided the rule of decision. Instead of applying Califor-
nia law, however, the court then proceeded to replace the
California rule with ite own irterpretation of federal law
based upon its unique theory of the economics of a “true
lease.” While interesting, this economic analysis has no
bearing on governing California law and, under Butner,
has no proper place in the analysis.

The State Burden of Proof. First, the court refused
to enforce California's burden of proof. The rule in Califor-
nia is unambiguous: a debtor has the burden of proving, by
clear and convincing evidence, that an agreement in the
form of a lease is actually a mortgage or financing device.
As the California Supreme Court held in a “sale-leaseback”

17

case cited and discussed at length (in other respects) by
the court of appeals:

It is without doubt the law, as repeatedly de-
clared in our decisions, that clear and convincing
evidence is required to justify a court in finding
that a deed which purports to convey land abso-
lutely in fee simple was intended to be a mort-
gage. That a deed purporting on its face to
convey the title absolutely may be shown by pa-
rol evidence to be something else - namely, a
mortgage — is a striking exception to the general
rule, and it has been universally held that the
character of the instrument cannot thus be
changed except upon clear and convincing evi-
dence.

Beeler v. American Trust Co., 24 Cal. 2d 1, 7 (1944) (em-
phasis added) (quotation omitted).

The court of appeals purported to wipe away this
established rule in two sentences: “Burdens of proof and
persuasion are supplied by the forum, not by the source of
substantive law. Bankruptcy law uses the preponderance
standard. Grogan v. Garner, 498 U.S. 279 (1991).” App. at
13. Neither is correct.

In Raleigh v. Illinois Department of Revenue, 530 U.S.
15 (2000), the Court held that, when state law provides
the rule of decision in a bankruptcy case, as it does here,
the bankruptcy court must follow and apply the state
burden of proof associated with the state law rule. Raleigh
involved whether a bankruptcy court had to apply the
burden of proof otherwise applicable to Illinois tax claims.
The debtor asserted that the taxing authority bore the
ultimate burden of proof. The taxing authority asserted

18

that, under state law, the burden was on the debtor and
should continue to apply in a bankruptcy case.

The Court first reiterated the basic principles of
Butner:

The “basic federal rule” in bankruptcy is that
state law governs the substance of claims, But-
ner, supra, at 57, Congress having “generally left
the determination of property rights in the assets
of a bankrupt’s estate to state law.” 440 U.S. at
54 (footnote omitted). “Unless some federal inter-
est requires a different result, there is no reason
why [the state] interests should be analyzed dif-
ferently simply because an interested party is in-
volved in a bankruptcy proceeding.” Id. at 55.

Raleigh, 530 U.S. at 20. The Court concluded that those
principles required the bankruptcy court to apply the
burden of proof that would have been applied had the
claim been litigated in state court:

The scope of the obligation is the issue here. Do
the State’s right and the taxpayer’s obligation in-
clude the burden of proof? Our cases point to an
affirmative answer. Given its importance to the
outcome of cases, we have long held the burden of
proof to be a “substantive” aspect of a claim. That
is, the burden of proof is an essential element of
the claim itself; one who asserts a claim is enti-
tled to the burden of proof that normally comes
with it.

Id. at 20-21 (emphasis added) (citations omitted).
Similarly, Grogan v. Garner, cited by the court of
appeals for the proposition that “(b)ankruptcy law uses the

preponderance standard,” App. at 13, demonstrates the
court's error. Grogan involved a question of whether a

19

particular debt could be discharged under the Bankruptcy
Code an issue as to which the Code itself, and not state
law, provided the rule of decision. Grogan, 498 U.S. at 283
(“the issue of nondischargeability has been a matter of
federal law governed by the terms of the Bankruptcy
Code”). Because the Code is silent as to the burden of
proof, the Court held that the default civil litigation
“preponderance of the evidence” standard applied. Jd. at
286-90. The Court never held that all questions in bank-
ruptcy are governed by a preponderance standard, or that
the burden of proof somehow always lies with the non-
debtor party. To the contrary, in a precursor to Raleigh, the
Court expressly observed that the validity of a creditor’s
claim is determined by rules of state law.” Jd. at 283.

Thus, unlike the court of appeals’ erroneous refusal to
apply state law in this case, bankruptcy courts regularly
apply clear and convincing standards of proof when
applicable state or other nonbankruptcy law requires it,
which can occur under all states’ laws in a variety of
substantive areas affecting property rights that may be at
issue in a bankruptcy case. This is consistent with the
general rule in the federal courts under Rule 302 of the
Federal Rules of Evidence, which provides that state law
presumptions apply when state law supplies the rule of
decision.

* See, eg, In re Ellis, 324 B.R. 595 (Bankr. M.D. La. 2005) (apply-
ing state law clear and convincing evidence standard regarding
reformation of a mortgage due to alleged mutual mistake); In re
Davenport, 268 BR. 159 (Bankr. N D. III. 2001) (applying state law
clear and convincing evidence standard regarding establishment of
resulting trust); In re Todd, 70 BR. 204 (Bankr ND. Iowa 1986)
(applying state law clear and convincing evidence standard regarding
correction of mortgage amount).

20

The court of appeals’ error in disregarding this Court’s
holdings and relieving United from its “clear and convinc-
ing” burden was outcome determinative. United submitted
no evidence below. It simply relied on the terms of the
documents. The district court held that this was not a
sufficient showing by United to satisfy its burden under
California law. The petitioners would have prevailed had
the court merely respected the applicable state law rule as
required by this Court’s decisions.

The State Statute of Limitations. The court of
appeals committed another outcome-determinative error
when it held that California’s statute of limitations for
challenges to government contracts like the Facilities
Lease was unenforceable in bankruptcy.

California has a statutory system that provides for
parties who seek to challenge the validity or enforceability
of a government contract to do so within sixty days after
publication of required notices relating to the contract. See
Cal. Civ. P. Code §§ 860-869. No such challenge may be
made after expiration of that period. Jd. § 869.

This statutory system is a statute of limitations.
Friedland v. City of Long Beach, 73 Cal. Rptr. 2d 427, 434
(Cal. Ct. App. 1998). It applies to contracts, like United’s
Facilities Lease with the Authority, that are integrated
components of a municipal bond issuance. Id. at 433-43.
Because no timely challenge was made to the Facilities
Lease, United’s belated, post-bankruptcy action to contest
the nature of the Facilities Lease was barred as a matter
of California law.

The court of appeals, however, refused to recognize the
California statute of limitations, holding, without citation
or analysis, that state procedures do not matter in

21

bankruptcy.” App. at 17. This is demonstrably false. In
Guaranty Trust Co. v. York, 326 U.S. 99 (1945), the Court
long ago held that state statutes of limitations are a
substantive component of state law and must be applied
by federal courts in cases where state law provides the
rule of decision. The Court framed the question as follows:

And so the question is not whether a statute of
limitations is deemed a matter of “procedure” in
some sense. The question is whether such a stat-
ute concerns merely the manner and the means
by which a right to recover, as recognized by the
State, is enforced, or whether such statutory
limitation is a matter of substance in the aspect
that alone is relevant to our problem, namely,
does it significantly affect the result of a litigation
for a federal court to disregard a law of a State
that would be controlling in an action upon the .
same claim by the same parties in a State court?

Id. at 109 (emphasis added). The Court answered affirma-
tively:

Plainly enough, a statute that would completely
bar recovery in a suit if brought in a State court
bears on a State-created right vitally and not
merely formally or negligibly. As to consequences
that so intimately affect recovery or non-recovery
a federal court in a diversity case should follow
State law. IHF a plea of the statute of limita-
tions would bar recovery in a State court, a fed-
eral court ought not to afford recovery.

Id. at 110 (emphasis added) (citation omitted). The Court
reaffirmed the vitality of this venerable rule as recently as
two years ago. Jinks v. Richiand County, 538 U.S. 456, 465
(2003).

22

The rule is as true in bankruptcy as it is in diversity
cases. In the Bankruptcy Code, Congress expressly chose
to extend statutes of limitation governing a claim avail-
able to a debtor, but only where the limitations “period has
not expired before the filing of the petition.” 11 U.S.C.
§ 108(a). The Court in fact has observed that a bankruptcy
estate “succeeds to no more or greater causes of action
against third parties than those held by the debtor”
immediately prior to the bankruptcy petition date. United
States v. Whiting Pools, Inc., 462 U.S. 198, 204 n.8 (1983).
Congress likewise observed in the Code's legislative
history: “[The Code] is not intended to expand the debtor’s
rights against others more than they exist at the com-
mencement of the case. For example, if the debtor has a
claim that is barred at the time of the commencement of
the case by the statute of limitations, then the trustee
would not be able to pursue that claim, because he too
would be barred. He could take no greater rights than the
debtor himself had.” S. Rep. 95-989 (1978), at 82 (empha-
sis added).’

As with its disregard of California’s burden of proof,
the court of appeals’ plain error in refusing to enforce the
statue of limitations changed the outcome in this case. If
the court had applied the state statute, the petitioners
would have prevailed. The failure to follow this Court’s

The court of appeals wrongly held that California statute of
limitations was bankruptcy specific and therefore preempted by the
Bankruptcy Code. App. at 17. In fact, the California statute has nothing
to do with bankruptcy law. It applies to all challenges to the validity
and enforceability of a specified category of government agreements.
Those challenges could be and are frequently made outside of bank-
ruptcy, as are challenges to the “true lease” nature of agreements.

23

decisions is a grievous error worthy of correction by the
Court.

III. The Opinion Below Nullifies An Established
Method Of Funding Improvements Of Public
Property And Has Far-Reaching Negative Con-
sequences.

The context of this case highlights the need for the
Court to articulate a clear, unambiguous rule as to what
constitutes a “lease” for purposes of the Bankruptcy Code.

First, the court of appeals essentially nullified (or at
least made much more expensive) an important mecha-
nism for funding improvements to public property like
airports. For decades, public agencies have used lease
revenue bonds to raise money to renovate and construct
public facilities. Lease revenue bonds involve the lease or
sublease of a portion of public property from a government
agency, coupled with a pledge of the rent payable under
the lease/sublease to the repayment of the bonds. One
fundamental aspect of this structure — and the reason why
it enhances credit ratings and lowers the cost of borrowing
— is the ability of the agency-lessor (or its bond trustee
assignee) to enforce the lease by evicting the lessee and re-
renting the property in the event of nonpayment, just as a
commercial landlord can evict a delinquent tenant and re-
rent office property if rent is not paid.

By concluding that debtors like United can repudiate
or recharacterize the leases that underpin lease revenue
bonds without fear of eviction or other consequences, the
court of appeals may have wiped out an entire category of
municipal financing, one that has been used repeatedly
and extensively in connection with airports and other vital

24

air transportation facilities. According to the amicus brief
submitted to the bankruptcy court by the Bond Market
Association and the National Federation of Municipal
Analysts:

Recharacterizing the Facilities Leases as “debt”
calls into question the underlying premise of
governmental ownership of the Airport Facilities
financed by the Airport Special Facilities Bonds —
as a matter of the reasonable expectations of the
credit markets, as well as a matter of tax law
and as a matter of economics. The market has re-
lied — not only in the case of United but also in
connection with many other airline special facil-
ity financings involving billions of dollars — on
governmental ownership as a basic premise for
the tax-exempt status of the bonds and for the ba-
sic security structure of the financing. If United
succeeds in its efforts to recharacterize the Lease
Arrangements, United’s position undercuts one
of the most fundamental elements of the care-
fully developed system for airport financing. Ab-
sent the market being able to rely on the
contractual obligations entered into by United
(and other airlines), Airport Special Facility
Bonds will no longer be an economical and effi-
cient tool for the development of air transporta-
tion facilities. To the extent that Airport Special
Facility Bonds can even be brought to market in
an environment where the market can no longer
rely upon the positions being taken by the air-
lines, the market will exact a high cost for taking
on the added risk of those financings. That in-
ability to “tap the market,” or the ability to access
the market only at a high cost, defeats not only
the purpose of Airport Special Facility Bond fi-
nancing, but also threatens the viability of one of

25

the most heavily utilized development tools for the
air transportation system.

Amicus Curiae Brief Of The Bond Market Association And
The National Federation Of Municipal Analysts Relating
To Debtor’s Motions For Summary Judgment And Cross
Motions For Summary Judgment, at 13 (emphasis added).

These warnings lend particular force to the Eleventh
Circuit’s observation that “the application of bankruptcy
principles in this context [of municipal financing] would be
particularly inappropriate.” Martin Brothers, 796 F.2d at
1440.

Moreover, the court of appeals opened the door to a
potential floodgate of challenges by other airlines. In the
few months following issuance of the court’s opinion, the
nation’s third- and fourth-largest airlines (Delta Air Lines
and Northwest Airlines) filed for bankruptcy in other
districts, and Delta already has initiated challenges
identical to that made by United. Billions of dollars of
airport lease revenue bonds currently are outstanding.
Given the current precarious state of the airline industry,
many of those bonds are now at serious risk of nullifica-
tion as a result of the court’s opinion.

This turn of events, and the opinion’s far-reaching
impact on municipal financing, make this case ripe for
review by the Court. Cf Securities Industry Ass n v. Board
of Governors, 468 U.S. 137, 142 (1984) (granting certiorari
ſblecause of the importance of the issue for the Nation’s
financial markets”).

26

CONCLUSION

The Petition should be granted to resolve the several
conflicts among the circuits with respect to this irnportant
issue involving the intersection of bankruptcy law, state law,
and municipal financing, and to address the court of appeals’
manifest misapplication of several of this Court’s precedents.

Respectfully submitted,

JAMES O. JOHNSTON

Counsel of Record

HENNIGAN, BENNETT & DORMAN LLP
601 South Figueroa Street, Suite 3300
Los Angeles, California 90017

(213) 694-1200

— and

HAROLD L. KAPLAN
Gary W. GARNER
MARK F. HEBBELN
GARDNER CARTON & DOUGLAS LLP
191 North Wacker Drive, Suite 3700
Chicago, Dlinois 60606
(312) 569-1000
Counsel for Petitioner HSBC
Bank USA, National Association

R. DAL GINTER

DOWNEY BRAND LLP

555 Capitol Mall, Tenth Floor
Sacramento, California 95814
(916) 444-1000

Counsel for Petitioner California
Statewide Communities Authority

App. 1

416 F.3d 609

United States Court of Appeals,
Seventh Circuit.
UNITED AIRLINES, INC., Plaintiff-Appellant,
V.
HSBC BANK USA, N. A., as Trustee, and California
Statewide Communities
Development Authority, Defendants-Appellees.
Nos. 04-4209, 04-4315, 04-4321.

Argued May 5, 2005.
Decided July 26, 2005.
Rehearing and Rehearing
En Banc Denied Aug. 23, 2005.*

Harold L. Kaplan, Gary W. Garner and Mark F.
Hebbeln, Gardner, Carton & Douglas, Chicago, IL, Kirk D.
Dillman, James O. Johnston (argued), Hennigan, Bennett
& Dorman, Los Angeles, CA, for Appellee HSBC Bank
USA, N.A.

R. Dale Ginter, Jamie P Dreher (argued), Downey
Brand, Sacramento, CA, for Appellant.

James H.M. Sprayregen, Marc Kieselstein (argued),
Kirkland & Ellis, Chicago, IL, for Debtor-Appellant.

William P. Smith, McDermott, Will & Emery, Chicago,
IL, for Amicus Curiae, Bank of New York.

Douglas W. Jessop, Jessop & Co., Amicus Curiae, City
of Denver.

Mark E. Abraham, Gould & Ratnet, Chicago, IL, for
Amicus Curiae, U.S. Bank National Association.

* Judge Ripple took no part in the consideration of this matter.

App. 2

David A. Golin, Gesas, Pilati, Gesas & Golin, Chicago,
IL, for Amicus Curiae, Regional Airports Improvement
Corp.

Charles P Schulman, Sachnoff & Weaver, Chicago, IL,
for Amicus Curiae, City of Los Angeles.

Before BAUER, EASTERBROOK, and MANION,
Circuit Judges.

EASTERBROOK, Circuit Judge.

What is a “lease” in federal bankruptcy law? Busi-
nesses that do not pay up front for assets may acquire
them via unsecured debt, secured debt, or lease; in each
event the business pays over time. Similar economic
function implies the ability to draft leases that work like
security agreements, and secured loans that work like
leases. Yet the Bankruptcy Code of 1978 distinguishes
among these devices. A lessee must either assume the
lease and fully perform all of its obligations, or surrender
the property. 11 U.S.C. § 365. A borrower that has given
security, by contrast, may retain the property without
paying the full agreed price. The borrower must pay
enough to give the lender the economic value of the secu-
rity interest; if this is less than the balance due on the
loan, the difference is an unsecured debt. See 11 U.S.C.
§ 506(a) and 5 11296b 2 NA). There are other ways in
which the Code treats leases differently from security
interests, but they don’t matter to today’s dispute.

During the 1990s United Air Lines entered into
complex transactions to obtain money to build or improve
premises at four airports — San Francisco, Los Angeles,
Denver, and John F. Kennedy in New York. For each
airport, a public body issued bonds that, because of the

App. 3

issuer’s status as a unit of state government, paid interest
that is free of federal taxation. The public bodies turned
this money over to United against its promise to retire the
bonds and reimburse administrative costs. At each airport,
United entered into a lease giving the body that had
issued the bonds the right to evict United from operational
facilities if it did not pay.

When United entered bankruptcy in 2002, however, it
took the position that none of these transactions is a
“lease” for purposes of § 365. United proposed to treat each
transaction as a secured loan, so that it could continue
using the airport facilities while paying only a fraction of
the promised “rent.” Chief Bankruptcy Judge Wedoff
concluded that the word “lease” in § 365 — a term not
defined anywhere in the Bankruptcy Code — includes “true
leases” but not transactions where the form of a lease is
used but the substance is that of a security interest.
Applying this approach as a matter of federal law, Judge
Wedoff concluded that the Denver transaction is a true
lease but that the other three are not. Jn re UAL Corp.,
307 B. R. 618 (Bankr. N. D. III. 2004). This meant that United
had to cure the default and resume full payments on its
Denver deal but could reduce its payments on the other
transactions and treat the difference as unsecured debt.

Everyone appealed. The district judge issued four
opinions, one for each airport, and held that al) four
transactions are “true leases.” Two are published: United
Air Lines, Inc. v. HSBC Bank USA, 322 B.R. 347
(N. D. III. 2005) (Denver), and HSBC Bank USA v. United
Air Lines, Inc., 317 B.R. 335 (N. D. III. 2004) (San Fran-
cisco). Relying principally on Butner v. United States, 440
U.S. 48, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979), and In re
Powers, 983 F.2d 88 (7th Cir.1993), Judge Darrah first

App. 4

concluded that state rather than federal law controls the
distinction between security interests and leases. Then,
applying California, Colorado, and New York law, he held
that each transaction must be treated as a “lease.” United
has appealed in all of these adversary actions. The San
Francisco dispute has been fully briefed; the other appeals
are being held for the disposition of this one. Parties to the
Los Angeles, Denver, and New York transactions have
presented their views as amici curiae. We confine our
attention in this opinion to the San Francisco transaction.

Since 1973 United has been the lessee of 128 acres,
used for a maintenance base, at San Francisco Interna-
tional Airport. The lease will end in 2013 unless the
parties negotiate an extension; rent depends on an inde-
pendent party’s estimate of the property’s market value. In
1997 the California Statewide Communities Development
Authority (CSCDA) issued $155 million in bonds itr
United’s benefit. United received the proceeds for use in
improving its facilities at the Airport though not at the
maintenance base. The transaction was accomplished
through four documents.

„ The sublease. United subleases 20 acres of
the 128-acre maintenance base to the CSCDA for
36 years. This term matches the debt-repayment
schedule rather than United’s lease with the Air-
port. The total rent CSCDA pays is $1.

„ The leaseback. The CSCDA leases the 20
acres back to United for a rent (paid to HBSC
Bank as the Indenture Trustee) equal to interest
on the bonds plus an administrative fee. The
lease has a $155 million balloon payment in 2033
to retire the principal. United may postpone final.
payment until 2038; if it does, the sublease also
is extended. United also is entitled to prepay; if it

App. 5

does, the sublease and leaseback terminate. If
United does not pay as agreed, the CSCDA may
evict it from the 20 acres. The leaseback in-
cludes a “hell or high water” clause: United must
pay the promised rent even if its lease from the
Airport ends before 2033, the property is sub-
merged in an earthquake (the Airport abuts San
Francisco Bay), or some other physical or legal
event deprives United of the use or economic
benefit of the maintenance base.

© The trust indenture. The CSCDA issues the
bonds, turns the $155 million over to United
against the promises made in the sublease, and
arranges for the Trustee to receive United’s pay-
ments for distribution to the bondholders. The
bonds are without recourse against the CSCDA.

© The guaranty. United commits its corporate
treasury to repayment of the bonds.

That the sublease and leaseback have the form of
“leases” is unquestioned. But does § 365 use form, or

substance, to distinguish “leases” from secured credit?

Although the statute does not answer that question in
so many words, every appellate court that has considered
the issue holds, and the parties agree, that substance
controls and that only a “true lease” counts as a “lease”
under § 365. See In re PCH Associates, 804 F.2d 193, 198-
200 (2d Cir.1986); In re Pillowtex, Inc., 349 F.3d 711, 716
(3d Cir.2003); In re Moreggia & Sons, Inc., 852 F.2d 1179,
1182-84 (9th Cir. 1988); In re Pacific Express, Inc., 780 F.2d
1482, 1486-87 (9th Cir.1986). See also, e.g., In re Continen-
tal Airlines, Inc., 932 F.2d 282 (3d Cir.1991) (same under
11 U.S.C. § 1110, another part of the Code dealing with
leases). We'll return to what a “true lease” might be; that
term is no more self-defining than the bare word “lease.”

App. 6

Before fleshing out the definition, we explain why we
agree with these decisions, because the reasons for prefer-
ring substance over form affect which substantive features
of the transactions matter.

Whether the word “lease” in a federal statute has a
formal or a substantive connotation is a question of federal
law; it could not be otherwise. See Reves v. Ernst & Young,
494 U.S. 56, 71, 110 S.Ct. 945, 108 L.Ed.2d 47 (1990);
Bryant uv. Yellen, 447 U.S. 352, 370-71 & n. 22, 100 S.Ct.
2232, 65 L.Ed.2d 184 (1980). (Whether federal law incor-
porates state law to answer the questions that result from
this choice is a different issue, to which we turn later. Cf.
United States v. Kimbell Foods, Inc., 440 U.S. 715, 99 S.Ct.
1448, 59 L.Ed.2d 711 (1979).) The Bankruptcy Code
specifies different consequences for leases and secured
loans. If these were formally distinct — in the way that
mergers and asset sales in corporate law are distinct —
then the statutory reference might best be understood as
adopting the established forms. But “lease” is a label
rather than a for. A transaction by which A sells a widget
to B in exchange for periodic payments, with B to own the
asset after the last payment, could be structured as an
installment sale, a loan secured by the asset, or a lease,
with only a few changes in verbiage and none in sub-
stance. It is unlikely that the Code makes big economic
effects turn on the parties’ choice of language rather than
the substance of their transaction; why bother to distin-
guish transactions if these distinctions can be obliterated
at the drafters’ will?

Many provisions in the Code, particularly those that
deal with the treatment of secured credit, are designed to
distinguish financial from economic distress. A firm that
cannot meet its debts as they come due, but has a positive

App. 7

cash flow from current operations, is in financial but not
economic distress. It is carrying toc much debt, which can
be written down in a reorganization. A firm with a nega-
tive cash flow, by contrast, is in economic distress, and
liquidation may be the best option. In order to distinguish
financial from economic distress, the Code effectively
treats the date on which the bankruptcy begins as the
creation of a new firm, unburdened by the debts of its
predecessor. See generally Boston & Maine Corp. v. Chi-
cago Pacific Corp., 785 F.2d 562 (7th Cir.1986). The new
firm must cover all new expenses, while debt attributable
to former operations is adjusted. Section 365, which deals
with leases, classifies payments for retaining airplanes
and occupying business premises as new expenses, just
like payments for labor and jet fuel. The rules for credit,
by contrast, treat debt service as an “old” expense to be
adjusted to deal with financial distress.

This works nicely when rent under a lease really does
pay for new inputs: each monthly payment on an airplane
lease covers another month’s use of a productive asset, just
as payments for jet fuel do. But “rent” that represents the
cost of funds for capital assets or past operations rather
than ongoing inputs into production has the quality of
debt, and to require such obligations to be assumed under
§ 365 to retain an asset would permit financial distress
from past operations to shut down a firm that has a
positive cash flow from current operations. Imagine a lease
of an airplane with a 20-year economic life that provided
for no rental payments during the first 10 years, followed
by rent at 2.5 times the market rate for the last ten (it
exceeds twice the spot-market price because the payments
must cover accrued interest on the deferrals). To separate
financial from economic distress it would be essential to

App. 8

separate the loan components of that “lease” from the
current-consumption components. The cost of capital hired
before the bankruptcy could be written down while the
expenses of current operations continued to be met.

When Congress enacted the Bankruptcy Code in 1978,
the legal system afforded rules that facilitated the disen-
tangling of credit and consumption components of leases.
Since 1939 this had been routine in tax law. See Helvering
v. F & R Lazarus & Co., 308 U.S. 252, 60 S.Ct. 209, 84
L.Ed. 226 (1939). See also, e.g., Frank Lyon Co. v. United
States, 435 U.S. 561, 98 S.Ct. 1291, 55 L.Ed.2d 550 (1978).
During the 1940s and 1950s much state law on the subject
was summed up and codified in the Uniform Commercial
Code. Section 1-201(37) of the 1958 Official Text separates
credit components, iri which the asset serves as security,
from consumption components this way:

Unless a lease ... is intended as security, reser-
vation of title thereunder is not a “security inter-
est”.... Whether a lease is intended as security
is to be determined by the facts of each case;
however, (a) the inclusion of an option to pur-
chase does not of itself make the lease one in-
tended 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 con-
sideration or for a nominal consideration does
make the leas? one intended for security.

A lease in which the consumption component domi-
nates often is called a “true lease,” while one in which the
asset serves as security for an extension of credit is
treated as a security agreement governed by the UCC’s
Article 9.

App. 9

No legally sophisticated person writing in 1978 could
have thought that the word “lease” in a text that distin-
guishes between current consumption (which must be paid
for in full) and secured debt (which may be written down
to ease financial distress) means any transaction in the
form of a lease. The need to look through form to sub-
stance would be apparent not only from the structure of
the statute but also from the fact that many of the leased
assets would be covered directly by the UCC. Section 365
in particular deals with leases of both personal and real
property; it would not be sensible to read the same word as
referring to substance when dealing with personal prop-
erty and form when dealing with real property. The
statute thus must refer to substance throughout § 365.
Nothing else respects both the structure of the Bankruptcy
Code and the way the legal community understood the
distinction between leases and security agreements in the
1970s.

Because the parties have made so much of the legisla-
tive history, we add that the understanding that § 365
deals with substance rather than form is reflected in many
of the documents that precede the Code’s enactment. The
passage to which the litigants pay the most attention
reads:

The phrase ‘lease of real property’ applies only to
a ‘true’ or ‘bona fide’ lease and does not apply to
financing leases of real property or interests
therein, or to leases of such property which are
intended as security.

Un a true lease of real property, the lessor re-
tains all risk and benefits as to the value of the
real estate at the termination of the lease...

App. 10

Whether a ‘lease’ is [a] true or bona fide lease or,
in the alternative, a financing ‘lease’ or a lease
intended as security, depends upon the circum-
stances of each case. The distinction between a
true lease and a financing transaction is based
upon the economic substance of the transaction
and not, for example, upon the locus of title, the
form of the transaction or the fact that the trans-
action is denominated as a ‘lease’. The fact that
the lessee, upon compliance with the terms of the
lease, becomes or has the option to become the
owner of the leased property for no additional
consideration [or] for nominal consideration indi-
cates that the transaction is a financing lease or
lease intended as security. In such cases, the les-
sor has no substantial interest in the leased
property at the expiration of the lease term. In
addition, the fact that the lessee assumes and
discharges substantially all the risks and obliga-
tions ordinarily attributed to the outright owner-
ship of the property is more indicative of a
financing transaction than of a true lease. The
rental payments in such cases are in substance
payments of principal and interest either on a
loan secured by the leased real property or on the
purchase of the leased real property.

S.Rep. No. 989, 95th Cong., 2d Sess. 64 (1978). This
passage is interesting because it illustrates how the legal
community thought in 1978 about the roles of form versus
substance in dealing with a werd such as “lease.” It would
be a mistake to find ruler of decision in this un-enacted
passage, see American Hospital Association v. NLRB, 499
U.S. 606, 615-16, 111 S.Ct. 1539, 113 L.Ed.2d 675 (1991),
but it does show that Congress shared the legal commu-
nity’s understanding that some transactions with the form
of a lease are best treated as security agreements.

App. 11

To say that substance prevails over form as a matter
of federal law is not to resolve all issues of detail — or for
that matter to imply that federal law supplies the details.
Which aspects of substance matter? The Senate Report
does not supply the answer. IRlestrictive language con-
tained in Committee Reports is not legally binding.”
Cherokee Nation u Leubitt. U.S. 125 S.Ct.
1172, 1182, 161 L. Ed. 2d 66 (2005). Reports are not enacted
and do not create rules independent of the text in the
United States Code. Anyway, this report sounds like a
reminder to be sensible rather than a formulary.

Because nothing in the Bankruptcy Code says which
economic features of a transaction have what conse-
quences, we turn to state law. All of the states have de-
voted substantial efforts to differentiating leases from
secured credit in commercial and banking law. Leases are
state-law instruments, after all, and the norm in bank-
ruptcy law is that contracts (of which leases are a species)
and property rights in general have the same force they
would have in state court, unless the Code overrides the
state entitlement. See Butner v. United States, 440 U.S.
48, 99 S.Ct. 914, 59 L.Ed.2d 136 (1979); see also, e.g.,
Raleigh v. Illinois Department of Revenue, 530 U.S. 15, 20,
120 S.Ct. 1951, 147 L.Ed.2d 13 (2000); BFP v. Resolution
Trust Corp., 511 U.S. 531, 544-45, 114 S.Ct. 1757, 128
L.Ed.2d 556 (1994); Nobelman v. American Savings Bank,
508 U.S. 324, 329-30, 113 S.Ct. 2106, 124 L.Ed.2d 228
(1993); Barnhill u. Johnson, 503 U.S. 393, 398, 112 S.Ct.
1386, 118 L.Ed.2d 39 (1992). A state law that identified a
“lease” in a formal rather than a functional manner would
conflict with the Code, because it would disrupt the federal
system of separating financial from economic distress; a
state approach that gives a little more or a little less

App. 12

weight to one of several “factors” does not conflict with any
federal rule, because there is none with which it could
conflict. Cf. In re James Wilson Associates, 965 F.2d 160
(7th Cir.1992).

United contends that the second and ninth circuits
have held that federal law supplies the definition of a
“lease” in addition to establishing a functional approach to
the inquiry. Perhaps some language in PCH Associates and
Moreggia could be read that way, though we think it more
likely that both courts were concerned with the first
question (whether the word “lease” in § 365 has a formal
or functional scope), which is a matter of federal law, than
with the second — what body of law identifies a “true lease”
under the functional approach? Neither opinion cites
Butner or any of the Supreme Court's other decisions
specifying that state law must be used whenever possible
to define the interests on which the Code operates. If
either the second or the ninth circuits believes that federal
law answers all questions concerning the operation of
§ 365, then we disagree; for the reasons we h~ve given, the
third circuit (which in Continental Airlines and Pillowtex
used state definitions) got this right. Indeed, we held
exactly this in Powers, a decision under § 365 that the
bankruptcy judge did not mention. Powers involves the
choice between lease and installment sales contract for
personal property; we cannot imagine any reason why
state law would define a “true lease” for personal property
while federal law would supply the definition for real
property.

So what does California law provide? The district
judge thought that California allows form to control, and
because United and the CSCDA chose the form of a lease
United is stuck with that characterization under § 365. If

App. 13

indeed California identifies leases in such a mechanical
fashion, then its law must yield, but we do not understand
it to distinguish leases from secured credit in this way.
Neither do we follow the district court’s conclusion that
form prevails unless “clear and convincing evidence”
supports a different characterization. Burdens of proof and
persuasion are supplied by the forum, not by the source of
substantive law. Bankruptcy law uses the preponderance
standard. See Grogan v. Garner, 498 U.S. 279, 111 S.Ct.
654, 112 L.Ed.2d 755 (1991). Anyway, burdens of persua-
sion are irrelevant to characterization of documentary
transactions. See, e.g., In re Schoonover, 331 F.3d 575, 577
(7th Cir.2003); In re Weinhoeft, 275 F.3d 604 (7th
Cir.2001).

Like the district judge, the parties in this court seek to
find California’s law in the decisions of federal bankruptcy
judges sitting in California, and they debate the signifi-
cance of what these judges have said about the subject. Yet
federal judges are not the source of state law or even its
oracles. To find state law we must examine California’s
statute books and the decisions of its judiciary. California
has enacted the UCC; there can be no doubt that it uses a
functional approach to separating leases from secured
credit with respect to personal property. California takes a
similar approach for real property as a matter of common
law. Burr v. Capital Reserve Corp., 71 Cal.2d 983, 80
Cal.Rptr. 345, 458 P.2d 185 (1969), and Beeler v. American
Trust Co, 24 Cal.2d 1, 147 P.2d 583 (1944), are especially
revealing.

Beeler arose from a sale and leaseback of real property.
When the tenant stopped paying, the court had to decide
whether he could be evicted under landlord-tenant law,
with the landlord retaining the fee title to the property, or

App. 14

whether instead the tenant retained an equity of redemp-
tion under the law of mortgage loans, so that any pay-
ments in excess of the market rental value would redound
to the tenant’s benefit. The Supreme Court of California
characterized the transaction as an equitable mortgage
despite the fact that the papers cast it as an absolute deed
plus a lease. It relied not only on the fact that the landlord
was a financial institution but also on the fact that the
rent was equal to the sum needed to pay off a loan and the
fact that the lessee would become an owner after some
years. (This is the UCC’s per se rule: If the lessee has an
option te acquire ownership at the end of the term for no
or a nominal payment, then the transaction must be
treated as secured credit.) The yearly rent was $3,000,
substantially less than the going rate for similar property
but exactly equal to the amount needed to amortize a
$60,000 extension of credit — and the $60,000 for which the
property had been “sold” initially was less than the market
price of equivalent real estate. The state court thought
that this deal had all the hallmarks of a mortgage loan
except the form — and the form had to yield. This was not a
“true lease” as the court saw it.

Burr posed the question whether a lease of personal
property should be treated as a loan; the answer mattered
because at the time California's usury law set a 10%
maximum interest rate on loans, but there was no price
control on leases. Burr needed money to expand his
business. He obtained cash by selling some of the existing
business’s property to a bank and immediately leasing it
back at a rental designed to amortize the extension of
credit. The Supreme Court of California held that this
form must be pierced to get at the substance: Burr had
borrowed money on security of the property subject to the

App. 15

lease, and as the interest rate in one of the parties’ three
transactions exceeded 10% the bank could not collect the

full agreed payment.

California has applied this approach in many other
cases, which we need not recount. See, e.g., Lovelady v.
Bryson Escrow, Inc., 27 Cal.App.4th 25, 32 Cai. Rptr. 2d 371
(1994). It has been more willing to follow form when that
will enhance tax revenues, denying parties a right to
pierce their own form at the state’s expense, when the
state treasury was not privy to the original choice. See,
e.g., Rider v. San Diego, 18 Cal.4th 1035, 77 Cal.Rptr.2d
189, 959 Pad 347 (1998); Dean u Kuchel, 35 Cal.2d 444,
218 Pad 521 (1950). The only state decision to which the
district judge referred is of this kind and held that it just
did not matter whether a given transaction was a “lease”
or something else. Desert Hot Springs v. Riverside County,
91 Cal.App.3d 441, 154 Cal.Rptr. 297 (1979). Instead the
question was whether a person who had leased some land
from a city for 50 years, built a city hall there, and leased
the improved parcel back to the city for a 15-year term
(substantially less than the structure’s useful life), had
retained a “possessory interest” subject to taxation under
Cal. Rev. & Tax Code § 107. The court’s affirmative answer
is unhelpful on a question of the kind we confront.
Whether the CSCDA has an interest that some other arm
of California’s government could tax is neither here nor
there.

The transaction between United and the CSCDA is
not a “true lease” under California law. (i) The “rent” is
measured not by the market value of 20 acres within the
maintenance base but by the amount United borrowed.
The hell or high water clause demonstrates the lack of
connection between the maintenance base’s rental value

App. 16

and United’s financial obligation. (ii) At the end of the
lease, the CSCDA has no remaining interest. The CSCDA
stresses that United will not “own” anything as of 2033; it
still would be the Airport’s tenant. But its full tenancy
interest reverts to it for no additional charge. Reversion
without additional payment is the UCC’s per se rule for
identifying secured credit. (iii) The balloon payment has
no parallel in a true lease, though it is a common feature
of secured credit. (iv) If United prepays, the lease and
sublease terminate immediately; in a true lease, by con-
trast, prepayment would secure the tenant’s right to
occupy the property for an additional period. The parties
have not cited any case from any state deeming an ar-
rangement of this kind to be a “true lease.”

We do not doubt that many financing devices are true
leases; the lessor owns the property and thus finances its
acquisition, relieving the lessee of the need to raise funds
itself, and net leases may measure rent by the lessor’s
financial commitments. United acquired many of its
airplanes that way. But in such a transaction the lessee
acquires an asset; from the lessee’s perspective, it is
engaged in securing assets with current value, and it can
escape the rental obligation by surrendering the asset.
United did not obtain the maintenance base from CSCDA;
it already had the base under its lease from the Airport,
and could not end the obligation to the CSCDA by vacating
the maintenance base. What United did was use an asset
(its leasehold interest in the maintenance base) to secure
an extension of credit, just as the business did in Burr, and
as in Beeler it agreed to pay “rent” equal to the price of
that credit rather than any element of value in the
“leased” premises.

App. 17

The CSCDA has filed a cross-appeal to argue that
United’s failure to contest the lease within 60 days of its
execution disables it from arguing that the arrangement is
not a “true lease.” California has what the parties call a
“validation statute,” which provides this deadline.
Cal.Code Civ. P. § 860, § 869. The cross-appeal is pointless.
The CSCDA wants us to affirm rather than alter the
judgment, and appellees may advance in support of their
judgments any argument preserved in the district court.
Massachusetts Mutual Life Insurance Co. v. Ludwig, 426
U.S. 479, 96 S.Ct. 2158, 48 L.Ed.2d 784 (1976). The cross-
appeal is dismissed as surplusage.

The district judge rejected the CSCDA’s contention,
stating that it had not been presented to the bankruptcy
judge. Although the CSCDA says otherwise, we need not
resolve that dispute. State procedures do not matter in
bankruptcy. State law defines property rights, but federal
law prescribes the hoops through which the litigants must
jump. California could not enact a law saying: Ҥ 365
always must be applied to documents with the form of
leases unless the debtor takes specified steps before
entering bankruptcy.” Matters that could not have been
determined before bankruptcy can't be foreclosed because
they were not so determined. See Brown v. Felsen, 442 U.S.
127, 99 S.Ct. 2205, 60 L.Ed.2d 767 (1979). Nor may states
insist that questions affecting the outcome of a bankruptcy
be adjudicated in state court; the federal bankruptcy
jurisdiction is exclusive. Issues that have been resolved in
state court (say, in pre-bankruptcy litigation) may well
have preclusive effect in the federal litigation. See, e.g.,
Grogan, 498 U.S. at 284-85 n. 11, 111 S.Ct. 654; Brown,
442 U.S. at 139, 99 S.Ct. 2205; Kelly v. Robinson, 479 U.S.
36, 47-49, 107 S.Ct. 353, 93 L.Ed.2d 216 (1986). But states

App. 18

may not compel potential debtors in bankruptcy to use
state tribunals before repairing to federal court.

What is more, the state validation statute does not
apply on its own terms. United is not challenging the
validity of the sublease and leaseback. It concedes that the
transaction is valid as a matter of state law and that it
owes the money. The question under § 365 is whether it
must pay in full to enjoy continued occupancy or whether,
instead, it may reduce payments to the value of the inter-
est secured by the leasehold and treat the residue as
unsecured debt. California’s validation statute does not
address that question and so is irrelevant in this litiga-
tion.

The transaction between United and the CSCDA at
San Francisco Airport is a secured loan and not a lease for
the purpose of § 365. The judgment of the district court is
reversed, and the case is remanded for further proceedings
consistent with this opinion.

App. 19

317 B.R. 335

United States District Court,
N.D. Illinois,
Eastern Division.
HSBC BANK USA, Appellant,

V.

UNITED AIR LINES, INC., Appellee.
California Statewide Communities Development Author-
ity, Appellant,

v
United Air Lines, Inc., Appellee.

Nos. 04 C 2836, 04 C 2837.

Nov. 16, 2004.

Mark F. Hebbeln, Gary W. Garner, Harold Kaplan,
Gardner Carton & Douglas LLP, Chicago, IL, Kirk D.
Dillman, James O. Johnston, Joshua M. Mester, Henni-
gan, Bennett & Dorman, Los Angeles, CA, for Appellant.

James Howard Mandell Sprayregen, Marc Kiesel-
stein, Todd A. Gale, Colby Anne Kingsbury, Kirkland &
Ellis LLP, Chicago, IL, for Appellee.

Robert Dale Ginter, Downey Brand LLP, Sacramento,
CA, for Defendant.

MEMORANDUM OPINION AND ORDER
DARRAH, District Judge.

This matter comes before the Court on the appeal of
the judgment of the bankruptcy court of March 30, 2004,
by HSBC Bank USA and California Statewide Communi-
ties Development Authority (“CSCDA”). For the reasons
that follow, the decision of the bankruptcy court is re-
versed.

App. 20

BACKGROUND

CSCDA is a joint exercise-of-powers government
agency consisting of a number of California counties,
cities, and other local government agencies. CSCDA is
organized pursuant to Chapter 5 of Division 7 of Title 1 of
the Government Code of the State of California (“Joint
Powers Act”) and an Amended and Restated Joint Exercise
of Powers Agreement dated as of June 1, 1988, among the
member local government agencies. Pursuant to the Joint
Powers Act, CSCDA is authorized to exercise the power of
its member local government agencies, among other
things, to issue revenue bonds to pay the cost and ex-
penses of acquiring or constructing publicly owned or
operated commercial aviation airports and airport-related
facilities.

On June 18, 1973, United entered into the “Mainte-
mance Base Lease” with the City and County of San
Francisco. Pursuant to the lease, United leased certain
ramp space and facilities at San Francisco International
Airport (“SFO”). To assist United in developing certain
facilities at SFO, United and CSCDA consummated a
transaction in 1997 pursuant to which CSCDA issued tax-
exempt revenue bonds in the amount of $154,845,000.00.
The funds from the sale of the bonds were made available
to United in accordance with the terms of the 1997 SFO
transaction documents.

The 1997 SFO transaction was comprised of multiple
documents and agreements. Three agreements germane to
the instant dispute are: (1) the Site Sublease, (2) the
Facilities Lease, and (3) the Indenture of Mortgage and
Deed of Trust (“Indenture”).

App. 21

Pursuant to the Site Sublease, United subleased to
CSCDA an approximately twenty-acre portion of the
premises leased to United under the Maintenance Base
Lease for the nominal rent of one dollar. The term of the
Site Sublease is defined as the period from September 1,
1997 to October 5, 2033, unless a shorter or longer period
is required to retire bonds to be issued by CSCDA. There
are no provisions for remedies for United for any default
by CSCDA.

CSCDA then sub-subleased the leased premises back
to United pursuant to the Facilities Lease. The term of the
Facilities Lease is identical to that of the Site Sublease.
The Facilities Lease’s rental is the amount necessary to
make the payments required under the Indenture — the
amount needed to pay the bonds in accordance with their
terms as well as administrative costs. The Facilities
Lease’s rental amount also constituted reasonable com-
pensation for the use and occupation of the relevant
portion of the SFO Maintenance Base Lease the 20-acre
portion of the 130-acres the City and County leased to
United. The Facilities Lease provides default provisions
and remedies, including CSCDAs right to take possession
of the leased facilities and relet them if United fails to
make the required payments.

The Indenture provides for the issuance of tax-exempt
bonds by CSCDA, for the SFO trustee te receive the
proceeds of the sale of bonds for purposes of funding
construction of defined improvements benefiting United,
and for the SFO trustee to receive the rental payments
from United under the Facilities Lease for the purpose of
paying the debt service on the bonds and ultimately
retiring them. The Indenture indicates that the bonds are
“limited obligations” of CSCDA, payable only from the

App. 22

revenue received from United and earnings on this reve-
nue. Pursuant to the Indenture, CSCDA assigned the
Facilities Lease, including the right to collect rents, to the
Indenture trustee, presently HSBC Bank USA.

On December 9, 2002, United filed a voluntary peti-
tion under Chapter 11 of Title 11, United States Code. On
March 21, 2003, United filed an Adversary Complaint,
seeking a declaratory judgment that certain of its payment
obligations related to airport improvements were not
obligations arising under “leases” pursuant to Section 365
of the Bankruptcy Code. Subsequently, all parties moved
for summary judgment on the issue of whether the
“leases” were true leases, as opposed to financing instru-
ments.

On March 4, 2004, the bankruptcy court granted
United’s motion for summary judgment. HSBC Bank and
CSCDA appeal that judgment to this Court.

LEGAL STANDARD

A bankruptcy court’s grant of summary judgment is
reviewed de novo. Hoseman v. Weinschneider, 322 F.3d 468,
473 (7th Cir.2003) (Hoseman). All of the facts and the
inferences therefrom are viewed in the light most favor-
able to the nonmoving party. Hoseman, 322 F.3d at 473.
Similarly, a bankruptcy court’s interpretation of statute is
a question of law reviewed de novo. See Hiram Walker &
Sons, Inc. v. Kirk Line, 30 F.3d 1370, 1378 (11th Cir.1994).
The Court reviews the bankruptcy court’s factual findings
for clear error. Hoseman, 322 F.3d at 473.

Summary judgment is proper if “the pleadings, depo-
sitions, answers to interrogatories, and admissions on file,

App. 23

together with affidavits, if any, show that there is no
genuine issue as to any material fact.” Fed.R.Civ.P. 56(c);
see also Celotex Corp. v. Catrett, 477 U.S. 317, 322-23, 106
S.Ct. 2548, 91 L.Ed.2d 265 (1986). All the evidence and the
reasonable inferences that may be drawn from the evi-
dence are viewed in the light most favorable to the non-
movant. Miller v. American Family Mut. Ins. Co., 203 F.3d
997, 1003 (7th Cir.2000). Summary judgment may be
granted when no verdict could reasonably be returned for
the nonmoving party. See Anderson v. Liberty Lobby, Inc.,
477 U.S. 242, 248, 106 S.Ct. 2505, 91 L.Ed.2d 202 (1986).

DISCUSSION

The bankruptcy court held that the Site Sublease and
the Facilities Lease between United and CSCDA were not
true leases for purposes of Bankruptcy Code § 365, finding
that the 1997 SFO transactions “... are the economic
equivalent of leasehold mortgages....” The bankruptcy
court applied federal law to determine if the instruments
were true leases, rather than applying state law, as argued
by the Appellants.

The appeal raises the following issues for review: (1)
did the bankruptcy court err by failing to apply state
(California) law to characterize the Site Sublease and the
Facilities Lease; (2) was it error for the bankruptcy court
to ignore Seventh Circuit precedent; (3) did the bank-
ruptcy court err in denying the Appellants’ motions for
summary judgment; and (4) did the bankruptcy court err

in granting United’s Motion for Summary Judgment.

The Appellants’ first two arguments on appeal are
intervelated. Appellants argue that the bankruptcy court
erred in failing to apply state law, as required by Seventh

App. 24

Circuit precedent, when determining whether the Site
Sublease and the Facilities Lease constituted true leases

for § 365 purposes.

Section 365(a) provides the trustee, or debtor-in-
possession in Chapter 11 cases, the power to assume or
reject unexpired leases. 11 U.S.C. § 365(a). Certain re-
quirements are imposed when the trustee wishes to
assume an unexpired lease in default. The trustee must
cure the default, compensate any parties that have suf-
fered pecuniary loss from the default, and provide ade-
quate assurance of future performance under the lease. 11
U.S.C. § 365(b). Leases of nonresidential real property are
deemed rejected unless assumed within sixty days after an
order for relief unless the court, for cause, grants addi-
tional time during that sixty-day period. 11 U.S.C.
§ 365(d).

The terms “unexpired lease” and “lease of nonresiden-
tial real property,” as used in Section 365, are not defined
in the Bankruptcy Code. In defining the terms, courts
have relied upon the legislative history of Section 502(b)(6)
of the Bankruptcy Code, which limits damage claims
resulting from lease terminations which are allowable to a
debtor’s landlord. The pertinent legislative history states:

Whether a “lease” is a true or la] bona fide lease, or in
the alternative, a financing “lease” or a lease intended
as security, depends upon the circumstances of each
case. The distinction between a true lease and a fi-
nancing transaction is based upon the economic sub-
stance of the transaction and not, for example, upon
the locus of title, the form of the transaction or the
fact that the transaction is denominated as a “lease.”

App. 25

S.Rep. No. 598, 95th Cong., 2d Sess. 64, reprinted in
1978 U.S.C.C.A.N. 5787, 5850. Based on this legislative
history, courts require that a lease in question must be a
“true” or “bona fide” lease for Section 365 to apply. See In
re Powers, 983 F.2d 88, 89 (7th Cir.1993) (deciding whether
rental agreements were true leases) (Powers); In re Moreg-
gia & Sons, Inc., 852 F.2d 1179, 1182 (9th Cir.1988) (Mo-
reggia),; In re Lunan Family Restaurants, 194 B.R. 429,
450 (Bankr. N. D. III. 1996), In re Hotel Syracuse, Inc., 155
B. R. 824, 838 (Bankr N. DN. V 1993) (Hotel Syracuse).

Generally, Congress has left the determination of
property rights in the assets of a bankrupt's estate to state
law. See Butner v. United States, 440 U.S. 48, 54, 99 S.Ct.
914, 59 L.Ed.2d 136 (1979) (Butner). The application of
state law is applied to both ownership interests in prop-
erty and security interests in such property. Nobelman v.
American Savings Bank, 508 U.S. 324, 329, 113 S.Ct.
2106, 124 L.Ed.2d 228 (1993). However, state law may be
displaced if “some federal interest requires a different
result.” Butner, 440 U.S. at 55, 99 S.Ct. 914. In order to
displace traditional state law, “the federal, statutory
purpose must be ‘clear and manifest. Otherwise, the
Bankruptcy Code will be construed to adopt, rather than
displace, pre-existing state law.” BFP v. Resolution Trust
Corp., 511 U.S. 531, 544-45, 114 S.Ct. 1757, 128 L.Ed.2d
556 (1994). “In the absence of any controiling federal law,
‘property’ and ‘interests in property’ are creatures of state
law.” Barnhill v. Johnson, 503 U.S. 393, 398, 112 S.Ct.
1386, 118 L.Ed.2d 39 (1992).

“Lease” is not defined in Section 365. However, the
legislative history applicable to a security interest states
that “|wjhether a consignment or a lease constitutes a
security interest under the bankruptcy code will depend

App. 26

on whether it constitutes a security interest under appli-
cable state or local law.” S. Rep. No. 595, 95th Cong., Ist
Sess. 314, reprinted in 1978 U.S.C.C.A.N. 5963, 6271; see
also Powers, 983 F.2d at 90; DWE, 157 B.R. at 330 (citing
legislative history of definition of security interest in
support of application of state law in application of Section
365). This legislative history supports a finding that the
bankruptcy code, as applied to leases in Section 365,
adopts, rather than displaces, pre-existing state law.

Furthermore, the legislative history of Section
502(b\6) cited above fails to demonstrate a “clear and
manifest” statutory purpose to displace traditional state
law. See BFP, 511 U.S. at 544-45, 114 S.Ct. 1757. This
legislative history indicates that whether a lease is a true
lease depends upon the circumstances of each case. This
requirement is consistent with state laws requiring that
the facts of each case be reviewed to determine whether a
lease is intended as security. See, e.g., Powers, 983 F.2d at
90 (Illinois and Indiana law require court to determine
whether a lease is intended as security by the facts of each
case); Pillowtex, 349 F.3d at 717 (under New York law,
whether a transaction creates a lease or security interest
is determined on a case-by-case basis); Pittsburgh Sports,
239 B.R. at 84 (Pennsylvania law requires an examination
of the particular facts and circumstances of each case).

This legislative history also states that the “distinc-
tion between a true lease and a financing agreement is
based upon the economic substance of the transaction.”
Reviewing the “economic substance” or “economic reali-
ties” is consistent with state law. See In re Yarbrough, 211
B.R. 654, 657 (Bankr.W.D.Tenn.1997) (Mississippi law
requires the court to look to the economic realities of the
transaction in determining whether a transaction is a

App. 27

lease or security interest); In re Vital Prod. Co., 210 B.R.
109, 112 (Bankr.N.D.Ohio 1997) (Ohio state law, as pro-
vided in the U.C.C., focuses on economic realities of a
transaction in determining whether the transaction is a
true lease); Jn re Nite Lite Inns, 13 B.R. 900, 907-08
(Bankr.S.D.Cal.1981) (Nite Lite) (considering the economic
substance of the transaction in applying California law to
determine whether transaction was a true lease); In re
Hoagland, 1996 WL 33406128 (Bankr.C.D.Ill. Feb. 26,
1996) (the economic realities of the transaction are rele-
vant factors under Illinois law in determining whether a
lease is a true lease). — — legislative history of
Section 502(b) fails to demonstrate a clear and manifest
statutory purpose to displace traditional state law. See
BFP. 511 U.S. at 544-45, 114 S.Ct. 1757. In essence,
United concedes this as it argues that the substantive
inquiry under both California law and federal law is the
same.

Federal courts, including the Seventh Circuit, have
applied state law in determining whether a lease is a true
lease for purposes of Section 365, citing Butner. See Pow-
ers, 983 F.2d at 90; In re Pillowtex, Inc., 349 F.3d 711, 716
(3rd Cir.2003) (Pillowtex); In re Sankey, 307 B.R. 674, 678
(D.Alaska 2004); In re Pittsburgh Sports Assoc. Holding
Co., 239 B.R. 75, 83 (Bankr.W.D.Pa.1999) (Pittsburgh
Sports), In re Fox, 229 B.R. 160, 164 (Bankr.N.D.Ohio
1998); In re DWE Screw Prod., Inc., 157 B.R. 326, 330
(Bankr.N.D.Ohio 1993) (DWE).

In contrast, some courts, including the bankruptcy
court here, have applied a federal rule of law, known as
the economic realities test, to determine whether a lease is
a true lease for purposes of Section 365. These courts cite
the above-quoted language of the legislative history of

App. 28

Section 502(b\6), read together with Section 365, in
support of their finding that a federal rule of law must be
applied in determining whether a lease of real property’ is
a true lease for purposes of Section 365 because these
aspects provide an adequate “federal interest” to justify
using a federal rule of law rather than state law to define
this particular property interest. See Moreggia, 852 F.2d at
1182; In re PCH Assoc., 804 F.2d 193, 200 (2nd Cir.1986)
(PCH), In re KAR Dev. Assoc., L.P, 180 B.R. 629, 638
(D.Kan.1995) (KAR); In re Tak Broadcasting Corp., 137
B.R. 728, 732 (W.D.Wis.1992).

However, based on the legislative history and the case
law, particularly Butner and Powers, the bankruptcy court
erred in applying federal law in determining whether the
leases at issue were true leases.

The Appellants’ third and fourth issues are also
related. Appellants argue that the bankruptcy court erred
in granting United’s motion for summary judgment and
denying the Appellants’ motions for summary judgment.
United argues that summary judgment was proper under
either federal law or California law because, substantively,
the law is the same.

Under California law, an agreement is presumptively
a lease of real property if it includes a designation of the
parties, contains a definite description of the leased
property, provides for periodic payment of rent for the
term of the lease, and provides a right to occupy the

Those sections of Section 365 applicable to both real and personal
property are specifically indicated. See, eg. 11 U.S.C. § 365(d)(1). Any
section applicable to only real property is specifically identified See,
eg. 11 U.S.C. § 365(dX4).

App. 29

property to the exclusion of the grantor. See In re SCCC
Assoc. II Ltd., 158 B. R. 1004, 1013 (Bankr.N.D.Cal.1993)
(SCCC) (emphasis added).

Here, the Facilities Lease designates the parties,
contains a definite description of the leased property,
provides for periodic payment of rent over the term of the
lease, and provides United with a right to occupy the
leased premises to the exclusion of the grantor. Accord-
ingly, the Facilities Lease is presumed to be a true lease
under California law. This presumption may be rebutted
by United by establishing by clear and convincing evidence
that the parties intended for the Facilities Lease to dis-
guise a substantive transfer of ownership of or an encum-
brance of the leased SFO Maintenance Facility. See SCCC,
158 B.R. at 1009-14; Fox v. Peck Iron & Metal Co., 25 B. R.
674, 688 (Bankr.S.D.Cal. 1982) (Fox) (emphasis added).

Whether a lease agreement is a true lease or one
intended solely for security is determined by determining
the intent of the parties at the time of the execution of the
document. See Fox, 25 B.R. at 688. The intent of the
parties is determined by reviewing all facts and circum-
stances of the transaction, including the economic sub-
stance of the transaction. See Fox, 25 B.R. at 688; Nite
Lite, 13 B.R. at 908. Factors considered in this analysis
include: (1) whether the transaction actually transfers the
normal! risks and responsibilities of landlord to the lessor;
(2) whether the payments under the lease are reasonably
designed to compensate the lessor for the use of the
property or simply reflect the repayment of the lessor’s
acquisition cost plus interest; Fox, 25 B.R. at 688; and (3)
whether the lessor retains an economically significant
interest in the property, SCCC, 158 B.R. at 1013.

App. 30

The application of these factors to the facts demon-
strates that the Facilities Lease was a true lease. Under
the Facilities Lease, United is required to pay the taxes,
maintenance, and insurance — generally referred to as a
triple net lease. While the payment of taxes, maintenance,
and insurance are typically viewed as usual obligations
indicating ownership, as opposed to a landlord-tenant
relationship, the use of triple net leases are not unusual
terms in ground leases. See SCCC, 158 B.R. at 1013.
Furthermore, United concedes that it could never own the
leased property or facilities. As such, United’s responsibili-
ties under the lease that are generally an indicia of owner-
ship fail to demonstrate that the lease is not a true lease.

The payments under the lease are also reasonably
designed to compensate Appellants. The aggregate rental
payments required by the Facilities Lease include the
amount needed to pay the bonds in accordance with their
terms and the administrative costs associated therewith.
However, the amount of the rental payments also consti-
tuted reasonable compensation for the use and occupation
of the 20-acre portion of the 180-acre SFO Maintenance
Facilities. HSBC’s expert demonstrated that United’s rent
payments were reasonable compensation for the use and
occupation of the relevant portion of the SFO Maintenance
Facilities. United provided no evidence to the contrary.
Furthermore, rent payments are frequently calculated
with reference to payment in respect to financing obliga-
tions. See City of Desert Hot Springs v. County of River-
side, 91 Cal.App.3d 441, 154 Cal.Rptr. 297, 301 (1979)
(Desert Springs). A lease-leaseback' arrangement ‘as a
method of financing construction’ is not inconsistent with
the existence of a lease.” Desert Springs, 154 Cal.Rptr. at
301. In addition, United could terminate the Facilities

App. 31

Lease by prepaying the rent due for the lease term, and
there was no reduction in rent corresponding to the
shorter lease term in the event of prepayment. An absolute
obligation to pay rent for the full lease term is indicative of
a true lease. See 7 Miller & Star California Real Estate §
19.86 (3d ed. 2001).

Lastly, the lessor retained an economically significant
interest in the property leased to United, and United
retained no interest in the leased property. United con-
cedes that it did not own, will not own, and cannot ever
own any of the facilities leased to United. The Facilities
Lease does not have an option to purchase at the end of
the lease. United has retained no interest at the end of the
lease.

United argues, and the bankruptcy court found, that
because CSCDA does not retain an ownership interest at
the end of the Facilities Lease, the Facilities Lease cannot
be a true lease. The bankruptcy court held this factor to be
the most important and concluded that the Facilities
Lease was not a true lease based on this factor alone.
However, this analysis and resultant finding focus on the
lessor instead of the lessee. The finding also fails to take
into account that CSCDA had a right to re-let the relevant
portion of the SFO Maintenance Facilities if United
defauited. The right to re-let is indicative of a true lease,
not a financing arrangement.

Under the bankruptcy court’s logic, every sublease
that has a term equal to the term of the underlying lease
would be a disguised financing arrangement rather than a
true lease because the sublessor has a lack of reversionary
interest at the end of the lease term. For example, if lessor
A executed a one-year lease of an apartment with lessee B,

App. 32

and lessee B subleased the apartment six months later to
sublessee C for the remaining six months, at the conclu-
sion of the sublease, the apartment reverts back to lessor
A. Under the bankruptcy court’s reasoning, the sublease
would not be a true lease because lessee B did not have a
reversionary interest at the end of the lease term. Accord-
ingly, the lack of a reversionary interest in CSCDA at the
end of the Facilities Lease does not dictate that the Facili-
ties Lease was not a true lease.

The Appellants also argue that United is equitably
estopped from changing its previous position that the
Facilities Lease was a lease. Under California law, the
elements of equitable estoppel are: (1) the party to be
estopped must be appraised of the facts; (2) that party
must intend that its conduct be acted upon, or must so act
that the other party has a right to believe that it was so
intended; (3) the other party must be ignorant of the true
state of facts; and (4) the other party must rely on the
conduct to its injury. See Ace Am. Ins. Co. v. Walker, 121
Cal.App.4th 1017, 18 Cal. Rptr.3d 1, 8 n. 2 (2004). Here,
there is no evidence demonstrating that United was
appraised of the fact that it would be filing for bankruptcy
and that the Facilities Lease would be an issue of dispute.
Accordingly, he doctrine of equitable estoppel is not
applicable.

Lastly, the Appellants argue that, under California
law, United had sixty days to challenge the Facilities
Lease and that United failed to do so; therefore, United
cannot now challenge the lease. Nothing in the record
indicates that Appellants presented this argument to the
bankruptcy court, and the bankruptcy court did not
address the issue in its March 30, 2004 judgment now on
appeal before this Court. Accordingly, this issue is waived

App. 33

on appeal. See In re Image Worldwide, Ltd., 139 F.3d 574,
581 (7th Cir. 1998).

CONCLUSION

Based on the foregoing, the March 30, 2004 judgment
of the bankruptcy court order, granting summary judg-
ment in favor of United based on its finding that the
Facilities Lease was not a true lease, is reversed.

App. 34

United States District Court,
Northern District of Illinois

Name of As- John W. | Sitting Judge
signed Judge Darrah if Other than
or Magistrate Assigned
Judge Judge
CASE 04 C 2836 DATE 11/15/2004
NUMBER
CASE TITLE HSBC Bank USA vs. UAL

In the following box (a) indicate the party fil-
ing the motion, e.g., plaintiff, defendant, 3rd
party plaintiff, and (b) state briefly the nature
of the motion being presented.

MOTION:

DOCKET ENTRY:

(1) © Filed motion of [use listing in “Motion” box above.
(2) (©) Briefin support of motion due

(3) © Answer brief to motion due Reply to answer brief
due

(4) (©) Ruling Hearing on set for at

(5) © Status hearing ſheld/ continued to} (set for/re-set for]
on set ſor at

(6) U Pretrial conference held/ continued to] (set for/re-set
for on set ſor at

(7) (©) Trial [set for/re-set for] om at
(8) © [Bench/Jury trial] [Hearing] held/continued to at

App. 35

(9) O This case is dismissed (with/without) prejudice
and without costs [by/agreement/pursuant to

D FRCP4(m) Local Rule 41.1
© FRCP41(a\1) 0) FRCP41(aX2)

(10) @ [Other docket entry] For the reasons stated in
the attached memorandum opinion and order,
the March 30, 2004, judgment of the bankruptcy
court order, granting summary judgment in
favor of United based on its finding that the
facilities lease was not a true lease, is reversed.
Enter Memerandum Opinion and Order

(11) @ For further detail see order attached to the
original minute order |

No notices required,
|_| advised in open court.
No notices required.
Filed | docketed
Notified counsel by Nov. 15, 2004
telephone. /s/ JTP
Docketing to mail =
¥ | notices. *
|_| Mail AO 450 form.
; date
Copy to judge/ meiled
magistrate judge. Date! notice
courtroom | received in mailing
MF deputy’s central Clerk's} deputy
initials Office initials

BEST AVAILABLE COPY

04 C 2837

11/15/2004

UAL vs. California Statewide
Communities Development Authority

In the following box (a) indicate the party fil-
party plaintiff, and (b) state briefly the nature
of the motion being presented.

Filed motion of fuse listing in “Motion” box above

Brief in support of motion due

Answer brief to motion due Reply to answer brief

due

ea ae ae

Status hearing [held/continued to] (set for/re-set for]
on get ſor att

Pretrial conference held / continued to] [set for/re-set

forljon _setfor at
Trial (set for/re-set for om at

[Bench/Jury trial) (Hearing) held/continued to at

App. 37

(9) © This case is dismissed [with/without] prejudice
and without costs (by/ agreement pursuant to]
O FRCP4(m) Local Rwe 41.1
O FRCP41(a\1) U FRCP41(a)2)

(10) @ (Other docket entry] For the reasons stated in the
attached memorandum opinion and order, the
March 30, 2004, judgment of the bankruptcy court
order, granting summary judgment in favor of
United based on its finding that the facilities lease
was not a true lease, is reversed. Enter Memoran-

dum Opinion and Order. (Original opinion under
case number, 04 C 2836, HSBC Bank USA v. UAL).

(11) @ [For further detail see order attached to the

original minute order.
No notices required,
— advised in open court.
* No notices required.
Notices mailed by
2828 _ Filed
Notified counsel by NOV 15, 2004—
telephone.
Docketing to mail
A notices.
— Mail A0 450 form.
Copy to judge
istrate judge
|. __ magistra Date
court- received in
MF Soom central Clerk’s
deputy’s Office
initials

App. 38

307 B.R. 618

United States Bankruptcy Court,
N.D. Illinois,
Eastern Division.
In re UAL CORPORATION, et al., Debtors.
United Air Lines, Inc., Plaintiff,
v
HSC Bank USA, as trustee, the California Statewide
Communities Development
Authority, the City and County of San Francisco, and
the Airports Commission
for the City and County of San Francisco,
Defendants.
United Air Lines, Inc., Plaintiff,
V.
The Bank of New York, Inc.,, as trustee, the Port
Authority of New York and New
Jersey, and the New York City Industrial
Development Agency, Defendants.
United Air Lines, Inc., Plaintiff,

.
U.S. Bank N. A., as trustee, the Regional Airports
Improvement Corporation, and
the City of Los Angeles, Defendants.
United Air Lines, Inc., Plaintiff,
v
HSC Bank USA, as paying agent, and the City and
County of Denver, Defendants.
Bankruptcy No. 02 B 48191.

Adversary Nos. 03 A 00975, 03 A 00976, 03 A 00977, 03

A 00978.
March 30, 2004.

James H.M. Sprayregen, Marc Kieselstein, David R.
Seligman, Todd Gale, Kirkland & Ellis, Chicago, IL, for
Debtors.

App. 39

Ronald Barliant, Andrew Weissman, Goldberg, Kohn,
Bell, Black, Rosenbloom & Moritz, Ltd., Chicago, IL; and
Katherine A. Constantine, Steven J. Heim, Dorsey &
Whitney, LLP, Minneapolis, MN; Mark J. Prager, Jill L.
Murch, Foley & Lardner, Chicago, IL, for U.S. Bank
National Association.

R. Dale Ginter, Sallie B. Armstrong, Jenna L. Clark,
Downey Brand LLP, Sacramento, CA, for California
Statewide Communities Development Authority.

Paul E. Chronis, Kristin L. Cantu, Hannah J. Mufson,
Nathan F. Coco, McDermott, Will & Emery, Chicago, IL,
for JFK.

Charles P Schulman, Arlene Gelman, Sachnoff &
Weaver, Ltd, Chicago, IL; John J. Bingham, Jr., Aaron E.
DeLeest, David A. Gill, Danning, Gill, Diamond & Kollitz,
LLP, Los Angeles, CA; Steven J. Heim, Patrick J.
McLaughlin, Katharine A. Constantine, Dorsey & Whit-
ney, LLP, Minneapolis, MN, for LAX and City of Los
Angeles.

David A. Golin, Gesas, Pilati, Gesas & Golin, Ltd.,
Chicago, IL; Rockard J. Delgadillo, Eduardo Angeles, John
M. Werlich, Office of the Los Angeles City Attorney, Los
Angeles, CA, for The Regional Airports Improvement Corp.

William W. Kannel, Timothy J. Langella, George
Hofman, Mintz, Levin, Cohen, Ferris, Glovsky & Popeo,
PC, Boston, MA; Douglas W. Jessop, Kerstin Cass, Jessop
& Company, PC., Andrew M. Schauer, Krys Boyle, PC.,
Denver, CO, for Denver Airport.

Gary W. Garner, Harold Kaplan, Mark F. Hebbeln,
Stephanie Wickouski, Gardner, Carton & Douglas, Chi-
cago, IL, for HSBC Bank USA.

App. 40

Jason E. Rios, Dale R. Ginter, Downey Brand, LLP,
Sacramento, CA, for California Statewide Communities.

Kirk Dillman, Michael Morris, Josh Mester, Henni-
gan, Bennett & Dorman, LLP, Los Angeles, CA, for HSBC
Bank.

MEMORANDUM OF DECISION
EUGENE R. WEDOFYF, Chief Judge.

Four related adversary proceedings are before the
court in these jointly administered cases. In each of the

proceedings, one of the debtors, United Air Lines, Inc.
(“United”), seeks a declaratory judgment that certain of its
payment obligations related to airport improvements are
not obligations arising under “leases” pursuant to § 365 of
the Bankruptcy Code (Title 11 U.S.C., the “Code”). The
defendants in the proceedings are other parties to the
instruments giving rise to the payment obligations. The
defendants have all asserted that these instruments are in
fact “leases” under § 365. Both United and the defendants
seek summary judgment. As discussed below, a “lease”
under § 365 must be a “true” lease, as opposed to a financ-
ing instrument. Because this is not the situation in three
of the four adversary proceedings, United is entitled to
summary judgment in those proceedings. In the fourth
proceeding, involving the Denver airport, a true lease is
involved, and the defendants are entitled to judgment.

Jurisdiction

Federa! district courts have exclusive jurisdiction over
bankruptcy cases. 28 U.S.C. 5 1334(a). Pursuant to 28
U.S.C. § 157(a), district courts may refer bankruptcy cases

App. 41

to the bankruptcy judges for their district, and, by Inter-
nal Operating Procedure 15(a), the District Court for the
Northern District of Dlinois has referred the pending
cases. When presiding over a referred case, a bankruptcy
judge has jurisdiction under 28 U.S.C. § 157(b)(1) to enter
appropriate orders and judgments in core proceedings
within the case. The pending adversary proceedings are
core proceedings under 28 U.S.C. § 157(b)(2)A) (matters
concerning the administration of the estate), § 157(b)(2B)
(allowance or disallowance of claims against the estate),
§ 157(b)(2M) (orders approving the use or lease of prop-
erty), and § 157(b)(2)(O) (“other proceedings affecting
the adjustment of the debtor-creditor or equity security
holder relationship”). See In re PCH Assocs., 60 B.R. 879,
872-73 (S.D.N.Y.), aff'd, 804 F.2d 193 (2d Cir.1986) (de-
claratory judgment action to determine the “lease” status
of an agreement is a core proceeding). This court therefore
has jurisdiction to enter final orders with respect to the
pending proceedings.

Undisputed Facts

The four adversary proceedings that produced the
present motions all involve a similar situation: tax-exempt
bonds were issued to finance the construction of airport
improvements for the benefit of United, and the debt
service on the bonds was to be paid with funds received
from United. The parties dispute the effect in bankruptcy
of the documents giving rise to United’s payment obliga-
tions, but there is no dispute about the identity or content
of these documents.

J. San Francisco International Airport (SFO) -
Adversary Proceeding No. 03 A 00975. At the San

App. 42

Francisco International Airport, United entered into a
Ground Lease with the City and County of San Francisco,
administered by their Airports Commission, on June 18,
1973 (the “SFO Ground Lease”). United was to use the
leased land for “construction and operation of aircraft
maintenance hangar, test and storage facilities” and for
administrative and supervisory operations, rather than for
loading and unloading commercial passengers and cargo.
(SFO Ground Lease at 4-5.) The lease had an initial term
of 20 years and was subject to two ten-year extensions at
the option of United. (Id. at 7.) Thus, the lease would
expire no later than 2113 [sic].

Some 24 years after the Ground Lease was executed,
United, the California Statewide Communities Develop-
ment Authority (a governmental agency authorized to
issue bonds, the “CSCDA”), and an indenture trustee (now
HSC Bank USA, the “SFO trustee”) entered into four
interrelated agreements, all dated August 1, 1997, in order
to finance a number of improvements in United's facilities
at the airport. The agreements included (1) a Site Sub-
lease (the “SFO Sublease”), (2) a Facilities Lease (the
“SFO Leaseback”), (3) an Indenture of Mortgage and Deed
of Trust (the “SFO Indenture”), and (4) a Guaranty

Agreement.

© The SFO Sublease. Pursuant to the SFO Sublease,
United leased to the CSCDA a portion of the property
covered by the FO Ground Lease. (SFO Sublease at 2 and
Exhibit A.) The term of the SFO Sublease is defined as the
period from September 1, 1997 to October 5, 2033, unless a
shorter or longer period (ending no later than October 5,
2038) is required to retire bonds to be issued by the
CSCDA (with the parties expressly recognizing that the
SFO Ground Lease might expire before the expiration of

App. 43

the SFO Sublease). (Id. at 2.) The rent that the CSCDA
was required to pay United for the entire term of the
sublease was $1, and there is no provision for remedies on
the part of United for any default by the CSCDA. (/d.)

© The SFO Leaseback. Under the SFO Leaseback, the
CSCDA leased back to United the identical property
leased to it in the SFO Sublease. (SFO Leaseback at 2.)
The term of the SFO Leaseback is also identical to the
term of the SFO Sublease. (Id. at 3.) However, the rent
United agreed to pay for leasing back the property that it
subleased to the CSCDA is defined by the amounts neces-
sary to make payments on the bonds to be issued under
the SFO Indenture, together with the costs of administer-
ing the financing. (Id. at 3-4.) The SFO Leaseback pro-
vides a full set of default provisions and remedies,
including the CSCDA’s right to take possession of the
leased facilities and relet them if United ‘ails to make the
required payments. (/d. at 16-19.)

© The SFO Indenture. The SFO Indenture generally
provides (a) for the issuance of tax-exempt bonds by the

Io see that the identical property is involved requires some effort.
The SFO Leaseback defines its “Leased Facilities” as they are defined
in the SFO Indenture. The SFO Indenture, in turn, defines “Leased
Facilities” as the “Demised Premises and the improvements to be
acquired, constructed ... and installed thereon or therein.” (SFO
Indenture at 9.) The Indenture defines “Demised Premises” as the real
property described in Exhibit A to the Indenture. (SFO Indenture at 6.)
Exhibit A to the SFO Indenture is identical to Exhibit A to the SFO
Sublease, which defines the property leased in that instr’... :ent.

* The SFO Leaseback requires United to pay as acditional rent
“Administrative Fees and Expenses.” (SFO Leaseback at 4.) The SFO
Indenture defines this term as “any administrative or other expenses
incurred by the |(CSCDA! or the Trustee” in connection with the SFO
Sublease, Leaseback, or Indenture. (SFO Indenture at 5.)

App. 44

CSCDA (SFO Indenture at 15, 37), (b) for the SFO trustee
to receive the proceeds of the sale of the bonds for pur-
poses of funding construction of defined improvements
benefiting United (id. at 20-22), and (c) for the SFO
trustee to receive the rental payments from United under
the SFO Leaseback for the purpose of paying the debt
service on the bonds and ultimately retiring them (id. at
29-33). The SFO Indenture makes clear that the bonds are
“limited obligations” of the CSCDA, payable only from
revenue received from United and earnings on this reve-
nue. (Id. at 15.)

¢ Guaranty Agreement. The Guaranty Agreement sets
out a guaranty from United to the SFO trustee of all
payments due under the bonds.

2. JFK International Airport (JFK) — Adversary
Proceeding No. 03 A 00976. At JFK International Air-
port in New York, United leases land from the Port Au-
thority of New York and New Jersey (the “Port Authority”)
under an Agreement of Lease (the “JFK Ground Lease”)
dated August 1, 1995. The Port Authority's rights in the
property derive from an “Agreement with respect to
Municipal Air Terminals” between the Port Authority and
the City of New York, dated April 17, 1947. The JFK
Ground Lease involves premises consisting of two adjacent
areas. (JFK Ground Lease at 2 and Exhibit A.) United was
required to surrender one of the areas (Area II- referred
to as Area 2 in the Exhibit and later agreements) no later
than July 31, 1999. The lease on the other area (Area 1
referred to as Area 1 in the Exhibit and later agreements)
has an initial term expiring on December 30, 2015, subject
to extension to July 31, 2024 if the Port Authority procures
an extension of its lease with the City of New York. (/d. at
3.)

App. 45

Within two vears of the execution of the JFK Ground
Lease, United, the Port Authority, the New York City
Industrial Development Authority (a governmental! agency
authorized to issue bonds, the “NYCIDA”), and an inden-
ture trustee (now the Bank of New York, Inc., the “JFK
trustee”) entered into a series of agreements to finance
construction of a United cargo handling and warehousing
facility and a ground service equipment facility at the
airport. These agreements — all but the first of which are
dated July 1, 1997 — include (1) a Company Sublease
Agreement, dated January 1, 1997 (the “JFK Sublease”),
(2) a Lease Agreement (the “JFK Leaseback (3) a Con-
sent to Subleases Agreement (the “Consent Agreement”),
(4) an Indenture of Trust (the “JFK Indenture”), (5) a First
Supplemental Indenture of Trust (the “JFK Supplemental
Indenture”), and (6) a Guaranty Agreement.

„ The JFK Sublease. Pursuant to the JFK Sublease,
United leased to the NYCIDA the “Facility Realty,”
consisting of Area 1 of the JFK Ground Lease. (JFK
Sublease at 2, Indenture at 9.) The term of the sublease
has several variables, but will extend no longer than the
maturity date of the bonds to be issued under the JFK
Indenture (October 1, 2032). (ad) The sublease also
terminates with the expiration or earlier termination of
the JFK Leaseback or the JFK Ground Lease. (Id. at 2-3.)
The rental to be paid by the NYCIDA to United for the

The JFK Sublease does not itself define the “Facility Realty”
involved, but it does incorporate definitions of capitalized terms from
the JFK Indenture. (JFK Sublease at 1). The Indenture, in turn, defines
“Facility Realty” as the land described in its appendices (JFK Indenture
at 9), and Appendix A to the Indenture describes the Facility Realty as
Area 1 of the JFK Ground Lease, using the same drawing as in Exhibit
A to the Ground Lease.

App. 46

entire term of the sublease is $10, and there is no provi-
sion for remedies on the part of United for any default by
the NYCIDA. Gd. at 4.)

© The JFK Leaseback. Under the JFK Leaseback, the
NYCIDA leased back to United the identical property
leased to it in the JFK Sublease. (JFK Leaseback at 15.)
The term of the JFK Leaseback is also substantially
identical to the term of the JFK Sublease. (Id at 15-16.)
However, the rent United pays for leasing back the prop-
erty that it subleased to the NYCIDA is defined by the
amounts necessary to make payments on the bonds to be
issued under the JFK Indenture. (Id. at 17-18.) The JFK
Leaseback provides a set of default provisions and reme-
dies, including the right on behalf of the NYCIDA (with
the consent of the JFK trustee) to terminate United's
interests in the subleased property if United fails to make
the required payments, but not including a right to take
possession of the leased facilities and relet them. (Id. at
39-43.)

© The Consent Agreement. In the Consent Agreement,
the Port Authority consented to the JFK Sublease and
Leaseback, with the proviso that “[t}he Subleases and the
financing transaction of which the Subleases are a part
are expressly and in all respects subject and subordinate
to all of the terms ... of the (JFK Ground Lease].”
(Consent Agreement at 2-3.)

* The JFK Indenture (at 59) provides for United to pay the
expenses of administering the Indenture “as provided in the AFK
Leaseback),” but the JFK Leaseback itself does not appear to provide
for such payment. This may be an inadvertent omission, since the JFK
Leaseback (at 17) makes reference to payment of rent in a $3.5 but
does not actually include such a section

App. 47

© The JFK Indenture and Supplemental Indenture.
The JFK Indenture and Supplemental Indenture generally
provide (a) for the issuance of tax-exempt bonds by the
NYCIDA (JFK Indenture at 22-32, JFK Supplemental
Indenture at 1-13, 15-16), (b) for the JFK trustee to receive
the proceeds of the sale of the bonds for purposes of fund-
ing construction of defined improvements benefiting
United (JFK Indenture at 33-35, JFK Supplemental
Indenture at 20-21), and (c) for the JFK trustee to receive
the rental payments from United under the JFK Lease-
back for the purpose of paying the debt service on the
bonds and ultimately redeeming them (JFK Indenture at
35-42). The Indenture makes clear that the bonds are
“limited obligations” of the NYCIDA, payable only from
revenue received from United and earnings on this reve-
nue. (JFK Indenture at 27-28, JFK Supplemental Inden-
ture at 3.)

© The Guaranty Agreement. The Guaranty Agreement
sets out a guaranty from United to the JFK trustee of all
payments due under the bonds.

3. Los Angeles International Airport (LAX) -
Adversary Proceeding No. 03 A 00977. United conducts
terminal operations at Los Angeles Internationa! Airport
(LAX) on property rented from the City of Los Angeles
pursuant to a Terminal Facilities Lease (the “LAX Ground
Lease”) dated June 4, 1981. This lease anticipated that
United would construct expanded terminal facilities with
financing possibly provided by or through the Regional
Airports Improvement Corporation, a governmental
agency authorized to issue bonds (the “RAIC”). (LAX
Ground Lease at 2, 13, 72.) The term of the lease, as
amended, was to commence November 15, 1981 (or later,
in the event of delayed City Council approval) and was to

App. 48

extend for 40 years, subject to earlier termination at the
time of the expiration of any long term tax-exempt bond
financing. (LAX Ground Lease at 15.) On November 15,
1982, United, the City of Los Angeles, the RAIC, and an
indenture trustee entered into a series of agreements to
effectuate the anticipated financing, including: (1) a
Partial Assignment of Terminal Facilities Lease (the “LAX
Assignment”), (2) a Facilities Sublease (the “LAX Lease-
back”), (3) a Contingent Lease Agreement, (4) an Inden-
ture of Mortgage and Deed of Trust (the “LAX Indenture”),
(5) a First Supplemental Indenture of Mortgage and Deed
of Trust (the “LAX Supplemental Indenture”), and (6) a

Guaranty Agreement.

„ The LAX Assignment. In the LAX Assignment,
United assigned to the RAIC all of United’s right and
interest in the LAX Ground Lease “as it relates and
applies to the RAIC Facilities“ the facilities that would
be constructed with the financing to be obtained through
the RAIC. (LAX Assignment at 2 and Exhibit A.) The only
consideration stated for this assignment is “the agree-
ments and undertakings by the parties hereto.” (Jd. at 2.)
The LAX Assignment terminates upon termination of the
LAX Leaseback. (/d.)

„ The LAX Leaseback. In the LAX Leaseback, the
RAIC leased back to United the right and interest in the
RAIC Facilities that the RAIC received through the LAX
Assignment. (LAX Leaseback at 1-2, 5.) The term of the
LAX Leaseback commenced on November 15, 1982 and
extends “until payment or redemption of the Bonds” to be
issued under the LAX Indenture and Supplemental
Indenture. (/d. at 3.) The rent to be paid by United for
leasing back the right and interest that it assigned to
the RAI’ ie defined as the amounts necessary to make

App. 49

payments on the bonds to be issued under the LAX Inden-
ture together with RAIC’s expenses of administering the
financing project. (Id at 4-5.) The LAX Leaseback contains
a full set of default and remedy provisions, including an
authorization for the RAIC to remove United from the
RAIC Facilities in the event of default and to “make efforts
to relet the RAIC Facilities.” (Jd. at 19-23.)

© The Contingent Lease Agreement. The Contingent
Lease Agreement effectuated the RAlC's rights in the
event of a default by United under the LAX Leaseback.
The agreement provides that, in the event that United's
rights under the LAX Leaseback are terminated because
of United's default, the City of Los Angeles will grant the
RAIC a 90-day option to enter into a new Ground Lease,
on the same terms offered to United, for the balance of the
remaining term of the Ground Lease. (Contingent Lease

Agreement at § 1.)

© The LAX Indenture and Supplemental Indenture.
The LAX Indenture and Supplemental Indenture gener-
ally provide (a) for the issuance of tax-exempt bonds by the
RAIC (LAX Indenture at 1, 13-20; LAX Supplemental
Indenture at 1, 3-4), (b) for the LAX trustee to receive the
proceeds of the sale of the bonds for purposes of funding
construction of the RAIC Facilities (LAX Indenture at 22,
LAX Supplemental Indenture at 6), and (c) for the LAX
trustee to receive the rental payments from United under
the LAX Leaseback (either directly from United or from
RAIC within one day of RAIC’s receipt of the payment
from United) for the purpose of paying the debt service on
the bonds and ultimately redeeming them (LAX Indenture
at 31-36). The bonds issued under the Indentures are to be
“payable both as to principal and interest, and premium, if
any, from the Revenues to be derived by the [RAIC] from

App. 50

the lease [back] of the RAIC Facilities to [United] ... and
from amounts received by the [Indenture] Trustee from
UAL, Inc .... pursuant to [the] Guaranty Agreement.”
(LAX Indenture at 93, LAX Supplemental Indenture at C-
2.)

„ The Guaranty Agreement. The LAX Guaranty
Agreement sets out a guaranty from UAL, Inc., the parent
of United (and a debtor in one of the related bankruptcy
cases) to the indenture trustee of all payments due under
the bonds issued pursuant to the LAX Indenture. The
guaranty does not address United's obligations under the
LAX leaseback.

The bonds issued pursuant to the LAX Indenture and
Supplemental Indenture were redeemed by subsequent
bond issues, pursuant to further supplemental indentures,
for which U.S. Bank N.A. serves as indenture trustee. The
later indentures incorporate the terms of the original LAX
Indenture relevant to the present dispute.

4. Denver International Airport (DEN) - Adver-
sary Proceeding No. 03 A 00978. At the Denver Interna-
tional Airport, the financing of improvements for United
was accomplished by three documents: (a) a “Special
Facilities and Ground Lease” (the “Denver Lease”), dated
October 1, 1992, (b) an ordinance of the City of Denver,
Ordinance No. 712, approved on October 14, 1992 (the
“Ordinance”), and (c) a Guaranty of United, dated October
1, 1992.

* The Denver Lease. The Denver Lease conveys rights
to United in two distinct sets of property: (1) about 45
acres of real property (described in Exhibit B to the Den-
ver Lease), and (2) a number of “facilities,” including
buildings, fixtures, and personal property (set out in

App. 51

Exhibit A), whose purchase and construction were to be
financed through bonds issued by the City of Denver. (Id.
at 1-2, 7-8, 15-16.) United’s obligations to pay rent under
the lease have two components: (1) “Ground Rentals,”
payable monthly, based on a rate per square foot plus costs
for common use services, and (2) “Facilities Rentals,”
payable at the times and in the amounts necessary for
debt service on the bonds through which the facilities are
financed. (Id. at 20-21.) Failure by United to make pay-
ment of either type of rent is an event of default, which
may result in termination of the lease and removal of
United from possession. (Id. at 45-47.)

„ The Ordinance. The Ordinance provides (a) for the
issuance and sale of tax exempt bonds by the City (Ordi-
nance at 10-11; Exhibit A at A-5), (b) for a “paying agent”
(now HSC Bank USA) to receive the proceeds of the sale of
the bonds for purposes of funding construction of the
facilities (id. at 15-16), and (c) for the paying agent to
receive the Facilities Rentals from United under the
Denver Lease for the purpose of debt service on the bonds
and their ultimate redemption (id. at 18). The bonds
issued under the Ordinance are “payable solely from the
Facilities Rentals payable under the Lease and amounts
payable under the Guaranty.” (/d. at 2, Exhibit A at A-2.)

„ The Guaranty. The Guaranty sets out a guaranty
from United to the paying agent of all payments due under
the bonds issued pursuant to the Ordinance.

United and twenty-seven related corporations filed
the pending Chapter 11 cases in December 2002. In March
2003, United filed the pending adversary proceedings.
Each seeks a declaratory judgment that United’s obliga-
tions to make payments on account of the outstanding

App. 52

bond issues do not arise under “leases,” but rather that the
documents outlined above constitute “disguised financing
arrangements.” In each adversary, the defendants an-
swered and counterclaimed for a declaration that the
payment obligations in question did arise under leases.
The parties engaged in discovery and then filed, briefed,
and argued the cross-motions for summary judgment now
pending.

Legal Discussion

Summary judgment is appropriate where the plead-
ings, affidavits, and other materials on file demonstrate
that there exists no genuine issue as to any material fact
and that the moving party is entitled to a judgment as a
matter of law. Fed.R.Civ.P. 56(c), incorporated into Fed. R.
Bankr.P. 7056; Massachusetts Bay Ins. Co. v. V

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40386016_0527%3A1. Public record. Not legal advice.