Finance Leasing

We recently completed a finance lease case. The following provides some of our thoughts on the subject:

Question: If I lease a computer or an office machine, such as a copier, can I withhold payment from the finance company if the computer or office machine does not work “as promised?”

Answer: No, the lessor must pay no matter what under Illinois Common law and the Uniform Commerical Code.

A. Legal Framework – Computer Form Contracts Are Enforceable For Important Policy Reasons.

In our society almost everyone who is literate has or uses a computer. Some computers are purchased; others are leased for a period of time. All computer leases in Illinois are governed by the Uniform Commercial Code. See Walter E. Heller v. Convalescent Home, 365 N.E.2d 1285 (Ill. App. 1^st Dist. 1977) (holding that Article 2 of the UCC applies to computer leases).

To avoid costly litigation with end users and to clarify their obligations, all computer companies have required end users to enter into written contracts, here known as the Equipment Leases and Software Licenses. These contracts are universally enforced by Illinois courts and the Seventh Circuit.

Moreover, as everyone knows, computers sometimes crash, freeze up or stop working – often for no apparent reason. For this reason almost all computer licenses (software or equipment) specifically disclaim the implied warranty of merchantability and fitness. See Robert W. Gomulkiewicz “The Implied Warranty of Merchantability In Software Contracts: A Warranty No One Dares To Give And How To Change That, 16 J. Marshall J. Computer & Info. L. 393 (1997). As a result, software companies do not typically warrant that their software will work. Instead, they disclaim warranties, including the implied warranty of merchantability and the implied warranty of fitness for a particular purpose.

B. Illinois Law Offers State of The Art Protection For Software Companies And Finance Companies.

Illinois law contains state of the art protections for computer companies and companies that finance computer and equipment leases. The Illinois Courts have a long (and unbroken) history of enforcing equipment leases and software licenses. See e.g., Christensen v. Numeric Micro, 503 N.E.2d 558 (Ill. App. 2d Dist. 1987) (holding that finance company could collect full payment from end user where the end user claimed that the computer “would not operate, and, when started, it began smoking.”); Walter E. Heller v. Convalescent Home, 365 N.E.2d 1285 (Ill. App. 1^st Dist. 1977) (enforcing a computer lease including provisions requiring the customer to pay even if the customer claimed some problem with the product and which prohibited the customer from suing the finance company directly); Trans Leasing v. Schmer, 550 N.E.2d 1285 (Ill. App. 1^st. Dist. 1990) (enforcing equipment lease against unconscionability challenge); see also Imaging Financial Services v. Graphic Arts, Inc., 172 F.R.D. 322 (N.D. Ill. 1997) (Keys, J.) (applying New York law and holding that the disclaimer of express and implied warranties in a computer lease is valid and binding); GreatAmerica Leasing Corporation v. Cozzi Iron & Metal, Inc., 76 F.Supp. 2d 875 (N.D. Ill. 1999) (Bucklo, J.) (enforcing equipment lease to bar claims of oral misrepresentations and following the Heller and Trans Leasing cases). These decisions constitute the Illinois law that is applicable to this diversity case.

Two Seventh Circuit cases authored by Judge Easterbrook and one United States Supreme Court decision have greatly increased the protections for computer companies and equipment leasing companies. See ProCD v. Zeidenburg, 86 F.3d 1447 (7^th Cir. 1996) (“shrinkwrap licenses are enforceable unless their terms are objectionable on grounds applicable to contracts in general (for example, if they violate a rule of positive law, or if they are unconscionable)”); Hill v. Gateway 2000, Inc. 105 F.3d 1147 (7^th Cir. 1997) (enforcing arbitration clause contained in Gateway’s shrinkwrap license – customer could opt out by returning the computer within 30 days); see also Carnival Cruise Lines v. Shute, 499 U.S. 585 (1991) (enforcing a forum-selection clause included among three pages of terms attached to a cruise ship ticket). These three decisions expressly allow a computer company to put a time limit on the end user’s revocation of acceptance. In Hill, the customer was required to return the equipment in 30 days. The decisions, recognizing the validity of a contract printed on the materials accompanying the software or hardware, are a huge benefit to the computer industry. Otherwise, computer companies would be forced to obtain a user's signature on a written contract, a tedious and highly costly process.

C. The UCC Law On Finance Leases Provides Bullet-Proof Protection To Finance Companies.

The drafters of the Uniform Commercial Code also included powerful protections for companies that finance equipment leases. The UCC recognizes the concept of a finance lease used only in commercial transactions like the transactions at issue here. The concept and purpose of a UCC finance lease is that one party provides the goods and another party provides the financing. Where the Lessee uses the goods for commercial purposes, the UCC finance lease law allows the Lessor to include strong warranty disclaimers, provisions that the lease is irrevocable even if there is poor performance (801 ILCS 5/2A-407(1), provisions that the lessee’s obligation to pay is “independent” of any performance obligation and a provision prohibiting the Lessee from suing the finance company. (810 ILCS 5/9-403). These provisions have been universally upheld by Illinois Courts. See cases cited below; see also 19 Williston on Contracts §53:19.

Many equipment leases and computer leases contain this provision: “The parties agree that Article 2A of the Uniform Commercial Code applies to this agreement and the lease hereunder and that this Agreement and the lease hereunder will be considered a finance lease under the Code.”

Section 5/2A-407 Irrevocable Promses; Finance Leases.

(1) In the case of a finance lease that is not a consumer lease the lessee’s promises under the lease contract become irrevocable and independent upon the lessee’s acceptance of the goods.

(2) A promise that has become irrevocable and independent under subsection (1); (a) is effective and enforceable between the parties, and by or against third parties including assignees of the parties; and

(b) is not subject to cancellation, termination, modification, repudiation, excuse, or substitution without the consent of the party to whom the promise runs.

Section 9-403 Agreement Not To Assert Defenses Against Assignee.

(b) Agreement not to assert claim or defense. Except as otherwise provided in this Section, an agreement between an account debtor and an assignor not to assert against an assignee any claim or defense that the account debtor may have against the assignor is enforceable by an assignee that takes an assignment.

These two provisions of the UCC essentially prevent any lessor of a computer or office machine from withholding payment to a finance company on the ground that the computer or machine did not work “as promised.”

D. Strong Policy Reasons Support The UCC Finance Lease Provisions.

The UCC finance lease provisions give finance companies bullet-proof protection from performance-related claims by lessees: the Finance company’s right to collect is unaffectd by any claimed complaints about the computer systems. The purpose of these protections is to allow commercial parties to more easily finance equipment and to protect the finance company from garden variety breach of lease claims by the Lessees. See 19 Williston on Contracts §53:19 (discussing policy reasons supporting the UCC’s Finance Lease provisions). See Wells Fargo Bank, N.A. v. BrooksAmerica Mortgage Corp., 419 F.3d 107 (2d Cir. 2005).

This protection for the finance company is important because the finance company only provides the money. It does not provide the computer or the equipment or the performance required - i.e., an 800 number and technical support people.

Wells Fargo is a classic example of a finance lease for computers. Wells Fargo financed a business’s purchase of some computers. The lessee signed a standard equipment lease and signed a Delivery and Acceptance Certificate. The lessee refused to pay on the ground that the computers didn’t work as expected. In response to the lessee’s claim that the computers did not perform as expected, the Wells Fargo Court held: “non-performance by the lessor is irrelevant; at least when the lessee was a sophisticated party and the party asserting the right to rental payments is a good-faith assignee.” (Emphasis supplied).

In Wells Fargo, the bank is basically saying - we provided the money only - it's not fair to make us service the equipment or make sure the equipment is working properly. It's simply too costly for the bank or finance company to do that.

In sum, the Illinois cases the Seventh Circuit’s cases and the UCC finance lease provisions – in connection with properly drafted UCC equipment leases - flatly bar any user from refusing to pay on the ground that the computer system did not work or did not meet the user’s expectations. The Illinois cases also bar the user from making raising any product issues or product performance issues as a defense or offset to the finance company's claim for payment. See e.g, Trans Leasing, Christensen, Heller, Pro Cd, Hill as cited above.

The Illinois cases place an insurmountable burden on the purchaser who claims that the computer did not work or the software didn’t function or the photocopier did not work as expected. No commercial purchaser in Illinois has ever successfully challenged an equipment or computer lease. See Trans Leasing, Christensen, see also 19 Williston on Contracts § 53:19 (4^th Ed.).

Many equipment leases contain a clause known as the "Hell or High Water" clause which requires the lessee to pay for the leased goods no matter what. This clause provides added strength to a UCC finance lease and makes the lease unbreakable.
In the industry, the clause that a business customer must pay under a financing lease even if the equipment is defective is known as a “Hell Or High Water Clause.” See e.g., Wells Fargo Bank v. BrooksAmerica Mortgage Corp., 419 F.3d 107 (2d Cir 2005) (holding that the “hell or high water clause at issue here makes BrooksAmerica’s obligation to pay rent absolute and unconditional.”); De Lage Landen Financial v. M.B. Management Co., Inc., 888 A.2d 895 (PaSuper 2005) (enforcing Hell or High Water clause in lease); 19 Williston on Contracts §53:19.

Edward X. Clinton, Jr.