March 30, 2015 Practice Points

Seventh Circuit Determines when Goods Are "Received" in Commercial Equipment Leases

The U.S. Court of Appeals for the Seventh Circuit held that Titan Leasing, Inc. breached the warranties of a nonrecourse loan from Wells Fargo Equipment Finance, Inc

by Ali Razzaghi

In Wells Fargo Equip. Finance, Inc. v. Titan Leasing, Inc., 768 F.3d 741 (7th Cir. 2014), the U.S. Court of Appeals for the Seventh Circuit held that Titan Leasing, Inc. breached the warranties of a nonrecourse loan from Wells Fargo Equipment Finance, Inc., by falsely warranting that a railroad locomotive, which Titan leased to Gerdau Ameristeel and which Titan used as security for the loan, had been delivered and accepted by Gerdau and that Gerdau had acknowledged the locomotive's receipt. The court looked to the parties' security agreement and underlying lease agreement, and to Uniform Commercial Code (UCC) Article 2A, to determine the meaning of the warranty terms, finding that lack of acknowledgement of receipt breached the warranty of receipt in the security agreement.

Gerdau leased the locomotive from Titan in summer 2008. During shipment, the locomotive was damaged and sent to Knoxville for repairs. It ultimately arrived at Gerdau's plant in summer 2009, at which time it was rejected by Gerdau on grounds that it needed further repairs. In March 2009, prior to the locomotive arriving at Gerdau's plant, Titan obtained a nonrecourse loan from Wells Fargo and used the lease with Gerdau as security for the loan. The security agreement contained a number of warranties, which, if breached, entitled Wells Fargo to recover the money it loaned to Titan. In particular, Titan warranted that, as of the date of the security agreement (March 6, 2009), the locomotive had been (1) delivered and (2) accepted by Gerdau, and that Gerdau had acknowledged (3) receipt and (4) acceptance of the locomotive. When Gerdau refused to make any payments on the lease, Wells Fargo seized control of the locomotive and sued Titan for breach of warranty.

The U.S. District Court for the Northern District of Illinois granted summary judgment in favor of Titan. The district court looked to both the lease and the UCC to see whether the locomotive had been "accepted" (warranty 2) by March 6, 2009. The lease provided that shipment of the locomotive, which occurred in summer 2008, constituted formal acceptance. Under UCC § 2A-515(1), 810 ILCS 5/2A-515(1), acceptance occurs when the lessee fails to make an effective rejection after having reasonable opportunity to inspect the goods. Because Gerdau had an opportunity to inspect the locomotive at the time of shipment, the district court concluded that the locomotive had been "accepted" as of March 6, 2009, under both the lease and the UCC.

On appeal, the Seventh Circuit noted that the district court failed to address the other three warranties in the security agreement. With respect to warranty 1 (that the locomotive had been "delivered" to Gerdau before March 6, 2009), the court observed that "delivery" was not defined in the security agreement, the lease, or the UCC. Even assuming, as Titan contended, that "delivery" was equivalent to "acceptance," such that the locomotive was both delivered and accepted at the time of shipment, the court found that warranty 3 (that Gerdau had acknowledged receipt) was still unsatisfied. As the court explained, "[n]either the lease nor the UCC equates 'delivery' with 'receipt,' and these sound like different words—the locomotive may have been 'delivered' and 'accepted' when shipped, . . . but was not 'received' until it reached Gerdau's plant. And until Gerdau acknowledged receipt, warranty 3 had not been fulfilled." Wells Fargo, 768 F.3d at 743. The court found no evidence to suggest that Gerdau ever acknowledged receipt of the locomotive. As such, the judgment of the district court was reversed, and Titan was required to repay the loan to Wells Fargo.

In reaching its decision, the Seventh Circuit explained that the distinction between "delivery" and "acceptance" on the one hand, and "receipt" on the other, was not simply one of semantics. The warranties contained in the security agreement were intended to ensure that Gerdau was satisfied with the locomotive, since a satisfied Gerdau was more likely to pay. Although delivery and acceptance were important steps in ensuring Gerdau's satisfaction, receipt followed by acceptance was more important. By acknowledging receipt and acceptance, Gerdau would have essentially been verifying that the locomotive conformed to the parties' lease, which, in turn, would have allowed Wells Fargo to advance the money with greater confidence of being repaid. In reality, however, Gerdau rejected the locomotive upon arrival at its plant, months after Titan warranted that Gerdau had acknowledged the locomotive's receipt and acceptance. The warranties in the security agreement were designed to protect Wells Fargo precisely from this scenario.

Keywords: acceptance, Article 2A, breach of warranty, commercial and business, delivery, equipment lease, receipt, security agreement, UCC, Uniform Commercial Code, litigation

Ali Razzaghi is with Frost Brown Todd LLC in Cincinnati, Ohio.

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